Battle Inside Fed Rages Over Bank Regulation (WSJ)

Monday, March 8, 2010

By JON HILSENRATH

The worst of the banking crisis may be long over, but the political contest over the Federal Reserve is entering a crucial phase in which its personality and role will almost certainly be redefined.

The Fed has tried to fend off very public efforts in Congress to strip it of responsibility for regulating America’s banks, but a less-visible battle has been playing out inside the central bank. The Fed has undertaken a wrenching reorganization of its army of 3,000 bank supervisors, which has centralized more power in Washington and sometimes pitted officials at the 12 regional Fed banks against those in the capital.

Fissures at the central bank boiled over last year in a meeting in the boardroom of a Fed branch office in Memphis. The presidents of the regional banks, which dot the country from Boston to San Francisco, complained to Fed Vice Chairman Donald Kohn that the Fed’s Washington bank-supervision group was adrift and not providing the district banks needed guidance on how to navigate a worsening banking crisis. Soon, though, Washington was more involved than ever. In one example: The Atlanta Fed was subjected to an especially thorough critical review of its performance as a regulator because of the large number of bank failures in the Southeast. 

“The stress level of the past few years has been pretty high,” says William Estes, 60 years old, who retired as head of the Atlanta Fed’s bank-supervision group. The group has since been reorganized. “At a certain point you’ve just had enough.”

 Though partly a turf war, the fight over—and within—the Fed is much more than that. It is part of a broad battle over how America’s financial system should be regulated, still unresolved 18 months after it stood at the brink. The ultimate outcome could shape finance as much as anything since the 1930s, when the Federal Deposit Insurance Corp. was created, or the 1990s, when banks gained freedom to cross state lines and build trading desks to compete with Wall Street.

 The effort will influence how financial firms interact with the public, who decides how much risk they can take and ultimately how profitable they are. At stake, beyond that, are the Fed’s effectiveness in guiding the economy toward low unemployment and low inflation, and America’s ability to avoid financial crises in the future.

Getty ImagesFed Chairman Ben Bernanke

 Before 2008, regulators and Wall Street had convinced themselves that a quarter-century of financial innovation had made the system safer by dispersing risk; responsibility was best left in the hands of banks’ risk managers rather than regulators. Today, a new mind-set prevails in many quarters, including the Fed. It now is guiding commercial banks on everything from how to pay employees to how to adjust for risks in areas like commercial real estate and construction loans.

“We have been conducting intensive self-examination of our regulatory and supervisory responsibilities and have been actively implementing improvements,” Fed Chairman Ben Bernanke said last month, in a plea to lawmakers to preserve the Fed’s powers. He told the Senate it would be a “grave mistake” to dilute the Fed’s supervisory power, arguing that doing so would hurt the central bank’s ability to steer the economy and respond to financial emergencies.

Mr. Bernanke has empowered a recent appointee to the Federal Reserve Board, Daniel Tarullo, to make the Fed a more assertive and nimble regulator. “The regulatory system did not keep up with changes in the industry and with new financial products,” says Mr. Tarullo, a Georgetown law professor and former Clinton White House aide who was a critic of bank regulators before the crisis. “Our job is to go ahead, within our existing authority, with the development and implementation” of a better approach, he says.

 When the U.S. created a central bank in 1913, a hotly debated compromise left power divided among Washington, New York and the other district Fed banks. Washington’s authority later grew, but the district banks have continued to play a major role, especially in regulation. The Fed board of governors in Washington has given the district banks many day-to-day duties in overseeing 800 small state-chartered banks and more than 5,000 bank holding companies. Some 17,000 of the Fed’s 20,000 employees work at the regional Fed banks.

 Five years ago, one Fed governor sought to centralize supervision of the biggest banks in Washington. “I felt we were not being as effective as we could be,” says Susan Bies, who has since left the board. “We didn’t have a strong enough overall view of what was going on throughout the system.” According to several people involved in the discussions, her effort was beaten back by Timothy Geithner, then president of the Fed bank in New York, which oversees some of the largest banks. Mr. Geithner, now Treasury secretary, declined to comment.

The district banks straddle an odd public-private divide. The board of each has three directors representing local commercial banks, three nonbankers chosen by banks, and three directors picked by the Fed in Washington. The boards select the district banks’ presidents, in consultation with Fed headquarters. The bank influence on boards has spurred charges of a structural conflict of interest.

The president of the Fed bank in Kansas City, Thomas Hoenig, disputes that, saying the boards have no say in supervision and provide useful input on the economy. “It is important to have information from them,” he said, arguing that the structure creates checks and balances that serve the nation well.

An idea still alive in the Senate Banking Committee is to hand the Fed’s supervision of small banks to some other agency. Mr. Hoenig recently told Congress the result would be “further empowerment of both Washington and Wall Street in regulating financial institutions.”

Camden Fine, head of a small-bank lobbying group, says shifting supervision of them from the Fed would leave the district banks “basically gutted.” Worried about that threat, regional bank presidents have been personally lobbying lawmakers and speaking out for their institutions more aggressively.

Tensions were high a year ago as Fed bank presidents met in the boardroom of a Fed branch in Memphis with Mr. Kohn, the vice chairman. Mr. Hoenig and other district-bank presidents wanted clear direction on what to look for and how to proceed, especially since they had been given a large task: “stress tests” on the 19 biggest banks to gauge how well they might withstand the worst economic scenario.

The district banks’ regulatory burden also had grown with the addition of institutions newly registered as bank holding companies, such as Goldman Sachs Group Inc. and Morgan Stanley. Some of the presidents say the Fed’s Washington bank-supervision division became demoralized by years of scant interest in regulation from former Chairman Alan Greenspan, and told Mr. Kohn they wanted more leadership from Washington.

Mr. Kohn, who recently announced plans to retire, declined to comment. Mr. Greenspan, in an interview, acknowledged that banks should have been forced to hold more capital. He said he regretted the Fed didn’t do more to stem the risky rise of “megabanks,” an issue he raised in 1999. Mr. Greenspan said he shouldn’t be blamed for imposing a deregulatory mind-set. As chairman, he said, he deferred to staff and other governors on regulatory matters.

Several weeks after the Memphis meeting, the Fed’s director of bank supervision and regulation in Washington, 64-year-old Roger Cole, decided to leave. He says it was just time to retire, after 35 years at the Fed, including three “very difficult” ones as director. His deputy, Deborah Bailey—a strong voice on supervision, whom Mr. Bernanke had asked to lead the stress tests—also decided to go.

New governor Mr. Tarullo, who envisioned a big role for centralized government oversight, took on an assertive role.

Though the biggest banks drew the most attention during the stress tests last April and May, Fed officials also worried about large regional ones, especially in the Southeast, the scene of many bank failures. Mr. Tarullo and his team tussled with the Atlanta Fed over Regions Financial Corp., an Alabama bank with assets of $116 billion. They wanted tough assessments of the losses Regions might face if Florida real estate worsened.

Regions advised investors it was likely to see $3.4 billion in combined 2009-10 losses, and no more than $5.9 billion in the worst case. Mr. Tarullo’s team told the Atlanta Fed those estimates were too low and pressed it to push harder, according to people involved in the tests. In the end, the Fed demanded Regions raise enough private capital to withstand $9 billion in possible losses. It did so.

Dennis Lockhart, president of the Atlanta Fed, wouldn’t comment on Regions. He said there was normal back-and-forth, sometimes intense, among banks, Atlanta supervisors and Fed officials in Washington.

A spokesman for Regions declined to comment, but bank officials have been critical of the stress tests. “We didn’t get credit for the significant de-risking that we took at the end of 2008,” Chief Executive Dowd Ritter told analysts in September. He noted that the Fed’s loss estimates have so far proved too pessimistic. Regions’s 2009 loss was $1.03 billion.

Fed officials see the stress tests as a turning point in their efforts to stabilize the financial system, prompting the 19 largest banks to raise $140 billion in private capital. Inside the Fed, the stress tests had another effect. They gave officials a road map for strengthening Washington’s hand in bank oversight, especially of the biggest institutions. Fed officials had been squabbling internally for several years about how to oversee the big banks, with Washington’s push for more control resisted by regional Fed banks, especially the one in New York.

The new approach teams economists with on-the-ground supervisors to take a broader view of risks flowing through the financial system, rather than the old bank-by-bank approach led by regional Fed banks. It also involves Washington-led “horizontal reviews”—comparing findings across banks to ferret out hidden risks and assumptions that are too rosy.

Mr. Tarullo began speaking of “horizontalism” and sketching out diagrams of triangles on yellow legal pads to show how the new approach to regulation would look, say people familiar with his approach.

There was more fallout for the Atlanta Fed. Its oversight of several small banks drew criticism from the central bank’s inspector general. In one case—the quick failure of a small start-up called Community Bank of West Georgia—the inspector general concluded the bank’s big exposure to risky construction loans “warranted a more forceful supervisory response.”

The Fed’s Washington supervision office, while acknowledging the Atlanta Fed had urged the small bank to address underwriting problems, agreed with the inspector general’s conclusion that more should have been done. Asked to comment, an Atlanta Fed spokesman deferred to the board in Washington.

Mr. Tarullo is pushing ahead aggressively to strengthen the Fed’s bank oversight. In a move seen as a sign of change, he and Mr. Bernanke have named a senior Fed economist, Patrick Parkinson, to run the bank-supervision unit at Fed headquarters.

Many bankers and regulators still “don’t fully appreciate the magnitude of what went wrong,” Mr. Tarullo says. “There is this kind of instinct [in Washington] to deflect all of the blame to somebody else.”

 

 

 

Fed’s Tightening Campaign: One Pork Chop That’s Likely Grounded (Seeking Alpha)

February 22, 2010

The CPI release on Friday amply demonstrated why inflation trading folks tend to ignore PPI. The PPI figure had scared people into thinking that the rise in consumer inflation, long-awaited (and coming!) was nigh.

It wasn’t. Headline CPI rose+0.2%, but the miss was entirely due to the miss in core inflation. Core CPI at -0.1% missed the consensus guess by a full two-tenths, which is a bit like a three-touchdown favorite losing by two touchdowns: it happens, but not very often. I, however, was delighted, since the model I follow had been giving a much lower central tendency to the year-on-year number.  For more, see Fed Tightening.

Millions of Unemployed Face Years Without Jobs (NYT)

By PETER S. GOODMAN

Published: February 20, 2010

BUENA PARK, Calif. — Even as the American economy shows tentative signs of a rebound, the human toll of the recessioncontinues to mount, with millions of Americans remaining out of work, out of savings and nearing the end of their unemployment benefits.

“There are no bad jobs now. Any job is a good job,” said Jean Eisen, who became unemployed more than two years ago.

Economists fear that the nascent recovery will leave more people behind than in past recessions, failing to create jobs in sufficient numbers to absorb the record-setting ranks of the long-term unemployed.

Call them the new poor: people long accustomed to the comforts of middle-class life who are now relying on public assistance for the first time in their lives — potentially for years to come.  For more …

Fed Raises Cost of Emergency Loans to Banks (WSJ)

By JON HILSENRATH

The Federal Reserve raised an interest rate it charges banks for emergency loans, and emphasized that a broader tightening of credit for consumers and businesses is still at least several months away. But the late-afternoon increase in the discount rate didn’t have the muted impact Fed officials hoped for.

Stock futures and bond prices fell, and the dollar rose against the euro.

“The Fed can talk all day about how the discount rate hike is technical and not a policy move, but the market sees it as a shot across the bow,” Christopher Rupkey, an economist at Bank of Tokyo-Mitsubishi, said in a note to clients. The Wall Street Journal

Can Someone Be Bored to Death? The Research Study Shows That a Boring Job Can Kill You

Can Someone Be Bored to Death? The Research Study Shows That a Boring Job Can Kill You.

Fed’s Plosser says central bank should sell MBS

Charles Plosser, president of the Federal Reserve Bank of Philadelphia, said the central bank should start selling mortgage-backed securities it bought to prop up the housing market sooner rather than later. “As the economic recovery gains strength and monetary policy begins to normalize, I would favor our beginning to sell some of the agency mortgage-backed securities from our portfolio, rather than relying only on redemptions of these assets,” Plosser said. CNBC/Reuters (2/17)

Paulson: Financial regulatory reform is needed immediately (NYT)

Henry Paulson, former secretary of the Treasury Department, writes that it is time to overhaul the financial regulatory system and that delays are creating uncertainty in the market, which is not helping the situation. “Our overriding goal in restructuring our financial architecture should be that taxpayers never again have to save a failing financial institution,” Paulson writes. The New York Times (2/15)

This belongs to Robert Reich — not me

One Free Market System for Wall Street, Another Free Market System for Main Street
Thursday, February 11, 2010
Washington is paralyzed by snow and partisanship. Nothing is getting done – even as the Great Recession pulls more Americans into its maw.

In the midst of this paralysis, the President was asked about the giant pay packages of Jamie Dimon, CEO of JP Morgan Chase & Co. ($17 mullion for 2009) and Lloyd Blankfein, CEO of Goldman Sachs ($9 million). “First of all, I know both those guys,” Obama said. “They’re very savvy businessmen. And I, like most of the American people, don’t begrudge people success or wealth. That’s part of the free market system.”

Free market system? As I remember it, American taxpayers forked out hundreds of billions to keep JPMorgan, Goldman, and other big Wall Street banks afloat through most of 2009. Had we not done so, Dimon, Blankfein, and most other top executives on Wall Street would not have earned a dime last year. In fact, some would be out on the street, reather than sitting pretty on the Street.

The free market system has been unleashed instead on average Americans. According to real-estate data firm First American CoreLogic, about one-fourth of American households with a mortgage are under water – owing more on their homes than their homes are worth. Mortgage-bond trader Amherst Securities estimates that 7.1 million of the 7.9 households now behind on their mortgage payments will lose their homes to foreclosure if nothing is done to modify their loans. Already cities and towns are littered with foreclosure sales, pulling down the values of all homes in the area.

Jamie Dimon, Lloyd Blankfein, and most of the rest of Wall Street don’t worry about what’s happening to homes on Main Street because their savings are invested in stocks and bonds. But most middle-class Americans do worry because most (if not all) of their savings are in their homes. As home values continue to slip, average Americans’ one big asset is shrinking.

The best way to help reverse this downward slide would be to let bankruptcy judges restructure shaky home mortgages, reducing what borrowers owe. The problem is, the big banks hate this. If mortgages could be restructured this way, the banks would take big hits. They’d be forced to cut the amounts owed by borrowers. They figure they do better by squeezing as much as they can out of distressed homeowners, then collecting as much as they can on foreclosed properties.

So, not surprisingly, the big banks have been mounting a major lobbying campaign to block legislation that would allow homeowners to use bankruptcy.

Bankruptcy has been part of the “free market system” for hundreds of years, but its details are determined through politics – the same politics that arranged the $700 billion bailout of Wall Street. In fact, you might say that during 2009, Wall Street went through its own kind of bankruptcy restructuring, with the generous aid of American taxpayers. JP Morgan Chase, Goldman Sachs, Morgan Stanley, Bank of America, Citigroup and Wells Fargo, along with their top executives, traders, and major investors, have benefited handsomely.

Now, a quarter of American homeowners need help restructuring their loans, but Wall Street is blocking the way.

Rather than defending the outsized paychecks of Dimon, Blankfein, and the rest of Wall Street as part of the free market system, the President needs to demand that Wall Street help homeowners on Main Street. The Obama White House should have made this a condition of getting the giant bailouts in the first place. The least it can do now is to is to make the free market system work for everyone.

What’s Ahead for the Economy and Politics in 2010

By Robert Reich
January 4, 2010

Just about everything you’ll hear coming out of Washington starting now is really about November’s mid-term election. The gravitational pull of the midterms was already apparent last year, as Republicans marched in perfect lockstep to vote against whatever the President and Dems proposed (Republicans always have authoritarian discipline on their side, which is why they’re Republicans) but you haven’t seen anything yet.

The Dems have enough votes to enact health care — the hurdle Bill Clinton failed to jump, contributing to the Republican takeover in 1994 — but when it’s enacted, expect the spin machines on both sides to be at full throttle. And because health care legislation won’t be implemented for another three or four years (depending whether the House or Senate versions prevail), Americans won’t be able to test the veracity of these wildly divergent claims. So don’t count on health reform to help Dems next November — nor harm them, either.

Foreign policy is just as unlikely to tip the scales. Sad to say, absent a draft most American families will read about American deaths in Afghanistan much the way they’ve absorb the U.S. body count in Iraq — as news items rather than personal tragedies. Nor will Iran’s nuclear capabilities, North Korea’s missile launches, Pakistan’s tumult, or Yemen’s terrorists have much electoral effect — unless terrorists commit an atrocity in America or on American travelers. Needless to say, China’s decision about whether and how much to revalue its currency, although important, will affect the votes of about three Americans (and I think I know all of them).

Issue Number One — the overriding concern that will determine more than anything how many seats the Dems lose next fall — is jobs. If unemployment is 10 percent or more next November, the Dems are in danger of losing the House and will almost certainly be short of the 60 votes they need in the Senate.

But why would employment be 10 percent or above next November? Surely, you say, there are enough signs of recovery that we can count on a lower rate. Don’t be so sure. Here are likely scenarios, with my probabilities:

Double-dip recession (10 percent likelihood). The commercial real estate market craters, carrying with it hundreds of regional banks and exposing how much junk is still on the books of major Wall Street banks. This triggers a long-awaited “correction” in the Dow and pushes the nation into another recession. Job losses rise. By November, the unemployment rate is back over 10 percent.

Stalled recovery (20 percent). Fearing inflation and overly confident of the strength of the recovery, the Fed stops buying up debt instruments and starts raising rates. These acts choke off the recovery. Unemployment remains at 10 percent.

Jobless recovery (40 percent). The stimulus remains in full force, the Fed keeps interest rates low, firms replace inventories and expand production. But with the average workweek hovering around 33 hours, employers don’t add new jobs; they just have current workers put in more hours. Result: No drop in unemployment.

Solid recovery (20 percent). Demand surges, employers decide to expand capacity. But they don’t add American jobs. Now that foreign workers have access to much of the same equipment and can be linked up to the U.S. so cheaply through the Internet, employers outsource abroad. Result: No drop in unemployment.

Strong recovery (10 percent). The recovery is strong enough for employers to start hiring American workers. Many jobless Americans who have been too discouraged to look for work to begin looking again. But because the BLS household survey (on which the official level of unemployment is based) depends on how many Americans are looking for work, the paradoxical result is for unemployment to remain in double digits.

In other words, I think the chances of unemployment being 10 percent next November are overwhelmingly high. But although voters are acutely sensitive to the rate of unemployment, they’re also influenced by the direction employment is heading. If it looks like jobs are coming back, they may forgive a high absolute level of unemployment — even one as high as 10 percent. But if it looks like jobs aren’t coming back, that we may be stuck with a high level of joblessness for years, voters will take out even more of their anxieties on Democrats next November.

The irony, of course, is that Republicans want to cut spending and reduce the deficit. If they had their way, we’d have double-digit unemployment as far as the eye can see.

NPR: Atul Gawande’s ‘Checklist’ For Surgery Success

January 5, 2010

Speaking about dealing with unexpected challenges in medicine, Atul Gawande — a surgeon who writes for the New Yorker when he’s not at his day job at Harvard Medical School — relates a story about a man who came into an emergency room with a stab wound.

“It was a single wound, about an inch in size, in his belly,” Gawande tells Morning Edition host Steve Inskeep.

The man’s injuries didn’t appear life-threatening, but his condition quickly turned.

“About ten minutes later, he crashed,” Gawande says. “When they got him open they found that the wound had gone — this is a pretty big guy — straight through more than a foot into him, all the way into his back and sliced open his aorta. And so afterwards they asked a few more questions of the family. ‘How did this happen?’ ‘Well, it was a Halloween party.’ ‘What exactly went on?’ And then they learned that the guy had stabbed him was dressed as a soldier carrying a bayonet. And if they had understood it was a bayonet, they would have thought about it quite differently.”

Gawande uses this anecdote, a simple miscommunication with the potential to cause so much tragedy, to illustrate an argument he makes in a new book called The Checklist Manifesto: How to Get Things Right.

“Our great struggle in medicine these days is not just with ignorance and uncertainty,” Gawande says. “It’s also with complexity: how much you have to make sure you have in your head and think about. There are a thousand ways things can go wrong.”

At the heart of Gawande’s idea is the notion that doctors are human, and that their profession is like any other.

“We miss stuff. We are inconsistent and unreliable because of the complexity of care,” he says. So Gawande imported his basic idea from other fields that deal in complex systems.

“I got a chance to visit Boeing and see how they make things work, and over and over again they fall back on checklists,” Gawande says. “The pilot’s checklist is a crucial component, not just for how you handle take off and landing in normal circumstances, but even how you handle a crisis emergency when you only have a couple of minutes to make a critical decision.”

This isn’t the route medicine has traveled when dealing with complex, demanding situations.

“In surgery the way we handle this is we say, ‘You need eight, nine, 10 years of training, you get experience under your belt, and then you go with the instinct and expertise that you’ve developed over time. You go with your knowledge.’”

To see if surgeons might perform better if the intricate steps necessary to avoid catastrophe were made explicit, Gawande and a team of researchers studied what happened when doctors used a reminder — what Gawande calls “a bedside aid” — to navigate complex procedures. (Click to see an sample “Surgical Safety Checklist.”)

“We brought a two-minute checklist into operating rooms in eight hospitals,” Gawande says. “I worked with a team of folks that included Boeing to show us how they do it, and we just made sure that the checklist had some basic things: make sure that blood is available, antibiotics are there.”

How did it work?

“We get better results,” he says. “Massively better results.

“We caught basic mistakes and some of that stupid stuff,” Gawande reports. But the study returned some suprising results: “We also found that good teamwork required certain things that we missed very frequently.”

Like making sure everyone in the operating room knows each other by name. When introductions were made before a surgery, Gawande says, the average number of complications and deaths dipped by 35 percent.

“Making sure everybody knew each other’s name produced what they called an activation phenomena,” Gawande explains. “The person, having gotten a chance to voice their name, let speak in the room — were much more likely to speak up later if they saw a problem.”

How did surgeons respond to the suggestion that they should change the way they operate? Says Gawande, many were resistant, at first.

“You can imagine the response” to the idea of running through a checklist before surgery, Gawande says. But when his team surveyed the doctors who used the checklist, “There was about 80 percent who thought that this was something they wanted to continue to use. But 20 percent remained strongly against it. They said, ‘This is a waste of my time, I don’t think it makes any difference.’ And then we asked them, ‘If you were to have an operation, would you want the checklist?’ 94 percent wanted the checklist.”

So why does Gawande think professionals have such a hard time admitting that having a reminder might be a good idea?

“Partly I think we have a hard time admitting weakness,” he says. “And one of the things we have to grapple with is that we have to assume we are fallible, even as experts.”

That’s a tough pill to swallow, and one made even harder given the way in which the media and entertainment industry present profiles of people who succeed in demanding situations.

“One of the things that struck me about the ‘Miracle on the Hudson’ when ‘Sully’ Sullenberger brought the plane down that saved 155 people after it was hit by geese over Manhattan and landed it in the river,” Gawande says, was that “Over and over again we wanted to say, ‘Look at this hero who piloted this plane down,’ and the striking thing was how much over and over again he said, ‘There was nothing that hard about the physical navigation of this plane.’ Instead he kept saying ‘it was teamwork and adherence to protocol.’”

Gawande says he experiences a similar displacement of credit when he performs a surgery.

“I come out of my operations and then I go out and talk to the family and they say ‘Doctor, thank you for saving my husband!’” Gawande says. “You feel a little bit like a fraud because you know how much you were dependent on everybody getting this right. And when we acknowledge it, that’s when we come back to ideas like checklists.”

Despite all the evidence, Gawande admits that even he was skeptical that using a checklist in everyday practice would help to save the lives of his patients.

“I didn’t expect it,” Gawande says with a chuckle. “It’s massively improved the kind of results that I’m getting. When we implemented this checklist in eight other hospitals, I started using it because I didn’t want to be a hypocrite. But hey, I’m at Harvard, did I need a checklist? No.”

Or so he thought.

“I was in that 20 percent. I have not gotten through a week of surgery where the checklist has not caught a problem.”

“The goal of the Safe Surgery Saves Lives Challenge is to improve the safety of surgical care around the world by ensuring adherence to proven standards of care in all countries. The WHO Surgical Safety Checklist (above) has improved compliance with standards and decreased complications from surgery in eight pilot hospitals where is was evaluated.”