Our friend Steven Lofchie, a partner at Cadwalader, Wickersham & Taft LLP and the Co-Chair of their Financial Services Group, had a fantastic take on a recent report distributed by the Volcker Alliance. The Volcker Alliance’s mission is to “rekindle intellectual, practical, and academic interest in the implementation of policy and serve as a catalyst for sustained government improvement.” In laying out their recommendations in this report, which seems to assume that properly organized regulators would have an almost Laplacian view of the future, they seem to have optimistically ignored numerous lessons on the vulnerability of experts to cognitive biases. For example, they ignore the pernicious bias of overconfidence, which often strikes experts operating in data poor, assumption rich environments. I’ll let Mr. Lofchie outline specific critiques here. – Chris Clearfield
The Volcker Alliance’s criticism of financial regulatory structure provides an excellent excuse to initiate a much needed discussion and debate about our regulatory framework.* In the interests of fostering that debate, here are a few areas of disagreement regarding what Mr. Volcker has to say about the cause of the problems as well as their proposed solutions:
Were I but King and Master of the Universe. Mr. Volcker’s thesis is that the U.S. government failed to anticipate and head off the financial crisis because it just didn’t have enough power, and even when it did, that power was not sufficiently concentrated in a single agency or person (see page 17). Given the nature of human frailty and imperfection, the argument that the solution to governmental failure is to provide the government with more power, and to make that power more concentrated, is unsound. Mr. Volcker’s argument would have more force if he were able to show, for example, that the Board of Governors of the Federal Reserve was trying desperately to shut down the housing bubble before the financial crisis. Sadly, it was not. Here, for example, is a link to a speech by former Federal Reserve Board Chairman Greenspan, in which he acknowledged that while the rate of increase in housing prices may have slowed, he was not especially concerned. The purpose of linking to this speech is not to point a finger at Mr. Greenspan, but rather to take issue with the notion that the answer to ignorance about the future is to create a single mighty regulator.
Let’s All Agree, but Not Indulge in Groupthink. Apparently, Mr. Volcker would place the Financial Stability Oversight Council at the top of his new regulatory pyramid. Even so, he does not like certain aspects of FSOC. For example, he thinks that FSOC is “too divided” to provide a “comprehensive, forward-looking view” or to “take decisive and timely action.” Additionally, he regrets FSOC’s inability to “require” other regulators to adopt rules that it would prefer to mandate. However, in what seems to be an utterly contradictory statement, he says that “the regulatory system must contain effective safeguards to ensure the independence of the responsible agencies; reduce the risk of groupthink; and guarantee a broad perspective in governance and decision-making” (at page 4).
We Are All Banks (and Should Be So Regulated). Mr. Volcker observes that non-banks now “hold two-thirds of all credit-market assets” (at page 1). The corollary of this observation is that these “shadow banks” are “potentially unstable” and “create a risk of contagion,” and so presumably should be regulated as if they were banks. Contrary views are possible: Isn’t it a good thing that credit is held outside of banks? Doesn’t that allow greater diversification of risk than if all credit assets were held inside of banks? Isn’t part of the reason that so much credit is held outside of banks because banking regulators have made offering loans much more expensive for banks? Since they’ve effectively pushed so much lending activity outside of banks, should the bank regulators really be given regulatory authority over all other lenders?
The Supremacy of the Banking Regulators at FSOC. The slightly reorganized version of FSOC at the top of Mr. Volcker’s regulatory pyramid would be dominated by banking regulators. At least five of the six members, and potentially all, would come from a single political party (although FSOC would be, according to Mr. Volcker, “non-partisan”). It is not that the banking regulators are unwise; the bank regulators have the most intellectual culture among all U.S. regulators. The problem is that they see the world through a bank regulator’s lens. They want to dictate not just what banks can own, but what non-banks can own; they want to control the risks taken not just by banks, but also by non-banks; and they want to control borrowing and leverage by banks and non-banks as well. But we are not all banks. Other imperatives exist besides freedom from risks, including the freedom to take risks.
The Volcker Alliance Report challenges us to have a real and important debate about fundamental structural issues. Congress should take up this challenge. As to Mr. Volcker’s solutions, the above commentary identifies two principal points of disagreement. First, Mr. Volcker’s advocacy for “safety” above opportunity presents great dangers. His structural solution - to give the bank regulators concentrated power and a dominant role - should be subject to significant scrutiny. Second, implicit in Mr. Volcker’s position is his advocacy for greater control and discretion for the government regulators of private entities. That solution ought not to be accepted even if proposed by a wise man. It is possible to revisit our system of financial regulation and improve it without the expansion of governmental power that Mr. Volcker envisions.
One may want to begin the discussion by linking to two articles (humbly submitted) by a different author: “The Future of Financial Regulation” and “Some Concerns with the Derivatives Legislation.” These two pieces anticipate some of the Volcker Alliance’s observations (by seven years) and offer a private citizen’s view of the workings of government regulation.
Mr Lofchie and his team distribute a free daily newsletter, which covers a broad scope of financial services news in the legal-regulatory space. If you’re interested in receiving this free newsletter, sign-up here. To learn more about his regulatory website, see the Cadwalader Cabinet, here.
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