Weekend Economists Down Under May 23-26, 2014

[Demeter]

57. Financial Crisis, Over and Already Forgotten

http://www.nytimes.com/2014/05/23/business/the-financial-crisis-already-forgotten.html

Michael S. Barr, a law professor at the University of Michigan who was an assistant Treasury secretary when the financial crisis was at its worst, is working on a book titled “Five Ways the Financial System Will Fail Next Time.”

The first of them, he says, is “amnesia, willful and otherwise,” regarding the causes and consequences of the crisis. (Let’s hope the others are not here yet.) Amnesia was on full view this week when the House Financial Services Committee held a hearing on “the dangers” of financial regulation. Mr. Barr, who helped write the Dodd-Frank financial overhaul law, was the sole witness who thought it made sense for regulators to study the asset management and insurance industries.

In his opening statement, the chairman of the committee, Representative Jeb Hensarling, a Texas Republican, proclaimed “it is almost inconceivable that an asset manager’s failure could cause systemic risk.” He also saw no danger to the system from insurance companies, which are “heavily regulated at the state level.”...My request for an interview with Mr. Hensarling was turned down. I would have asked him about Long-Term Capital Management and the American International Group. The first, a money manager, caused a crisis when it failed in 1998; the other, an insurance company, had to be bailed out in 2008....That hearing was part of an attack on the Financial Stability Oversight Council, known as FSOC (pronounced “F-sock”). That group, established by the Dodd-Frank law, is headed by the Treasury secretary and includes the heads of eight financial regulatory agencies, and is supposed to coordinate the work of all of them. The council has the authority to designate large nonbank financial institutions as “systemically important,” and thus allow the Federal Reserve to require them to have more capital. So far the council has identified three such institutions, A.I.G., GE Capital and Prudential. The Fed has yet to actually impose regulations on them, so we really don’t know much about the effect of such designations, but that has not kept both the mutual fund industry and the insurance industry from lobbying heavily. They do their best to leave us with the impression that the only asset managers around are plain-vanilla mutual fund companies. Hedge funds, like Long-Term Capital, are studiously ignored.

FSOC also has the authority to suggest that one of its regulatory members act on an issue it sees as systemically important. It has done so on money market mutual funds, but so far the Securities and Exchange Commission has not acted. It is far from clear that FSOC is going to try to impose any regulation on large mutual fund companies, but the council is gathering information on them and asking questions of them. That seems to have outraged the industry and its friends in Congress. The campaign against FSOC has been innovative in its arguments. The mutual fund industry says that designating a fund manager as systemically important could raise its costs. Those costs could be passed on to fund investors, who are taxpayers, and so would amount to a taxpayer bailout...

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