On self-regulation in banking
I spoke to Max Keiser recently about a number of issues in a wide-ranging interview featured below. In the video, Max and Stacy Herbert talk about some of the hot button issues of the day like the banking sector in Ireland and the lack of criminal prosecutions in the US for the first 13 minutes or so. In the last half of the video I talk to Max about a lot of topics including gold, mortgage fraud, WikiLeaks, currency revulsion, and sovereign debt.
Let me focus on one: fraud. It is astounding when you think that the US suffered the worst financial crisis in three-quarters of a century after an epidemic of fraud and it hasn’t yet seen any major prosecutions. And, yes, in 2004 the FBI warned of a mortgage fraud ‘epidemic’ and sought to head off the ‘next S&L crisis’. So let’s get that straight.
The financial commission tasked with looking into this has devolved into a partisan shambles, with the Republicans pre-emptively releasing its own version of events scrubbed of any anti-banking connotations in terms like "Wall Street" and "shadow banking" or the words "interconnection" and "deregulation". What is likely to happen if the mortgage and foreclosure crisis becomes a systemic legal problem?
My take: We will see efforts to fix the problem by changing the rules much as the end of mark-to-market fixed the credit writedowns problem in 2009. That’s America’s idea of bank regulation.
Apropos regulation, I like Ron Paul but I believe he goes overboard when he says:
"I don’t think we need regulators. We need law and order. We need people to fulfill their contracts. The market is a great regulator, and we’ve lost understanding and confidence that the market is probably a much stricter regulator."
How would I have phrased it?
"I don’t think we can count on regulators because they are often captured by industry. We need law and order too. We need people to fulfill their contracts. And the market is usually a great regulator too, and we’ve lost understanding and confidence that the market can probably be a much stricter regulator."
See the difference? The difference is that, while I don’t trust regulators to do their jobs any more than Paul, I don’t trust the banks to self-regulate. Self-regulation is to regulation what autoeroticism is to eroticism.
Let me run my parable of self-regulation in banking by you again. It’s called "Ms. Watkins, why does Charlie have lit dynamite?
You are a teacher at a local primary school. Each school day you and some of your colleagues watch over the children at the school playground to make sure all of the children follow the rules and keep their hands to themselves. Your role is to keep the children safe. Mind you, this is a Montessori School where the philosophy is to let children explore within set boundaries. But, if a child hurts another or a child’s behavior poses an immediate risk to others, you always step in.
In fact, one child, Charlie has been a bit of a problem recently. Charlie is one of the biggest kids at the school, a boisterous sixth grader who likes to push and play with matches. Last July 4th, it seems he got a hold of a video on the Internet blog Credit Writedowns on how not to use fireworks. Contrary to the video’s intention, he rather liked seeing things blow up and courting danger. You see Charlie is a bit of a pyromaniac. You have repeatedly had to stop Charlie from bringing matches to the playground and lighting things on fire. But, recently you have had to confiscate firecrackers and suspend him from school.
But, one day a new headmaster comes to the school. He doesn’t believe much in the need for teachers to monitor the children. The children can monitor themselves. Unfortunately, Charlie has a bit of a following at school and before you know a lot of the kids are lighting firecrackers on the schoolyard. No one gets seriously hurt – just a few minor burns here and there. So Charlie ups the ante to M-80s like he saw in the video. There was a serious close call when he put the frog in a jar with the M-80, but self-monitoring has worked pretty well and there have still been no major casualties.
That’s when little John comes up to you and asks, “Ms. Watkins, why does Charlie have lit dynamite?”
Here’s a tale that goes the other way. In Germany, for years riders on public transportation have self-regulated, meaning there are no police officers around to over-police Germany’s subways, trams, and trains. You can enter the tram from the back. When you get on the Pendelzug (commuter train), no one is checking tickets. They don’t even have turnstiles. But, every once in a while the police do come through to check – so that the potential of getting caught is a deterrent to would-be free riders. Germans generally respect law and order and this system functions well. This is the best example of self-regulation. But notice, the Police are still active. They still have a presence at major subway stations and central train stations. It isn’t the kind of self-regulation that Ron Paul seems to advocate in his quote.
Here’s something I think Ron Paul can get behind, though. Banking is a cartel and the price one pays for insolvency is seizure by the regulator. Risk capital takes the hits first, and only afterward does the taxpayer. There is no reason companies like Lehman should not fail. But you have to have the pre-conditions to do so without excessive amounts of contagion. That’s where too big to fail is still a problem. See my post "Replacing market failure with regulatory failure" where I go a bit more into this.
In any event, there was an epidemic of fraud and we did in fact have the next S&L crisis – and I would argue it was because of criminally low interest rates and a lack of regulatory oversight. So where are the civil and criminal prosecutions, where are the perp walks? How do you enforce self-regulation, if the biggest players have virtual immunity from prosecution? It doesn’t make any sense to me.
For those of you who like a little venom, Max delivers in the video. This is not the BBC.