A Set of Economic Comments
Dealbook on the New York Times for the past several days has published a series of articles on the financial crisis and the way forward. It’s a modern media approach to exploring and perhaps developing economic policy.
Say what you will about Web 2.0 and its effect on traditional media. If the Gray Lady can accelerate progress toward better functioning markets by building on its historic place as “the newspaper of record” (should it be “the news source of record” in the 21st century?), more power to it. By opening its content to a wider variety of voices, it might even mitigate the problem it created for itself over the past several decades of being criticized for bias.
As you can see in the right column on my home page, I link to my aggregated comments in several fora. The Times doesn’t appear to have a particularly convenient way to do the same thing, so for what they’re worth, below are the three comments I’ve made on the Dealbook series. You may want to read the posts by Jonathan Knee and Joe Grundfest for context.
Oct. 6, 2009
How Do We Avoid Another Crisis?
Link. Unrestrained competition was, indeed, a contributor. The most effective check on such competition is better information in the marketplace.
The crisis resulted from violations of Securities Law 101 with respect to asset backed securities — “register or find an exemption.” ABS were typically registered for a year via the posting of unstructured tough-to-compare ASCII text on EDGAR and then deregistered because they had fewer than 300 investors. That’s when the frenzy to slice and dice the now-private ABS started.
This netherworld of securities regulation was wonderful for people earning commissions for selling the opaque products, but where competition did the most harm was among buyers who felt pressured to earn larger “low risk” returns. The solution is not to destroy competition, but to enhance it via a return to basic securities law compliance — the same sort of compliance that has worked well for public company securities disclosure for 75 years.
How? Well, U.S. GAAP didn’t work very well before the FTC in 1933 and then the SEC in 1934 started requiring its rigorous use. GAAP doesn’t extend to the details of ABS for the obvious reason that it was designed for the disclosure of public company securities, not asset backed securities. Fortunately, the very technology that contributed to the Internet boom has also contributed to the development of an analog to GAAP for ABS in the form of an XML-based XBRL taxonomy. Requiring ABS disclosure in XBRL would put ABS on an even footing with public companies, which are now required to use XBRL. The taxonomy is ready. All that is needed is the political will to require its use. (By the way, several hedge funds used it to structure ABS for themselves data before the crisis, and not surprisingly did better than most in the crisis. See http://www.wired.com/techbiz/it/magazine/17-03/wp_reboot.)
Oct. 6, 2009
What’s Needed Is Uncommon Wisdom
Link. Professor Grundfest, you must be suppressing your typical optimism as a teaching tool. Didn’t FDR create the SEC as a strong independent agency with broad statutory powers to solve exactly the problem you so eloquently explain? Granted, the SEC can’t ban subsidies for real estate investment relative to business investment. But to the extent real estate interests are converted to security interests, it can at least work to level the playing field. One way to do so would be to require the sort of disclosure I described in my comment on Mr. Knee’s post. Why not rewrite Reg. AB to do so? I’m sure you could come up with a dozen more creative ways to use existing SEC authority to improve capital markets in light of the recent crisis. And you would only need three votes to do so — not 218 + 60. Granted, the SEC operates in a political and emotional environment. But things were even more political and emotional in 1934, when it launched GAAP disclosure. Ok, there might be no Joe Kennedy these days, but getting three or four or five SEC commissioners behind thoughtful rather than foolish regulatory responses is at least worth a try, don’t you think? (From Wikipedia: “One of the crucial reforms was the requirement for companies to regularly file financial statements with the SEC, which broke what some saw as an information monopoly maintained by the Morgan banking family.”) Can’t someone step forward to supply the leadership needed to help common wisdom understand the main lessons learned from 75 years of largely successful securities regulation, particularly that using large amounts of other people’s money (what is today called systemically risky behavior) should be accompanied by meaningful disclosure of all material information about how you’re using that money?
Second Comment
Link. Richard, my theory is that Prof. Grundfest is using a bit of reverse psychology to try to generate some leadership. Just for the record, the SEC didn’t loosen liquidity requirements in 2006. What you’re referring to is the voluntary program instituted in 2004 described in 2006 Congressional testimony:
…in 2004 the Commission amended its net capital rule to establish a voluntary, alternative method of computing net capital for well capitalized broker-dealers that have adopted strong risk management practices. This alternative method permits a broker-dealer to use mathematical models to calculate net capital requirements for market and derivatives-related credit risk. As a condition to that exemption, the broker-dealer’s ultimate holding company must consent to group-wide Commission supervision, thus becoming consolidated supervised entities, or CSEs. — http://www.sec.gov/news/testimony/2006/ts091406rldc.htm
See also http://www.aei.org/issue/28851, which notes that the 2004 regulation did its job of protecting brokerage customers at Bear and Lehman. Perhaps the Black Swan was that the Treasury and Fed decided the normal bankruptcy process was inadequate to provide for an orderly resolution of Bear, one of the Fed’s primary dealers. Had an FDIC-style resolution or an expedited bankruptcy process been imposed on Bear, perhaps Lehman would have reduced rather than expanded its leverage between March and September 2008, or a least there would have been better infrastructure in place to deal with Lehman. That reminds me — why isn’t some sort of super bankruptcy agency for mega financial institutions, with extra authority to claw back compensation, being considered? Not only could that expedite resolutions, but it might also create incentives for large financial firms to stay on the normal bankruptcy side of the large/mega dividing line — and if they cross the large/mega line, take on less risk. Just a thought…
