Where’s the Reform?

We keep hearing about the global financial collapse and how several things played into its creation. Since the credit markets are mostly dried up, loose credit to purchase overpriced assets is no longer an issue. Still hanging out there with no real substantive policy discussion is Financial Reform. Has the current administration forgotten the complete lack of oversight by the SEC in the areas of derivatives, credit default swaps, and all those fancy little arrangements that allowed imprudent lenders to pass the trash? Where also is a hard look at Moody’s and other raters that actually applied a triple A label to stuff that is still unraveled?  Why aren’t we fixing what is obviously broken?

Dizard at Financial Times asks the question. What is the status of the structural reforms and laws required to fix the broken securities markets? It’s a very good question because both the SEC and the FED failed in their oversight duties of several markets. They’ve both asserted they didn’t have the legal standing to act or to provide that oversight. In that case, we have another example of oversight malpractice by the congressional committees designed to keep the financial and banking systems strong. They need to sort out responsibilities and enact laws to ensure oversight exists.

Here is one of the articles major points which is reform of rating agencies. He sees no progress on that front and believes we’re seeing some major maneuvering that ensures job security and protects fragile egos.

The financial system has a peacetime officer corps in a wartime situation. The people in positions of responsibility are principally interested in preserving their careers and avoiding public embarrassment. There are rare and important exceptions, such as Paul Volcker, who has nothing to prove about his integrity, and who is past any need to advance his career.

To identify what has to be done to put securities markets, banking and regulation on a sound basis for the future, the people at the top might have to admit to the specifics of their own past mistakes. They would also need a command of detail of the workings of the financial system that they have avoided acquiring over the years, since it was much more advantageous to spend one’s time scheming and toadying.

This is a naturally occurring aspect of human nature, but it is usually kept in check by periodic crises, which thin the herd and force the survivors to adapt. The “great moderation”, also known as periodic monetary bail-outs, in developed countries for the past couple of decades has prevented that process.

Let’s consider a specific issue, the reform of the leading US ratings agencies…So what are the federal regulators, and Congress, actually doing about ratings agency reform?

It seems the SEC is too busy doing damage control (especially over the Madoff debacle)  to actually try to figure out what happened, what when wrong, and suggest fixes.  Obama appointee Mary Schapiro was quoted as saying that the ratings agencies’ conflicts should be looked into, however she suggests a long period of time to solve problems with the system.  That does not sound very promising to me.

Dizard reports that things at the Fed are no better.  He additionally points out that congress is basically AWOL on the subject.

Sean Egan, whose Egan-Jones rating agency is one NRSRO that is paid by the investors, not the issuers, is frustrated by the slow progress in the reform process. “You have to back up to why the markets are frozen, and the answer is a lack of credibility in risk assessment,” Mr Egan says…

There is a widespread assumption that the Federal Reserve is available as a universal, supreme regulator of all financial risk. However, the Fed staff are preoccupied with figuring out the details of the various “temporary” support programmes. Not many of them have operating experience in financial markets; they were employed to take the long view on monetary policy, not for the tactical execution of investment programmes. Those are very different disciplines.

Congressional leaders know that. Democratic and Republican senators share a high degree of scepticism about the ability of the Fed, effectively, to redesign and then run the financial world.

In the past, there were Wall Streeters of both parties with sufficient weight and creditability to identify problems and put together solutions. Not now. All we need to end the remaining illusions, is, I believe, one more big trauma. Auto companies?

The response by FDR’s administration to the financial crisis of the 1930s was  the now defunct Glass- Stegal act.  The congressional author of this act (Senator Carter Glass) had this prepared way ahead of time and was just looking for the right president to sign it.  In fact, Paul Volcker already released his GROUP OF THIRTY framework at a presser on January 15.  There was meager MSM coverage on this most important piece of work and we seem to have NO follow-up on any point of it within the Obama administration.  Some one from the media should ask about follow-up.

In fact, I believe we do not have a member of Congress at the moment that is competent to draft a bill of the magnitude of Glass-Stegal.  You’ve heard me criticize Rep. Barney Frank for being asleep at the wheel for a number of things including oversight of Fannie and Freddie.  He didn’t even think there was a problem with solvency when they were months away from bankruptcy.   We still don’t have a framework to deal with these two entities.  Frankly, I beginning to think of Frank as a barrier to reform.  Don’t even get me started on Senator Citibank Dodd or Vice President MBNA Biden.

There are many problems that need to be tackled in a decent piece of law enacting oversight reform.  First, what is going on with these derivatives markets and does the SEC or the FED need to regulate the entities involved.  We obviously had a complete failure in these markets because the underlying assets value as well as their risk was badly priced.  Banks thought that they had some insurance  with these credit derivatives and this obviously was a misjudgment or a fairy tale.   How did the  Ratings Agencies risk fail to correctly rate these financial instruments?  Was their model incorrect?  Why were politicians allowed to inject themselves into the process–especially at the SEC?  Why did both the SEC and the FED  failed to regulate and ensure proper capital buffers? Again, who has responsibility for the hedge funds, as an example? Why did we see so many banks (including Fannie and Freddie) pay their loan officers based on production of volume?  Why did the heads of these entities get bonuses not based on the performance of the portfolio but the size?  Rather than actually lending to help communities and businesses sustain themselves over the long run, why were institutions with fiduciary responsibility allowed to focus so completely on share holder profits?  Why were prudential underwriting standards thrown to the wind?   What role did the congressional oversight committees play in enabling bad behavior both in banks and investment companies?  Can we actually find evidence of oversight malpractice?

Finally, why aren’t we holding these people accountable and why has any talk of reform completely disappeared?  There are plenty of U.S.  business magazines and papers that should go to administration pressers and start asking some of these questions.  Otherwise, it will be just another call from the wilderness of across the pond and the wilderness of a blogging academic.