The health of the financial system was one of the big items on the agenda at the Milken Institute Global Conference in LA last week.
In the accompanying video, I discuss the state of the banking industry - and bank regulations - with two renowned experts: Chicago Booth professor and former IMF chief economist Raghuram Rajan and James Barth, a senior fellow at Milken and co-author of Guardians of Finance.
The good news is Rajan, who presciently warned about a potential banking crisis in late 2005, believes the financial system is safer today for three main reasons:
- After being burned in 2008, banks have pulled back from risk-taking.
- Banks have more capital today vs. 5 years ago.
- New regulations, such as Dodd-Frank, "have the capacity of letting authorities do more than they used to be able to do."
Barth agrees, with one big caveat: "We don't yet know what the regulations are going to be," he says. "Not all the regulations have been put in place...there's still some bickering back and forth between financial institutions and regulatory authorities."
The most recent bickering occurred last week during a meeting between Fed officials and the CEOs of Goldman Sachs (GS), J.P. Morgan (JPM), Bank of America (BAC), Morgan Stanley (MS), State Street (STT) and U.S. Bancorp (USB).
According to various reports, the CEOs reaffirmed their frustrations with the so-called Volcker Rule, which would severely limit banks from putting their own capital at risk. Bank executives also expressed concern about new proposed regulations that would limit the amount of exposure big banks could have to any one counterparty, most notably other big banks.
The meeting "was notably largely for the long silences from the central bank's side of the table," The WSJ reports.
In sum, the comments and recommendations from the bank CEOs were met with total silence from Fed officials, who were led by Governor Daniel Tarullo. "Neither governor Tarullo nor Federal Reserve staff would, during the meeting, respond to views expressed by the bank representatives," the Fed said in a statement.
Federal Reserve rules prevent officials from commenting on proposed regulations and the phrase "during the meeting" leaves room for comment in other venues. But a silent stare is pretty cold and probably won't do much to improve relations between the banks and their regulators.
While that's certainly an improvement from the days of "regulatory capture," tensions between banks and their regulators could complicate future discussions on new regulations and the implementation of existing ones, most notably the Volcker Rule. The rule is supposed to go into effect on July 21 but there remains a lot of confusion about what obligations banks between now and the two-year period they have to get in compliance, The WSJ reports.
Next Crisis: Question of 'When', Not 'If'
As the haggling and bickering over the details proceeds apace, both Barth and Rajan agree new rules and regulations are needed, which itself has been the subject of some debate in recent years.
"There is no way we have ruled out further crisis," Rajan says. "We will learn over time what we didn't fix."
In the interim, "most important is to get incentives on both sides right," he says. "Get the incentives on the banks right so they don't go out on a flyer; get the incentives on the regulators right so they don't take a back seat and say 'the market will take care of itself.'"
Barth, meanwhile, believes "a new watchdog-type agency" is necessary to oversee regulatory authorities and make sure they're enforcing the rules already on the books. "If [regulators] had done a better job leading up to the crisis it wouldn't have been severe," he says, suggesting new oversight of the regulators would be like instant replay in professional sports.
Given the ongoing battles over Dodd-Frank and the Consumer Financial Protection Agency, it's hard to imagine Congress approving yet another new regulatory body -- even if the idea actual has some merit.
Here's More Daily Ticker Coverage from the Milken Global Conference