It’s a pleasure to participate in the launch of this new blog. I’m looking forward to the dialogue and interaction with my co-bloggers and readers. I’ll be blogging mostly about central banking, financial regulation, and public finance (where each of these interacts with “regulation” as our overarching theme), although I may indulge from time to time a comment on other topics.
First up is one of the most anticipated final rules to come out of Dodd-Frank. The federal banking agencies—the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, and the Board of Governors of the Federal Reserve System—have finalized the “liquidity coverage ratio” (LCR), part of its Dodd-Frank mandated implementation of the Basel Committee on Bank Supervision’s December 2010 reform package, as revised in January 2013. This is the agencies’ effort to regulate, under Dodd-Frank’s Section 165, “enhanced supervisory” rules covered by the Basel proposals.
One player in the discussion—the National Association for State Treasurers—isn’t very pleased with the final result. The NAST’s reaction gives us a nice case study of the kinds of arguments that interested parties use in trying to influence the rulemaking process. More after the jump…
A bit of background. The BCBS is the committee responsible for formulating international standards of bank regulation. The latest iteration, Basel III, is the Committee’s reaction to the financial crisis. There is a great deal of confusion in the popular press about capital regulation and its relationship to the liquidity coverage ratio: the first refers to the capital structure banks can take—how much of their activities is funded by debt versus equity—and the second refers to how much “cash in the vaults” a bank has to have on hand in case the credit markets seize and they can’t roll over their debt. The main event in banking reform has been on the capital structure; see Anat Admati and Martin Hellwig’s superb book here, and their and their co-authors’ very extensive efforts here.
But the LCR is different, although capital regulation is frequently mistaken for it. From the final rule:
The final rule establishes a quantitative minimum liquidity coverage ratio that requires a company subject to the rule to maintain an amount of high-quality liquid assets (the numerator of the ratio) that is no less than 100 percent of its total net cash outflows over a prospective 30 calendar-day period (the denominator of the ratio)
You can see the many variables here: what constitutes “high quality liquid assets”? Why 100 percent? Why for 30-days? Who are the companies subject to the rule? When will they be required to have these assets in place? These are the questions that the agencies had to parse and that the final rule is meant to address.
Here is where NAST comes in (Note: the letter doesn’t seem to be online; I received it from a proprietary news service, and have posted it on my website.). In a letter published it released the day before the final vote, the Association expressed two problems with the final rule. First, it asserted that it was “surprised to learn that federal regulators quietly posted their intent before the Labor Day Holiday [sic] to vote on significant and potentially very harmful rules.” The consequences of the rule would be devastating (more on that in a moment), and “[a]ll of these effects would take place without full public discussion and a clearly-stated rationale.” To remedy this, [t]he National Association of State Treasurers urges federal regulators to halt this rush to judgment and listen to the voice of reason. Take the time to allow public discussion to cast sunshine on this rule’s consequences instead of rushing this train down the track toward a destructive collision. America’s state and local communities deserve no less. This is the procedural critique: this all happened too quickly, before the public could “cast sunshine on the rule’s consequences.”
But the second critique is a substantive one. NAST takes issue of the final rule’s exclude from the formal definition of “High Quality Liquid Assets” the public securities of the kind that NAST members issue, even though the rule allows sovereign debt to be included in that definition. It is the comparative injustice that rankles NAST.
These are two different but very common critiques of regulatory reform that are worth a bit more attention. Call the first—the rush-to-judgment, surprise-us-on-Labor-Day, rushing-this-train-down-the-track claims—the cable news critique: it’s easy to follow, hard to take the other side, and, very often, factually wrong or incomplete. No one would defend a rule that’s rushed and secret (except, I guess, the people or organizations who stand to benefit from it).
But this is not what happened. It’s true that the finalization of the rule occurred on the Wednesday after Labor Day, but according to Dodd-Frank section 165—under which the rule was promulgated—the rule could have come at any time after July 10, 2013 (three years after the passage of the Act). The agencies circulated a proposed rule roughly a year ago. And Chair Yellen commented on the very issue that NAST disputes in her semiannual Congressional testimony last July (available here; start at Senator Hagan’s question at 2:11:35).
NAST knows this. They commented on the proposed rule back in January, and made the same substantive arguments they make again. Calling it a “surprise” or “rushed” is, as the Association well knows, disingenuous at best.
So much for the procedural argument. What of the substance? Anyone watching the Eurozone over the last six years will surely wonder whether the argument that sovereign debt represents the highest quality assets: the conclusion that some of these securities do meet that definition has been one of the most enduring critiques of the Basel process.
NAST is, in my view, makes a compelling argument in this respect: the idea that all sovereign bonds are superior to all municipal bonds (or sub-federal bonds) is surely not correct. This is the equitable argument: it’s not fair to penalize us for doing something that others get to do, when we are no different than they are. Of course, this is a race-to-the-top, race-to-the-bottom kind of argument. Liquidity is a continuous variable, not a binary one, and the agencies’ clearly want to draw the line between high- and medium- quality assets as close to cash-ready as possible; NAST and other public entities would prefer that line-drawing exercise to happen farther down the spectrum.
NAST’s cable news argument is very silly, as I’m sure they know. But their equitable argument is harder to dismiss. If litigation follows—and judging from their invocation of key words like “arbitrary and capricious” and “not rational,” it would seem NAST is at least considering it—the fight will be on the rationality of the place where the agencies have drawn this line. I think the agencies are fully covered here: parsing what asset classes get what kind of coverage in a complicated formula are well within the agencies’ expertise, especially since the statute itself grants so much authority to them.
But from the perspective of thinking about arguments that people and organizations make against regulations, NAST gives us examples of two common animals found in this jungle. The cable-news argument is often necessary to get the attention of, well, cable news networks, even where—as here—there’s nothing serious here. The equitable argument—that other guy is just as bad or even worse than us, so why did he get the better treatment?—is the meat of the critique. Whatever the low likelihood of change coming from the courts, one could imagine a world where the agencies revisit this conclusion if experience supports NAST’s view of the consequences.