It’s still in the early days of 2014. I think it’s finally stopped snowing in the East, the sun has come out and the stock market is continuing to outperform the woe purveyors. Republicans and Democrats have gotten something done on the budget; lions have laid down with lambs; geopolitically, the world’s a mess but no one seems to care back home. The financial crisis of 2007 and 2008 is beginning to fade into history. Things are pretty good and likely to get better for quite some time.
Isn’t it, therefore, a great time to reset? To reset some of the regulatory and legislative excesses stitched together with little reflection during the crucible of the late, great credit crisis? What appeared to make sense in the middle of that crisis simply doesn’t make a great deal of sense anymore and it’s time for a reset. As John Maynard Keynes famously said, when the facts changed, he changed his mind. Shouldn’t we? It is the height of hubris and willful incuriousness to ignore four years of data and not recalibrate.
If we were to recalibrate, let’s think of some of the things we might rethink.
Let’s start with the Volcker Rule. We all now understand that prop trading, as it is conceived in the Volcker Rule, had precious little to do with the credit crisis. The Volcker Rule seems to have a lot more to do with punishing nefarious bankers than derisking international banking. So how ‘bout we fix what is a “covered fund” so that banks can buy senior securities in CLOs and indeed from legacy CMBS without being concerned that somehow they will violate this Rule? While we are at it, why don’t we rethink the whole idea? What fundamentally is wrong with financial institutions investing side-by-side (skin in the game) with other investment vehicles? It’s hard to see the causal connection between that and what went wrong in 2007. It’s hard to see what evil it will do going forward.
Basel III – can we pause for a second and try to make sense of this? Out of a miasmic hostility to anything associated with that Voldemortium word “securitization,” Basel III continues to punish structured product. Why? There is an awfully good article written the other day in the American Banker by Per Kurowski, who was the executive director of the World Bank in the early 2000s making the point, I’d say obvious point, except it has been so rarely made or made well that what is likely to kick a bank in its capital ratio ass is not what they know might go wrong, but what they don’t know what might go wrong – the famous unknown unknowns. So here we are, punishing structured product and encouraging investment in sovereign debt which we pretend is riskless. First of all that sets up a potential disaster if the ongoing and far from finished sovereign debt crisis breaks out yet again, and at the same time, starves real businesses from capital formation.
How about risk retention? Really, can’t we do something with this? Do we really still believe that risk retention creates a sort of alignment of interests that would prevent the type of financial disaster that we experienced in 2008? Did we not notice the portfolio lenders failed? Did we not notice that land loans and construction loans which led the parade of miserable failures were the asset classes in which the lenders were all in, with 100% skin in the game? Did that make a real difference? But skin in the game has consequences; it is sand in the transactional gears of capital formation that will increase the costs to the borrower. If we have to live with it, let’s at least mediate it with some sensible changes based upon four years of perspective. For instance, why in the world does the SEC continue to refuse to treat super low loan-to-value single obligor securitizations as if they were a straight up conduit requiring risk retention? Given the political abandonment of principles personified by the Qualified Residential Mortgage, does anyone possibly think that a 45% loan-to-value loan on a marquis office building is somehow riskier to the bondholders than a pile of Qualified Residential Mortgages that our consumer advocacy constituencies made the risk retention folks agree are low risk assets? Really?
In general, could we stop trashing securitization? There’s been a few green shoots amongst the global apparatchik that maybe securitization isn’t so bad. We best get over it. Between the continued impairment of the European banks, the generally higher RBL Standards and a general broad set of disincentives for credit formation, we best get used to the fact that the shadow banking community is critical for growth in our economy. So, at least let’s stop treating them as a bad guy in a Batman movie.
Can we go back and rethink the whole SIFI, GSIFI too big to fail nonsense? There may be institutions that are so large that their failure would have systemic consequences but is the risk of the systemic consequences really worse than the medicine of turning these institutions into highly regulated wards of the state? Does SIFIness really achieve its goal? Certainly, we will fill the coffers of our regulatory community and require government hiring, which I guess might have a small positive on the unemployment front, but will all that really help us grow the economy? I rather doubt it.
And one more thing. That thing which is Reg AB II, which has already been both on and off the docket of the SEC this spring and where at least a narrow set of issues has been reopened for more public comment, is full of things that need rethinking. It’s the stuff that one does while one tries to fly a jet airplane while building it. It’s not that it’s all bad, or that much of it is wrong; it just needs to be rethought. Some of it is awful, draconian and some of the process will be expensive and deliver very little real reward. It just needs to be rethought and now is the time to do it.
Look, I’m sure there’s more. In general, I think everything done while the economy was on a war footing in 2007 and 2008 needs to be rethought and tested for continued vitality. So much was done with limited time to reflect and with a bubble of populist anger under the wings of our elected officials. It ought to be rethought. It’s time for a reset. Okay, it didn’t work for President Obama with Mr. Putin, but that doesn’t mean it’s not a really good idea.