While there are many sectors of the financial services industry that likely feel they were on the losing end of yesterday’s 80+ page regulatory reform proposal, there was one true winner- the rating agencies. In fact, the proposal has arguably strengthened their position. The proposal does not address the misalignment of interests between the agencies and issuers, but does recommend less reliance on ratings alone when making investment/credit decisions while remaining silent on encouraging new firms to enter the market.
So, in effect, the proposal recognizes the ratings are worthless and shouldn’t be relied on but doesn’t want any new competitors who might be slightly more competent to add a shred of legitimacy to the process and capitalize on the quid-pro-quo fee arrangement which will remain intact. It looks like the proposal’s subtitle, A New Foundation: Rebuilding Financial Supervision and Regulation, needs an overhaul of its own.
Overhaul Leaves Rating Agencies Largely Untouched [NYT]
Regulation
Within the thick blanket of new regulatory proposals unveiled today was a plan that would require firms securitizing loans to retain 5% of the credit risk and prohibit hedges for that risk which would “undermine the economic tie between the originator and the issued asset-backed security”. The issue of aligning interests in ABS trades is a valid one. However, when the Fed sees zero interest for the first round of CMBS TALF loans, and the administration has paid such lip service to the need to reignite the securitization market, picking a seemingly arbitrary amount of credit risk for ABS issuers to retain is a confusing first step at best.
Wall Street Calls Obama’s Mortgage-Market Debt Plan a Burden [Bloomberg]
If Ben Bernanke thought he could keep the Fed (semi)-independent of the rest of Washington, he may get a rude awakening soon. Congress is looking to provide the GAO with the authority to audit all of the Fed’s activities. The thought of greater Congressional scrutiny has to make Bernanke reach for the Pepto and hope that he doesn’t wake up in a cold sweat haunted by the vision of Maxine Waters marching down the corridors of the Fed trying to fire every ex-Goldman employee herself. Best of luck Ben.
Congress seeks to open Fed actions to more scrutiny [FT]
The SEC, fresh off an impressively long stretch of missing virtually everything they were supposed to catch, is ramping up its efforts to become a remotely credible regulator. After being publicly humiliated by the widespread ineptitude of missing the Madoff fraud as well as its own insider trading scandal, the new SEC Chairman, Mary Schapiro, is determined to create a new kind of SEC.
I wanted to be very clear almost from my first day — not just with words, which are pretty easy to string together, but with actions — that this is a new SEC that is moving in a decidedly different direction and at a decidedly different pace,
Given the rhetoric coming out of Washington regarding evil speculators, it should come as no surprise that hedge funds, derivatives, and short-selling are three of the primary targets in the SEC’s cross hairs. Schapiro clearly has a huge uphill battle ahead of her. She is head of an organization where people still take issue with categorizing the Madoff miss as a failure. Effective regulation can help markets avoid the meltdowns we saw last year, but the risk of the SEC becoming over zealous to restore its image looms large.
SEC Chief Strives To Rebuild Regulator [Washington Post]
Once upon a time, markets in this country functioned based on economic Darwinism. It was pretty simple: the strong survived, the weak perished and the strong were then rewarded by feasting on the remains of the economically inept. In what is sure to be the first of many intrusions from the various regulators in this dynamic, the FDIC wants to tilt the scales in the game of Hungry Hungry Hippo resulting from forthcoming bank failures. The FDIC estimates that up to 780 banks are going to bite the bullet over the next 24 months. So far PE firms have been having a field day snapping up failed institutions. But now the powers that be at the FDIC are concerned that the likes of Blackstone and Fortress are succeeding a little too much in their quest to carry out the principal mandate of private equity firms and it might be time for someone else to have a go. In their mind, this sort of thing should really be kept in the banking circle of trust and PE firms are outside the circle. The FDIC is reportedly considering “encouraging” stronger banks to step into the ring and take a piece of this pie. At the end of the first inning the score is Creeping Regulatory Intervention 1; Adam Smith 0.
We’re no fans of protectionism — least of all, regulation coming out of the People’s Republic of Canada. However, with Stephen Harper at the helm, things have gotten better for our mildly dull, if not downright slow, neighbors to the north. Case in point: The National Post reports today that the Canadian Radio-television and Telecommunications Commission (CRTC) has just approved a new porn channel, on the condition that it show 50% Canadian content.
We’re going to have a lot to say about the costs of Treasury Secretary Hank Paulson’s Blueprint for a Modernized Financial Regulatory Structure. Before that, however, it’s worth noting that there is little to admire about our current financial regulatory structure. Largely a product of the financial crises of the past, the structure was unwieldy, arguably created a bureaucratic structure at odds with the constitutional framework of our Republic and tended to serve the interest of the very financial institutions it sought to regulate at the expense of individual investors and the broader public. The array of regulatory bodies we live with were largely “captured” by the securities and banking industry, although “capture” is probably the wrong term because it implies that they were independent at some point. Many were built to serve the interests of Wall Street, so no capture was necessary.
The best that can be said about the current system is that we have years of experience with it. We understand how it operates, how it fails and what its strengths are. This is a conservative point but one that needs to be made: regulatory innovation inevitably leads to “unintended consequences” and unanticipated costs. At the very minimum, the costs of adjusting to a new regulatory structure need to be taken into account. We may not be risking our lives and sacred honor by declaring the need to dissolve the longstanding financial regulatory bonds, but we may be risking our fortunes.
That said, we’re headed deep into the details of this bold new world Paulson has proposed. The Treasury has released a cheat sheet here. But if you are really ambitious, follow us into the 212 page blueprint. We welcome your insight, of course, in the comments below or via email to tips@dealbreaker.com.
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