2008 Financial Crisis

Remembering a day that was too big to forget

Posted on by j.giglio

This month marks the anniversary of the collapse of Bear Stearns, once Wall Street’s fifth-largest investment bank. The demise of the 85-year old institution signaled the real start of the 2008-2009 financial crisis. Eight years later, we can only hope our leaders learned something from the experience.

The collapse and Bear’s subsequent bailout by the Federal Reserve, with the support of the Treasury Department and JPMorgan Chase sent shockwaves throughout the financial system. Bear’s incredibly rapid demise raised serious questions about the banking industry’s use of leverage, inadequate oversight of commercial and investment banks, and the role of the Fed and other regulators in preventing the failure of major financial institutions.

Late on Sunday afternoon, March 16, 2008, Bear’s board of directors accepted JPMorgan Chase’s offer to purchase the company. Less than 18 months after its stock was trading at an all-time high of $172.61 a share, Bear Stearns had little choice but to accept the humiliating offer of $2 a share.

JPMorgan Chase later raised the bid to $10 per share and the Fed provided $30 billion in collateral guarantees to facilitate the deal. The Fed considered Bear too large and too interconnected to fail and saw no choice but to arrange a bailout to prevent a global market crisis. It was hoped that the Bear rescue would nip the problem in the bud and avoid the damage to the larger financial world that many policymakers thought would result from the failure of a major investment bank.

The precise nature of the transaction seemed unclear, but the Fed appeared to be accepting responsibility for the toxic, illiquid assets on Bear’s balance sheet if their eventual liquidation resulted in a loss. In this sense, it appeared that the Fed became the residual owner of these securities and put the federal taxpayer on the hook for Bear’s reckless risk taking activities. Some believe that this action exceeded the Fed’s power.

The first sign of trouble at Bear was the July 2007 collapse of two of its hedge funds. The funds had invested heavily in collateralized debt obligations backed by subprime mortgages, and their failure alerted the rest of the financial system to this contagion.

The hedge funds’ collapse also raised concerns about the firm’s own exposure to mortgage-related securities. It damaged the firm’s reputation, weakened its finances and served as the precursor to Bear’s ultimate collapse. Within a year “the plumbing had stopped working” and credit ceased to flow through the financial system.

Hopes that a global financial crisis could be averted proved misplaced just six months later when Lehman Brothers, another bank that was heavily involved in the mortgage business and was even larger than Bear filed for Chapter 11 bankruptcy on September 15, 2008. The public backlash against the Bear bailout made rescuing the 158 year-old Lehman Brothers politically untenable, especially just weeks before a hotly contested presidential election.

The 2008-2009 financial crisis proved to be the most expensive in history. On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd­ Frank), one of the most sweeping financial reforms in U.S. history.

The law’s stated aim is to “promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail,’ to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.” Essentially, Congress’s intent was to reduce system-wide risk and to prevent another financial collapse.

Let’s hope policy makers actually learned enough about how the economy and the financial system fit together from the 2008-2009 financial crisis to avoid future learning experiences. They would be well advised to recall the words of that prolific author, anonymous, who said, “The past is prologue: but which past?”

originally published: March 5, 2016

Corporations’ interest vs. the public interest

Posted on by j.giglio

There is much truth to the cliche that politicians are primarily interested in getting re-elected. To achieve this goal they cater to the small group of voters who are paying attention to the details of the legislative process – and often looking to cook up a raiding party on the public interest to promote their own goals.

Take a provision tucked into the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd­ Frank), one of the most sweeping financial reform bills in U.S. history, which President Obama signed into law in 2010. Dodd-Frank demonstrates that policy making is dominated by powerful businesses and other well-organized special interests.

In the aftermath of the historic bailout of the financial system and major banking houses in 2008 and 2009, which precipitated the worst economic downturn since the Great Depression, the financial industry fell under intense criticism and scrutiny. The omnibus 2,300-page bill was passed in response to this financial and economic crisis.

Its stated aim was to “promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail,’ to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purpose.” It was supposed to reduce system-wide risk and prevent a financial collapse like the one in 2008.

While the law did not lay a hand on Fannie and Freddie Mac, major players in the 1997-2007 housing bubble and the subsequent financial crisis, it did address the subject of “conflict minerals” that was promoted by certain non-governmental organizations supported by celebrities such as George Clooney and Brad Pitt.

These activists lobbied Congress and got them to state that the exploitation and trade of certain conflict minerals was fueling a humanitarian crisis in the Democratic Republic of the Congo that warranted the imposition of disclosure requirements.

The NGOs argued that profits from conflict minerals have helped fund the conflict between rebel militias and government troops in Congo that has claimed millions of lives and resulted in widespread human rights abuses, including violence against women and the conscription of children as soldiers.

The conflict minerals are tantalum, tin, tungsten, and gold, which are used in many industries. Tungsten, for example, is used in the screens of cellphones and tin is used to solder circuit boards.

Congress directed the Securities and Exchange Commission to promulgate a rule requiring thousands of publicly traded U.S. companies to investigate whether they or any of their suppliers use minerals mined in the conflict-ridden parts of Congo and to annually disclose the origins of conflict minerals necessary to its operations if the minerals originate from Congo or an adjoining country.

Supporters of the Dodd-Frank conflict minerals provision and of the SEC implementing rule argue that such disclosures reduce the violence involved with the mining of conflict minerals. Opponents argue that they are burdensome and costly to administer.

Combating brutal human rights abuses in the Congo is surely a good idea, but is a Wall Street Reform bill the appropriate place to do it? And is the SEC the right entity to implement the law?

And what are the boundaries of corporate social responsibility? How much responsibility does a firm have for its supply chain? Are there alternative and transparent approaches to dealing with the issue of conflict minerals? Corporations cannot be asked to solve all the world’s problems.

The financial industry was widely criticized for its intense lobbying efforts to shape Dodd-Frank’s legislative and rule making process. But they were not the only ones to convince lawmakers eager to curry favor with powerful special interests to include provisions in the legislation that promote their own rather than the public interest.

Originally Published: October 10, 2015

America’s own Greece- Puerto Rico

Posted on by j.giglio

While much attention has been focused on the Greek drama, out-of-control debt is rearing its ugly head closer to home. The small island of Puerto Rico is in a bad way; the lyrics may be different but the melody is the same.

The governor of Puerto Rico dropped the bombshell last month that there is no way the island can pay its $72 billion in public debt. He pledged to begin developing a debt restructuring plan.

Since the financial meltdown of 2008, debt is like a canker spreading across the globe. The Greek analogy may be overused, but in one respect it is relevant. Greece and Puerto Rico are among many governments with too much debt and not enough economic growth to generate the tax revenues needed to cover it.

Short of a federal bailout, the island will be unable to repay its debt between now and the Second Coming. To paraphrase Margaret Thatcher: “Puerto Rico has run out of other people’s money”.

Puerto Rico is by far the most indebted American territory or state, owing $20,400 per capita. Since 2005, the island’s economy has shrunk by about 10 percent. Its unemployment rate is above 12 percent; more than double the national average. Since government benefits are more lucrative than a minimum wage job, just 40 percent of the adult population is working or looking for work. The U.S. labor participation rate is 63 percent.

Moreover, high labor costs have proven onerous for many businesses. Generous overtime provisions, excessive paid vacation benefits and job security regulations that are more costly than on the mainland all magnify employment costs and kill the demand for labor. The island’s population has also declined from 3.8 to 3.5 million since 2005 as Puerto Ricans leave for Florida and other parts of the U.S.

Until 2006, Puerto Rico’s economy was kept afloat by tax incentives for American pharmaceutical, textile, electronic and other firms that manufactured there. When the tax breaks disappeared in 2006, it contributed to the loss of 80,000 jobs. Puerto Rico’s economy has been in free fall ever since. The weak economy drives the middle class to the U.S., the shrinking population results in a smaller tax base and the beat goes on.

Puerto Rico’s bonds, unlike those of states or municipalities, are exempt from federal, state, or municipal taxes everywhere in the United States. Thanks to this competitive advantage, they were quite attractive to bond funds and investors in the highest tax brackets. More than 180 municipal bond funds have at least 5 percent of their portfolios in Puerto Rican bonds. Many hedge funds and distressed debt buyers stepped in to buy Puerto Rico’s bonds at deep discounts as the island’s economy worsened and its credit rating dropped below investment grade in early 2014.

Unlike municipalities, states and Puerto Rico are barred from seeking bankruptcy protection. The Governor has appealed to Washington to change the law so the island can seek bankruptcy protection, buy time to restructure debts and get its fiscal house in order.

Chapter 9 of the bankruptcy code allows a company or municipality to get new financing from markets while continuing to function as debts are restructured or written down. The importance of orderly debt restructuring was in evidence during the recent bankruptcy process that helped Detroit to restructure its $18 billion in debt.

Without allowing Puerto Rico access to the partial remedy of bankruptcy, the island has no chance of pulling out of its death spiral. Like Greece, Puerto Rico is stuck in a vicious cycle and badly needs structural reforms to set the economy on a sustainable path. The challenge is to grow the economy while at the same time fixing its public finances.

There is one lesson to be learned from Greece: Expect Puerto Rico’s fiscal crisis to get worse if debt restructuring and the implementation of reforms to make the island economically competitive are delayed.

Originally Published: August 1, 2015

How to manage pension liability

Posted on by j.giglio

Americans today exist amid the tension between hope for better times and the scars of the worst financial crisis since the Great Depression. Among the fiscal challenges we face are states and cities that are struggling to keep up with their promise to set aside enough money to fund public employees ‘defined benefit pension plans as those governments also struggle to recover from the longest economic downturn since the 1930s.

As difficult as it will be to live up to their pension promises, governments must avoid the temptation to increase their contributions to pension systems by raising taxes on average Americans. This would only deepen the wounds of those hit hardest by the 2008 financial crisis and subsequent Great Recession.

While corporate America has shifted to defined contribution retirement plans, most state and local government employees still participate in defined benefit plans. There is plenty of evidence that these plans lack the funds to make good on the promises made to public employees, but little evidence that structural reforms are being implemented.

Defined benefit plans promise a set monthly payment during retirement. Major challenges of managing these plans include estimating future retiree obligations and making accurate assumptions about variables such as length of service, future salary levels, retiree mortality and expected return on pension fund assets

Investment returns are critical, since investment earnings account for the majority of public pension financing. Any shortfall must be made up by increasing contributions or reducing benefits. One common flaw in pension plan management is undervaluing liabilities by assuming unrealistic rates of returns on pension assets.

Even small changes in rates of return can have a significant effect on assets. A Congressional Budget Office study found that with an 8 percent projected rate of return, unfunded liabilities amounted to $700 billion for state and local pension plans. If the projected rate of return dropped to 5 percent, the unfunded liability more than tripled to $2.2 trillion.

Public pension funds generally assume a high rate of return. For example, many base pension contributions on an assumed 7.75 percent annual return on fund investments, which is difficult to achieve in a near-zero interest rate environment.

Since actual returns have been less than the assumed rates, unfunded liabilities have increased.

There is no consensus on how best to deal with this crisis and preserve the sustainability of public pension plans. Since the 2008 financial crisis, nearly all states have enacted changes to make their defined benefit pension plans more solvent. Common options for overhauling the plans range from increasing employee contributions to benefit reductions, including cost of living adjustments and increases in eligibility requirements such as increasing the retirement age for new employees.

A handful of states have passed reforms that replace defined benefit plans with some version of defined contribution plans for new employees. Others have borrowed money through the issuance of pension obligation bonds, floating tax-exempt bonds at low interest rates in the hope of investing the money in securities with higher yields.

Still other states have changed their asset allocation mix to generate higher returns, investing in alternative investments such as private equity, real estate, hedge funds, commodities and derivatives. But along with higher expected returns, these investment vehicles also bring greater risk.

As part of the struggle to deliver promised benefits, some pension plans have begun to focus on investment management fees. For example, the California Public Employees’ Retirement System, the country’s biggest state pension fund with about $300 billion of assets, announced plans earlier this year to cut back on the $1.6 billion in management fees it paid to Wall Street firms last year.

Tough choices are needed to get public pension funds plans back on track. But in the current economic environment, increasing governments’ contributions to the plans by raising taxes on average taxpayers who have already taken a beating in recent years should be avoided at all costs.

originally published: June 27, 2015

The allure of Wall Street’s lusty pleasures

Posted on by j.giglio

Many people believe that a relatively few individuals were the real villains behind the financial heart attack of 2008: Those on Wall Street; in banks and other financial institutions; on the faculties of the nation’s leading graduate business schools, writing financial jabberwocky for small-circulation journals; setting policy in the West Wing of the White House and on Alan Greenspan’s Federal Reserve Board.

It’s popular to believe they hijacked the free market ideal because they could. It was American as handguns. They then proceeded to twist it to serve personal agendas at great cost to the. American people. Enough financial violence was done to make Attila the Hun look like Mother Teresa.

Some of these hijackers could have been hopeless psychopaths whose brains were wired in such a way that they actually got more pleasure scamming $10 from widows and orphans through elaborate Times Square shell games than by honestly earning $100 selling Bibles door-to-door.

In fact, everything needed to understand them is contained in several film noir classics.

Presumably, the only defense against such psychopaths is to isolate them before they can do too much damage. But the overwhelming majority of those assumed to have turned the free market ideal into a rip­ off of the American public probably started as fundamentally decent individuals, as morally straight as church deacons.

So what turned these Boy Scouts into shameless hustlers eager to sell their mothers 10 times over for a fast buck? The answer is clear enough to anyone who’s ever been bedazzled by Billy Wilder’s corrosively breathtaking  1944 movie “Double Indemnity,” with Barbara Stanwyck’s pathologically definitive scarlet woman promising poor schnook Fred MacMurray riches and sexual ecstasies beyond his wildest dreams if he helps her with a murderous insurance scam, all while working her own angles and making her own rules. If only he would bend a few rules. Just a little. Even for a short time.

Now imagine Stanwyck is America’s free market and MacMurray  is the Wall Street schmuck who should have known better.

Money and sex are hopelessly tangled in the male consciousness. So when a scarlet woman strutting in capitalism’s strapless red gown turns her wet-lipped allure loose on them and moves in close enough to fill their lungs with her dizzying perfume, what hungry Wall Street player is strong enough to resist her? Or even care when their homes and hearths and panoply of family values go rushing down the drain?

And if worse comes to worst, they can always stand up in court and plead the equivalent of Adam’s excuse when God scolded him for having eaten the forbidden fruit.

Barbara Stanwyck’s definitive portrayals of scarlet women throughout her .long career make these performances especially relevant in helping us appreciate why so many men in our male-dominated society remain confused little boys who get sex and money all mixed up. They become ·ready prey for the allure of money and power and all too eagerly sacrifice their careers, families, and very lives for the promise of a tainted dollar.

To our good fortune, many of these classic films noir are now available on DVDs and various video ­ streaming services. So be on the lookout for “The Lady from Shanghai,” “The Maltese Falcon,” “Out of the Past,” “Touch of Evil,” “The Killers” and many others.

Nothing beats movies from the classic noir era when it comes to exploring the darker side of human nature and providing us with psychological insights into why so many Americans are driven to behave like schmucks. Or at least they offer some convenient and reassuring explanations. 

originally published: May 9, 2015

Billions in bonuses on Wall Street at the expense of Main Street

Posted on by j.giglio

Seven years after the traumatic 2008 financial crisis, millions of Americans still have not recovered. But a few others are doing quite well, thank you. One of the first signs of the impending implosion in financial markets occurred in the summer of 2007 when two Bear Steams hedge funds with major investments in mortgage-backed securities collapsed. It was the beginning of the end for the world’s fifth largest investment bank, which, during its 90-year run, had developed a maverick reputation in the white-shoe culture of investment banking.

During the wee hours of March 24, 2008, just before Asian markets opened, the federal government forced Bear to announce its sale for a few pennies on the dollar to JPMorgan Chase, an offer that would not have been made without government assistance.

The deal was backstopped by the Federal Reserve’s commitment to buy upwards of $30 billion worth of mortgage-based securities in Bear’s portfolio that Morgan regarded as “too toxic to touch.” It was hoped that the Bear rescue would stem any fallout from spreading into the larger financial world, which many policymakers viewed as likely following the failure of a major investment bank.

Bear’s collapse was a critical event signaling the start of a great unraveling. One of the things that made Bear’s demise such a watershed event was the federal government’s direct involvement in orchestrating the deal that saved the company from having to file for bankruptcy.

Previously, the federal government would become so intimately involved only when a deposit-taking commercial or savings bank got into financial trouble.

If they screwed up and failed? Others would learn from their mistakes. That’s what was supposed to happen under capitalism. That is until the federal government got bushwhacked by Bear, a “don’t get no respect” underdog, and found itself in a jam.

So the feds had to throw out the standard game plan, even if it meant the Federal Reserve buying $30 billion worth of mortgage-backed securities from Bear that nobody else would touch as the financial tsunami of 2008 began rolling across the globe.

Bear Steams may have ceased to exist on March 24, 2008, but it continued to haunt the financial world like Marley’s ghost for months thereafter as the global meltdown continued, marked by formerly solid financial institutions turning into basket cases that could no longer survive on their own – after years of shooting up on short-term borrowings and boozing away on risky trades that blew up in their faces.

At the beginning of 2008, Merrill Lynch, Goldman Sachs, Morgan Stanley, Lehman Brothers and Bear were the five largest stand-alone investment banks in the world. By the end of the year all would be gone.

Goldman Sachs and Morgan Stanley were converted to bank holding companies while Lehman Brothers filed for bankruptcy and Merrill Lynch was acquired by Bank of America. These supposedly omnipotent institutions proved to be giants with feet of clay.

The financial crisis precipitated the worst economic downturn since the Great Depression, costing millions of Americans their jobs, homes, life savings and hopes for decent retirements. Since then, workers’ median incomes have effectively stayed unchanged while inequality between the top and bottom of the income scale has risen sharply.

Meanwhile, we recently learned from the New York State comptroller that Wall Street banks handed out $28.5 billion in bonuses in 2014. The average bonus was $172,860, more than three times the median household income of about $52,000. To say that anyone is surprised would be selling the truth below wholesale.

It’s reassuring to know that some folks have recovered very nicely from the financial crisis. But Main Street America will apparently have to learn to live with the wounds from the financial crisis.

originally published: March 28, 2015

The beginning of another bank crisis?

Posted on by j.giglio

One definition of insanity is doing the same thing over and over and expecting a different result. Late  last month, the Federal Housing Finance Agency, which regulates Fannie Mae and Freddie Mac, announced that the two institutions would start purchasing mortgages with down payments as low as 3 percent instead of the already absurdly low 5 percent minimum both institutions currently require. These FHFA-insured loans are for borrowers with weak credit.

Also, the federal regulator announced loosened mortgage lending rules. It removed the 20 percent down payment requirement for high-quality mortgages that banks determine to have low risk of default and made it less likely that Fannie and Freddie will force lenders to buy back mortgages that go bad.

By expanding the types of mortgages Freddie and Fannie will buy, the FHFA hopes to spur banks to make more loans to first-time buyers and increase homeownership among those with low and moderate incomes. These watered-down underwriting standards are a big win for affordable housing advocates and the banking and real estate industries.

But the feds are sowing the seeds for another meltdown by loosening recently enacted safeguards. Bookshelves sag with encyclopedic volumes arguing that a major factor in the financial apocalypse of 2008 was relaxed lending practices that led to the housing bust. How quickly we forget.

Back then the weakening of underwriting standards, and especially low down payments, increased home ownership and housing prices, which led to a housing price bubble. The banks had packaged and sold to investors bundles of risky mortgages with teaser rates that ballooned after a few years. Many borrowers ended up defaulting on the loans when the interest rates spiked. As a result, the value of the mortgage securities plummeted, and banks and investors holding them lost billions.

The debacle helped ignite the financial meltdown that plunged the economy into the deepest recession since the 1930s and necessitated taxpayer bailouts of banks and Fannie and Freddie. Following this debacle, there was a push to tighten mortgage lending standards and have banks retain a small portion of the loans they sold as stipulated in the Dodd-Frank Act of2010.

Those of you who’ve seen the classic movie “It’s a Wonderful Life” will remember George Bailey describing to his nervous depositors how the home mortgage business worked. You would visit your local bank and, among other things, the institution would require you to pay a significant portion (like 20 percent) of the purchase price upfront. Along with this down payment, purchasers would be required to demonstrate proof of income.

By granting a home mortgage, George’s thrift institution was exposing itself to risk. A buyer could fail to make the monthly mortgage payments. And since the institution kept the mortgage on its books as an asset, it remained exposed to this risk until the mortgage was paid off.

This process meant the initial lending decision was based on careful consideration of the customer’s creditworthiness. To the extent feasible, the institution would seek to grant mortgages only to its own customers so it could be confident that the homebuyers were safe credit risks. The pluses and minuses of this simple model are obvious.

By selling the packaged loans to others, banks could remove the loans from their balance sheets, which allowed the banks to increase their loans without technically violating the rules in regard to minimum capital ratios.

Providing low down-payment loans to borrowers with weak credit, then bundling and selling those loans drove the American financial system to the brink of collapse. Less than a decade later it appears that no one remembers.

originally published: November 8, 2014

The beginning of another bank crisis?

Posted on by j.giglio

One definition of insanity is doing the same thing over and over and expecting a different result. Late  last month, the Federal Housing Finance Agency, which regulates Fannie Mae and Freddie Mac, announced that the two institutions would start purchasing mortgages with down payments as low as 3 percent instead of the already absurdly low 5 percent minimum both institutions currently require. These FHFA-insured loans are for borrowers with weak credit.

Also, the federal regulator announced loosened mortgage lending rules. It removed the 20 percent down payment requirement for high-quality mortgages that banks determine to have low risk of default and made it less likely that Fannie and Freddie will force lenders to buy back mortgages that go bad.

By expanding the types of mortgages Freddie and Fannie will buy, the FHFA hopes to spur banks to make more loans to first-time buyers and increase homeownership among those with low and moderate incomes. These watered-down underwriting standards are a big win for affordable housing advocates and the banking and real estate industries.

But the feds are sowing the seeds for another meltdown by loosening recently enacted safeguards. Bookshelves sag with encyclopedic volumes arguing that a major factor in the financial apocalypse of 2008 was relaxed lending practices that led to the housing bust. How quickly we forget.

Back then the weakening of underwriting standards, and especially low down payments, increased home ownership and housing prices, which led to a housing price bubble. The banks had packaged and sold to investors bundles of risky mortgages with teaser rates that ballooned after a few years. Many borrowers ended up defaulting on the loans when the interest rates spiked. As a result, the value of the mortgage securities plummeted, and banks and investors holding them lost billions.

The debacle helped ignite the financial meltdown that plunged the economy into the deepest recession since the 1930s and necessitated taxpayer bailouts of banks and Fannie and Freddie. Following this debacle, there was a push to tighten mortgage lending standards and have banks retain a small portion of the loans they sold as stipulated in the Dodd-Frank Act of2010.

Those of you who’ve seen the classic movie “It’s a Wonderful Life” will remember George Bailey describing to his nervous depositors how the home mortgage business worked. You would visit your local bank and, among other things, the institution would require you to pay a significant portion (like 20 percent) of the purchase price upfront. Along with this down payment, purchasers would be required to demonstrate proof of income.

By granting a home mortgage, George’s thrift institution was exposing itself to risk. A buyer could fail to make the monthly mortgage payments. And since the institution kept the mortgage on its books as an asset, it remained exposed to this risk until the mortgage was paid off.

This process meant the initial lending decision was based on careful consideration of the customer’s creditworthiness. To the extent feasible, the institution would seek to grant mortgages only to its own customers so it could be confident that the homebuyers were safe credit risks. The pluses and minuses of this simple model are obvious.
By selling the packaged loans to others, banks could remove the loans from their balance sheets, which allowed the banks to increase their loans without technically violating the rules in regard to minimum capital ratios.

Providing low down-payment loans to borrowers with weak credit, then bundling and selling those loans drove the American financial system to the brink of collapse. Less than a decade later it appears that no one remembers.

originally published: November 8, 2014

Dancing on the edge of absurdity

Posted on by j.giglio

There can be little doubt that one of the causes of the 2008 financial crisis was diminished regulatory control , the seeds of which were sown during the three preceding decades.

Recent legislation re-regulates financial markets, but attracting the best and brightest to regulatory jobs is proving to be a major challenge. The congressionally authorized Financial Industry Regulatory Authority, a not-for-profit self-regulator,  may offer a solution to the problem.

Beginning with the Carter administration and accelerating during Reagan’s presidency, the banking industry,  among others, was steadily deregulated. Not only were leveraging requirements continually lowered but watchdog organizations such as the Securities and Exchange Commission were weakened both by legislation and the appointment of free-market advocates.

Successive administrations were enthusiastic advocates of deregulation. The dominant economic paradigm was that markets are efficient and inherently maximize welfare and work best when managed least. Moreover, with free-market advocates in charge of regulatory agencies such as the SEC, many existing laws were ignored or rarely enforced.

For example, observers repeatedly warned the Securities and Exchange Commission about suspected irregularities at Bernard Madoff’s investment firm, which was later revealed to be a multi-billion dollar Ponzi scheme. In spite of several warnings, no serious investigation was undertaken until after the firm’s spectacular collapse.

One reason offered for poor financial regulation is that government agencies are seriously disadvantaged when it comes to attracting the best and the brightest. The salaries of elected officials tend to impose an artificial ceiling on how much public employees can be paid. Even though these ceilings ignore marketplace realities, elected officials are reluctant to raise them by advocating higher salaries for themselves because it looks bad to voters.

Consequently,  Americans are told that many government regulatory agencies lack the talent to regulate financial markets because they can’t pay the going rate for good people. Thus, the regulatory agencies’ best and the brightest flock to higher-paying jobs with firms they regulate. This leaves the public to complain that our regulatory agencies are less effective than they need to be.

But not all regulators are underpaid. According to the Bond Buyer ‘s annual salary survey of 21 industry regulatory groups, compensation for the chairman and CEO of Financial Industry Regulatory Authority , which oversees the 4,100 securities firms and over 636,000 stockbrokers in the United States, was $2.63 million in 2013.

The perks aren’t bad either, he receives $20,000 annually for admission fees, dues, and house charges to one club each in the Big Apple and Washington, and up to $20,000 annually for personal finance and tax counseling, as well as spousal travel for certain business-related events. Financial Industry Regulatory Authority also paid four of its top executives more than $1 million in 2013. These folks can spend more for one dinner than the average American -whose wages have been flat for decades – spends on a vacation.

Let’s put these salaries in perspective: The President earns $400,000 annually. Janet Yellen, the chair of the Federal Reserve who has sway over the entire world economy as opposed to just American stockbrokers, earns $201,700. Securities and Exchange Commission Chair Mary Jo White makes $165,300. White’s predecessor at the SEC, Mary Shapiro, was fresh from running Financial Industry Regulatory Authority, which gave her a $9 million severance to ease the pain of a low government salary.

These are clearly difficult times for national financial regulators. They are challenged with implementing hideously complicated Dodd-Frank legislation that is supposed to safeguard and stabilize the financial system to avoid another financial crisis.

At 2,319 pages, the Dodd-Frank Act is the most far-reaching financial regulatory undertaking since the 1930s, requiring regulatory agencies that had been withering to enact 447 rules and complete 63 reports and 59 studies within tight congressional deadlines.

It may be at the edge of absurdity, but just maybe the best way to attract the best and the brightest would be to expand the number of one-percenters by outsourcing all regulation to not-for-profit entities such as Financial Industry Regulatory Authority.

originally published: October 25, 2014

Dancing on the edge of absurdity

Posted on by j.giglio

There can be little doubt that one of the causes of the 2008 financial crisis was diminished regulatory control , the seeds of which were sown during the three preceding decades.

Recent legislation re-regulates financial markets, but attracting the best and brightest to regulatory jobs is proving to be a major challenge. The congressionally authorized Financial Industry Regulatory Authority, a not-for-profit self-regulator,,  may offer a solution to the problem.

Beginning with the Carter administration and accelerating during Reagan’s presidency, the banking industry,  among others, was steadily deregulated. Not only were leveraging requirements continually lowered but watchdog organizations such as the Securities and Exchange Commission were weakened both by legislation and the appointment of free-market advocates.

Successive administrations were enthusiastic advocates of deregulation. The dominant economic paradigm was that markets are efficient and inherently maximize welfare and work best when managed least. Moreover, with free-market advocates in charge of regulatory agencies such as the SEC, many existing laws were ignored or rarely enforced.

For example, observers repeatedly warned the Securities and Exchange Commission about suspected irregularities at Bernard Madoff’s investment firm, which was later revealed to be a multi-billion dollar Ponzi scheme. In spite of several warnings, no serious investigation was undertaken until after the firm’s spectacular collapse.

One reason offered for poor financial regulation is that government agencies are seriously disadvantaged when it comes to attracting the best and the brightest. The salaries of elected officials tend to impose an artificial ceiling on how much public employees can be paid. Even though these ceilings ignore marketplace realities, elected officials are reluctant to raise them by advocating higher salaries for themselves because it looks bad to voters.

Consequently,   Americans are told that many government regulatory agencies lack the talent to regulate financial markets because they can’t pay the going rate for good people. Thus, the regulatory agencies best and the brightest flock to higher-paying jobs with firms they regulate. This leaves the public to complain that our regulatory agencies are less effective than they need to be.

But not all regulators are underpaid. According to the Bond Buyer ‘s annual salary survey of 21 industry regulatory groups, compensation for the chairman and CEO of Financial Industry Regulatory Authority , which oversees the 4,100 securities firms and over 636,000 stockbrokers in the United States, was $2.63 million in 2013.

The perks aren’t bad either, he receives $20,000 annually for admission fees, dues, and house charges to one club each in the Big Apple and Washington, and up to $20,000 annually for personal finance and tax counseling, as well as spousal travel for certain business-related events. Financial Industry Regulatory Authority also paid four of its top executives more than $1 million in 2013. These folks can spend more for one dinner than the average American -whose wages have been flat for decades – spends on a vacation.

Let’s put these salaries in perspective: The President earns $400,000 annually. Janet Yellen, the chair of the Federal Reserve who has sway over the entire world economy as opposed to just American stockbrokers, earns $201,700. Securities and Exchange Commission Chair Mary Jo White makes $165,300. White’s predecessor at the SEC, Mary Shapiro, was fresh from running Financial Industry Regulatory Authority, which gave her a $9 million severance to ease the pain of a low government salary.

These are clearly difficult times for national financial regulators. They are challenged with implementing hideously complicated Dodd-Frank legislation that is supposed to safeguard and stabilize the financial system to avoid another financial crisis.

At 2,319 pages, the Dodd-Frank Act is the most far-reaching financial regulatory undertaking since the 1930s, requiring regulatory agencies that had been withering to enact 447 rules and complete 63 reports and 59 studies within tight congressional deadlines.

It may be at the edge of absurdity, but just maybe the best way to attract the best and the brightest would be to expand the number of one-percenters by outsourcing all regulation to not-for-profit entities such as Financial Industry Regulatory Authority.

originally published: October 25, 2014