Thursday, July 26, 2012

Rep. Jeb Hensarling: first prominent Republican to call for banks to have "transparent balance sheets"

In his Wall Street Journal column, Congressman Jeb Hensarling showed there is bipartisan support for requiring banks to provide transparency.

Regular readers know that transparency is the simple solution that renders the vast majority of the Dodd-Frank Act unnecessary.

Mr. Hensarling focuses on the tremendous amount of prescriptive regulation that the Dodd-Frank Act generates and concludes that requiring banks to provide transparency would be more effective.
After an all-night session, Democrats (who then held the House majority) produced a 2,300-page behemoth they touted as a panacea for financial crises.... "too big to fail" is actually enshrined into law, and Dodd-Frank's voluminous rules are proving to be some of the most confusing, complex and harmful our capital markets have ever seen. 
Dodd-Frank was based largely on the premise that regulators lacked the authority to prevent Wall Street from taking outsize risks. But that was the wrong diagnosis—and it led, inevitably, to a prescription for the wrong remedy.
One of the primary beneficiaries of Dodd-Frank is the financial, academic, regulatory complex (FARC).  With this Act, FARC grew immensely in size and power.

First, implementation of Dodd-Frank required significant growth in the prescriptive regulation industry at both the agencies writing the laws and at the banks in terms of personnel to advise on and implement the regulation.

Second, implementation of Dodd-Frank increased FARC's power because it made the financial markets more dependent on FARC to ensure they functioned properly.
Before the crisis, regulatory mistakes and incompetence abounded—but almost no examples of a lack of regulatory authority can be found.
This was true in the US where we practiced intrusive regulation and in the UK where they practiced light-touch regulation.
Federal regulations were not the solution to the crisis but its principal cause....
These regulations were the cause to the extent that we substituted prescriptive regulations for transparency.
Having incorrectly diagnosed the problem, Dodd-Frank's authors wrote 400 new regulations. These generally fall into one of two categories: those that create uncertainty and those that create economic harm.
A prime example is the so-called Volcker rule. This 300-page proposal (to limit the kinds of investments banks can make) is not yet finalized by regulators. The proposal includes roughly 1,300 questions covering nearly 400 topics—and is so confusing that it elicited more than 18,000 comment letters from market participants and the public....
Regular readers know the simple way to implement the Volcker Rule is to require banks to provide ultra transparency and disclose on an on-going basis their current global asset, liability and off-balance sheet exposure details.

With this information, market participants, including regulators, could see if the banks were engaging in proprietary trades that are banned under the Volcker Rule.

Rather than a 300 page proposal with roughly 1,300 questions covering nearly 400 topics, the result would have been a two page proposal saying no proprietary trading and ultra transparency for monitoring compliance.

The financial, academic, regulatory complex prefers the 300-page proposal and is fighting against the 2-page proposal with ultra transparency.
The House Financial Services Committee estimates that private-sector job creators will have to spend 24,180,856 hours each year to comply with Dodd-Frank—and that's only for the 224 rules that have been written to date. 
William Isaac, a former chairman of the Federal Deposit Insurance Corporation, has predicted that hundreds if not thousands of community financial institutions will ultimately buckle under the regulatory load. 
As one community banker in my native Texas remarked, "My major risks are not credit risks, risks of theft, risks of some robber coming in with a gun in my office; my number one risk is federal regulatory risk."....
In short, the financial, academic, regulatory complex's growth is damaging as it favors the Too Big to Fail banks at the expense of the community bankers.
So where do we go from here? For starters, the president should work with Congress to phase out the government-sponsored enterprises and transition them to the private market....
Your humble blogger has argued that the key to doing this is to require that structured finance securities and covered bonds provide observable event based reporting.  All activities like payments or defaults involving the underlying collateral are reported to market participants before the beginning of the next business day.

With observable event based reporting, investors can assess the risk of and value covered bonds and structured finance securities and, if they buy them, know what they own.

Currently we do not have observable event based reporting.  As a result, the private label mortgage backed securities market is closed and we are dependent on the government-sponsored enterprises.
Next, Dodd-Frank's bailout authority must be repealed. The way to address the risks posed by financial institutions would be more transparent balance sheets and a meaningful application of capital and liquidity standards. As long as companies have enough capital to cover their risks and absorb potential losses, we don't need federal regulators micromanaging credit allocation....
Please re-read the highlighted text as Congressman Hensarling nicely summarizes the simple fact that transparency works to prevent financial problems from occurring.

When banks are required to provide ultra transparency, market participants can assess the risks the banks are taking and can exert discipline on the banks to restrain their risk taking.  At the same time, market participants can exert discipline on the banks to have capital that is meaningful in relation to the risk the banks are taking.
If Americans want the jobs and economic growth that flow from innovative, competitive and transparent capital markets, we should commit to making this anniversary Dodd-Frank's last.
And replace it with an Act that restores transparency to the financial system.

At a minimum, this Act would require that banks provide ultra transparency and that asset backed deals ranging from covered bonds to structured finance securities provide observable event based reporting.

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