Friday, June 3, 2011

Another prediction under the FDR Framework appears to becoming reality

On a number of occasions, this blog has observed that financial reforms are subject to a race to the bottom as regulators from different countries negotiate global standards. The one notable exception is the disclosure requirements under the FDR Framework as they are subject to a race to the top.

A number of articles have appeared over the last couple of days describing the race to the bottom.  For example, the Wall Street Journal ran an article on wrangling going on between regulators in the US and Europe.
Top U.S. and European policy makers continued wrangling on Thursday over global efforts to prevent another financial crisis, including the best way to ensure banks have enough capital to withstand potential losses. 
In a private meeting at the U.S. Treasury Department, Treasury Secretary Timothy Geithner told Michel Barnier, the European Commissioner for Internal Market and Services, that Europe needs to perform rigorous "stress tests" on its banks and ensure they have adequate capital cushions to survive financial problems, according to people familiar with the meeting. 
Mr. Geithner warned Mr. Barnier that Europe risks putting itself at a disadvantage given that U.S. firms are much better capitalized, and therefore less vulnerable, than their European counterparts, these people said. 
In the absence of current asset and liability-level disclosure, market participants do not know if the US banks are solvent, let alone well capitalized.  Apparently the US regulators forgot that they lost their credibility on this issue by claiming the large banks were well capitalized prior to the credit crisis and the need to bail-out these same institutions.
Mr. Barnier, meanwhile, defended European institutions and told Mr. Geithner the U.S. should fully implement a previous international agreement on capital, known as Basel II. U.S. officials are concerned Basel II isn't stringent enough and doesn't adequately measure a bank's risk. 
Even if there is agreement on standards for capital or liquidity, it is difficult to enforce this agreement on anything other than disclosure.  Disclosure is easy to enforce because investors will pay a premium for securities with better disclosure over those that are opaque.
Another area of disagreement concerns banker pay. Mr. Barnier told Mr. Geithner the U.S. should impose stricter curbs on bonuses. The U.S. has shied away from strict compensation curbs, such as caps on pay, and has instead sought to change the structure of compensation so that it's more closely tied to an institution's long-term financial health. Mr. Geithner reiterated those views, people familiar with the meeting said.
The U.S., meanwhile, is moving ahead with its own efforts to force big financial firms to hold larger capital reserves. 
In a speech to be delivered Friday, Federal Reserve Governor Daniel Tarullo is expected to make the case for additional capital charges for systemically important financial institutions. Mr. Tarullo is expected to outline the Fed's thinking on the form the surcharge should take though he won't specify a certain amount. 
The speech is aimed at tamping down intense behind-the-scenes lobbying by some large financial institutions opposed to any additional capital requirements and to stake out the Fed's position ahead of upcoming international discussions.

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