With regulatory reform, what's old is new again.
At a Senate Banking Committee hearing Thursday, senators turned away from recent hot-button issues like whether proprietary trading should be banned and refocused on a central question: how to resolve big, interconnected firms that stumble?
"There clearly is a consensus about wanting to end 'too big to fail,' " Committee Chairman Chris Dodd said. "Having said that, how to get from Point A to Point B is not an irrelevant issue. … What are the implications if one institution should fail … but a lot of healthy companies … are connected to the failure of that institution?"
Hal Scott, a Harvard Law School professor, said interconnectedness is a more pressing issue than the so-called Volcker Rule, a series of reforms proposed last week by the Obama administration to curb the activities and growth of large banks. "If banks are too big to fail this proposal has no effect on them. … It does nothing to stop them from getting bigger," he said. "The degree of interconnectedness is what drives bailouts."
Gerald Corrigan, the managing director of Goldman Sachs Group Inc., agreed. "This is really, Mr. Chairman, the crux of the issue," the former president of the Federal Reserve Bank of New York said. "What I have been arguing for years is that those institutions should be able in the matter of a couple hours to put together counterparty exposures across all markets, across all situations. … That is how you deal with interconnectiveness."
Corrigan also addressed this question earlier in the week at a gathering of bankers and regulators discussing the future of financial services oversight. "The fact of the matter is no one's ever executed an orderly wind-down of a large and complex financial institution," Corrigan said. "It's never been done, and the reason is that it's damned hard to do."
A critical hurdle, he said, is getting detailed financial data to regulators on short notice.
Among the needed disclosures, he said, are a bank's exposure to all counterparties, its valuations of all asset classes, liquidity information, legal agreements, risk management frameworks and financial positions with exchanges and clearing houses.
At Tuesday's meeting, hosted by the American Bankers Association and Deloitte, Jane Carlin, Morgan Stanley's global head of operational risk management, said she was both "inspired and overwhelmed by" Corrigan's list of necessary disclosures.
In a panel discussion, she said the current mood among both banks and regulators represents something of a "data-chase" mentality, and that as compliance rules require institutions to continue to produce more and more information, the sheer quantity of data seems to trump its quality.
The concern is that regulators are not able to meaningfully consume and share the data provide by the industry. "There was plenty of data, real and meaningful data … albeit on a siloed basis," Carlin said. "Unachievable data demand will be the next epiphany."
Regulators said they do share data, but agreed improvements are needed. "We don't have a way to tag or structure in a way that ties [data] together cleanly," said Charles Boucher, information technology director for the Securities and Exchange Commission.
Michael Duffy, chief information officer at the Treasury Department, conceded demands on firms to produce financial information will likely outpace regulators' ability to consume it.
At Thursday's hearing, Corrigan suggested institutions develop and implement their own internal stress tests and run hypothetical tests to assess their exposure.
Sen. Richard Shelby, the panel's top Republican, told reporters later that stress tests could be a helpful tool, but said they should be conducted by regulators. "I think stress tests are always good to test the viability of an institution but I think that rather than banks doing it, I think the regulators need to do it," the Alabama Republican said.
Shelby also told reporters that he supports the "spirit of the Volcker rule" because it focuses on the safety and soundness of institutions and tries to minimize risk. Asked whether he would prefer to seek limits on a firm's interconnectedness rather than on liabilities, he said: "We don't know yet. This is a serious question."