Introducing Two New Financial Regulators

Friday, 19 Apr 2013 06:47 PM

By Robert Feinberg

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The 22nd Annual Hyman P. Minsky Conference held in New York this week by the Levy Institute of Bard College and the Ford Foundation provided an opportunity to see two of the new faces among the many individuals who share responsibility for regulating financial institutions.

A process is under way that will see a turnover at the regulatory agencies. Treasury Secretary Tim Geithner has already been replaced by Jack Lew; there are indications that Ben Bernanke will be replaced as chairman of the Federal Reserve by the vice chairman, Janet Yellen; Mary Schapiro has been replaced at the Securities and Exchange Commission by Mary Jo White; Gary Gensler’s term as chairman of the Commodity Futures Trading Commission expired a year ago, and he may be replaced if the administration can nominate someone who can be confirmed; and Ed DeMarco, who has been serving in an acting capacity as director of the Federal Housing Finance Agency, may be replaced soon at the behest of Democratic legislators furious that he has blocked efforts on their part to secure reductions in principal for homeowners whose mortgages are delinquent.

Two important regulators who spoke at the conference deserve to be included on the list of regulators to watch, even though they would tend to be overlooked, because they don’t occupy the most prominent posts. The first is Benjamin Lawsky, who has served for about a year in the newly created job of Superintendent for Financial Services of the State of New York. This new office combines the functions of the previously separate superintendents of banking and of insurance.

Although Lawsky did not say this explicitly, a reorganization of some sort was in order after the insurance regulator, Eric Dinallo, along with the federal Office of Thrift Supervision (OTS), fumbled the case of AIG, one of the key failures in the timeline of the 2008 episode of the ongoing financial crisis. The OTS has been abolished as a separate entity, now folded into the Office of the Comptroller of the Currency (OCC), and in New York, the insurance superintendent has been folded into this new office that has jurisdiction over both banks and insurance.

Lawsky bears watching not only because of the theoretical importance of his job, but because it was evident from his presentation that he is planning an ambitious agenda that will make him a figure worth watching on the national stage, as he sometimes works in conjunction with federal regulators and sometimes prods them into action and financial institutions into compliance.

In his speech he discussed the philosophy of federalism he has developed with the help of his general counsel to explain how his work relates to that of federal regulators. In the normal course of his work, the relationship can be called “cooperative federalism.” When the federal authorities need to be prodded into action, this will be “persuasive federalism.” Finally, in cases where persuasion is insufficient to elicit the degree of cooperation needed from federal regulators and from regulated institutions, then “coercive federalism” will be applied. At the same time, he stated that regulation would be conducted with a view to maintaining the status of New York as the leading financial center in the world.

Among the specific issues Lawsky laid out as his regulatory agenda were the following:

Force-place insurance. When homeowners fall behind in their mortgage payments, they often also fail to pay the premiums on their homeowner’s policies. Mortgage agreements empower lenders to purchase insurance on behalf of the homeowners, in order to protect the collateral, but Lawsky’s office has found that lenders often take advantage of the situation to charge premiums 10 times as large as normal and arrange that payments be made to companies that have a relationship with the lender and kick back some of the money. Lawsky stated that in order to halt this practice, his office has settled with the two companies that represent 90 percent of this industry, and he plans to cover the remaining 10 percent.

Anti-money laundering rules. A number of large banks, most notably HSBC, have been found to have violated rules against money laundering and against doing business with drug dealers and Iranian banks. Lawsky has settled with some of these banks and plans to continue to be active on this issue.

Monitors and other consultants. The Senate Banking Committee has recently held two hearings on the role of monitors and other consultants who are employed to ensure compliance with regulatory orders but whose work has come into question, often because of inadequate supervision on the part of the OCC and the Fed. Lawsky stated that his office is working on “innovative initiatives” for bringing these programs under effective management by the agencies that put them in place.

Private equity acquisition of insurance companies. Lawsky’s office has found that private equity firms have ramped up their acquisition of insurance companies that write fixed- and variable-annuity policies to nearly 30 percent from 7 percent only a year ago. He is concerned about real and potential abuses by firms whose focus tends to be on short-term profits that can maximize the return from sale of public offering of the firm, perhaps at the expense of the ability of the companies to fulfill their contracts over the long term.

Captive insurance companies. Lawsky has also found that financial institutions that sell insurance have returned to a practice that contributed to the 2008 episode by using special-purpose entities to offload risk to offshore and off-balance-sheet entities in order to make the holding companies appear less risky than they are. He plans to monitor this situation and take action before it can lead to another massive failure such as AIG.

The other new player worth watching is Mary John Miller, who is the new Deputy Assistant Secretary of the Treasury for Domestic Finance serving under Lew. Her speech said nothing new, repeating what has become a tired narrative of how the administration is going to use the new powers conferred under the Dodd-Frank Act to wind down the policy of “too big to fail,” while at the same time working to ensure that the policy will not be tested, because hopefully no systemically important financial institution will fail.

This double talk is confusing only to the extent that readers take it seriously. The default assumption, so to speak, must be that nothing has changed in the decades of the financial crisis, except that the exposure has increased dramatically and the authorities have become more creative and aggressive in devising ways to subsidize the largest financial institutions. Miller’s speech indicates that they have also become more creative in finding ways to muddy the issue of the extent of subsidization of the largest, too big to fail institutions.

Her performance when she testifies before Congress will bear watching, but based on this speech, expectations should be set very low.

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