Barney Frank on Regulation, and the Great LOLR Transformation
Pic credit: In the Butt
First of all, can I say that hearing Barney Frank talk about regulation is like hearing my grandma talk about having sex? Chew on that one for a minute.
Secondly, if anyone understands what Frank meant by his thoughts in this speech to the National Press Club on July 27th, I would really appreciate getting the translation. I'm not even sure if this is meant to be obscure as much as it is just poorly-worded and vague. Perhaps Frank and Tim Geithner share a speechwriter.
You can have the most complete regulatory powers given to individuals who simply do not believe regulation is ever useful, and it won't work. And frankly, Alan Greenspan, as he has acknowledged, came close to that by flatly refusing to use many of the regulatory powers given to the Federal Reserve. That was in the old days. The Federal Reserve led other bank regulators into becoming born-again consumer advocates. It's been one of the most interesting conversions we have seen recently in the United States.
But, it is made easier for those who believe firmly in never regulating, never to regulate, when no responsibility is fixed on who should do it. The more you disperse responsibility, the harder it is to overcome that aversion. On the other hand, it is true, if you had wonderful regulators firmly committed to trying to propose rules that would stop the bad things, or minimize the bad and let the good go, they could overcome regulatory inefficiency. But, we can't legislate on the assumption that we're going to either have people totally opposed or wonderful super-regulators. We need to regulate for normal human beings, and that's what we hope to do because we think it is important, both that there be regulatory structures that provide focused responsibility for the right side of regulation, and the appointment of individuals to do it. It's best to have both, but it is better to have at least one than to have neither. And we think we can structure it so you do get both, at least for the near term.
Because it is very important when you get new regulations, and this is something that we shouldn't lose sight of, by definition in the political process, that the new regulation is going to come under the aegis of people who believe in it and the first set of regulators will be good ones. And that's very important.
I might recommend "The Consolidation of Financial Regulation: Pros, Cons, and Implications for the United States" from Richmond Fed's Spring 2009 Economic Quarterly to cleanse the mental palate after engaging in that drivel from our boy BF.
Also, I find it entertaining that Lender of Last Resort is truncated to LOLR and cannot believe I did not pick up on that earlier. LOLR! I LOLR over the Fed constantly (this, of course, is no laughing matter. I take regulation seriously =/):
[T]here is one oft-stated reason to keep the central bank as a bank regulator: Without day-to-day examination responsibility, the central bank will have difficulty making prudent LOLR lending decisions. Central banks typically allow certain institutions to borrow funds, usually on a short-term basis, to cover liquidity shortages. For example, a bank facing deposit withdrawals that exceed the bank’s easily marketable (liquid) assets will be forced to sell other assets. Since bank assets are often difficult for outsiders to value, rapid sales of these assets are likely to generate losses for the bank. To allow banks to overcome this “fire sale” problem, central banks provide access to LOLR loans.
LOLR loans are frequently made to institutions with uncertain futures. The decision is likely to be controversial and subject the decisionmaker to close political and public scrutiny. If the central bank incorrectly decides not to lend to an institution that is healthy but has a short-term liquidity problem, that bank may fail. Such a decision may mean that valuable resources will be wasted reorganizing the failed bank. Alternatively, if the central bank incorrectly decides to lend to an institution that is unhealthy and the bank ultimately fails, then uninsured depositors have escaped losses, leaving these losses to instead be borne by the deposit insurer or taxpayers. Further, if the central bank frequently lends to unhealthy banks, banks will be more willing to make risky investments knowing that the LOLR is likely to come to their aid.
Given the dangers of incorrect LOLR decisions, the decisionmaker will require careful counsel from a knowledgeable staff. This kind of knowledge is likely to be gained only by individuals who are involved in day-to-day examination of institutions. Further, the decisionmaker is likely to get the best input from staff that report directly to the decisionmaker so that poor decisions are punished and good decisions are rewarded. Consequently, the combination of the need for day-to-day knowledge and for proper incentives for providing good information argues in favor of keeping regulatory responsibility with the entity that provides LOLR loans, typically the central bank.
The authors do not necessarily present a case either for or against a consolidated financial regulator in the United States, nor do they appear to endorse or discount the idea of the central bank as ultimate regulator in this particular piece.
I hate admit as much but I think the regulators are in a better position to weigh in on this issue than Barney Frank, who appears to be confused as to his responsibilities to the voters of Massachusetts. Frank's thoughts, however, compel me to point out here that central banker cojones (the ones he implied Alan Greenspan did not exercise) are the problem. He insists that regulation is only as strong as the homicidal maniac weilding the axe, which naturally concerns us just slightly. Alan Greenspan was not wrong to leave a few bullets in the Fed's chamber, and a reasonable person might argue here that BF doesn't even understand the Fed mandate and is therefore not qualified to postulate on it, let alone make decisions that have a material consequence on the issue.
(Ironically, I kept F-bombs out of this post and here's Karl Denninger over at Market Ticker saying STFU to BF. Hilarious)