Obama on Financial Rescue and Recovery: market regulation and the "false choice"

In case you missed it, President Obama spoke this morning on the financial crisis and recovery efforts (see Obama Remarks on Financial Rescue). In terms of regulatory overhaul, President Obama remarked that it is a "false choice" to believe that entrepreneurism and innovation are sacrificed by regulation. Something President Obama has stressed is "common sense" rules of the road. People's memories seem to falter once a crisis begins to pass. After all, government intervention seems to work, so why burden business with onerous regulations? For my part, I believe the United States has been lucky in its ability to slow the financial crisis and begin rebuilding. Recovery, though, may turn out to be much slower than we might hope (see Recovery Slower). As we've said here before (see War of Wealth), this country has been down the road of bank failures and financial crisis before. President Obama and Chairman Bernanke (see Bernanke Sees Progress) are telling us that something substantial needs to change. With competing issues like health care and impending flu concerns, will we heed the warnings that are Obama, Bernanke and others have delivered? Or, will we continue on with business as usual? Hmm, the markets are up today (see Bloomberg) .

- JSM

Bank Stress Test Skit on SNL

In case you missed it:

- JSM

Keynote Speech by John Dearie of Financial Services Forum

Over at University of Memphis' Symposium on Financial Services Reform, John Dearie of the Financial Services Forum gave the keynote speech. Mr. Dearie agreed with earlier presenters that we must first decide what is to be regulated and, second, determine what is the point of regulation. That is, what are the objectives to be obtained.

Mr. Dearie discussed the changes in financial products that have altered our marketplace and urged that a number of factors require consideration in establishing a new supervisory framework. Among those:

• Global financial systems. The global nature of our marketplace requires consideration due to the interconnectedness of markets.
• Innovation. Mr. Dearie also cautioned against putting financial institutions in a "regulatory box." As such, the supervisory function can only be successful if innovation is not discouraged or impacted in a way that impairs competitiveness.
• Risk. The supervisory objective to help identify and manage risk and be responsive to changes in the marketplace to ensure safety and soundness.
• Cost. Moreover, the cost of the supervisory system must be considered. Mr. Dearie argued that the American supervisory system costs many times over that of other countries, such as the U.K.

How to accomplish this? Rather than scrapping the current structure, Dearie's plan is dubbed GLBA plus (named after the 1999 Gramm-Leach-Bliley Financial Services Modernization Act, Pub.L. 106-102) Federal, state and local supervision would continue under this model. This plan would preserve the specialization of current regulatory agencies. Regarding federal bank examinations, bank examination powers should be consolidated into one agency, the Office of the Comptroller of the Currency (with the Office of Thrift Supervision folded into the OCC). To the extent that non-traditional entities do not have an existing designated regulator, like hedge funds, such entities would only have intervention in an emergency. The Federal Reserve would remain as an overseer of the financial system as a whole as an umbrella supervisor. This will result in: lower costs; focus on a single regulator for the financial system as a whole; comprehensive supervision; preservation of regulatory specialization; more consistency; increased principles based supervision; and more likelihood of political success.

So, will this work? The mood at the Symposium was mixed. There is a lot to like about having the Federal Reserve keeping an eye on the financial system as a whole. After that, though, it gets a bit murky on how state and federal agencies might coordinate particular challenges. This is not intended to be overly critical of Mr. Dearie's position, as he is just thinking this through himself and how financial products will develop is uncertain to all. The GLBA plus proposal might be a modest regulatory fix with big results or merely perpetuate a system of limited oversight without substantial changes. For the time, it is good to have the discussion take place to ensure that attempts are made not only toward the current, but also any future crisis.

— JSM

Who's LIBOR?

Photo by AMagill

One small silver lining of this crisis is that lots of terms with which I struggle with commercial law students are now splashed all over the front pages of financial and general news outlets. Perhaps the most important example is LIBOR.

The London Interbank Offered Rate is the interest rate at which a series of 16 banks are willing to lend to each other--overnight or for various longer intervals, like 3 months, and in a variety of currencies, most prominently U.S. Dollars and Euros. Bloomberg today has one of the clearest and most insightful discussions of LIBOR, its history, and the various ways it is being used to gauge the seize-up in the credit markets. Gavin Finch and Ben Sills offer a particularly lucid explanation of why the TED spread is a stark indication of how much banks distrust each other (or at least their ability to repay loans) and how that spread has really increased recently (spiking to levels far above what we saw in the 1987 crash and after the collapse of LTCM in 1998). The scariest passage:

Central bank efforts to tame Libor have had little impact because instead of lending the extra cash, banks are holding it on deposit with the ECB at a loss. [empahasis added] On Oct. 6, banks borrowed 13.6 billion euros from the [European Central Bank] at ... 5.25 percent. At the same time, they deposited 42.6 billion euros overnight at 3.25 percent.

This is just crazy! Can anyone say "irrational pessimism" (or, I guess, "negative/reverse arbitrage")? I hope these banks soon begin listening to Jean-Claude Trichet's exhortation for everyone to "keep their composure" and start acting like market players again.

Anyway, for those of us in the education industry, LIBOR is likely more important to our students than we might have realized. Many private student loans are pegged to 3-month U.S. Dollar LIBOR, and if these loans readjust before that index returns to "normal" levels, our students might face a crushing increase in current or expected student loan interest payments (much like poor Maureen McNally, mentioned in the Bloomberg story, whose LIBOR-pegged mortgage payments have jumped 50%, not to mention Danilo Coronacion, who oversees a $60 million debt with interest pegged to LIBOR).

At least overnight LIBOR rates (both $ and €) fell last night, so let's hope this trend continues and spreads to the longer maturities (especially the all-important 3-month rates).

Update: Further confirmation that LIBOR is the bellwether:

"Everyone's watching the Libor, looking for the credit market to thaw and it's not there yet,'' said Alec Young, a New York-based equity strategist at Standard & Poor's. "Until you get some convincing thawing in the credit markets, the threat of a global recession and a global profits recession remains and it's going to be difficult for stocks to build momentum.''

Some Damn Foolish Thing in the Balkans

That's what Bismark predicted would set off the war that seemed inevitable. The trigger turned out to be the assasination of Archduke Franz Ferdinand, heir to the Hapsburg throne. The assassins were seven young men. All were members of a secret Serbian nationalist movement. All had tuberculosis which was a death sentence in 1914. The rest, as they say, is history.

Two days ago, at a Brookings Institute conference on Turmoil in Housing and Financial Markets, former Treasury Secretary Lawrence Summers (now at Harvard's Kennedy School) observed that there is no single root cause of the current financial crisis and no simple single solution. The fix, he said, requires "multiple instruments targeted to multiple objectives." One response to the housing crisis currently getting most of the attention is to regulate institutions so they won't make mistakes again. People and businesses make mistakes and they always will, whether government regulates them or not. Summers offered another approach --reforming the financial system to make it safe for institutions to fail. The goal should be reduction of systemic not individual risk of failure.

Summers noted that even without subprime mortgages, the US economy was still vulnerable to leverage bubbles and might still have found itself in crisis. Blaming the current financial crisis on submprime mortgages, he said, is like blaming World War I on the assassination at Sarajevo.

Upcoming Conferences of Interest

Three conferences next month may be of interest to some of our faithful readers. I know they all interest me. I also know that, by the time I get home from the first of the three, I will have been out of town four of the last five weekends and would risk serious marital discord by attending either of the latter two. But, don't let that stop you from attending.

First up, chronologically, is "A Debtor World: Interdisciplinary Academic Symposium on Debt," May 2 & 3 at The University of Illinois College of Law, which is co-sponsoring with the American Bankruptcy Institute. The conference's self-stated goal is to "explore debt as neither a problem nor solution but as a phenomenon. Many different academic disciplines can make important contributions to help us understand why consumers and businesses decide to borrow money, what happens to businesses and consumers under a heavy debt load, and what norms and institutions societies need to encourage the efficient use of debt. Much of this knowledge is compartmentalized into intellectual silos that are rarely cross-fertilized. The goal of the conference is to promote the sharing of this knowledge." The line-up of speakers is eclectic and impressive and the conference promises to be time well spent. Conference registration is still open; however, the conference-rate block of hotel rooms may well be gone.

On May 22 & 23, the University of Houston Law Center's Center for Consumer Law, under the direction of our friend Richard Alderman, presents "Teaching Consumer Law: The Who, What, Where, Why, When and How." The conference faculty includes academics, advocates, and practitioners from the U.S. and several foreign countries and the program appears designed to appeal to attendees with varying degrees of experience and expertise in consumer law and in related areas of substantive law that have substantial consumer dimensions to them (e.g., bankruptcy, sales, payments). In addition to the inherent pleasure of spending two glorious May days in my hometown, conference attendees will be feted to Texas-style Bar-B-Q (known elsewhere as barbecue) and, for a nominal charge, a Houston Astros home game at lovely Minute Maid Park (formerly known as Enron Field and the Ballpark at Union Station). Conference and hotel registration are still open, as of this posting.

Rounding out the month, on May 30 & 31, Emory University School of Law's Center for Transactional Law and Practice hosts "Teaching Drafting and Transactional Skills: The Basics and Beyond." With panels geared toward both neophytes teaching courses that are ripe for infusing drafting and other transactional skills and those already teaching drafting and other transactional skills in their courses who are looking for fresh ideas, "[t]his conference offers those who teach drafting and transactional skills the knowledge and tools they need to comprehensively train students who are studying these areas of law" and "those at the forefront of developing these new courses a forum in which to exchange ideas about teaching, and promoting the teaching of, transactional law and skills." Among an excellent group of speakers is our friend and colleague Scott Burnham, whose book, Drafting and Analyzing Contracts (LexisNexis 3d ed. 2003), is a must-read and who is a most excellent house- and office-guest. Conference registration is open, as of this posting. Attendees are responsible for their own accommodations. For those who want to compare Texas-style Bar-B-Q to Carolina-style barbecue, at the far end of the Emory campus is a wonderful place called Dusty's. It's worth a visit if for no other reason than to buy some sauce to take back home with you.

Classification of "Financial Services"

The term "financial services" refers to an assortment of institutions that provide the means for people to save for the future, hedge against risks, acquire capital for consumption and organize capital for investment. Actors who undertake this intermediation function facilitate social gains from trade.

The The Department of the Treasury Blueprint of A Modernized Financial Regulatory Structure (March 2008) makes a provocative observation about the "financial services" sector and the term itself. Our current regulatory structure organizes financial services institutions into legally distinct categories, (e.g., commercial banks, other insured depository institutions, insurers, companies engaged in securities and futures transactions, finance companies, and specialized governmental companies such as Freddie Mac and Fannie Mae). These categories in part reflect distinctions in the way these actors function as capital intermediaries. In ways we hardly notice, however, the legal categories both reflect and entrench distinctions that regulation, not function, makes important.

For example, we perceive a legal difference between a commercial bank and an "other depositary institution" because the law that regulates commercial banks is different than that which regulates other depositary institutions. To accommodate the regulatory difference, we invent and deploy different words to describe the differently regulated actors. The most famous example of this may be the "non-bank bank" a term coined in the 1980's for a financial institution that did not meet the regulatory definition of a "commercial bank" and thus avoided the prohibition against interstate banking for commercial banks. The words we use to describe and importantly to think about "financial services" institutions make non-functional distinctions important.

The Blueprint proposes a new regulatory regime for intermediaries in which non-functional regulatory distinctions give way to functional ones. It opens a discussion on the possibility and realization of optimal regulation free of the restraint the current regulatory classification system imposes.

The proposal is both thrilling and terrifying. Mastery of the elaborate financial services classification system, like its biological counterpart, is not cheaply acquired or easily relinquished. For those players who have invested in manipulating the present regime to their advantage, the prospect of change threatens their return. The Blueprint invites financial services lawyers (and others who might be) to abandon the old vocabulary and embrace and create a new legal field that as yet has no name.