Gilded Age Regulation

Mark Carney, Governor of the Bank of England, gave a remarkable speech in London this week at the Conference on Inclusive Capitalism (found at Carney’s Inclusive Capitalism Speech). Carney’s speech is eloquent, philosophical, and thought provoking. What makes the speech noteworthy is the explicit call for “meaningful change in the culture of banking.” Think of it as regulation by guilt trip, fitting for the new gilded age.

The fact that Carney feels compelled to plea for empathy from the leaders of the organizations he oversees is a testament to the industry’s power. Regulation by law and policy alone have proven insufficient. That Her Majesty the Queen’s central banker is resorting to pleading with bank executives to think of the impact of their behavior on society, and not simply of themselves, is revealing as to the extent to which the global banking industry’s reputation has deteriorated.

The reasons for this reputational fallout are straightforward. During the crisis of 2008-09, central banks bailed out many major banks, without demanding meaningful limits on executive compensation. (I use the word “meaningful” because there were some limits imposed, as outlined in this October 2008 WSJ article on pay, but the efficacy of those limits is questionable in light of the compensation data reported in the years since.) In numerous cases, the taxpayer bailout funds subsidized bonuses – including those at non-bank bailout recipients such as AIG – that effectively rewarded management teams for taking excessive risks that contributed to the worst financial crisis since the Great Depression.

Carney’s speech serves as a welcome coda to the U.S. bank bailout narrative spun by former Treasury Secretary Timothy Geithner. In an interview during the promotional tour for his recently published book, “Stress Test: Reflections on Financial Crises,” (Crown Publishers), Geithner explained the government actions taken to stem the crisis with what sounds more like rationalization than rationale. The transcript of his comments (found at Geithner PBS Newshour Interview) included this metaphysical treasure:

“[T]he thing about financial crises, the deep panics like we faced, is the things you have to do to protect people from the risk of mass unemployment are deeply unfair and they’re totally counterintuitive, because they involve doing things that look like you are rewarding the people, the arsonist who took that much risk.”

Maybe it is just me, but if the use of taxpayer funds to subsidize bonuses at “too big to fail” banks and other financial institutions did not, in substance as well as form, amount to rewarding “the people … who took that much risk,” then what exactly was that subsidization rewarding?

I am sure Former Secretary Geithner did his best to save the U.S., and by implication, the global financial system from the abyss into which it veered starting in the fall of 2008. Should I bump into him on the subway, I just might belt out a hearty “For He’s a Jolly Good Fellow,” for Mr. Geithner for helping to prevent another Great Depression, for his new book, and his new job as the president of a private equity firm. Two cheers for Mark Carney for boldly stating the obvious need for greater social consciousness among the global banking elite.

More than five years after the depths of the crisis, we have a global banking industry with even larger global banks run by management teams who have long ago “moved on,” likely to make little time for reflection on Carney’s plea for cultural change. The “regulation by guilt trip approach” we are witnessing is, at its worst, a sign of regulatory capitulation. In this gloomy interpretation, Carney’s plea for cultural change is a tacit admission of the lack of political might to institutionalize the incentives to bring about and enforce that change.

The “silver lining” in the cloud that was the financial crisis of 2008-09 and its economic legacy may be that there is precedent for progressive action amid straight talk from financial regulators in the wake of financial market crashes; particularly, those crises that have caused lasting damage to the economy. Time will tell whether the Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) will rise to the level of historic importance of the Federal Reserve Act (1913), but Geithner’s and Carney’s public comments warrant some reflection on the regulatory mindset of the early 20th century.

Robert L. Owen, the Chairman of the Senate Committee on Banking and Currency during the founding of the Federal Reserve System in 1914, spoke to something far more fundamental than the inclusiveness of capitalism to the well-being of ordinary Americans when he asserted (as quoted in this St. Louis Fed Paper):

“It is the duty of the United States to provide a means by which the periodic panics which shake the American Republic and do it enormous injury shall be stopped.”

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