Streetwise Professor

No, it’s not that both can make you cry.  It’s that if Sen. Blanche Lincoln (D-AR), chair of the Senate Ag Committee has her way, futures trading on both will be banned.  Onion futures have been banned since 1958, and the passage of Public Law 85-839 (legislation spearheaded by Gerald Ford, by the way).  Since that time, onions have had the dubious distinction of being the only commodity in which futures trading is specifically banned.  Now, the draft of Lincoln’s derivatives regulation bill would give onions company, by proscribing futures trading on “motion picture box office receipts, or any index, measure, value, or data related to such receipts.”

Now you could make a case–a weak one, but a case nonetheless–for the onion ban.  There were periodic manipulations of onion futures in Chicago.  Onions are perishable, and short sellers would sometimes bring in a few extra carloads of onions and deliver them.  Due to the perishability, a modest enhancement in supply would crater the price, generating a profit for the futures short.  There are stories that the price of onions would fall below the cost of the bags they were delivered in.

That said, empirical studies of the effects of the ban have shown that the ban did not reduce the volatility of onion prices.  Thus, the ban didn’t have any measurably beneficial effect.  But the CME (where onions were traded) has moved onto other things, and the market isn’t big enough to make it worth anybody’s while to lobby Congress to get the ban lifted.  So it has remained, a quaint curiosity.

Given that movie futures haven’t even started to trade yet, dire stories of adverse effects are, pardon the pun, mere speculation.  But a visible, connected, and influential interest group, that just happens to give Democrats in particular large sums of money, supports a ban.  So it made it into Lincoln’s bill, and into the news, ironically, on the day that the CFTC gave initial approval for such contracts.

But oh, were this the worst part of the bill.  As it is, it is merely a visible, risible, symbol of just how bad the bill is.  I will blog more on it later, but it has all the bad things in the Dodd and Frank bills, and much more to boot; it is the Dodd bill on steroids–or meth.  It is chock-full of anti-bank populism.  Most notably, it precludes any swaps dealer from having access to the Fed window.  As if banks can’t get themselves in financial trouble the old fashioned way, with no derivatives involved.

(It would be interesting to hear an explanation of how, if derivatives dealing is as obscenely profitable as Timmy! and Gensler and various Congresspeople argue, depriving banks of this revenue is going to make them healthier and less likely to require government help.)

Moreover, although the Lincoln bill mandates clearing, and offers only very limited exemptions from the clearing requirement, it also denies clearinghouses access to the discount window.  Even those broadly supportive of wider use of clearing recognize the potential systemic issues, and recommend that clearinghouses have access to central bank liquidity facilities.  But Stella–I mean, Blanche–thinks differently.  (Maybe somebody should tell her about the near death of the CME and CBT clearinghouses on 20 October, 1987.)

Let’s see, Congress  creates systemically important institutions that concentrate risk by mandating clearing, and then deprives them of access to the lender of last resort whose responsibility is to provide liquidity to systemically important institutions in times of crisis.  Just how is that supposed to work?

It was widely thought that Lincoln’s bill would be more moderate than Dodd’s but the reverse turned out to be true.  Some reporting suggests that she was near a compromise with her committee’s ranking Republican, Saxby Chambliss, but that the White House pressured her to back off.  The administration certainly made derivatives regulation a centerpiece of its rhetoric last week, and has evidently decided that anti-bank, anti-derivatives populism is a winning political issue that will put Republicans in an uncomfortable position.  Lincoln is in trouble in her re-election bid, so she could use the populist cred too.

It has all the appearances of a good cop-bad cop routine.  Don’t like the Dodd bill?  Just look how bad the alternative is.   Sad to say, I think that this means that the Dodd bill, or something close to it, is likely to become law.

As derivatives legislation wends its way through the Senate, with the Dodd bill and another being written in the Senate Ag committee, the battlelines are pretty well drawn.  The administration in particular is still on the clearing bandwagon, and is overtly hostile to any proposals to exempt end users from the clearing requirement.  The most strident rhetoric on this issue emanates from Gary Gensler (go figure), but also from Treasury.  Deputy Treasury Secretary Neal Wolin said: “we will oppose all attempts to create loopholes or carve-outs.”

By “carve outs,” he is referring to end user exemptions, primarily.  Which is all so ironic.  If you think through how clearing works in futures markets, it is primarily a mechanism to shift default risks from end user customers (the buy side) to the clearinghouse members.  That is, it is a customer protection institution.  But here many customers are adamantly opposed.  Thus, there must be some costs that offset–and indeed, more than offset–the benefits associated with this customer protection.

But instead of an effort to step back, and ask “why” and consider in an intellectually serious way what are the costs and benefits of clearing, the administration and many on Capitol Hill plunge ahead.  When they attempt to explain end user opposition at all, they stoop to asinine conspiracy theories.  Gensler, for instance, attributes the end user opposition to their being waterboys for the dealer banks.

Yeah, Caterpillar, etc., are just creatures of the banks.  Whatever, Gary.

But this is all so odd.  Gensler argues that the dealer banks routinely rape their customers, by exploiting the purported lack of transparency in the OTC market to extract supercompetitive spreads.

So, why would the rape victims (in one of Gensler’s narratives) be the willing supplicants of the banks (in another)?  Stockholm Syndrome?  Battered Spouse Syndrome?

Can we please have a serious discussion, with some serious analysis of trade-offs, rather than these dueling, and facially inconsistent, morality tales?

Yeah, I know.

But I will say that in Europe they are being far more serious and adult.  (And it kills me to have to say that.)  For instance, Jeremy Grant reports that European regulators recognize the legitimacy of end user concerns:

Industrial companies have won recognition from European regulators that they should be granted exemptions from sweeping regulation of the over-the-counter derivatives markets.

It marks a partial victory amid fears that a crackdown on off-exchange derivatives markets, blamed by some for exacerbating the financial crisis, could unfairly penalise corporate users of such instruments.

. . . .

In a “discussion paper” from the European Commission’s directorate general for internal markets, regulators say that “in principle, non-financial institutions could be exempt from the clearing obligation”.

It says the main mechanism for transferring risk to the real economy during the crisis was through the financial sector. “This suggests that the appropriate boundary for a clearing obligation is between the financial sector and the non-financial sector.”

Richard Raeburn, chairman of the European Association of Corporate Treasurers, said: “This suggests that [the Commission] supports the need for an exemption for non-financial users. It is certainly the first time that we’ve seen such a clear statement.”

Eact in January sent a letter to Brussels, signed by 160 companies, warning that without exemptions there could be “a reduction in the amount of funds allocated to productive investment in the [European] economy”.

Just how to structure the exemption is still under discussion.  But at least there is a recognition that there are serious issues that deserve serious discussion.

Could somebody in Europe pick up the clue phone and give Gensler and Wolin and Dodd a call?

Grant also reports that the Europeans recognize that clearing is not the deus ex machina that will descend from the heavens and solve all the systemic risk problems.  Indeed, they understand that clearinghouses can create systemic risks, and hence it is advisable to proceed carefully in ordering a new market structure by fiat:

Watchdogs are concerned about the possibility that proposed linkages between clearing houses could pose fresh dangers to the financial system.

They fear two-way or three-way linkages between clearers could trigger a domino effect if one clearer was to default.

What?  You mean that clearing doesn’t eliminate interconnections in the financial system?  Who knew?  (I know who doesn’t know, sad to say.)

In fact, contrary to the bologna constantly ground out by Timmy! and Gensler et al, clearing creates a particular interconnection among financial institutions–the same financial institutions (by and large) that are too interconnected today in the OTC market.  Multiple clearinghouses creates another set of linkages.  These can by systemically problematic.

The Europeans haven’t sorted through all these issues yet.  But at least they recognize them.  We, alas, are governed by know nothings masquerading as know it alls.

Which suggests a new administration spokesman on derivatives market regulation.

Barney Frank stomped his little feet in anger at the fact that his former senior staffer Peter Roberson decamped to become a lobbyist for ICE.  Frank has barred Roberson from contacting staff for as long as he is head of the Committee.  House rules preclude Roberson from contacting staff for a year.  Wouldn’t it be sweet, I mean ironic, if the the year long bar, rather than the as-long-as-Frank-chairs-the-committee restriction turned out to be the binding constraint?

I had some dealings with Roberson late last summer.  He contacted me about my interest in, and availability for, testifying about OTC derivatives in front of the House Banking Committee.  I indicated that I would be interested and available, but about a week later Roberson told me that Frank did not want me to testify.  (Imagine that.)

Said personal rejection by Frank I wear as a badge of honor.

Economics of Contempt makes a point that I’ve advanced for well over ten years now (including fairly recently in a guest piece at FTAlphaville.) Namely, that clearing depends on price transparency and liquidity to work; it does not create these things.  Clearinghouses consume price transparency and liquidity–they don’t create them.

Moreover, trying to clear things for which price information is lacking due to a lack of trading can create systemic risks, rather than reduce them.  CCPs can’t price risks adequately for illiquid products.  Moreover, they have a very difficult time of managing the risks of any defaulted positions in illiquid products.  This means that taking on exposure to these products puts the CCP at risk, which, in turn, creates the potential for a clearinghouse failure, an eventuality that EoC “would rather not see . . . in [his] lifetime.”  Having stared it in the face (in 1987), I concur wholeheartedly.

EoC echoes another frequent SWP argument, namely the chronic misinterpretation of the AIG debacle.  He notes that contrary to what is commonly stated, AIG’s positions WERE collateralized, and indeed, it was the collateralization mechanism that was the proximate cause of the firm’s demise.  Those who flog the clearing solution really, really, really need to spell out how having AIG pay variation margin to a CCP, instead of Goldman and Deutsche Bank and French banks, would have made any substantial difference whatsoever.  (See the post “It’s a Wonderful Life: AIG Edition” for my statement of this argument.)  Indeed, it could have made things worse.

It should also be emphasized that collateralization is often the positive feedback mechanism that creates systemic events; big collateral/margin calls in the aftermath of big market moves lead to liquidation of positions, which moves prices more, which weakens the financial position of those affected by the initial price moves more, etc. Geithner and Gensler and others suggest that more, and more rigid, collateralization (via a clearinghouse) unambiguously reduces systemic risk.  Not so.  It is more plausible to say that collateral can mitigate some moral hazards, and can be a way of pricing some risks, and can be a way of mitigating one-off, non-systematic defaults.  But it can also be the doomsday machine that accelerates the spread of financial distress.

The Futures Industry Association, a trade group for futures commission merchants and exchanges, has come out strongly in opposition to the CFTC’s proposed energy position limits.  The most interesting thing to me about the FIA letter is the fact that one of the central pillars of its argument is similar to an objection I’ve been raising for some months: specifically, that the CFTC doesn’t have a legal leg to stand on because (a) Congress has authorized the CFTC to impose limits when “it is necessary to diminish, eliminate, or prevent” the “undue and unnecessary burden” of “excessive speculation” that causes “sudden or unreasonable fluctuations or unwarranted changes in the price” of any traded commodity, but (b) CFTC has made no finding that excessive speculation that causes unreasonable price fluctuations exists, or has existed, in energy products.  Indeed, it’s worse than that.  CFTC’s attitude has been “we don’t got to show you no steenking evidence.”  CFTC, and notably Chairman Gensler, have also invoked repeatedly the idea that concentration is a danger that should be controlled through position limits.  But the Commodity Exchange Act is silent on concentration in this context.

The FIA letter is quite blunt: “Substantively in the absence of the ‘necessary’ finding, the CFTC lacks the statutory authority to adopt position limits.”  FIA also states that “[t]he ‘excessive concentration’ and ‘uncontrolled speculation’ themes the CFTC cites are both factually unproven and legally irrelevant.”  The letter states further that the “‘excessive concentration’ focus is misguided.”  I agree with all this, and have said and written as much over the past year (or more).  I further agree with the FIA’s statement that “FIA is not aware of any convincing or even credible evidence that large traders with speculative positions in energy futures markets have trumped fundamentals as the determining factor in energy futures prices.”  (Emphasis in original.)  Again, agreed.

To summarize, like the FIA, I believe that the CFTC position limit proposal is unjustified and legally dubious.  It is unjustified because there is no credible evidence, or logical argument even, that speculation has distorted prices.  It would be nice to make policy on the basis of, you know, evidence, wouldn’t it?  (Isn’t this the administration that said it was going to base policy on science, not politics?)  It is legally dubious because the CFTC’s authority to impose limits is not absolute.  The CFTC can impose limits pursuant to a particular purpose laid out in statute, but the CFTC’s justification for its proposal (a) does not show that its limits are in fact necessary to achieve that purpose, and (b) includes considerations that are altogether absent from the statute.

This is regulatory overreach based on no evidence.  Other than that, it’s great!  Kudos to the FIA for joining me in pointing that out.

In an uncharacteristically dyspeptic opinion piece on his newsletter, John Lothian concludes that CFTC Chairman Gary Gensler has his eye on something more than Chairmanship of what has long been an also ran among Federal agencies:

There has been talk in Washington, Chicago and in the media that Gary Gensler has ambitions to become the next Treasury Secretary should Tim Geithner’s reputation continue to take a beating and be force out.  It has been written, said and whispered that he is positioning himself for this promotion.  After seeing him in action at Boca, I tend to agree with this assessment.  We have had short-timer CFTC Chairmen before, with ambitions for greater jobs.  One only has to think of Reuben Jeffrey, who was mailing it in as CFTC Chair shortly after being named to the position, or so it seemed at the time.

To which I say: well, yeah.  When asked by a reporter for my appraisal of the CFTC commissioners last August, I wrote that it was pretty clear that Gensler had his eye on Treasury.  It’s only become clearer since then.

And in his campaign, Gensler is willing to say anything–anything–even if it is misleading, or untrue.  Consider what he said in an interview with Jeremy Grant at the FT (available here, for now, anyways): “The dealers collectively nearly burned down the financial system . . . . We know that.”

It is no doubt true that firms that are dealers, namely Lehman and Bear, failed, thereby shaking the financial system to its foundations.  We know that other firms that serve as dealers dealt with AIG (which was not, as commonly understood, a dealer), and that these dealings played some role in AIG’s bailout (exactly what role none of the principals involved will state forthrightly or consistently).  We know that other firms that serve as dealers, such as Citi and BofA and Merrill, were in desperate financial trouble.

But it is misleading, and a non sequitur, to assert that these events justify the kinds of regulation that Gensler is flogging endlessly in purple prose.  For once, I would like Gensler to state specifically what these various dealers did, qua dealers, that put the financial system at risk, and how the proposed regulations would address this behavior.

Again: read the Valukas report on Lehman.  The catastrophic investments that Lehman made involved pretty much everything but its OTC derivatives business (which was in the black to the tune of $21 billion).  Residential real estate, commercial estate, CDOs, private equity, leveraged loans, you name it.  Merrill and Citi and BofA were also torpedoed not by their activities as OTC dealers, but as underwriters of and investors in CDOs and other real estate related investments.

It is a bait-and-switch to say that “dealers” cratered the financial system to justify regulation of dealer activities.  Doing so suggests that it was the OTC dealing activities that were the root of the problem, when they clearly were not.

But, you might argue: OTC derivatives dealing creates interconnections between firms that can communicate financial contagion.  It is definitely true that the events make plain something I’ve flogged myself for well over a year: namely, that balance sheet risk arising from other investments and activities is an important determinant of the default risks posed by any dealer firm.  But it is just this kind of risk that clearinghouses do not and cannot price, nor effectively control.  And it is just this kind of risk that can be spread to big financial firms via their interconnection through a clearinghouse.  Clearing does not make interconnection go away: it reconfigures the interconnections, and does so in ways that can be riskier, not safer.

So, balance sheet risk is arguably a problem, but clearing is quite definitely not the solution; exchange trading and post-trade price transparency are even less relevant to this problem.  Indeed, it can make the balance sheet risk problem worse, and will do so IMHO.

It is, in short, perfectly consistent to excoriate the banks for what they did (and sadly, for what some continue to do) while opposing the proposed regulations of OTC derivatives.  These banks are big, complex, and engage in a wide variety of activities.  Some of the risks that banks ran proved ruinous, or nearly so.  But the OTC  dealing activities are not high on the list of those risks, if they are there at all.  But that doesn’t stop Jeremiah (or is it Ahab?) Gensler.

And a shout out to Stacy-Marie Ishmael at FTAlphaville who joins me in mocking (though she is more gentle in her mocking than me) Gensler’s fondness for metaphors over-the-top, mixed, and just plain wrong*.  But literary merit–not to mention fairness or accuracy–is of little moment when there is a political battle to be fought–or a cabinet post to be won.

* I am still chuckling over the Mrs. O’Leary’s cow Genslerism.  It is the perfect metaphor for him to use.  Like much of what Gensler peddles, the story of Mrs. O’Leary’s cow was a complete myth.

The clearing debate is getting more complicated, with major brokerages/FCMs clamoring to be admitted to OTC derivatives clearinghouses:

MF Global Holdings Ltd., Hexagon Securities LLC and at least 19 other financial firms are pressing regulators to force swaps clearinghouses to lower entry barriers in order to improve competition in a $605 trillion derivatives market dominated by the world’s biggest banks.

Brokers formed an association last month that hired a Washington-based law firm to pursue the issue with lawmakers and regulators, said Mike Hisler, a partner at New York-based Hexagon. They also seek tougher conflict-of-interest laws to ensure that a bank’s derivatives desk doesn’t influence clearinghouse decisions that could shut out new competitors.

There are numerous issues here that cut in different ways, and make policymaking treacherous.  Indeed, these are issues that I have raised in some of my academic work.

One issue is market power.  I’ve shown that in the presence of substantial scale and scope economies (which definitely exist in clearing), a coalition of intermediaries can form a cooperative firm to provide these services that is (a) smaller than optimal, and (b) immune to competitive entry.  The basic idea is that by adding just enough members to ensure that any other competing effort does not have the scale or scope to compete, this decisive coalition (which consists of the most efficient suppliers, e.g., the big dealers) can reap market power rents even if the cooperative itself charges marginal cost prices.  So, it is potentially problematic to permit a clearing cooperative firm to limit membership.

But there is another issue.  The whole idea behind a clearinghouse is to mutualize risk and, hopefully, to reduce systemic risk.  Admitting anybody willy-nilly is contrary to these goals.  Permitting less financially solid, not to say dodgy, entities imposes costs on the more solid ones, unless those risks can be priced effectively.  But, as I’ve argued extensively, clearinghouses typically do not have the information or the incentive to price the balance sheet risks of members properly.  Moreover, since the price setting process will inevitably be political in such an organization, it is likely (for reasons similar to what Peltzman described in his famous JLE ’75 article on regulation) that the prices will transfer wealth from the efficient to the inefficient (i.e., from the low risk to the high risk).  (A median voter-style analysis leads to a similar result.) Thus, open entry is a recipe for moral hazard–and systemic risk.  And hence, more financially solid firms have an incentive to bridle at the prospect of being required to share risk with other entities.

Allowing anybody in also increases the heterogeneity of the membership, which makes governance more costly and cumbersome.

This is just another example of the dilemmas posed by the network-nature of financial markets generally, and clearing in particular.  Scale and scope economies make competition difficult, if not impossible; efficiently scaled-entities are very large relative to the total market, and arguably natural monopolies.  These scale and scope economies can be exploited to exercise market power by limiting entry.  But permitting open entry creates its own difficulties, especially in clearing, because member heterogeneity that is inevitable with open entry, and member heterogeneity can be expected to lead to cross subsidies.  In this context, that means that some risks are underpriced, and riskier firms can expand and the expense of less risky ones.  That hardly comports with the putative objective of forcing more things onto clearinghouses.

In their rush to find a “solution” and the resulting embrace of clearing, regulators and legislators have largely ignored these very real challenges.  Mandating an expansion of clearing, and micromanaging the organization and governance of clearinghouses (as Gensler has advocated, and as the Lynch Amendment does), will involve unintended consequences.  These consequences will almost certainly undermine the ostensible objectives of these initiatives.

Again: Fools rush in.

The Valukas report on Lehman makes for interesting reading.  One of the most interesting things in the report is what isn’t in it: specifically, OTC derivatives.  Given the hyperventilating over the role of OTC derivatives in the financial crisis, this is quite important news.

Yes, OTC derivatives are mentioned, but in only the most perfunctory way.  Valukus concludes that Lehman’s methods for valuing its OTC derivatives was sound, and that alternative valuation methods gave very similar estimates of the value of Lehman’s positions.  Moreover, he notes that Lehman’s OTC derivatives positions were in the money to the tune of $21 billion, which represented only about 3.3 percent of the firm’s assets.  And that’s about it.

It is clear that the OTC derivatives were not the problem with Lehman.  Indeed, they were arguably the only thing that WASN’T a problem with the firm.  The huge losses were in residential real estate-related positions, commercial real estate, private equity, and leveraged loans.

Even the collateral and contagion issues were associated with other activities, notably repo funding.  In this regard, its interesting to note that, unsurprisingly, the mechanism that is often held out as the way of protecting the safety of the system—collateral—is actually what fed the death spiral.

The report also should open some eyes about the other supposed magic bullet—clearing.  Valukas concludes that there is a colorable case against the CME to claw back losses that resulted from the sale at a deep discount of Lehman’s house positions with the CME clearinghouse.  Valukas states, however, that preemption under the Commodity Exchange Act, the immunity of self-regulatory organizations, and the safe harbor provisions of federal bankruptcy law may shield the exchange from these claims.  I don’t know much about the first two things, but based on my knowledge/experience it is very plausible that the safe harbor provisions would apply here.

But that’s not the main thing of interest here.  It is evident that the Lehman bankruptcy posed risks to the CME clearinghouse, and hence its members.  After finding out about the impending bankruptcy, the CME ordered Lehman to trade for liquidation only, but the firm added to its positions over the next couple of days.  Moreover, the exchange failed in its initial attempt to get members to buy Lehman’s positions in bulk; it decided on this approach after concluding that liquidating the positions on the open market would have been extremely disruptive, given their size and the chaotic conditions in the market.  Several days later the positions were auctioned in bulk, but only at a steep discount.  Resolution of the problem clearly stressed the CME.  (There’s nothing in the report about what happened with SwapClear.  It would be interesting to know more about that.)

Note that the CME clearinghouse was at risk while these positions were still held at Lehman.  The risk posed by these positions didn’t magically disappear.  Moreover, note that what sparked the crisis was Lehman’s balance sheet risk, not the risk of its cleared positions.  This is the kind of risk that clearinghouses have little ability to measure, manage, or price.

In the end, the CME worked through the problems, though there were doubtless some sleepless nights.   Yes, the clearing process worked, but so did the OTC market.  The point is that the failure of a big member posed a big risk to the clearinghouse—and hence its members.  Clearing doesn’t make risk go away, or eliminate systemic risk.

In brief, the Valukas report on Lehman does not comport with the received narrative of the crisis, in which OTC derivatives play a central, and malign, role, and in which clearing is the panacea.  The narrative is so entrenched, however, I doubt that the facts will make any difference.  It will be interesting to see whether the Usual Suspects acknowledge this reality.  I am not holding my breath.

I’m just back in Houston from speaking at a conference at the Columbia Law School, titled “The Financial Crisis: Can We Prevent a Recurrence?”  It was probably the best conference I have ever attended.  It was a gathering of a truly talented group of academics (mainly legal scholars, but some economists), practicing lawyers, finance practitioners, central bankers (US and non-US), and government folks, all of whom offered excellent insights on various aspects of the crisis, and policy responses to it.  The organizers, Jeff Gordon of Columbia and Howell Jackson of Harvard Law School, are to be congratulated for putting on a phenomenal event.  It was a privilege to participate.

I spoke on clearing.  (Go figure.)  My remarks were well received, I think.  Robert Pozen of MFS Financial Management said in his remarks that he didn’t agree with a lot of what I had to say, but that any supporter of mandated clearing (which he is) had to take my critique seriously, and address the concerns I’d raised.  Which is quite fair.  I don’t claim to have all the answers, but I think I have good questions, and hope that posing them will contribute to the formulation of better policy.  (I started my talk with Hayek’s quote “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”  I think that some in policymaking circles think they know far more than they do about the systemic implications of clearing, and all I aim to do is what Hayek says economists should do.)

The conference finished up with a session on “Radical Solutions.”  Charlie Calomiris and Luigi Zingales gave very interesting talks that echoed two major SWP themes, namely that too big to fail is the result of governments’ inability to commit credibly not to bail out, and that the ultimate source of moral hazard and the excessive growth of financial institutions is that their creditors are convinced that they will be bailed out, and hence are willing to lend on terms that do not reflect risk.  They offered interesting proposals to address these problems.

One thing that struck me throughout the event is the widespread belief that financial reform efforts are dead in the water.  Some considered that unfortunate.  Others, including yours truly, were not so negative; not that I/we don’t believe that some sort of reform is needed, just that the alternatives on offer are likely to be counterproductive.

Today’s luncheon speaker was Henry Hu, a University of Texas law prof now heading up the SEC’s new Division of Risk, Strategy, and Financial Innovation.  I don’t always agree with Henry–I have criticized his analysis of the “empty creditor” problem, for instance–but he is obviously a thoughtful man who is bringing tremendous energy and enthusiasm to his DC job.  In his talk, he asked the audience to let him know whether they observed any new product or trading strategy that threatened to destabilize the financial system.  That’s fine, but I would also hope that he would be equally alert to regulations or legislation that could have deleterious effects; and be particularly alert to the creation of policies that could encourage the development of problematic strategies and products in direct response to such policies.

Friday’s dinner speaker was Simon Johnson.  I have an extremely mixed reaction.  I share his concern about too big to fail, and the potential for legislative and regulatory capture by the finance industry.  But given that I consider much of the proposed legislation to be counterproductive, unlike Johnson I don’t believe that it is axiomatic that bank opposition to this legislation is an outrage.  His is a very Manichean world view, with big finance as the epicenter of evil, and those who fight big finance as the avatars of goodness.  Not quite that simple, IMHO.

It was weird, to say the least, to hear someone channeling Andrew Jackson in a Brit accent.  He started out talking about TR taking on the trusts, and FDR taking on the banks, but I was thinking that his real hero should be Andy Jack.  Sure enough, a few minutes later he said that the true first opponent of financial oligarchy was Jackson.

Again, I have some sympathies; much of Jackson’s critique was correct, as is some of Johnson’s.  But much of Jackson’s criticism was misguided, and what’s more, the system that he advocated to replace the corrupt Second Bank of the US was plagued by chronic instability and crisis.  Johnson was less than candid about Jackson’s banking legacy: he would only admit that the post-Jackson banking system was “complex.”  But to admit that a previous populist response to concentrated financial power was hardly ideal would undermine Johnson’s populist jeremiad against today’s concentrated financial power.  That failure to confront the possibility that a populist reaction can be destructive undercuts Johnson’s credibility in my eyes.

Johnson’s tone was also extremely off-putting.  It was snide and arrogant.  He came off as a populist provocateur poseur.  Not particularly appealing.  But worth hearing nonetheless.

At the conference, there was a lot of agreement about the underlying causes of the crisis.  There was, however, less agreement about policy responses going forward.  That’s not surprising, but given the caliber of the people at the conference, it does suggest that we are in for a long debate over policy going forward.

And while I was at the Columbia conference, SWP daughter Renee was at a conference at Texas A&M, sitting 10 feet from George H. W. Bush and Barbara Bush.  And someone really important: Chuck Norris.  And she lived!  (He gave the death glare to one of her friends who was laughing too hard at something.)  Nobody quite that famous at Columbia, but it was worth the trip nonetheless.

My testimony at trial (in Chicago) in Trading Technologies v. eSpeed was quoted in the Court of Appeals for the Federal Circuit’s decision on the case.  I testified on behalf of TT.  The good guys won, at trial, and before the Federal Circuit.