Warranted Criticism

Four years ago this month, after encountering severe financial difficulty, Bear Stearns was acquired in a fire-sale merger by JPMorgan. Three years ago today, Congress announced they’d hold hearings a week later regarding fair value accounting—a hearing which ultimately pressured the Financial Accounting Standards Board to revise the rule. Four days after Congress’ announcement, the 2007-2009 bear market ended.

While it’s quite a stretch to pin the entirety of the financial crisis on fair value accounting, the disastrous impact on banks holding illiquid assets like mortgage-backed securities (MBS) seems to have played a material role. And fair value combined with seemingly random decisions made by the US government—regarding which firms to bail out and which not to, what to do about TARP and what to do with it—seem likely to have been major drivers of the bear market.

To be sure, the housing market was weak, and some banks were overextended. But absent haphazard government policy—on the part of regulators—and a negative feedback loop created by fair value standards, it seems likely there would have been materially less uncertainty and distortion. History might look very different, though it’s impossible to know exactly how.

But that’s not the story some regulatory proponents would like you to hear. Instead, they suggest a deregulatory era (that we can find little if any statistical evidence of) left regulators without necessary tools to defang the panic. This drives suggestions banks and other interested parties should stand down criticisms and challenges as the government tries to create said tools now—principally under Dodd-Frank. Essentially, they propose granting more leeway to regulators.

Competing versions of what happened in 2008 and after will always and forever exist. However, we caution against taking the “banks were under-regulated” version at face value. Many regulators labeled MBS and the like “toxic assets” then. And maybe they were—for a very short while. These same assets have contributed to record Fed profits the last few years, calling the moniker into question. Similarly, the government just booked a $2.8 billion profit on AIG debt—money we’re told is “taxpayer” gain. (No word on when you can expect your check. Maybe it’s in the mail.)

The simple fact is regulators had plenty of power to make different decisions than they did. But they didn’t, and Dodd-Frank does nothing to make them any wiser. It’s just a new set of rules, written by politicians (as all regulation is). What’s more, 18 months after Dodd-Frank’s passage, fewer than a quarter of the mandated rules are written. Maybe those charged with drafting said rules aren’t so convinced a regulatory reshuffling is as high a priority as many alluded to at the time. (A political ploy to be seen as having “done something,” perhaps?)

Or maybe—and understandably—dissecting a complex tome of rules, directives and studies takes a bit of time. Especially considering the broad, sweeping nature of the law. Not all of it even targets indentifying and curing the root cause of the credit crisis. After all, Dodd-Frank brought the Consumer Financial Protection Bureau and the Durbin Amendment, two creations utterly unrelated to the financial crisis—unless, that is, you’d like to argue payday lending and overdraft and debit-card swipe fees caused the panic.

From our vantage point, a great strength of America’s rulemaking process is interested parties can comment and legally challenge proposed rules. Kowtowing and ceding carte blanche authority to regulators doesn’t necessarily reduce risk. More regulation is no panacea—it potentially increases uncertainty and creates different kinds of future, unanticipated risks. To disregard this implies regulators have both the power and necessary knowledge to essentially outthink markets. History says otherwise, and we strongly doubt the future is so very different.

With all due respect, we’d suggest regulators shelve the browbeating and let the rulemaking process move forward as is. If the government’s proposed rules are actually fair, reasoned and wise, they should be able to withstand criticism and legal challenge. If not, chances are they shouldn’t be in force to begin with.