Moderated by Thomas Easton, The Economist
Sheila C. Bair is chair of the Systemic Risk Council at CFA Institute and senior advisor to the Pew Charitable Trusts. Previously, she served as the 19th Chairman of the Federal Deposit Insurance Corporation (FDIC). Before joining the FDIC, Ms. Bair was the Dean’s Professor of Financial Regulatory Policy for the Isenberg School of Management at the University of Massachusetts, Amherst. Her recent book, Bull by the Horns, recounts her experiences at the FDIC during the financial crisis. Ms. Bair received a bachelor’s degree from the University of Kansas and a JD from the University of Kansas School of Law. A book summary for Bull By the Horns is available via getAbstract.
Among the pertinent questions for Sheila to address are these:
Is the political heart for true financial reform still beating?
- What remains to be done to alleviate systemic risk?
- Why are financial reforms that promote stability and minimize systemic risk important to a banking sector that supports a well-functioning, free-market economy?
- What reforms will affect the investment management sector in the United States and Europe?
My session notes follow. As always, these are contemporaneous notes. I make no guaranty as to their accuracy or completeness.
- Investors are key to system stability.
- Axiomatically, investors were hurt in and by the financial crisis.
- Good, common sense regulation is imperative. But the public interest is diffuse and the public is highly cynical. The issues are complex and progress is slow.
- Bank capital levels need to go up – capital via equity rather than bonds. Good capitalization is a competitive strength.
- Securitization needs greater investor protection. But regulators have largely abdicated.
- “To big to fail” needs to be eliminated. Capital allocated on account of implied government support is counterproductive.
- Better and more meaningful disclosure has got to happen. Better discipline demands better information – disclosure.
- Improved financial literacy is required at the investor level.
- Everybody deserves some blame for the financial crisis.
- Five ways investors can contribute to system stability.
- Do your own homework/research – don’t rely on regulators and others.
- Well informed investors are crucial.
- Market discipline is required. Find and analyze the assets. Examine liabilities and assets. Tangible common equity is key. Over-reliance on risk-weighted assets (GAAP and IFRS).
- Consider what happens if/when things go south. Where are the assets? How to get at them? Counterparties?
- Don’t buy just because you can borrow cheaply to do so (don’t reach for yield and ignore the red flags). Resist the temptation.
- Bailouts should not be the new paradigm.
- Buffet says he has no understanding of derivative obligations; GAAP and regulators disagree about them. How can any of us “do our homework”? Obvious risks and warning signs were ignored. Transparency needs to increase. Rules (accounting, capital and regulatory) are too complex and complexity leads to mistakes. Low interest rate policy allowing us to make the same mistakes as last time. If you don’t understand the risks, don’t invest.
- What about the regulatory capture theory? Not corruption, but a cognitive capture – more a function of interaction and the lack of a broader perspective.
- Another financial meltdown? System a bit safer now, but certainly possible. Monetary policy has gone on far too long and we don’t know what risks have been created thereby. Too much reliance on debt, which is fragile. Debt is rigid – you have to pay it back. Nobody understands the new risks that have been created.
- Anything about the bank financial structure that is a major concern? Derivatives, credit default swaps, etc. Major concern.
- Few bank mergers today – breakups possible? Good thing? Well managed regional banks that stuck to their process did reasonably well. Diversification of bank business lines creates serious management problems. Middle approach – big banks create silos – makes a lot of sense. Complex categories should not be supported by consumer deposits. It’s difficult to determine how banks are allocating capital. Maybe the big banks are worth more in pieces.
- How do we reconcile too big to fail and regulator use of large banks to bail out failures? Great question. Rapidly deteriorating situation and few tools. Dangerous to build expectations that nobody will be allowed to blow up.
- Are large asset managers a hue category of systemic risk? No eligibility for regulatory safety net. They need to be less connected (longer-term). It would be better to deal with troublesome practices via regulation. But more Title I designations likely but a mistake.
- Should America become Canada? Canada has never had a banking crisis. US banks say Canadian banks simply piggy-back on them. Canadian system has real advantages – less political influence on regulation (campaign finance in particular); healthier attitude toward regulation.
- Does FDIC insurance limit the incentive for consumers to do their homework about their local bank(s)? She’s fine with $250k FDIC coverage limit increase despite moral hazard risk. Market discipline isn’t likely at the level – don’t have acumen and resources. Market discipline needs to be performed at the bondholder level.
- Dracula-esque system – “shadow banking”? We need a new term because she doesn’t think “shadow banking” is a pejorative. But we need regulation though to control risks in the shadow sector, especially as it relates to leverage.
- Why no increase in down payment requirement? Politics.
- Most bank regulation looks at bank assets rather than liabilities. Is that enough? Look at liabilities and make them fully secure? Wouldn’t have to worry about depositors and overnight runs. But she doesn’t want to go that far. Nothing like that on the table. Took a long time to get leverage limits down. Equity funding has resiliency advantage, but what happens in a downturn? Funding disappears.
- Would the Volcker Rule help? It helps with low-hanging fruit but not a magic bullet. Good cultural message – a bank’s job at least includes customer service. It shouldn’t all be about prop trading.
- What should be done about money market funds? Floating NAV consistent with underlying assets. Guarantees without underlying capital are highly dangerous.
- Hold top management personally liability? Yes. We need more accountability (even though how high is a difficult question). Why should shareholders pay before the criminals? Why hasn’t anybody gone to jail?