The first decade of this century proved how essential effective regulators are to prevent economic catastrophe and epidemics of fraud. The most severe failure was at the Federal Reserve. The Fed’s failure was the most harmful because it had unique authority to prevent the fraud epidemic and the resulting economic crisis. The Fed refused to exercise that authority despite knowing of the fraud epidemic and potential for crisis.
The Fed’s failures were legion, but five are worthy of particular note.
- Greenspan believed that the Fed should not regulate v. fraud
- Bernanke believed that the Fed should rely on self-regulation by “the market”
- (Former) Federal Reserve Bank of New York President Geithner testified that he had never been a regulator (a true statement, but not one he’s supposed to admit)
- Bernanke gave the key support to the Chamber of Commerce’s effort to gimmick bank accounting rules to cover up their massive losses – allowing them to report fictional profits and “earn” tens of billions of dollars of bonuses
- Bernanke recently appointed Dr. Parkinson as the Fed’s top supervisor. He is an economist that has never examined or supervised. He is known for claiming that credit default swaps (CDS) (the financial derivatives that destroyed AIG) should be unregulated because fraud was impossible among sophisticated parties.
Each error arises from the intersection of ideology and bad economics.
The Fed’s regulatory failures pose severe risks today. Three of the key failed anti-regulators occupy some of the most important regulatory positions in the World. Each was a serial failure as regulator. Each has failed to take accountability for their failures. Last week, Dr. Bernanke asserted that bad regulation caused the crisis – yet he was one of the most senior bad regulators that failed to respond to the fraud epidemic and prevent the crisis. As Dr. Bernanke’s appointment of Dr. Parkinson as the Fed’s top supervisor demonstrates, the Fed’s senior leadership has failed, despite the Great Recession, to learn from the crisis and abandon their faith in the theories and policies that caused the crisis. Worse, the Fed is an imperial anti-regulator, seeking vastly greater regulatory scope at the expense of (modestly) more effective sister regulatory agencies. The Fed’s failed leadership is setting us up for repeated, more severe financial crises.
Dr. Parkinson as Anti-Regulator
This essay focuses on Chairman Bernanke’s recent appointment of Dr. Parkinson to lead the Fed’s examination and supervision. My central point is that Dr. Bernanke appointed Dr. Parkinson because he shared Dr. Bernanke’s anti-regulatory ideology and has never changed those views even in the face of the Great Recession. The anti-regulator policies that Bernanke and Parkinson championed were the principal drivers of the fraud epidemic that have produced recurrent, intensifying crises.
Bernanke’s appointment as the Fed’s top supervisor of an individual that had no experience in regulation, in the midst of the greatest crisis of our lifetime, is irresponsible and dangerous on its face. No ideology has proven more disabling in this crisis than neoclassical economics. Dr. Parkinson is a neoclassical economist. The “skills” an economist would purportedly bring to supervision have proven to be disabilities in identifying and understanding fraud and risk.
We need not rely on generalities – Dr. Parkinson has a record relevant to supervision that we can evaluate. The most revealing aspects of that record fall into three categories. First, Dr. Parkinson was a leading proponent of the obscene (and successful) effort to prevent CFTC Chair Born from taking regulatory action to prevent destructive credit default swaps (CDS). Second, Dr. Parkinson, like Greenspan and Bernanke, subscribed to the naïve view that fraud was impossible in sophisticated financial markets and that credit rating agencies were reliable. Third, Dr. Parkinson endorsed the international “competition in regulatory laxity” that Dr. Bernanke (belatedly) warned has degraded regulation on a global basis. Here are the key passages from Dr. Parkinson’s congressional testimony:
Professional counterparties to privately negotiated contracts also have demonstrated their ability to protect themselves from losses from counterparty insolvencies and from fraud. In particular, they have insisted that dealers have financial strength sufficient to warrant a credit rating of A or higher. This, in turn, provides substantial protection against losses from fraud.
If this opportunity is lost, the Board is concerned that market participants will abandon hope for regulatory reform in the United States and take critical steps to shift their activity to jurisdictions that provide more appropriate legal and regulatory frameworks.
The “opportunity” Dr. Parkinson feared would be “lost” was to remove the CFTC’s ability to regulate CDS. Anti-regulation would “win” the international competition in laxity. His policies made possible the catastrophe that is AIG. Dr. Bernanke is aware of Dr. Parkinson’s record of anti-regulatory failure. He chose Dr. Parkinson because of that record in order to ensure that the Fed would not take regulatory actions that would upset the biggest banks, particularly the systemically dangerous institutions (SDIs) that are the real governors of the Fed’s anti-regulatory policies.
The financial industry is highly regulated and controlled, one of the most regulated in the world. To suggest that it is lack of regulation that is the cause of a problem is at best to admit ignorance in one's subject. Don't forget either, the decades old push to expand home ownership and lower credit standards. Then the Fed pumped money into the system all decade. Wake up and be honest.
The FED doesn't have enough power. It's power should be commensurate with it's responsibilities.Regulatory and supervisory decision-making processes should lie entirely with the Board of Governors, and that the Board should be reconstituted to include the Secretary of the Treasury, the Comptroller of the Currency, the Chairman of the Federal Home Loan Bank Board, the Director of the Federal Deposit Insurance Corporation, the Director of the Office of Thrift Supervision, the National Credit Union Administration, the Securities Futures Commission, and the Chairman of the Securities and Exchange Commission, etc.
C.W. you are undoubtedly making an ideological argument. You are in essence saying things are fine because there is regulation move on. You don't go any deeper to ask, how effective are the regulations? Are there regulations in the right places? Are the regulations effectively being enforced? Unfortunately, a lot of the policy makers had the notion that self-regulation was occurring, and there is no problem. That turned out to be false. Watch the clip of "No to Born, No to Regulation" here. http://www.pbs.org/wgbh/pages/frontline/warning/cron/ What I am saying is not the least bit controversial. Dr. Black is hardly ignorant, he is a professor and used to be a deputy director at the former Federal Savings and Loan Insurance Corp during the S&L crisis of the 1980s.
@ C.W….Clearly someone has stumbled onto this blog and Dr. Black's contributions without performing some "background." I'm not even an accountant by trade, but I do know that a leverage ratio of 35:1, common to many of the larger risk takers, creates an insolvent balance sheet. I also see the rationale behind Mr. Black's "accounting control fraud" explanations."Lower credit standards" is one thing….outright fraud in the underwriting and issuance of mortgages is another.It appears that the regulators of which you write, have been asleep at the wheel….or non-existent.