May 24, 2012

A Regulator Who Knows No Bounds

Hester Peirce

Former Senior Research Fellow
Summary

Gensler is correct that bad decisions made in one country can affect other countries’ economies, but U.S. regulators can’t shock proof the world. Perhaps Chairman Gensler, who, earlier this week, was complaining to the Senate Banking Committee about not having enough resources to do his job, should not try to add transactions conducted in Europe and Asia to his regulatory plate.

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In a speech on Monday, Commodity Futures Trading Commission Chairman Gensler seized upon JP Morgan’s London trading travails as the latest example of just how easy it is for bad decisions made overseas to bounce over the Atlantic and harm the American financial system.  Gensler’s solution is to let the CFTC regulate financial firms’ activities worldwide. 

Gensler is correct that bad decisions made in one country can affect other countries’ economies, but U.S. regulators can’t shock proof the world.  Perhaps Chairman Gensler, who, earlier this week, was complaining to the Senate Banking Committee about not having enough resources to do his job, should not try to add transactions conducted in Europe and Asia to his regulatory plate. 

A letter last year from the Japanese Financial Services Agency pushed back against Gensler’s regulatory hubris:  “As [the Dodd-Frank Act] is a US law, naturally we expect this law to be applied to US entities incorporated in the U.S.  For Japanese financial institutions, laws and regulations of Japan, which are consistent with the internationally agreed framework … , should apply.”

In supporting his case for greater international reach for the CFTC, Gensler looked back to the 2008 crisis and the AIG experience:

As the financial system failed in 2008, most of us learned that the insurance giant AIG had a subsidiary, AIG Financial Products, originally organized in the United States, but run out of London.  The fast collapse of AIG, a mainstay of Wall Street, was again sobering evidence of the markets’ international interconnectedness.  Sobering evidence, as well, of how transactions booked in London or anywhere around the globe can wreak havoc on the American public.

Chairman Gensler should have told the other part of the story, which is that AIG’s domestically regulated domestic insurance subsidiaries were a large part of AIG’s downfall.  The state-regulated insurance companies were involved in a multi-billion dollar program of lending out securities short-term and investing the lending proceeds in risky, long-term residential mortgage backed securities. 

Many of banks put at risk by AIG’s aggressive securities lending program were foreign.  Using Gensler’s logic, European regulators of those banks should be clamoring to regulate American insurance companies like AIG.  Just as having European regulators telling U.S. insurance companies what to do would not be palatable to most Americans, an American regulator’s efforts to regulate foreign transactions will not be welcomed abroad.

Chairman Gensler would do well to focus on his domestic mandate, which should include a clear message that firms must bear the consequences of their own bad decisions about where and with whom to do business.  Regulators can’t be everywhere all the time and they should not pretend they can protect the financial system from every bad event here at home, let alone across the world.