Monday, October 1, 2012

Update on FinReg Politics

. Monday, October 1, 2012

Awhile back Thomas and I wrote a chapter for a Research Handbook summarizing positive theory in political economy on global financial regulation. (The book is here; an ungated draft version of our chapter is here.) As we were writing many governments were revising their regulatory standards in response to the global financial crisis, and the international standards created by the Basel Committee were undergoing revision as well. We were pleased that most of our speculations -- which came directly from a variety of researchers in the IPE literature -- were borne out by later developments. It was one of the few validations of IPE work that emerged from the crisis. But things can change, and the politics of financial regulation doesn't stay still for long.

One of the key arguments that we made was that the revisions to the Basel accords were highly likely to benefit banks in the US. Indeed, the U.S. government left capital regulation out of the Dodd-Frank Act almost entirely, choosing the international forum. Previous IPE research suggests that this is done in order to advantage domestic US firms, which should only be expected since all regulations involve redistribution, and thus creates both winners and losers. It's seemed pretty obvious that the winners would be US firms, and the losers would be firms in Continental Europe and Japan. (I've blogged about this before.) In the chapter Thomas and I wrote we explained how this was just a continuation of a dynamic going back to the creation of the first Basel accord in the mid-1980s.

Fast-forward a few years and the same dynamics appear to be in force:

THE European Banking Authority (EBA) released its second report monitoring compliance with Basel III regulations on September 27. The big finding is that the aggregate European banking sector needs about 338 billion euros of additional equity capital to comply with the rules. While firms have several more years to adjust their balance sheets and raise funds, this seems like a tall order, especially given what has happened to bank share prices [wkw: which have declined dramatically since 2008].
In the US, which are generally better-capitalized than their European and Japanese competitors, the new international rules are likely to harm small banks more than big banks, as the new standards increasing the complexity involved in compliance. Perhaps this is why large US banks have remained relatively quiet about their new Basel obligations, unlike many of the provisions in Dodd-Frank, while smaller banks have screamed bloody murder. The increase in complexity rewards large firms with the technical capacity to navigate the system. The new Basel demands for more capital hurt firms with less capital, and for whom it is more expensive to acquire it. On both dimensions, large US banks are in a better position than their smaller domestic rivals or competitors in other jurisdictions.

On these points it is interesting to read Felix Salmon's take on Sheila Bair's new book (which I've not read), in which we find:
Tim Geithner involved himself quite deeply in Basel III negotiations. Bair can’t stand Geithner, and ascribes malign intent to everything he does. Geithner asks questions about Basel III without explicitly saying what his own opinion is? “It wasn’t clear whether Tim was trying to build consensus among the U.S. regulators or trying to stir the pot.” Geithner agrees to push for higher capital standards — exactly what Bair wanted all along? Well, that’s just his way of trying to marginalize her:
Bair sees the entire episode as a power play by Geithner. She argues he was trying to blow up the meeting between international regulators so that the issue would be kicked higher to the Group of 20 finance ministers who were set to meet in November. If the G-20 took over negotiations, Geithner would be leading the U.S., not Bernanke. The FDIC would have little say in the final number.
I'm more sensitive to the idea that Geithner's involvement was a power play than Salmon, although more likely Bair was less Geithner's target than Bernanke. And I doubt that Geithner ever wanted to leave the Fed out of the process -- that would be absurd and it didn't happen -- rather than ensure that he remained actively involved in the process. Geithner is routinely accused of pushing for policies that benefit the US banking sector, both in his time at Treasury and before when he was at the US Fed. I think many of the more moralistic of these criticisms are a bit much -- after all, shouldn't a healthy banking sector should be a goal for regulators? -- but the general drift seems to fit the data fairly well. There's no doubt that things would look a bit different if Bair, or Elizabeth Warren, was in charge.  And this fits in with the general tenor of the story I'm trying to tell: US policymakers have the well-being of US firms in mind when they go into international negotiations. Or, as Salmon puts it:
[I]t’s entirely natural that Geithner, who moved straight to Treasury from the presidency of the New York Fed, would take an interest in Basel III: after all, the New York Fed generally provided most of the frontline negotiators hammering out details far from the view of principals like Bair. And, it’s worth noting, the New York Fed was actually very aggressive in the Basel negotiations — much more aggressive, actually, than the higher-level negotiators from Washington. That was the culture Geithner came from, and if he was more sympathetic to Citi and BofA than Bair was, he was also well aware that the tougher the capital-adequacy standards, the better the competitive position of US banks in general, vis-a-vis their woefully undercapitalized European counterparts.
In this particular case this is good from the perspective of those hoping for a stricter regulatory state, since the US (along with the UK and Switzerland) were the ones pushing for tighter capital and liquidity requirements, while the Germans, French, and Japanese resisted. Needless to say the Americans won on most points, with the major concession being a longer phase-in period to give European banks a chance to play catch-up. Many major US banks are already in compliance.

This narrative complicates usual regulatory capture stories. For example, if US firms push US regulatory authorities to impose stricter regulations in order to lock in an advantaged market position, should those who favor the regulatory state approve? Well, that's a tricky one isn't it. But this tends to happen following regulatory innovations: incumbents are advantaged, while new entrants and possible competitors are disadvantaged. And indeed, the Too Big To Fail banks have only gotten bigger since the crisis.

This is something that a political economy approach can, and does, help us understand.


Emmanuel said...

Geithner doesn't strike me as sinister, either. Misguided perhaps, sinister no.

BTW, I am concerned that an Edward Elgar hardcover costs $245 [!?] Is your upcoming edited volume which I have a contribution to going to cost that much? Certainly I cannot afford it...

Kindred Winecoff said...

My impression is that EE's model is to publish many of these Research Handbooks, often in niche areas. They can't sell them to a wide enough audience to make their money back, so they market libraries primarily. Hence the high prices.

Contributors should get a free copy, however.

Update on FinReg Politics




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