The Faculty Lounge

Bringing Public Interest into Systemic Risk Regulation

Kim Krawiec’s fascinating study of the Volcker Rule implementation process (available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1925431)  brings to life a fundamentally important question that has been on my mind for some time now.  Is there a way to ensure that the interests of the taxpaying public, and the broader society, are effectively represented in the process of decision- and policy-making in the financial services regulation? Is it possible to incorporate public interest representation directly into that process, especially with respect to systemic risk containment? After all, it is us, the people, the taxpaying general public and the broader society, who bear the ultimate costs of a major financial crisis. The latest crisis is a vivid reminder of that simple fact of life, as the post-crisis recession, rising unemployment, public budget cuts, and loss of funding for social programs continue hurting the poorest segments of our society the most. This increasingly visible public dimension of systemic risk in the financial market creates a fundamental tension within the existing regulatory framework that is not equipped to deal directly with the broader societal interests and relies primarily on technocratic tools and solutions.

The Dodd-Frank Act deals with this issue only indirectly and, essentially, by giving more power to financial regulators. The statute creates new regulatory bodies, expands jurisdiction of the existing ones, and gives them all broad (and notoriously vaguely defined) authority to make all sorts of new rules. These rules are expected to shape behavior of private market actors, primarily on individual entity-level, in ways that would ultimately reduce systemic risk. This is, of course, an over-simplification of the Dodd-Frank regulatory philosophy but it does capture its fundamentally structure-oriented approach to systemic risk regulation. The question is, of course, why would we think that regulatory agencies are the best – or, indeed, the only – defenders and protectors of the public interest in avoiding systemic financial crises?  After all, the regulators have notoriously and consistently failed to foresee or prevent the accumulation of excess leverage and risk in the financial system.

Industry capture is definitely a big part of an explanation for this regulatory failure. Recently, there has been a lot of great new scholarship (including very insightful articles by Dan Schwarcz and Cristie Ford) analyzing the dynamics of regulatory capture in the financial sector, as well as potential ways to counteract its effects.  In the financial sector, regulatory capture is particularly pervasive, difficult to avoid, subtle, and insidious.  It goes far beyond the visible “revolving door” phenomenon and manifests itself through the deeper ideological cooptation of the regulatory apparatus, as the industry effectively dominates the regulatory agenda and frames the debate in terms beneficial to the industry.  The informational asymmetry between regulators and the industry, especially in the context of today’s increasingly complex financial markets, further solidifies the industry’s excessive influence over the regulatory decision-making.

The Dodd-Frank Act does not address the problem of regulatory capture. It focuses more on broadening regulators’ intellectual perspective, mostly by creating the Office of Financial Research as an independent research center with broad information-gathering powers.  If the OFR functions as planned, it should help to alleviate the informational asymmetry problems but not necessarily the incentive problems.  Ultimately, Dodd-Frank does not disturb the familiar pattern of financial regulation as a dialogue between regulators and private industry actors, making decisions behind closed doors. The public, as usual, is asked not to worry its pretty little head and let the experts – regulators and financial institutions – figure out the highly technical solutions to the systemic risk problem.

 I think, this deeply-embedded view of regulatory process as involving only those two actors is one of the key underlying flaws in the existing system of financial sector regulation.  Unquestioned, it stands in the way of altering the current incentive structure of the regulators and the industry, to ensure that their actions take into account the broader public interest in financial and economic stability. Ultimately, systemic risk prevention is itself a political problem: it requires balancing of the public’s interest in long-term financial stability against private actors’ interests in pursuing economic gain.  Thus, the key to successful reform may be to move beyond technocratic solutions (disclosure, capital adequacy, etc.) and confront that fundamentally political problem. In my next post, I outline some steps toward tackling the political problem of systemic risk.

"Reforming Financial Reform" Starts Today!

As I mentioned previously, we’ll be hosting an on-line forum, Reforming Financial Reform?, here at the Lounge today and tomorrow. I am very excited about this discussion and hope that you will enjoy it too.  This is a great group of scholars eager to share new ideas and research with Lounge readers.  I’ve already benefitted from the email exchanges we’ve had as a group over the past week, and I invite you Lounge readers to join in at any point with comments, questions, and the like over the next few days. 

To get us started, I’ll take a stab at outlining the main issues I expect these bloggers will address during the forum.  

(1) Why worry about the financial reform process? 

The recent financial crisis and extensive Dodd-Frank reforms have prompted renewed interest in and study of the process of financial reform. Disproportionate industry influence is a perennial worry of scholars of the regulatory process.  What can students of financial reform learn from these theories and evidence? Does financial reform pose special questions and concerns?  

(2) Is the danger that financial reform is insensitive to public concerns or too sensitive?

As noted, industry influence is a perennial worry, but some worry about the opposite extreme – elected officials overly sensitive to ill-informed public sentiment may respond to financial crises with unwise legislation that fails to adequately balance the benefits of regulation against the costs.  Which is the bigger worry in the current environment?  Does it depend on the issue, the timing, something else? 

(3) How might we reform financial reform?

Assuming that either excessive industry influence or excessive public pandering, or both, is problematic, what should we do about it?  Some of our guests will address the nitty-gritty of reform, including policies, organizational structures, and regulatory changes that might be utilized to correct any perceived imbalances.

As a reminder the forum participants are below, and should be chiming in later today with their thoughts:

Cristie Ford, Assistant Professor, University of British Columbia

Erik Gerding, Associate Professor of Law, University of Colorado

Kimberly D. Krawiec, Kathrine Robinson Everett Professor of Law, Duke University

Brett McDonnell, Professor of Law; Solly Robins Distinguished Research Fellow, University of Minnesota

Saule T. Omarova, Assistant Professor of Law, University of North Carolina

Daniel Schwarcz, Associate Professor of Law, University of Minnesota

Faculty Lounge Forum: Reforming Financial Reform? Sept. 12-13, 2011

Remember that we’ll have some great guests here at the Lounge on Sept. 12-13 to discuss issues of financial reform.  Everyone is looking forward to sharing new ideas with Lounge readers, and to soliciting feedback and input on works-in-progress.  Hope you loyal Loungers can join us for the discussion!

The recent global financial crisis has forced many statutory, legislative, economic, and political changes.  It has also prompted a reevaluation of this landscape by scholars of financial regulation. 

Numerous researchers, pundits, and observers of all sorts have questioned the substantive content of recent financial reform: does it do enough? Too much?  The right things?

But others go deeper, questioning the very process by which financial regulation takes shape within the U.S. and other countries and analyzing the future prospects for meaningful financial reform. Do existing political and regulatory models, largely developed by reference to other subject-matter areas, accurately describe the world of financial reform and regulation?  Is special-interest capture particularly acute with respect to financial reform?  Does systemic risk create distinctive regulatory hazards and problems?  Is financial regulation prone to over- and/or under-reaction, simply responding to the public’s angers and fears over the most recent financial crisis, scandal, or news item? 

On September 12-13, 2012, guest-bloggers at The Faculty Lounge will discuss these topics in a special forum on financial regulation, “Reforming Financial Reform?”  Each participant has published extensively on the financial regulation process. Many plan to share new works-in-progress with forum participants and Lounge readers. 

So, tune in on September 12-13 to hear from and talk to:

 Cristie Ford, Assistant Professor, University of British Columbia

Erik Gerding, Associate Professor of Law, University of Colorado

Kimberly D. Krawiec, Kathrine Robinson Everett Professor of Law, Duke University

Brett McDonnell, Professor of Law; Solly Robins Distinguished Research Fellow, University of Minnesota

Saule T. Omarova, Assistant Professor of Law, University of North Carolina

Daniel Schwarcz, Associate Professor of Law, University of Minnesota

 

Faculty Lounge Forum: Reforming Financial Reform? Sept. 12-13, 2011

The recent global financial crisis has forced many statutory, legislative, economic, and political changes.  It has also prompted a reevaluation of this landscape by scholars of financial regulation. 

Numerous researchers, pundits, and observers of all sorts have questioned the substantive content of recent financial reform: does it do enough? Too much?  The right things?

But others go deeper, questioning the very process by which financial regulation takes shape within the U.S. and other countries and analyzing the future prospects for meaningful financial reform. Do existing political and regulatory models, largely developed by reference to other subject-matter areas, accurately describe the world of financial reform and regulation?  Is special-interest capture particularly acute with respect to financial reform?  Does systemic risk create distinctive regulatory hazards and problems?  Is financial regulation prone to over- and/or under-reaction, simply responding to the public’s angers and fears over the most recent financial crisis, scandal, or news item? 

On September 12-13, 2012, guest-bloggers at The Faculty Lounge will discuss these topics in a special forum on financial regulation, “Reforming Financial Reform?”  Each participant has published extensively on the financial regulation process. Many plan to share new works-in-progress with forum participants and Lounge readers. 

So, tune in on September 12-13 to hear from and talk to:

 Cristie Ford, Assistant Professor, University of British Columbia

Erik Gerding, Associate Professor of Law, University of Colorado

Kimberly D. Krawiec, Kathrine Robinson Everett Professor of Law, Duke University

Brett McDonnell, Professor of Law; Solly Robins Distinguished Research Fellow, University of Minnesota

Saule T. Omarova, Assistant Professor of Law, University of North Carolina

Daniel Schwarcz, Associate Professor of Law, University of Minnesota

The Daily Show "Celebrates" Dodd-Frank

For those who haven't seen this yet . . .

The Daily Show With Jon Stewart	Mon - Thurs 11p / 10c
Dodd-Frank Update
www.thedailyshow.com
Daily Show Full Episodes Political Humor & Satire Blog The Daily Show on Facebook

HT: Brett McDonnell

Today’s Circularity in Government Award Goes To

The recent GAO Report on banking entity activities prohibited by the Volcker Rule: 

As required by section 989 of the Dodd-Frank Act, GAO . . . reviewed the trading and fund activities of the largest U.S. bank holding companies and collected selected data on their profits, losses, and risk measures. 

But GAO: 

determined . . . that collecting data on other proprietary trading [i.e. outside of stand-alone prop desks] was not feasible because the firms did not separately maintain records on such activities and because of the uncertainty over the types of activities that will be considered proprietary trading until the completion of the required rulemaking.  We also collected data on hedge and private equity fund investments that the bank holding companies believed to be restricted by the act.  . . . Revenues and losses from these firms’ hedge fund and private equity fund investments followed a similar trend [of small revenues relative to other activities.]

Translation: Congress told us to study prop trading in order to assist with Volcker Rule implementation and rule making, but we can’t do that until after Volcker Rule implementation and rulemaking because until then we won’t know what prop trading is. Also, since Congress did not fully define which activities were prohibited under the hedge and private equity fund restrictions, we asked banks which of their fund activities they believed were restricted by the statute.  They said, “not much.”

To be fair, the Merkley and Levin (among other) rants against GAO are only slightly less absurd:

The GAO study is a major disappointment.  At best it is incomplete.  At worst it is misleading.  . . .

Congress provided a definition of proprietary trading to work with; direction to look at proprietary trading wherever it exists; and direction to look at how proprietary trading losses can contribute to instability of financial institutions.

Rather than follow the statutory directions, GAO has examined in detail only proprietary trading which occurs on distinct ‘stand-alone’ proprietary trading desks and gave only passing consideration to the risks and conflicts of interest associated with proprietary trading more broadly.  Just a fraction of all proprietary trading occurs on stand-alone desks . . . 

But Congress did not, in fact, provide a definition of proprietary trading, which is rather the point. Admittedly, the section 989 definition of proprietary trading (the section that directs the GAO study) is broader than the 619 definition, as Merkely and Levin point out.  However, it seems to me that even that definition contains substantial ambiguities and, in any event, doesn’t resolve the lack of data problem.  

More fundamentally, GAO’s inability to obtain detailed information on prop trading activity outside of designated prop desks -- the same data that regulators will clearly need for effective rule enforcement – would seem to be a sign of the many problems inherent in the Volcker rule, rather than problems with GAO.

You can read the full Merkley and Levin letter to GAO here (Download Merkley Levin Letter to GAO 6-23-2011) and GAO’s response.

 

Related Posts:

Dodd-Frank By The Numbers: A Volcker Rule Case Study

Dodd-Frank By The Numbers: The Volcker Public Comments

Dodd-Frank By The Numbers: Screwing Joe The “Plummer”

Dodd-Frank By The Numbers: The Volcker Meeting Logs

Dodd-Frank By The Numbers: The Wrap-Up

Taub, DC Circuit Mark Dodd-Frank At Year One

Having wrapped up my part in the one-year Dodd-Frank forum held at the Glom for the past two days, I now have time to note that Jennifer Taub has two posts over at theParetoCommons taking stock of Dodd-Frank one year later.  She includes some thoughts on what we should celebrate and where gaps remain. 

And, as most of you will already know by now, the DC Circuit struck down the SEC’s proxy access rule.  Bainbridge has a collection of some blog reactions, both positive and negative.

Dodd-Frank By The Numbers: The Wrap-Up

Many thanks to Brett McDonnell for pressing me on a few open questions my prior posts left him with. His comments have helped me to clarify in my own mind the problems I see with the Volcker Rule and the legislative process that gave rise to it. 

In particular, I do not believe that a critique of responsibility-shifting delegations of the sort I have argued the Volcker Rule may represent depends on some notion of the optimal rule, though I can see why Brett might draw that inference from my prior posts (which suggests I need to work on the language some more as I write this paper).  Instead, the inference to be drawn, I would argue, is about the optimal governmental body for making such decisions -- Congress versus regulatory agencies – and the trade-offs that we make among transparency, accountability, and efficient lawmaking.  And this is especially worth emphasizing, given that we don’t know yet the final rule or how effective enforcement will be.

I do not contend that legislators are immune from interest group pressure or are more likely to enact substantively better laws.  Brett is correct about the pressure for the legislature to “do something” – whether it makes any sense or not – in the wake of a financial crisis.  Nor do I mean to suggest that the problem of interest group influence on the lawmaking process would conveniently vanish were Congress to legislate precisely rather than to delegate. In fact, as argued by some commentators, interest groups might wield even more influence when policy is made directly by Congress, rather than through delegations (because it would place more power in the hands of legislative committees and their leaders).  Moreover, Congress should delegate substantive lawmaking to agencies under many circumstances, such as when it makes sense to harness agency expertise, when an agency can make policy more efficiently, or when uncertainty about the future renders ex post gap filling prudent.

But the legislature does offer an advantage in terms of policymaking: transparency and electoral accountability. Direct policymaking by Congress, for all its faults, renders legislators' actions more observable by voters, who then have an opportunity to hold them accountable for their choices. So the question of appropriate delegation is, to my mind, really a matter of degree, motivation, and trade-offs under the particular circumstances.

One particular irony here is that, though Brett disavows any SILR (Slightly Imaginary Larry Ribstein) leanings, I actually am a bit of an SILR, particularly when it comes to financial regulation.  Like Brett, I am not a particular fan of the Volcker Rule.  Though I remain concerned about bank risk-taking (indeed, financial institution risk-taking more broadly), I have doubts that the Volcker rule, even a better-designed one, is the right approach to address that concern.  In short, I chose to study it, not because of any particular belief in the rule’s wisdom, but because I suspected – based on the congressional maneuvering that accompanied its passage and the importance of proprietary and fund activities to banks’ bottom line – that it would illustrate a point about whose voice gets heard on financial reform issues as the sausage is really getting made, so to speak. 

But I’m not as confident that the benefits of vague laws given little effect by agency interpretations outweigh the costs.  Aside from the false signal to voters (and, potentially, other governmental actors) about the state of financial regulation, these moves have other, potentially unintended, consequences.  Let’s remember that even a Volcker rule that fails to substantially alter proprietary trading and fund investment activity will impose costs – banks have reorganized their activities to comply with the mechanics of the law and there will be ongoing compliance and oversight expenses.   

There is really much more to say on this, but I’ve exhausted myself with this anniversary celebration and have probably exhausted you patient readers as well.  As I mentioned, my goal with these posts was to float some preliminary data and ideas for a work-in-progress (something I'm usually too wimpy to do at an early stage).  So, feel free to send comments my way. 

Related Posts:

Dodd-Frank By The Numbers: A Volcker Rule Case Study

Dodd-Frank By The Numbers: The Volcker Public Comments

Dodd-Frank By The Numbers: Screwing Joe The “Plummer”

Dodd-Frank By The Numbers: The Volcker Meeting Logs

 

 

Dodd-Frank By The Numbers: The Volcker Meeting Logs

In my last post, I discussed the public comment letters. Now, I want to talk about the agency meeting logs.  As part of the new transparency efforts associated with Dodd-Frank implementation, the Federal Reserve, the CFTC, the SEC, and the FDIC began disclosing their contacts regarding Dodd-Frank shortly after the bill was signed into law last July.  These logs give some insight into the work of statutory interpretation and implementation that goes on behind closed doors: who is meeting with the regulators that will ultimately determine the scope of the Volcker Rule?  What interests do they represent?  What are the topics on which they are meeting?  What questions are being asked and answered and what sort of information is being conveyed? 

Table 1 shows the federal agency meetings with financial institutions to discuss the Volcker Rule posted between July 26, 2010, and July 5, 2011.  To save space in this post, I have included only the top 10 institutions individually, as well as the total number of financial institution meetings. 

As you can see from Table 1, JP Morgan Chase, Morgan Stanley, and Goldman Sachs met with federal agencies most frequently on the Volcker Rule, with 27, 13, and 12 meetings, respectively.  In total, 216 financial institutions met with federal regulators regarding the Volcker Rule during this time period.

Table 2 shows federal agency meetings to discuss the Volcker Rule with law firms representing financial institutions.  In total, these law firms met with agencies 24 times during the relevant time period. Davis, Polk; Sullivan & Cromwell; and Debevoise met most frequently with federal regulators, with 8, 6, and 5 meetings each. 

Table 3 shows financial industry trade associations, lobbyist, and policy advisor meetings with federal agencies to discuss the Volcker Rule – a total of 25.  SIFMA (The Securities Industry and Financial Markets Association), the Financial Services Roundtable, and the Managed Funds Association met most frequently with federal agencies -- 8, 5, and 2 times, respectively.

Table 4 shows public interest group and research or advocacy organization meetings with federal agencies to discuss the Volcker Rule -- a total of 9 meetings, primarily with labor union representatives. Finally, Table 5 shows a total of 9 meetings by other persons and organizations: namely, Senators Merkley and Levin and their staffs, and Paul Volcker and his staff.  

In sum, whereas financial industry representatives met with federal agencies on the Volcker Rule a total of 265 times, “public interest groups” -- by which I mean nothing more technical than an entity or group that might reasonably be expected to act as a counterweight to industry representatives in terms of the information provided and the types of interpretations pressed  – met only 18 times, even if we include the Merkley, Levin, and Volcker meetings under the heading of “public interest group” meetings.  This is roughly the same number of times that a single financial institution -- JP Morgan Chase – met with federal agencies on Volcker Rule interpretation and implementation, and a total meeting ratio of almost 15 to 1. 

A few notes here.  First, July 5, 2011 is our cut-off date for collecting meeting logs.  But because different agencies have different lag times for updating their logs after meetings take place, there were agency meetings prior to July 5 that were not yet posted by that date. 

Second, for these purposes, I have defined “financial institution” broadly to include not only commercial and investment banks, but also asset managers and investment advisors, as well as insurance companies.  This does not mean that these different types of institutions raised identical concerns at every meeting. But, although the exact subject matter of the meetings differed according to the particular regulatory concern faced by each group, the important point for these purposes is that nearly all of the industry representatives to meet with federal agencies on Volcker were seeking clarifications on the rule’s application to their activities -- most often, a clarification that the Volcker Rule would not prohibit the activities in question.

Finally, I should emphasize that not all meetings are created equal.  Many of the meetings in Table 1are group meetings, often as part of an industry trade association meeting.  For example, 27 separate financial institution representatives were listed in attendance at an April 7, 2011, SIFMA-SEC meeting with Chairman Schapiro. 

Perhaps more tellingly, nearly all of the public interest group meetings in Table 4 are of this nature.  For example, representatives of AFL-CIO, Laborer's International Union of America, AFSCME, and SEIU are logged for an October 13, 2010, SEC meeting with Kayla J. Gillan and Jim Burns.  These are 4 of the 5 meetings by public interest groups with the SEC (Americans for Financial Reform met separately with the SEC on April 13, 2011).  And all of the public interest group meetings with the CFTC on Volcker took place together, on March 16, 2011.

And the identity (or number) of agency representatives at certain meetings may signal something about the importance of the event.  For example, the log for an August 3, 2010, CFTC meeting with SIFMA and ISDA at which the Volcker Rule was discussed (along with other Dodd-Frank provisions) lists 53 SEC and CFTC staff members in attendance. But Goldman Sachs CEO, Lloyd Blankfein, is logged as meeting alone with SEC Chairman Mary Shapiro (along with Chief of Staff Didem Nisanci, and Robert Cook, Director of Trading & Markets) on March 9, 2011. Mr. Blankfein met with Ms. Shapiro again on Oct. 8, 2010, at an SEC-Financial Services Roundtable meeting, at which Jamie Dimon of J.P. Morgan, Robert H. Benmosche (President and CEO of AIG), Richard K. Davis (President and CEO) of U.S. Bancorp, and other major financial institution CEOs are logged as being in attendance.

What to make of this data?  For me, it suggests that those worried that Dodd-Frank left too many details to be filled in my regulators, giving industry a second chance to lobby for important exemptions and interpretations, were at least barking up the right tree.  Federal agency contacts with industry representatives significantly outpace those of any potential countervailing voices in terms of both quantity and quality. 

Does this prove that regulatory agencies are captured or not regulating in the public interest?  No, of course not.  But regulators are only human.  They have limited time, expertise, personnel, and budgets.  Although comment letters and meetings are not by any means the only source of information and persuasion to which regulators are subjected, the meeting logs (particularly when combined with the data on the public comment letters) paint a very one-sided picture of influence, information, and pressure – influence, information, and pressure that largely take place in the absence of meaningful public scrutiny.

In my next, and final, post, I’ll be back to address some of Brett McDonnell’s always-thoughtful comments, and will wrap up with some concluding thoughts.  

 

Related Posts:

Dodd-Frank By The Numbers: A Volcker Rule Case Study

Dodd-Frank By The Numbers: The Volcker Public Comments

Dodd-Frank By The Numbers: Screwing Joe The “Plummer”

 

 

Dodd-Frank By The Numbers: Screwing Joe The “Plummer”

In my last post, I was discussing the public comments on the Volcker Rule, specifically Table 3, included again in this post, which shows the breakdown of comments by word count, and Chart 1, which displays this information graphically, showing the distribution of word count by: private individual not using the PC form (in red), private individuals using the form (in blue), and all others (in green). 

As noted, the spike at comments of less than 50 words are all (with one exception) letters from private individuals.  As you might expect in a comment of less than 50 words, these are short, non-substantive, and provide no meaningful guidance or relevant information to regulators, beyond the fact that members of the public continue to be angry about the financial institution bailouts.

To illustrate, the shortest comment received by FSOC, from a member of the general public, is only a single word: “regulate!” In contrast, the longest comment, received from SIFMA (the Securities Industry and Financial Markets Association) measures 19,500 words and advises FSOC that:

the key definitions in this [the hedge and private equity] portion[s] of the Volcker Rule are generally overbroad: they sweep in entities and vehicles that Congress never intended to be treated as hedge funds or private equity funds and which Congress expected the implementing agencies to exclude from the general definition through the exercise of their regulatory discretion.

In between these two extremes lie the comments to the right end of Chart 1, nearly all of them from industry (or the occasional public interest group, think tank, or academic).  These industry and trade group comments are lengthy, contain cogent arguments on behalf of a generally narrow interpretation of the Volcker Rule’s scope of prohibited activity, advance detailed legal arguments relying on numerous statutes and cases, reference the Dodd-Frank legislative history, and often contain detailed empirical data. 

In contrast, comments from the general public tend to be short (the average word count, excluding the PC form letters, is 86), lack specific suggestions or recommendations for interpreting and implementing the Volcker Rule, generally urge that the rule be “enforced” or “adopted,” and express anger over bank risk-taking and the resulting bailouts that followed.  One letter, stating “Reinstate the Volcker Rule!” is typical.  Others are amusing. 

Said one:

in regards to the Volker Rule, just how stupid do you think the working class is? we just passed the two bills of financial reform and here, not even 3 months later, you big banks are at it again to screw joe the plummer.

Said another: “Being the crooks you are you will ignore this.” And finally, one of my favorites:

I support the Volker Rule. I also support a Barney Frank rule which states that congressmen and senators should make no law or rule or provision what states that every citizen the United States has a right to have a home.  . . .  PS - I still cannot believe that he won re-election. Cannot believe people are that stupid. Regards, Frank

To put all of this into context, the Volcker rule comment process was, in many ways, an astonishing campaign victory for public interest groups generally and Public Citizen, particularly.  This display of private individual interest in the Volcker Rule – a rather arcane and technical piece of legislation – is somewhat astonishing.  Unlike consumer protection or executive compensation, proprietary trading and hedge fund investments by banks are not sexy topics, even post-crisis.  The average consumer likely has no idea what proprietary trading is, much less what sorts of risks it might pose to the financial system. 

At the same time, however, this series of posts aims to illustrate how, even under these favorable circumstances, it is optimistic to think that such public-interested efforts can counterbalance the extraordinary influence and lobbying power that affected financial institutions are bringing to bear on important issues of financial reform, such as those embodied in the Volcker Rule.  There’s too much at stake for industry, and they have the money, the information, and power. 

In my next post, I’ll discuss the next phase in the Volcker Rule gap-filling game: the agency meeting logs. 

Related Posts:

Dodd-Frank By The Numbers: A Volcker Rule Case Study

Dodd-Frank By The Numbers: The Volcker Public Comments

 x-posted at The Conglomerate 

Dodd-Frank By The Numbers: The Volcker Public Comments

As I mentioned in my prior post, I’ll be using the Volcker Rule as a case study to demonstrate that an important critique of Dodd-Frank – the extent to which it leaves core substantive definitional work to regulatory agencies -- is a legitimate worry of the statute’s critics.  This analysis paints a picture of robust industry representation in the rulemaking process and progressively less public involvement in and attention to the Volcker Rule as the action moved from the legislature, to the initial call for public comments, to the more in-depth face time with regulators.

Let’s begin with the public comment letters. The newly formed Financial Stability Oversight Counsel’s first action was a request for public comments on the Volcker Rule, after which it received over 8000 comments – at first blush, an extraordinary display of public interest in a fairly technical piece of financial reform legislation. 

But, “wait!” you might say.  “I thought you just said that the public didn’t care about Volcker implementation and that’s why Congress may have left the legislation vague to begin with!  This is exactly the type of academic double talk I can’t stand!”

  Let me explain.  The FSOC concluded that, of these 8000 comment letters, roughly 6,550 “were substantially the same letter arguing for strong implementation of the Volcker Rule.” The FSOC gave no further information about these letters and did not make them publicly available. But, based on our analysis of the remaining comment letters (which I’ll get to in just a moment) we believe that the 6,550 identical letters are the result of a Public Citizen (PC) action campaign, which provided a form letter urging the prompt implementation of the Volcker Rule and the closing of any loopholes.

We analyzed and hand coded the remaining roughly 1,450 comment letters.  The FSOC concluded that these “remaining 1,450 comments each set forth individual perspectives from financial services market participants, Congress, and the public.”  Nothing could be further from the truth.  Tables 1-3 provide some very preliminary summary statistics on these comments. Click on any image to enlarge. [Caveat: We crunched to get these out for the Dodd-Frank anniversary, so they’ll need some clean-up and correction. But the general pattern should hold.]

First, we excluded duplicate postings by FSOC, leaving us with a total of 1374 comments.  Of these, as detailed in Table 1, 1281, or 93%, were submitted by private individuals.  The remainder was submitted primarily by industry members and trade groups, along with a small number of submissions from public interest groups, think tanks, academics, and congressional members. Again, at first blush, these numbers seem to confirm an extraordinary public interest in the Volcker Rule – the raw number of private individual comments dwarfs the comments submitted by all other categories of actors combined, including industry actors.

Yet, let us break down further these 1281 letters submitted by private individuals, as shown in Table 2.  Of these, 766 use the same PC form letter, with some slight variations, as the other 6,550 identical letters that the FSOC did not post.  Because many of these letters include some opening anecdote or concluding thoughts – such as a personal travail arising from the financial crisis –or, in some instances, use only a portion of the form (typically, the demands), these comments were not all identical.  Therefore, they escaped whatever recognition software or rough exclusion methods FSOC used. Yet, they are the same – nearly identical -- substantive letter.  Thus, of the 8000 letters received by FSOC on Volcker, 7316 (or 91%) are an identical form letter.

Let us now examine the remaining 515 comments submitted by private individuals that were not traceable to the PC form letter and compare them to letters from other groups.  Table 3 shows the breakdown of comments from some of these groups by word count and evidences several patterns of interest.  Chart 1 displays this information graphically, showing the distribution of word count by: private individual not using the PC form, private individuals using the form, and all others. 

There are three spikes in the data, at less than 50 words, at 200-249 words, and at 250-299 words (note the larger bin size in the far right bar, representing comments with 800 words or more).  The spikes at 200-249 words and 250-299 words represent the PC form letter and its slight variations, discussed above (in it’s original form that letter is 244 words.) 

The spike at comments of less than 50 words are all (with one exception) letters from private individuals, represented in red in Chart 1.  As you might expect in a comment of less than 50 words, these are typically short, non-substantive, and provide no meaningful guidance or relevant information to regulators, beyond the fact that members of the public continue to be angry about the financial institution bailouts. 

In my next post, I’ll briefly compare the content of some these comments.

Related Posts:

Dodd-Frank By The Numbers: A Volcker Rule Case Study

 x-posted at The Conglomerate

Dodd-Frank By The Numbers: A Volcker Rule Case Study

A year ago, during the first Conglomerate Masters Forum on Dodd-Frank, many of the commenters, including me, were critical of the legislation.  I was not alone in my complaints that Dodd-Frank left too many important details of the legislation to be filled in over the coming years by regulators. In fact, the media and commentators had already invoked public choice critiques of Dodd-Frank.  Many were particularly worried that the filling in of important details left open by the legislation would take place outside of the public glare that accompanied the congressional deliberations on the statute and provided the large Wall Street firms with another opportunity to shape the final law in their favor.  This potential was heightened as memories of the financial crisis faded and the general public -- temporarily galvanized by massive financial institution bailouts into an interest in the normally-arcane topics of credit derivatives, systemic risk, and moral hazard -- turned their attention to other political issues. 

An examination of theory and evidence confirms that these fears were not misplaced.  Over the next few posts, I’ll use section 619 of the Dodd-Frank Act, popularly known as the “Volcker Rule,” as a case study to illustrate these points.  I had hoped to be able to post a paper to SSRN detailing this data by now, but alas, I am too slow.  But I’ll include in these posts a first cut of the data I’ve collected on this, with the assistance of three excellent Duke law students, Nilesh Khatri, Daniel Luna, and Robert Blaney, who have spent all summer reading public comment letters and federal agency meeting logs, rather than hanging out at the beach.  Special kudos to Nilesh for his creation of spreadsheets that even I can’t mess up.

Subject to important exceptions, the Volcker Rule prohibits “banking entities” from engaging in proprietary trading and from “acquiring or retaining any equity, partnership, or other ownership interest in or sponsor[ing] a hedge fund or a private equity fund.” Both parts of the rule – the ban on proprietary trading and the restrictions on fund investment and sponsorship – are subject to substantial ambiguities that will require agency definition and rulemaking.

On the public choice critique, let me start with the theory.  The political conditions surrounding the passage of Dodd-Frank were ripe for what might be termed a “responsibility-shifting delegation.” Due to negative public sentiment surrounding the financial crisis and the pubic anger over the bank bailouts that accompanied it, bank risk taking – an issue of traditionally low public salience – was temporarily transformed into an issue about which the public cared deeply, yet had little expertise or knowledge by which to judge the success of legislative outcomes. There was thus substantial public interest in the legislative process surrounding the Volcker Rule, including the various accommodations and concessions necessary to gain the votes for Dodd-Frank passage.  Both the public and the press followed these developments closely, and expressed frequent concern, even outrage, at signs that the financial industry might escape the consequences of its role in precipitating the financial crisis.

Yet, these same facts suggest that lawmakers may have found it politically advantageous to delegate to agencies the authority to fill statutory gaps and ambiguities in the Volcker rule, rather than legislating with specificity these highly complex and contested provisions. The Volcker rule thus promised Congress the possibility of claiming credit for meaningful financial reform through public-interest rhetoric about preventing banks from gambling with public money, while providing the banking industry a second chance at escaping the most onerous restrictions of the Rule through successful lobbying during the rule-making process. 

My remaining posts will focus on the evidence. As feared by many Dodd-Frank critics, that evidence suggests that the powerful interest groups most affected by the Volcker Rule did not waste the additional opportunities provided by the provision’s important gaps and ambiguities. Instead, as evidenced by both pubic comment letters and meeting logs, they actively lobbied agencies to adopt favorable definitions, interpretations, and exemptions.

This evidence also demonstrates a corresponding waning of public attention to and interest in the Volcker rule once the action moved to the regulatory agencies. Despite initial indications that the public interest in bank risk-taking survived into the crucial regulatory rule-making phase, a closer look reveals that these signs are misleading. Contrary to first impressions, the Volcker rule did not galvanize the public into an involvement in the gap-filling process, despite notable efforts from some public interest groups. 

In my next post, I’ll be back with much more, starting with a detailed analysis of the nearly 8000 public comment letters received by the FSOC on Volcker.

x-posted at The Conglomerate 

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Happy Birthday Dodd-Frank

Dodd-Frank turns one today and there is a forum going on at The Conglomerate to mark the occasion.  I’ll be participating, as I did in last year’s Glom forum to mark the statute’s passage.  I will not call it a “celebration,” since if I remember correctly most of the commenters last year were fairly critical.  It will be interesting to see if views have changed in the intervening year – mine have not, as you will soon see. 

I’ll be cross-posting my thoughts here, but naturally you should head over to the Glom over the next two days to see the forum in its full glory.  The forum posts will be collected here.

 

Will He? Or Won't He?

Updated:  July 18

It would appear that the correct answer is ... "he won't."  Apparently former Ohio attorney general Richard Cordray will get the nod.  Story here.

 

Will President Obama nominate Elizabeth Warren to run the new Consumer Financial Protection Bureau, scheduled to opens its doors on July 21?

The current issue of TIME Magazine offers some thoughts in a story entitled "Elizabethan Drama."

End of an Era

Pork Bellies Going Down
Trading Places at MOVIECLIPS.com

 

From the Chicago Tribune:

The Chicago Mercantile Exchange said it is shutting down its iconic frozen pork belly futures market at the end of business on Friday.

The contract for a slab of frozen meat from which bacon is cut started trading in 1961 and as of Friday was the oldest existing CME livestock futures contract.

The closing had been expected. Trading in pork belly futures had dropped to nearly zero in recent years after the meat industry became integrated and used fresh pork bellies instead of frozen ones to make bacon.

. . .

Pork bellies had their heyday in the late 1960s and 1970s, when they were the CME's most popular agriculture contract.

And from the FT:

“Because of a prolonged lack of trading volume and after significant discussion with industry participants, CME will be delisting frozen pork bellies futures and options” effective Monday, exchange parent CME Group said in a report to traders.

Pork bellies, used to make bacon, were once an anchor product at the CME. Launched in 1961, the contracts were used by slaughterhouses and food companies hedging price risks and speculators taking a punt on price direction.

As bellies futures predated the creation of financial futures, some traders also used them to protect against macroeconomic risks, said John Lothian, president of the electronic trading division at brokers Price Futures Group in Chicago.

“In the early 1970s, there were people that used pork bellies as an inflation hedge,” Mr Lothian said.

 

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Who’s Meeting With The CFTC on Dodd-Frank?

Goldman, Sachs, of course.  Risk has the information here.

Why does this matter?  Because, as I said a year ago when Dodd-Frank was passed, the statute is long, costly, needlessly complex and punts the bulk of meaningful issues to regulators.  Those regulators are now beginning to fill in the substantial gaps and ambiguities left by Dodd-Frank, and are doing so outside of the temporary public glare that – thanks largely to anger over the bank bailouts -- accompanied the legislative process.    

To be clear, I’m not suggesting that the CFTC, or any other agency, should engage in the substantial rulemaking required by Dodd-Frank without information and input from industry.  I shudder to imagine the utter silliness of financial regulation under such conditions.  Rather, this is a broader argument, and one that I’ve made before in other contexts, about Congressional accountability and second chances for industry capture in a less transparent setting.

According to the Risk analysis of CFTC meeting logs, Goldman Sachs has been the most active meeting participant, meeting with CFTC officials 52 times, followed by Morgan Stanley, with 32 meetings, and Barclays Capital, with 25.  Delta Strategy Group had the most of the trade association/lobbyist meetings, with 42, followed by ISDA at 22, and MFA at 20.  Law firms representing derivatives market participant clients are dominated by Skadden, with 23 meetings, Winston & Strawn, with 23, and Sullivan & Cromwell, with 19. Clearing houses, trading platforms, exchanges, trade repositories, asset managers, and hedge funds are also well represented in terms of frequency of CFTC meetings. 

According to Risk: 

In terms of subjects discussed, the most popular by far was the definitions within the Dodd-Frank Act – specifically, how regulators will categorise swap dealers and major swap participants. Approximately one fifth of all meetings – 190 in total – were spent either entirely or partly discussing how the CFTC will determine which firms will be obliged to centrally clear swap transactions and which will be exempt from the requirements.

My RAs and I have been doing a similar analysis on the Volcker Rule for all federal agencies with rulemaking authority under Volcker that also includes a content analysis of the far more numerous public comment letters.  I’m planning to have a rough cut of the numbers ready to share with you for the upcoming one-year Dodd-Frank anniversary, on July 21.

For now, though, I’ll just say that our analysis paints a similar picture of industry representation in the rulemaking process and progressively less public involvement in and attention to the Volcker Rule as the action moved from the legislature, to the initial call for public comments, to the more in-depth face time with regulators. Despite initial indications that the public interest in bank risk-taking survived into the crucial regulatory rule-making phase, a closer look reveals that these impressions are misleading. Contrary to first impressions, the Volcker rule did not galvanize the public into an involvement in the gap-filling process, despite commendable efforts from several public interest groups. 

I’ll be back with the details in a few short weeks.

Follow @KimKrawiec

Call for Papers: Regulation in the Fringe Economy

From an email I recently received from friend Jim Hawkins (University of Houston):

        The symposium Regulation in the Fringe Economy represents the most significant attempt to date by legal scholars to address the vexing legal and social issues created by lenders on the fringes of the economy who offer payday, auto title, for-profit college, and refund anticipation loans. A complete list of confirmed participants and their paper topics is available at the conference website: http://law.wlu.edu/fringe.

        The Frances Lewis Law Center and the Washington and Lee Law Review are delighted to sponsor this conference which will take place on November 11, 2011 at the Washington and Lee University School of Law in Lexington, Virginia. The Washington and Lee Law Review will publish a symposium issue featuring the conference papers in 2012.

        The sponsors’ goal is to encourage and recognize excellent legal scholarship in this area. To advance their goal, the sponsors invite lawyers, judges, and scholars to submit papers on regulation in the fringe economy. Papers on related high-risk consumer financial products are also encouraged. An author should submit his or her manuscript in an exclusive submission on or before August 15, 2011. A submission should be no longer than 50 pages or 15,000 words. A limited number of submissions will be accepted. Authors will be notified of the acceptance of their paper and participation in the symposium no later than August 20, 2011.

        Selected authors will present their papers at the November 11 conference. All participants are asked to provide their own travel expenses. Papers specifying the conference may be mailed to the Washington and Lee Law Review or sent electronically to [email protected]. The Law Review Articles Editors and Washington and Lee University School of Law Professor Margaret Howard will review the papers.

        Even if you are not able to submit a paper, the sponsors invite you to attend the conference. There will be no charge for attending. The Frances Lewis Law Center is a licensed Virginia Continuing Legal Education provider which will supply Virginia CLE credit for those attending.

Is This "Insider Trading"?

Readers who teach corporate securities law may find fodder for classroom discussion of "insider trading" at this link.

Check Processing and Overdraft Charges

WARNING:  This post includes a citation to the Uniform Commercial Code.  Viewer discretion is advised.

Assume that a bank is presented on a single day with multiple checks drawn on the customer's account.  No big deal if the account has sufficient funds to cover all of the checks.  But what if the account has a balance insufficient to cover all of the checks?  ("How could this occur?" you might ask.  Perhaps the customer has made an innocent math error in tracking the account balance.  Or perhaps the customer erroneously assumed that certain checks might not be presented for payment until after upcoming payroll deposits would hit the account.)  Now the bank must decide in which order it will pay the checks, creating the possibility that some checks will be dishonored (or perhaps be subject to overdraft charges).

As a general rule, the UCC gives the bank complete discretion in determining the order in which checks will be paid.  (See 4-303(b).)  A few years ago, a student directed my attention to this article in USA Today,  which indicated that eight of the nation's ten largest banks paid same-day checks in the order of largest to smallest.  If we assume that the largest checks we write may be the most important (e.g., monthly mortgage and car note payments), then the policy makes some sense.  The trade-off, though, is that under such a policy the number of checks that may be adversely affected increases.  And as that number increases, so, too, might the various fees.

Now comes word that Citibank will start paying checks in the order of smallest to largest in a few months.

Good idea?  I suppose it depends.  If you keep a minimum balance in your account and avoid jaw-dropping math errors, you probably don't care about the policy because it rarely, if ever, affects you.  But if you're living from paycheck to paycheck and struggling to make ends meet, then maybe you'll see a reduction in those annoying fees.  (But might your chances of a mortgage default or a vehicle repo increase?)

Will other banks follow Citibank's action?  Only time will tell.  My guess?  Don't expect a stampede.

Midwest Corporate Law Scholars Conference

I've been asked to post the following info on the Midwest Corporate Law Scholars Conference.  Inquiries may be directed to Prof Eric Chaffee at Dayton Law School.

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Corporate Law Scholars Conference  
June 15, 2010
The Ohio State University Michael E. Moritz College of Law
 
The Midwest Corporate Law Scholars Conference (MCLSC) meeting will be Wednesday, June 15th, at The Ohio State University Michael E. Moritz College of Law in Columbus, Ohio. This is the second annual meeting of the MCLSC, and we are opening up the meeting to all corporate law scholars.  Presentations will start in the morning and end late afternoon. There will be an on-campus lunch and breakfast, as well as an informal off-campus dinner Wednesday night following the end of the conference. We welcome all on-topic paper submissions and will attempt to provide the opportunity for all submitted papers to be presented.  Junior scholars are particularly encouraged to submit papers, and we will attempt to assign a commentator for each junior paper presented. 

To submit a presentation, email Profess Eric C. Chaffee at [email protected] with an abstract or paper by March 15, 2011. Please title the email “MCLSC Submission – {Name}”. If you would like to attend, but not present a paper email Professor Chaffee with an email entitled “MCLSC Attendance”.  Please specify in your email whether you are willing to serve as a commentator. A conference schedule will be circulated in May.

Conference Organizers:
Barbara Black
Eric C. Chaffee
Steven M. Davidof

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