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Off Target

“During the recent crisis, we had a number of powers that might have been used on too-big-to-fail institutions,” Esther George said at the Hyman P. Minsky Conference in New York on Wednesday. “But [they] were not employed to any notable extent.”

What Ms. George, president of the Kansas City Fed, implies here is that the powers available to authorities in 2008 would have been sufficient to rein in high-risk banking practices, but pre-2008 regulators (including the Fed itself) did not execute those powers.

If this is the case, why have we had to put up with Dodd-Frank? It is a huge piece of legislation whose only purpose seems to be, at least based on George’s statements, (1) a political exercise to make lawmakers feel important and (2) an opiate to satisfy a public that wants Wall Street bankers to feel their share of the pain.

So I have some questions for Esther George:

    1. Dodd-Frank – what gives?

    2. Was the inaction leading up to 2008’s financial crisis stem from a decision to favor market corrections over managed controls, or did authorities just not see the impending disaster?

    3. If regulators had the power but decided not to act, will they act the next time around (say in ten years time when the next generation of people are in control)?

    4. If the regulators did not see the pending crisis, why bother to give them more power and put more restrictions on banks? That seems like locking the door after the horse has bolted.

Ms. George also supports the Volcker rule, though many of my capital markets peers and I don’t understand how the Volcker rule would be written or implemented. Most people who try to define “proprietary trading” find the endeavor a lot more difficult than they originally thought.

And the Dallas Fed wants to start breaking up large banks. Their purpose is also a mystery. Some of the financial industry’s major problems have little to do with the size of our most successful banking institutions; AIG was not even a bank, and Lehman was a big institution, but not a really large one.

Size and practices are not the issues anyway.

One issue is the complex interaction between all the players, and the domino effect when one falls over. Another issue is the morality of the practices.

I liked the move to principle-based regulations. Many of the decision makers at the large banks knew that there was a problem with instruments such as mortgage backed securities, but went ahead with them anyway. Their short term quarterly performance would have been hit if they hadn’t. Besides, everybody else was doing it – and there was no law against it.

My solution: Discard Dodd-Frank and write a principles-based law that basically states that market practitioners must (1) refrain from doing anything stupid and wrong (meeting your 10Q number is not an excuse to skirt this), and (2) act as a regulator and shout out if you are getting your lunch eaten by the unprincipled crowd; it is your duty to report market manipulation, not to pile in and grab short-term profits at the country’s long-term expense.

Too-big-to-fail is a political excuse that has gone on too long. We have oligopolies in plenty of our markets (e.g. cell phone service, enterprise database software and auto manufacturing) that work well even with a few very large players.

I respect Esther George, but I’d like to see her build an ethical bar to hold the industry to. She should use her power to act now and set a standard that builds trust in our institutions regardless of size.

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