Tuesday, July 1, 2008
Chris Cox in Chavez's Venezuela
"The Fed's opening of new lending facilities to large investment banks this spring, after financing the sale of Bear Stearns [BS], has helped restore confidence to financial markets. It has also posed some difficult questions. ... When [BS] was acquired by J.P. Morgan, Bear's overall capital ratio comfortably met the [Fed's] 10% 'well-capitalized' standard for commercial bank holding companies. Yet this didn't prevent a run on the bank. ... Investment banks, according to the conventional wisdom, were not subject to a run because they do not take deposits. Instead the SEC regulation was supposed to protect the broker-dealer's customers, which it did. ... It is clear that these protections are no longer enough. The Bear experience demonstrated that an investment bank can suffer a crisis of confidence that leads it customers and counterparties to precipitously withdraw funds--and threaten the financial system. This threat is what led the Fed to use its authority as 'lender of last resort' in the Bear crisis. ... [T]he Fed was required to find that Bear's imminent bankruptcy constituted an emergency threatening a severe, adverse impact on the economy. But making Fed lending available to all investment banks has exposed a lack of symmetry with respect to the explicit statutory terms on which commerial banks get this privilege. ... [R]elatively intrusive regulation has long been thought necessary to mitigate the moral hazard problem of central bank backstop liquidity, and other elements of the banking safety net such as deposit insurance. Now the provision of backstop liquidity to the major investment banks has unavoidably reduced the penalties they face for taking excessive risk. ... In my judgment, explicit legislative authorization for what is now a purely voluntary program of SEC supervision [of investment banks] is vital. ... Properly functioning investment banks are a critical engine of growth and innovation. We must be careful to construct a regulatory approach that meets our regulatory objective without disouraging risk-taking or neutering Wall Street's ability to fuel economic growth and innovation", my emphasis, Chris Cox (CC) at the WSJ, 19 June 2008.
The US no longer has the "rule of law". The Fed's invoking "emergency" to bail out JPMorgan reeks of Chavez and "decree laws" in Venezeula. No, I repeat no action CC proposes will reduce "moral hazard". What are CC's "regulatory objective[s]"? To maximize investment banker compensation? How about reducing "moral hazard" this way: any financial institution, aside from deposit takers, must decide if it wants "backstop liquidity". If it does, its executives go to the local OCC office and sign an agreement making the executive personally liable, not subject to extinguishment in bankruptcy for three times his last three years compensation. Such agreements, in the case of publicly-held companies, like National City, would be filed as Form IA-1. Form IA-2 would be the executive's annual statement of compensation and assets and liabilities. Deposit takers must be subject to this. If the executive can't meet his obligation, when the time comes for it, he is forced into bankruptcy. I suspect these enterprises will view risk differently when their managers know their personal fortunes are on the line and any monies they received during the last three years could be returned, thrice! If one doesn't want to be subject to this, let him work somewhere else. Suppose BS had gone bankrupt. What then? My guess, oil might be $20 a barrel cheaper, similarly, wheat, corn, soybeans, etc. all would be cheaper. Well CC, do you think avoiding BS bankruptcy was good for the "economy" whatever that means? I don't. Or maybe you think the "economy" starts at the Battery and ends on 57th Street and only includes Wall Street MDs earning over $2 million a year?