Wednesday, November 23, 2011

Regulators' information monopoly: the definitive statement on why monopoly must end now!

Gretchen Morgenson and Louise Story wrote a must read article in the NY Times on how the financial regulators' work with the financial institutions they supervise to not only keep relevant information from market participants, but to actually misrepresent the information that does go to market participants.

Since its inception, this blog has repeatedly observed that the financial regulators' monopoly on all the useful, relevant information on the banks is a significant source of financial instability.

Regular readers know that without current asset, liability and off-balance sheet exposure details, market participants cannot assess the risk of the banks.  Instead, market participants are reliant on the Fed and other financial regulators who have access to this data to properly assess the data and convey what they found.

This article is very important for a number of reasons including:
  • Financial regulators are part of Wall Street's Opacity Protection Team; and
  • It confirms that the problem with the current regulatory structure identified in the Nyberg Report on the Irish Financial Crisis also occurred in the US.  Specifically, information that was uncovered by the examiners was unable to reach the top of the regulatory structure or to be conveyed to market participants.
There is only one way to fix this problem and that is to require each bank to provide ultra transparency on an on-going basis.

It is only when all market participants can access current asset, liability and off-balance sheet exposure details that regulators can no longer block the assessment of the data or conveying what the results of the assessment to the market.

Until banks are required to provide ultra transparency, market participants should assume that the regulators  have something to hide.

The stress tests being run by the Fed are confirmation that the Fed is hiding something.  Otherwise, why not let the market participants run their own stress tests by requiring ultra transparency as suggested by Dallas Fed President Richard Fisher.

In the whodunit of the financial crisis, Wall Street executives have pointed the blame at all kinds of parties — consumers who lied on their mortgage applications, investors who demanded access to risky mortgage bonds, and policy makers who kept interest rates low and failed to predict a housing market collapse. 
But a new defense has been mounted by a bank executive: my regulator told me to do it. 
This unusual rationale is presented by the bank executive in one of the few fraud suits brought against a mortgage banking official in the aftermath of the financial crisis — the one filed by the Securities and Exchange Commission against Michael W. Perry, former chief executive of IndyMac Bancorp, which failed spectacularly in mid-2008. 
After being accused of fraud and misleading investors about his company’s financial health just before it collapsed, Mr. Perry set up a Web site this fall to defend himself. 
In a document on the site, he said that a top official at the federal Office of Thrift Supervision, IndyMac’s overseer, directed and approved an action related to the S.E.C.’s allegations. 
“It was O.T.S. who had the final say regarding IndyMac Bank’s capital levels,” Mr. Perry wrote. 
He went on to say that Darrel W. Dochow, former regional director for the Western region of the agency and a financial regulator for more than 30 years, had “specifically directed” Mr. Perry to backdate IndyMac’s report to regulators to include an $18 million cash infusion that would make it appear well capitalized. 
The shift masked IndyMac’s problems for any investors trying to assess its soundness and allowed it to continue attracting large deposits crucial to its operations....
Mr. Dochow was not accused of wrongdoing by the commission or any other prosecutor, though his role has been criticized by the inspector general of the Treasury Department, which oversees some bank regulators.... 
The IndyMac collapse, with its multibillion-dollar cost to the Federal Deposit Insurance Corporation fund, highlights the role played by federal overseers of financial companies in the years leading up to the crisis. 
It also raises questions about whether government officials should be held accountable for dubious conduct related to the failure of an institution and whether the government has avoided pursuing some cases because of the roles regulators have played. 
For years, some bank overseers have maintained cozy ties with the institutions they monitor, treating bankers like clients because of the fees that banks pay to be regulated. 
This is one form of regulatory capture.

Fortunately, requiring ultra transparency addresses it as banks will be subject to market discipline even if they are not subject to regulatory discipline.
The Justice Department could not cite any regulator that it had named in a prosecution related to the crisis.  
However, Mr. Dochow’s conduct was referred to Justice for possible criminal charges in 2009, according to Eric Thorson, the inspector general of the Treasury Department. Mr. Thorson said Mr. Dochow’s action “was clearly improper and wrong.”...
A point that Occupy Wall Street and the 99% would agree with.
IndyMac is not the only institution whose questionable accounting was approved by regulators in recent years, though it is by far the largest of several highlighted by the Treasury inspector general. 
Even if regulators are involved in wrongdoing, they have some immunity. Internal disciplinary measures are rarely taken against regulators who perform badly in their jobs, say government officials.
Just look at what how the SEC treated its staff that dropkicked the Bernie Madoff ponzi scheme.
Some regulatory shortcomings may be chalked up to innocent mistakes and failures to spot problems. Still, some economists and lawyers would like the government to examine regulatory actions leading up to the financial crisis to determine whether officials actively participated in improper behavior. 
And, they say, in cases like Mr. Dochow’s, penalties should be levied on overseers who acted improperly. 
“The word conspired needs to be used here,” said Edward J. Kane, a finance professor and regulatory expert at Boston College who is familiar with the case. “Dochow conspired with IndyMac management to misrepresent this. He was trying to fool certainly the F.D.I.C. and the public, and anyone who lost a dollar as a creditor to this institution was harmed by relying on something they had every right to rely on.”
Whether he did or he did not, my point is that the regulatory system needs to be changed by the requirement of ultra transparency to make it impossible for this sort of activity to happen in the future.
Mr. Dochow was known within the O.T.S. to be bank-friendly. One former examiner said: “His approach was negotiating with the banks, as opposed to regulating the banks, and viewing them more as clients, as opposed to people or entities that needed to comply.” 
According to three former examiners who worked with Mr. Dochow but who requested anonymity because they feared retaliation from regulatory colleagues, he would sometimes negotiate between the banks and their lower-level O.T.S. overseers, arguing that an institution should be allowed to keep one component of its regulatory rating high if another was dropping. That way, the composite score representing a bank’s financial standing, would change little, if at all....
This is part of the regulatory structure problem identified in the Nyberg Report.  Information comes in to the regulator but is then buried.  The result is the financial crisis we are now in.
It would be difficult and unusual for the Justice Department or the S.E.C. to bring a case against a bank regulator, longtime securities lawyers say. Regulators enjoy some immunity from allegations of wrongdoing under the Securities Exchange Act, which says that you cannot file a case against an officer of a United States agency for violation of a securities law if the officer was acting within the scope of the job. 
For financial regulators like Mr. Dochow, a conflict comes into play when banks run into trouble — on one hand, regulators try to help banks maintain their stability. But, on the other hand, securities laws require companies to be transparent in their disclosures to public investors.
Requiring ultra transparency ends this conflict.
Any financial crisis case that named a regulator probably would turn into a huge political battle, because it would question many of the nontransparent acts that bank regulators take while trying to save banks, said Denise Voigt Crawford, former commissioner of the Texas securities board and now a law professor at Texas Tech University. 
In any prosecution of bank regulators, she said, “you’d have the Justice Department in a fight with the policy goals of the Department of Treasury. Particularly in this environment, you know the banking regulators would fight it tooth and nail.”
Is it a good thing that regulators take many nontransparent acts while trying to save banks?

It is far better for the financial system if there is ultra transparency.  With this information, market participants can exert market discipline on the banks before they need to be saved and presumably prevent them from having to be saved by regulators.  For their part, regulators can reinforce market discipline.
Some longtime lawyers go further and say the overall scarcity of cases related to the financial crisis might be in part because regulators want to avoid scrutiny of their own kind. 
“It’s not just one 30-year-old wunderkind who was responsible for the financial crisis,” said Dennis C. Vacco, who was the New York State attorney general in the 1990s and now is a lawyer at Lippes Mathias Wexler & Friedman. “Once you start pulling the string through in these complex cases, you might be surprised what you find at the other end.” 
Mr. Vacco continued: “What’s at the end of the string? The defense may be that ‘at the highest echelons of the financial institutions, we were in regular contact with the government.’ “
Which is exactly what the Nyberg Report found occurred in Ireland.  To prevent this from ever re-occurring requires ultra transparency as the foundation for a 21st century financial system.

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