Fed to launch new bank exam teams

The Federal Reserve plans to intensify its scrutiny of bank lending and financial health with teams made up of experts in a variety of new areas. Fed Governor Daniel Tarullo outlined the plan during a Senate Banking Committee hearing in Washington today. The overhaul, which would make reviews more uniform across the banking system, builds on the stress tests the central bank completed on the biggest 19 banks in May, he said. “We are prioritizing and expanding” the examination process to “assess key operations, risks and risk management activities of large institutions,” Tarullo said in his testimony today. “This program will be distinct from the activities of on-site examination teams so as to provide an independent supervisory perspective. This work will be performed by a multidisciplinary group composed of our economic and market researchers, supervisors, market operations specialists and accounting and legal experts,” Tarullo said.

A regulatory tussle has been unfolding since the Obama administration proposed strengthening the Fed's regulatory profile. The major regulators have each opposed some aspect of the plan in hopes of maintaining their own powers as the winds of change blow in.

Two sides to the Fed-as-Regulator debate

Lee C. Bollinger, president of Columbia University in New York, says the U.S. needs a "First Amendment for the economy" after a failure of regulation that could be fixed by giving the Fed more responsibility. Bollinger called the economic crisis a “huge failure of public regulation”, and proposed an independent regulator based upon the judicial system which could issue written rulings and change precedents. Bollinger said the Fed had the capacity to stand outside the system as an independent regulator to monitor risk.

On the flip side, Harvard professor and author Amar Bhide says in a WSJ opinion piece that the Fed has done such a terrible job at financial regulation it would be unthinkable to give it more power, and goes so far as to say we should be talking about dismantling the Fed, not increasing its power. Bhide goes on to write that Fed's regulatory mission has become so big as to be unmanageable and proposes a minimum of splitting the monetary policy and regulatory functions of the Fed as was done with the Maastricht Treaty that established the European Central Bank.

Also in the news...

CFTC Chairman Gary Gensler said he believes the agency must seriously consider setting stricter limits on traders who place bets on energy contracts. His remarks are the just the latest example of a shift in tone for the commodities regulator vis a vis trading curbs and other regulatory measures. Gensler went on to say that "every option must be on the table to curb "excessive speculation", which the WSJ called out as politically expedient remarks in its editorial on "The Politics of Speculation". In addition, Goldman Sachs talked its own book by saying attempts to curb speculation may prove "disruptive" to markets.

Regulators sit in judgment of CIT

While bond investors seem to have come through with a $3B private bailout for CIT Group, it appears regulators will have the final say on the troubled lender. CIT needs an exemption from the Federal Reserve and approval from the Federal Deposit Insurance Corp. to transfer assets from a holding company to its bank in Utah. It can then raise customer deposits to fund those assets. Earlier this year the regulators allowed a transfer of $5.7 billion in student loans by CIT, but more recently they have seemed reluctant to grant additional transfers. Bondholders hope, however, that with a private-sector deal in hand, the regulators will take a second look and allow more transfers. Even though CIT's long-term plans center around the regulatory waiver, no imminent action is expected on that front, a person familiar with the matter said. For more details on the CIT situation, check out this story from the WSJ.

Battle joined on consumer financial protection agency

The Obama regulatory plan has now been percolating through the financial world for two weeks, and the reaction has been mixed. Predictably, banks and mortgage lenders are placing top priority on killing the proposal to create the so-called Financial Products Safety Commission. The banks and their lobbyists are bracing for a big fight, unhappy with the extension of powers being discussed for the new regulator. The proposal delivered to Congress calls for stripping away all the consumer responsibilities that are currently assigned to existing regulators like the Fed, FDIC and OCC. Among the powers being discussed, the new agency could set standards for traditional mortgages and could restrict or prohibit certain types of mortgages.

Links:

• The collateral damage from lawmakers releasing confidential Federal Reserve emails could be a less open regulatory process as banks and regulators may share less information with eachother.
• The Supreme Court decided with New York 5-4 in Cuomo v. Clearing House Association. The decision affirms that New York's AG could demand mortgage data from federally chartered banks to seek evidence of discrimination under the state's fair lending laws.
• Morgan Stanley pulled in its risk-taking in 2009, and it's now seeing the downside of that strategy.
• There is some grumbling about the selection process for the job of Head of the NY Fed.
• The FDIC is seeking limits on the ability of private equity firms to buy up failed banks.
• Sometimes it's better to be lucky than it is to be good....
  

G-20 moves forward on regulatory framework

The new era of finance is now dawning in earnest. Word from the G-20 meetings in London is that world leaders have agreed on a regulatory framework for countering excesses that led to the current global financial crisis. In particular, the group called for stricter limits on hedge funds, executive pay, credit-rating agencies and bank risk-taking. In addition, they pledged more than $1T in emergency aid to assist with collateral damage from the crisis. While countries will mainly be left to regulate their own markets and companies, the G-20 recognized a need for some global oversight by establishing a new Financial Stability Board to promote regulator cooperation and work with the IMF. Hedge funds defined as "systemically important" will be subjected to greater regulation and oversight. Pay and bonuses will be examined to create "sustainable compensation schemes". Accountants will need to improve valuation methods and creit rating agencies will need to meet a new code of standards.

Meanwhile, focusing back on the US, KC Fed President Thomas Hoenig endorsed the notion of the Federal Reserve becoming the regulator for systemic risk in US finance. In Geithner's recent proposal, such a systemic-risk regulator would have the authority to compel companies to boost their capital and curtail borrowing, as well as to seize companies get into trouble.

The Financial Stability Forum agreed to move towards creating stricter capital requirements for banks around the world, reversing their prior view of giving financial institutions more flexibilty in how they calculate reserves.

Ron Resnick, co-founder of financial consulting firm CounselWorks has an interesting piece on his views about government assumptions in the regulation of financial firms. He questions Treasury's new supervisory and regulatory foundation based upon the concept of "systemically important firms".

Summers: AIG Proves Regulatory Regime is Unsatisfactory

Get ready for a new front to open in the compensation wars. Last week, Reuters reported that Citigroup is writing bonus guarantees to attract traders in London. And once again, A.I.G. is at the center of the bonus battle with news that it will be making good on $165mm of bonus guarantees. The disclosure has, predictably, touched off a firestorm in the court of public opinion, with White House economist Larry Summers firing the first shot on CBS' Face the Nation Sunday. Yes, there is something outrageous about the poster-child for the credit crisis taking $170B of public funds to stay afloat and then paying out big incentive money to employees. But, what can be done? A.I.G. is in a unique position, to say the least. The government, concerned about systemic risk and the devastating market consequences of allowing the company to fail, feels like it must prop up the giant insurer. A.I.G. seems to understand this and, rather than deal with legal challenges to employment contracts, has decided to honor those deals. But let's think of it from an employees perspective. Let's turn back the clock to January 2008. You are a credit default swap salesman. Your space is one of the few seemingly robust parts of the credit market, and there is a healthy bid for your services. You are happy at Broker X, but AIG comes calling and blows you away with an offer. Of course, as is convention in the finance world, you aren't going anywhere without guaranteed money for, let's say two years. Why do you hod out for this? Well, you just never know what can happen, markets turn, bosses leave, things happen, and this is maybe that chance to have a some security for a couple of years. Now it is March 2009 and the world is an entirely different place. The move to A.I.G. was a big stinker, but you were smart to negotiate that guarantee because you are protected. God thing you paid that compensation lawyer big bucks to make sure it was all kosher. Management can come and ask you to take a decrease or defer some money, but why would you do that for a firm that may not be around next month, let alone next year? That's the way it works (worked?) on Wall Street. Are these contracts indeed bulletproof? Should A.I.G. and the government spend time, money and energy renegotiating these contracts? The answer is likely "no". But, what the government will do is add this situation as one more arrow in its regulatory reform quiver. By expressing outrage, the court of public opinion will tend to fall on the government's side, and if you look closely at Summer's remarks yesterday, he said "What the lesson is, is this: We don't really have a satisfactory regulatory regime in place." The drumbeat is continuing in the march toward a dramatic overhaul of the financial regulatory system. The regulatory reform train is finally starting to pickup speed. The Obama plans key points were revealed this morning, and they center around the Federal Reserve getting new powers to monitor and address broad risks across the economy. Also proposed are Changes to bank oversight, more transparency for inter-bank money flows, tougher capital requirements for big banks, and a consolidation of consumer protection enforcement.

The links:

• More bad PR for A.I.G. As if news that it paid guaranteed bonuses wasn't enough to keep the spin-doctors busy, the list of its counterparties that were streamed payments after bailout funds were received is out.
• A great profile of Thain's hubris by Greg Farrell and Henny Sender in the FT Weekend.
• Unhappy Anniversary Bear Stearns; it's hard to believe it's been a year since the powder-keg of Wall Street exploded. WSJ's James Freeman says there is still a lot we haven't figured out since then.
• The WSJ's Real Time Economics blog has a view on what to do first in avoiding another financial calamity.
• Paul Krugman says Europe's financial crisis could be way deeper than that of the U.S.
• Roubini says beware of the dead-cat bounce.
• The G-20 is split on hedge fund regulation.
  

Regulation Monday

The regulators are back in the top of the news this morning, with two prominent articles in the NY Times Business pages. SEC chief Mary Schapiro has used her first month to move aggressively toward reversing major decisions by prior chief Cox, and to strengthen the enforcement program which has been blasted for missing several huge frauds. Cox had a policy which required enforcement lawyers to obtain consent of commissioners before moving to resolve major cases. With the commission largely made up of opponents of government regulation, the residual effect was to discourage cases and reduce penalties. Schapiro is under the gun to restore crdibility to the agency, as Congress prepares legislation which may overhaul the entire securities regulatory structure. Schapiro is moving quickly to adopt rules to minimize conflict of interest at credit-rating agencies, as well as looking at new restrictions on short selling. Schapiro's moves will be made more challenging by news of the latest collateral damage from the Cox era, as the Agency faces scrutiny for its handling of allegations of insider-trading by former Lehman executives. Sen. Grassley wants answers...

• Bank stress testing will be in the spotlight this week as the Obama administration scrutinizes the financial condition of the 20 biggest banks to assess their fitness to weather a worse downturn than expected. The U.S. said that banks would have access to capital necessary to keep them afloat. Read the joint statement from Treasury, FDIC, OCC, OTS and Federal Reserve here.
  
• More news on "Creeping Nationalization" as the Obama administration may take another step in that direction if it converts the government's preferred shares in Citigroup into common equity to help the stumbling giant withstand losses. Paul Krugman says just do it, but Gerald O'Driscoll says to beware.
  
• Phil Gramm, often pointed to as the architect of deregulation weighs in on Gramm-Leach-Bliley and what it all meant.
• From Bloomberg, word that the US and Europe are discussing joint regulation of the $28T credit default swap market.
• US regulators are being forced to sell real-estate loans of failed banks at a discount to lure buyers spooked by the likelihood of increased loan losses.
• A major CDO is bankrupt.
• Sen. Dodd tells Al Hunt short-term bank nationalization is a possibility.
• Sovereign CDS is being used to speculate on currency strength.