Edward J. McAniff, one of the nation’s leading banking lawyers, shared his insights on navigating the banking regulatory landscape in a series of lectures at the Banking Law Fundamentals (BLF) seminar hosted by Berkeley Center for Law, Business and the Economy from September 25-27.
The lectures stemmed from a common notion that it is impossible to anticipate and recognize what consequences regulatory changes will have on the banking industry without looking through the prism of our past. Throughout the seminar McAniff convincingly and eloquently demonstrated that the only framework capable of explaining this complex and fascinating body of law is one that is built upon awareness of how the U.S. banking regulation came to be in its present confused state. The structure of regulation is then best understood as a reflection of the interplay between the nature of banking activities, themes underlying the American culture, and historical developments.
At the outset McAniff acknowledged that the astonishing complexity of rules governing banks, comprising the most intensive and extensive body of U.S. regulation, is in part due to the critical role that banks play in operating the economy. “Banks are central to the economy – they provide liquidity, transfer wealth immediately, act as intermediaries, the Fed uses them to distribute the national debt… Clearly there is no way to run a modern economy without a banking system.” However, while the significance of banks can justify the need for regulation of on their activities, themes prevalent in American history explain its illogical, internally inconsistent, fragmentized, and reactionary structure.
In particular, McAniff sees Thomas Jefferson and Alexander Hamilton as exemplars of the continuing dichotomy between laissez faire market theory and pragmatic approaches to governing. On the other hand, there also exists an over-reaching and strikingly predominant notion of antipathy toward aggregation of power. McAniff believes that this antipathy permeates the American culture and has led to an expanded version of “Separation of Powers.” The concept of dividing the power and thereby controlling it is manifested in the tension between federal and state governments, centralized and diffused ownership structures, large and small businesses, and even between the traditionally mercantile North and the traditionally agrarian South. Lastly, McAniff describes the historically crisis-driven nature of banking regulation as a consequence of an “engrained notion built into the system that Americans can achieve their full potential on their own, free from government intrusion”.
These themes comprise the organizational building blocks of U.S. financial institution regulation and are due to their cultural entrenchment resistant to change. McAniff creatively illustrates this byzantine structure as “dividing legislation, regulation and regulators into industry-based silos (banking, securities, and insurance), which are further subdivided as a result of intricate cultural tendencies, standing amidst regulatory gaps.” This organization inevitably leads to regulatory gaps and overlaps, as well as opportunities for regulatory arbitrage that triggers a “race to the bottom” among regulatory agencies.
Standing in stark contrast to the European and Australian approach of adapting regulation in response to coalescence of the markets, the U.S. has never even conducted a comprehensive review of its disjoined groups of federal regulators. Instead, the U.S. approach involved series of piecemeal fixes that only further complicated the structure as mentioned themes operated to prevent substantive change. According to McAniff, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) enacted in response to the Global Financial Crisis serves as a perfect depiction of mentioned themes in action (however unfortunately). Despite the fact that the need for a simplified structure has long been apparent, Dodd-Frank failed to bring about real structural reform while creating an economic environment that obstructs rather than facilitates the banking industry.
McAniff did not hide his skepticism about the extent of recovery possible under the current system or the likelihood that the government will be able to assess the shortcomings of the regulatory structure with an unbiased perspective in the near future. In support of this he cites the obvious discrepancy between Dodd-Frank and various independent international entities in identifying causes of the Global Financial Crisis. Indeed, Dodd-Frank allocated all of the blame on the private sector and sought to remedy the crisis with regulation that decreased revenue, increased expenses and increased capital requirements for the banks, while entirely failing to address bubble problem. This approach resulted in what is now the worst recovery form a financial downturn in the history of the United States.
In contrast, McAniff pointed to the The Laroisere Report as the most comprehensive, unbiased and accurate description of the causes. The report lists the trading mindset, the view that the market is an infallible judge of value, purchases and sales of assets without appropriate analysis of credit and risk, wide-spread failure for proxies for such analysis, unthinking the acceptance of derivatives as moderators of risk, and the determination of the OECD countries to abstain from the regulation of derivatives, as six most significant causes—all are results of a herd mentality or of mob psychology and are directly correlated with the Dutch Tulip Crisis and the English South Sea Bubble. These factors were responsible for a massive failure of risk management by almost every participant in the system, including financial regulatory agencies worldwide. While no regulatory system that can prevent mass ignorance or lack of common sense, McAniff reminds us that such characteristics are however, facts. Because of this, he contends that regulation of financial institutions ought to properly take account of their impact and of their ability to exacerbate economic difficulties into crises.
Among other major causes the report also lists the U.S. pursuit of an easy money policy despite emergence of real estate bubbles, the U.S. failure to regulate the shadow banking system, accounting issues, and finally the undue and unjustified reliance on economics and economists. Siding with the report’s analysis, McAniff added that the list of causes thus implicitly includes the structural inadequacy of U.S. Regulation as well as “Satan’s sin of intellectual pride” manifested in “self congratulatory statements by many prominent economists to the effect that they knew how to avoid significant downturns in the economy or, certainly how to get out of them, which were remarkably off the mark”.