The Financial Rescue - Beyond the Headlines

10-9-08

The Financial Rescue - Beyond the Headlines
 
Critical issues lost in the minutia of the moment
 
Craig McCrohon, a partner in the Firm’s corporate, transactional and bank regulatory practice, brings his perspective from nearly 20 years ago during the savings and loan crisis. He worked for the legal staff of the U.S. Senate Banking Committee that wrote the last financial rescue plan in 1989.
 
The shock of the financial crisis has jolted the federal government into demolishing decades of financial regulation in a matter of days with the passage of the Emergency Economic Stabilization Act. Newspapers, magazines and cable news shows have relayed the basic story. However, in the never ending reply of sound bites and articles with the latest Congressional drama, several themes have largely been ignored by the mainstream media. Following are a few of the issues that will likely emerge from the footnotes of scholarly articles to the headlines of next year’s financial newspapers. The review below is not an explanation of the crisis or a summary of the recent legislation. Instead, it is a review of some critical governmental matters lost in the high decibel debate surrounding the crisis.
 
 1. The devil is NOT in the details. 
 
The most striking aspect of the rescue law is its amoeba-like simplicity. In general, it is a check for several hundred billion dollars, a small committee of the government’s top financial regulators, and a general instruction to be fair and efficient. Some last-minute horse-trading resulted in increased deposit insurance to $250,000, tax breaks, suspension of mark-to-market accounting, and general prescriptions for additional regulation of selected securities and executive compensation. In the end, the law resembles more the drastic 1933 bank holiday and home loan buyback than the intricate re-engineering of regulations of the savings and loan bailout two decades ago.   Then, Congress passed a series of laws aimed at addressing specific regulatory issues in real estate lending practices, director and officer liability, and deposit insurance, among other things. The current crisis, however, moved too fast to permit the traditional tinkering with regulations and give-and-take among competing trade associations.   The conclusion of the White House and Congress was that the tidal wave of financial uncertainty required massive intervention, not legislative deliberation.
 
2. Whither the lobbyists? 
 
The bailout is so vast and so rapid that the traditional wrestling match among interest groups became a side show.   In 1989, with the measured pace of the legislation, competing factions within the financial industry had significant influence over the legislation. However, the current crop of rotten mortgage-backed securities - directly or indirectly - through the financial system led to a rarely seen degree of harmony among the various subsectors. Small banks held the preferred stock of Fannie Mae and Freddie Mac; large banks individually held large portfolios of mortgage-backed securities and loans; bulge-bracket banks held mortgage-backed securities and depended on the related underwriting income. The initial failure of the legislation in the House of Representatives provided dozens of Congressmen, and their industry and political allies, the chance to negotiate special provisions in the bill. However, the typical intra-industry give-and-take failed to materialize in the frantic efforts to pass the bill.
 
3. Federal Reserve - Regulatory Superpower. 
 
Since the 1930s, lawyers and banks have plied their trade amidst a cold-war among turf-conscious regulatory agencies. The Securities and Exchange Commission eagerly sought to regulate securities activities of commercial banks; the Department of the Treasury sought to expand the powers of the banks it supervised - and therefore the Department of Treasury’s own influence; the Federal Reserve worked to maintain its hegemony over monetary policy by expanding beyond traditional banks and methods to inject or withdraw cash in the U.S. financial system. Last spring, the Department of Treasury unveiled a revolutionary plan to rearrange regulatory responsibility among the federal regulators. The September financial crisis created such drastic realignment of investment and commercial banks that the “radical” plan of a few months ago now appears laughably modest - like comparing a freewheeling 1960s rock concert with the etiquette of a Victorian garden party. The winner in all of this has largely been the Federal Reserve. In a matter of days, investment banks outside the daily operational supervision of the Federal Reserve fell like dominoes. The need for liquidity provided by Federally-insured deposits, and the occasional loan from the Federal Reserve drove these proud stock and bond houses into the restrictive realm of the Federal Reserve. The Securities and Exchange Commission and the bank regulatory arm of the Department of the Treasury could only stand on the sidelines and watch as decades of competition ended in a matter of days.
 
4. On Main Street - The World Forever Changed. 
 
The financial earthquake created a consolidation of banks, brokers and insurers that would have otherwise taken years and included anti-trust court battles, lengthy negotiation over regulatory exemptions and the delicate arrangement of multi-billion dollar financing. Within just a few days: check, check and check.
 
The result: gargantuan financial platforms that may undermine the competitiveness of small players. This crisis resolution was not so much from sea to shining sea, but from lower Manhattan to Midtown. Given the sheer size of these new firms, an understanding of the full impact of the consolidation may take decades. 
 
For operators of smaller independent banks, the major restructuring may offer opportunity.  As the roll-up slowly accelerates, these independent institutions could profit by selling to larger competitors and compete for loan and deposit customers. In the short run, integration of large organizations could distract these new behemoths from catering to main street. 

Comments? With such a fluid industry and regulatory situation, we appreciate your thoughts on the future of bank regulation and law. Contact Cy Griffith at cgriffith@burkelaw.com or your Burke, Warren attorney.