Assorted Thoughts on Financial Regulation

The financial regulatory reform debate is starting to kick into high gear, and I hope to bang out a post on financial reform this weekend. But in the meantime, here are a few general (and somewhat random) thoughts relating to financial reform:

• My nomination for the Ten Worst Decisions in the Financial Crisis List (you know, if that list existed, which I think it should): Citi’s decision to bail out its SIVs and bring over $100bn in toxic assets back onto its balance sheet. Really this was Vikram Pandit’s decision — the day after he was appointed CEO, he decided to bail out the biggest Citi-managed SIVs and bring ~$50bn in toxic assets back onto Citi’s balance sheet (reversing the bank’s previous position, which had been that it wouldn’t bail out investors in SIVs without liquidity puts). If you’re wondering how Citi ended up with so many toxic assets, and how regulators missed such a massive build-up of risk on Citi’s balance sheet, this is your answer. This is also why I’m somewhat sympathetic to the regulators (in this case, the NY Fed). For supervisory purposes, all these toxic assets were gone from Citi’s balance sheet, because these were true-sale securitizations to bankruptcy-remote SIVs. Then, all of the sudden, the toxic assets were back on Citi’s balance sheet. And it’s understandable that regulators didn’t foresee that Citi would voluntarily agree to buy back $100bn in assets that it had previously sold in true-sale securitizations.

• It’s true that the idea that “what’s good for Wall Street is good for America” has been disproved, but that does NOT prove the opposite—that is, it doesn’t prove that “what’s bad for Wall Street is good for America.” It’s frightening how many commentators fail to grasp this distinction. Which brings me to…
• Cutting into Wall Street’s profit margins shouldn’t be an explicit goal of financial reform. In other words, we shouldn’t look for where the Street has the highest profit margins, and then say, “OK, now how can we cut into those profits?” In most instances, enacting sensible regulation based on an objective weighing of the evidence will lower Wall Street’s profit margins anyway. But the fact that the Street is going to profit from a particular regulatory change doesn’t necessarily make the regulatory change ineffective, or insufficiently “tough on Wall Street.” One argument I hear a lot on OTC derivatives is that we need to push them onto exchanges rather than clearinghouses because Wall Street would still make fat profits if they just went through clearinghouses. That’s not a coherent argument for why public policy should require exchange-trading for standardized OTC derivatives.

I’ll address OTC derivatives reform more this weekend.