Dimon versus Bernanke on financial regulation

JP Morgan Chase CEO Jamie Dimon asked a very interesting question to Fed Chairman Ben Bernanke.  As reported in a Bloomberg article,

Dimon asked whether the central banker has measured the cumulative effects of new capital requirements, mortgage standards and other rules imposed on the system in the wake of the U.S. financial crisis...  

Dimon asked Bernanke if he “has a fear like I do” that overzealous regulation “will be the reason it took so long that our banks, our credit, our businesses and most importantly job creation to start going again. Is this holding us back at this point?” 

“There’s no more subprime, there’s no more Alt-A, there’s no more mortgages being packaged, the CMBS market has been completely reformed,” he said, referring to commercial mortgage-backed securities. “I have a great fear someone’s going to try to write a book in 20 years and the book is going to talk about all the things that we did in the middle of the crisis to actually slow down recovery.”

According to the Bloomberg article, Chairman Bernanke responded

Dimon’s points are valid, Bernanke said at the American Bankers Association’s International Monetary Conference. 

The central bank doesn’t have the quantitative tools to study the net impact of all the regulatory and market changes over the last three years, he said. “It’s too complicated,” Bernanke said, adding that he said he thinks there’s a way to safely regulate banks while preserving their ability to deliver “basic financial services.” 

“But there is some trade-off there and you’re right to point that out,” Bernanke said. “It’s probably going to take a bit of time before we over time figure out where the cost exceeds the benefits and we make the appropriate adjustments.”

According to a Reuters' article, Chairman Bernanke also

[A]sked Dimon to give the new regulations time. The financial crisis revealed "lots of weak spots" that regulators must address, he said. 

"We are trying to develop rules that make sense, that are consistent with good practice, but which don't unnecessarily impose costs or unnecessarily constrict credit," he said.

According to a Wall Street Journal article, Chairman Bernanke observed that

"While it is true there are a lot of regulations in the pipeline there is a good reason why financial regulation has been reformed," .... "We have to take steps to make sure we don't have a repeat of what happened," Mr. Bernanke said, noting this can be done "in a way that preserves the key functions of banking." 

Mr. Bernanke said Mr. Dimon's roster of changes "made me feel pretty good" because it showed policy makers were responding to shortcomings exposed by the financial crisis. While he acknowledged there has been no study on how the new rules will affect the flow of credit, the Fed chief said market participants have to accept the trade-off between conducting business and maintaining the safety of the broader economy.

The question and answer are revealing.

• The question because it directly raises the issue of do the regulators have any idea of what they are doing and the impact of their actions on the global financial markets.

• The answer because it is a confession that the regulators do not know what the impact of their actions on the global financial markets will be.

Regular readers of this blog know that your humble blogger finds this answer to be totally unacceptable.  However, it is not surprising given that regulators and legislators rushed to create new rules without asking the simple question of why did the previous set of rules and their regulatory implementation not work.

Regular readers of this blog also know that you do not have to wait for 20 years to read a book about all the programs and regulations that have been enacted since the beginning of the credit crisis that have been very expensive to taxpayers and only delayed the recovery.  You can simply read this blog.

Quite simply, because the regulators and legislators either do not understand or choose to ignore the fact that the global financial system is based on the FDR Framework, they have enacted a number of programs and a regulatory agenda that are of limited benefit.

If the regulators and legislators had adhered to the FDR Framework and its requirement that market participants have access to all useful, relevant information in an appropriate, timely manner, they would have dispensed with the vast majority of the Dodd-Frank Act and its related regulations.

Had the Dodd-Frank Act simply required that all financial institutions, broadly defined to include the trading and financing subsidiaries of non-financial companies, disclose their current asset and liability-level data on a daily basis, it would have achieved far more at far less cost.

With this disclosure, market participants would have had the information they needed.  They could have

• determined for themselves which financial institutions are solvent and which are insolvent [no need for extend and pretend policies or future bailouts as regulators can look at the price of a financial firm's debt relative to its peers to know when to step in and resolve them.]

• actually analyzed counter-party risk and properly price and limit their exposure based on the counter-party's risk level [thereby bringing market discipline, as oppose to regulatory discipline, to the financial institutions for the first time].

The FDR Framework's simple low cost disclosure solution would both prevent a repeat of what happened and preserve the key functions of banks without the myriad of financial regulations that have been and are being drafted since the financial crisis began.