Thursday, November 15, 2012

Washington and the financial regulators are not about to crack down on Wall Street

In a Propublica article, Jesse Eisinger looks at the ongoing implementation of the Dodd-Frank Act and concludes that Washington and the financial regulators are not about to crack down on Wall Street.

Regular readers know that with limited exceptions, the Consumer Financial Protection Bureau and the Volcker Rule, the Dodd-Frank Act was written by lobbyists for Wall Street's benefit.  The act was never designed to crack down on Wall Street.  It was designed to protect Wall Street and the opacity that Wall Street thrives on.

For example, the act created the Office of Financial Research.  The idea behind OFR is that it will operate like the National Weather Service and collect all the useful, relevant information about the financial system.

Unlike the National Weather Service which makes its data available to anyone who asks, by law, OFR must keep its data confidential.  All it can share is the results of analyses conducted by its in-house analytical team.

Hence, OFR is nothing short of the black hole in the financial system where transparency goes to die as the reason that transparency works is that it lets every market participant independently assess the information and come to their own conclusion.  A conclusion that they then act on when determining both the amount and price of any exposure.
Surely, reformers can now ride in and save the day, right? 
Alas, no. While the rule making will speed up, the core problems with the financial system and its regulators are deeper than personnel and sadly impervious to which party occupies the White House. They are bipartisan and structural.... 
The structural issues go deeper. The Commodity Futures Trading Commission and the Securities and Exchange Commission still exist as two separate agencies, a huge missed opportunity for Dodd-Frank and one borne of politics. 
The C.F.T.C. is protected (and bashed) by the Senate Agriculture Committee, the S.E.C. by the Senate Banking Committee. Merging the agencies would mean that one of those committees would lose power, so forget about that. ... And, anyway, these agencies are still run by commissions, not single heads, and they rely on Congress for their financing. It's little surprise that such a structure creates plodding impotence. 
"One of the biggest weaknesses of Dodd Frank is that we failed to look long and hard at true independence of regulators," a frustrated and regretful Senate staff member, who worked on the legislation, told me the other day....
 Did the Senate staff member expect Wall Street and its lobbyists to say this was a problem?
Or take the Volcker Rule, one of the most prominent symbols of the financial overhaul. The rule, which was intended to prevent banks from speculating with money backed by taxpayers, still has not been finalized almost two and a half years after Dodd Frank passed. 
It's the subject of multiple-agency negotiations, which are going about as well as that phrase would suggest. Representative Barney Frank, Democrat of Massachusetts, had called on the regulators to finish up by Labor Day. That came and went. Senators Carl Levin, Democrat of Michigan, and Jeff Merkley, Democrat of Oregon, the authors of the provision, fired off a letter a few weeks ago, urging the regulators to finish their work. 
Now, it would be good if regulators were assiduously working to radically simplify the rule, which is a bloated monstrosity filled with loopholes and exemptions. But they aren't. Instead, they're squabbling over petty turf issues....
Regular readers will recall that the Volcker Rule could be written in 2 pages.  Page one would repeat the Volcker Rule and its prohibition on proprietary trading.  Page two would require banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

As Mr. Volcker said, you know proprietary trading when you see it.  With ultra transparency, all the market participants could see if a bank engaged in proprietary trading.  This would make it easy for regulators to enforce the rule.
Dodd Frank is so sweeping in scope yet so picayune in application that it will be close to impossible for the public to tell whether it's making a difference.
Dodd Frank is designed not to make a difference.

Any effort to truly crack down on Wall Street will start with transparency and providing market participants with access to all the useful, relevant information so they can independently assess the risk and make a fully informed investment decision.

Dodd Frank is designed to protect opacity.  As a result, it calls providing pricing information transparency.

Everyone knows that pricing information is not transparency.

The first step of the investment cycle is for the market participant to independently assess a security.  Transparency is focused on providing all the useful, relevant information for this assessment.

The second step of the investment cycle is to look at the prices shown by Wall Street.

The last step of the investment cycle is to compare the independent assessment of the security against the prices shown by Wall Street in order to make an buy, hold or sell decision.

The lesson that investors relearned at the beginning of the Great Recession is that if you cannot do the first step, stop.  Buying and selling based on price is simply blindly betting.

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