Streetwise Professor Claims Bipartisan Support for Restoring Glass-Steagall Is “Misguided”

University of Houston Finance Professor Craig Pirrong characterized bipartisan advocates who would restore the Glass-Steagall Act (“Glass-Steagall”) in order to prevent future crises as “wholly misguided.”

Professor Pirrong identified the imposed separation between securities underwriting and commercial banking as the “part of the Glass-Steagall Act which its worshipers are most intent on restoring.” He argued that the banking structures outlawed by Glass-Steagall were not “materially important in causing the 2008 crisis,” noting that institutions responsible for nearly bringing down the financial system were mostly standalone investment banks and not depository institutions. Professor Pirrong stated that reimposition of a Glass-Steagall law would be potentially destructive:

Glass-Steagall restrictions are largely irrelevant to preventing financial crises, and some of their effects – notably, the creation of an investment banking industry largely reliant on hot, short-term money for funding – actually make crises more likely.


Lofchie Comment: The restoration of Glass-Steagall is a financial regulatory “reform” having a political moment. Most people seem to approve of it without knowing what it means or why it could be beneficial. The strangest premise of Glass-Steagall is the idea that commercial banking must be separated from investment banking in order to protect the banking business. In reality, the business of making commercial loans on collateral that is either illiquid or nonexistent seems far riskier than the business of securities underwriting. See CATO Institute Director Mark Calabra’s report, “Did Deregulation Cause the Financial Crisis?

IOSCO Requests Comments on Study of Liquidity in Corporate Bond Markets

IOSCO requested comments on a consultation report reviewing liquidity issues in the secondary corporate bond markets. The study found no reliable evidence that liquidity in these markets deteriorated markedly from historic norms for non-crisis periods.

According to IOSCO, industry perceptions of the development of bond market liquidity between 2004 and 2015 are mixed but “the majority of both buy-side and sell-side respondents to the IOSCO survey perceive market liquidity to have decreased.” The report stated “these perceptions were generally based on personal experience and not supported with data or data analysis.” IOSCO stated, however that “[w]hile some of the relevant metrics (turnover ratio, dealer inventories, and block trade size) might indicate potential signs of lower liquidity, most metrics reviewed show mixed evidence of changes in liquidity (bifurcation of trading, average trade size, and average number of counterparties or market makers) or some evidence of improving liquidity (trading volume, bid-ask spreads, and price-impact measures).”

IOSCO noted that:

 . . . there is no reliable evidence that regulatory reforms have caused a substantial decline in the liquidity of the market, although regulators continue to monitor closely the impact of regulatory reforms.

IOSCO requested comments from market participants on the conclusion that bond market liquidity has not substantially declined. IOSCO also requested information about:

  • specific dealer inventory levels (gross and net) of corporate bonds held for the purpose of market making in corporate bonds, between 2004 to the present date;
  • statistics concerning dealer quoting behavior;
  • the number of counterparties that various buy-side and sell-side firms are trading with;
  • orders that investors tried to execute but could not do so for various reasons; and
  • the time it takes participants to execute trades in secondary corporate bond markets.

Comments on the report must be submitted by September 30, 2016.

Lofchie Comment: Market participants are adamant that liquidity has declined. Regulators are adamant that liquidity has not declined or that, if it has declined, it is because of factors other than regulatory change. Who, then, is one to believe? Consider this: the regulators control the terms of this debate; they put out the reports. Before embracing their position, here are a few observations that should give one pause:

First, the report concedes that “regulatory requirements, e.g., higher capital and leverage requirements, have reduced dealer ability and willingness to allocate capital to proprietary and market making activities, hold positions (particularly large inventories) in corporate bonds over time, and actively trade corporate bonds.” Given these changes in market regulation, it would actually be rather weird if liquidity had not declined. In fact, for it to keep steady, there would have to be some material liquidity-boosting developments in the market, but IOSCO does not report any.

Second, the regulators describe market participants’ perception as not being based on any reliable evidence. What the regulators really mean when they say this is that market participants are making a judgment based on their perceptions (rather than on having done studies independently) because as the regulators themselves concede, the evidence really does exist; it is just mixed.

Third, that the regulators and market participants are drawing opposite conclusions based on “mixed evidence” could indicate that different factors are being viewed as important. The regulators are asserting, for example, that the “bid/ask” spread is an important measure of liquidity. Conversely, market participants are saying that the bid/ask spread is less important than the size of the trade to which the spread relates. If the size of the trade is very small, the fact that the bid/ask spread is narrow is of much less relevance to them. So who is right as to which evidentiary measure is important? Here is one view: the persons who are the best judges of a product (which for this purpose includes a “market”) are those who actually use it; i.e., the market participants.

Regulators Highlight Progress in Treasury Market Structure

In 2015, staff members from the U.S. Treasury Department (“Treasury”), the Board of Governors of the Federal Reserve System (“FRB”), the Federal Reserve Bank of New York, the SEC and the CFTC (collectively, “Joint Member Agencies”) issued a Joint Staff Report on the U.S. Treasury Market. The report detailed the “significant volatility” that took place in the Treasury markets on October 15, 2014 and involved record trading volumes, an unusually rapid round trip in prices, and a deterioration in liquidity in a short amount of time.

On August 2, 2016, the Joint Member Agencies issued a statement highlighting actions and accomplishments over the past year that “further enhance the public and private sectors’ understanding of changes to the structure of the U.S. Treasury market and their implications.” The Joint Member Agencies reaffirmed the findings in the Joint Staff Report and voiced their commitment to following the steps that it contained.

The Joint Member Agencies highlighted the following actions, among others:

  • The Treasury published a request for information about the evolution of the U.S. Treasury market structure as part of a comprehensive official sector review of the U.S. Treasury market.
  • The Treasury, the CFTC, the SEC and the FRB signed a memorandum of understanding (“MOU”) in order to permit the sharing of information about U.S. Treasury cash and related derivative markets among the agencies. The MOU will facilitate the analysis of major market events.
  • On July 19, 2016, the SEC published a proposed FINRA rule that would require member brokers and dealers to report U.S. Treasury cash market transactions to a centralized repository. The SEC also requested comments on the proposal.
  • The SEC published proposed amendments that would enhance the transparency and oversight of alternative trading systems, and solicited public comment on whether such rules should be applied to systems that trade only U.S. Treasury securities.
  • The CFTC published and requested comments on a proposed rule concerning specific aspects of automated trading in futures markets, including U.S. Treasury futures. The proposal covers pre-trade risk controls and requirements (i.e., registration with the CFTC, and development, testing and monitoring standards) for market participants using algorithmic trading systems on U.S. futures exchanges.

Lofchie Comment: The Joint Member Agencies’ statement makes no mention of two significant issues in the government securities markets. First, only one major clearing bank for government securities is expected to exist in the near future. Second, the new leverage limitations are reported to damage the repo market in government securities significantly. These negative developments are probably the result of new regulations.

The disappointing thing about the Joint Member Agencies’ statement is not the potential of the rules it mandates for creating negative or unintended consequences, since new rules are merely experiments that may succeed or fail, and failed experiments are sometimes necessary. What disappoints is that the agencies seem unwilling to acknowledge those failures, which is like refusing to analyze the results of unsuccessful scientific experiments. It would be better for the agencies to acknowledge and address failure openly, since examining past mistakes is the best way to learn from them.

Hanke on IMF pressure from politicians…

The FT published my letter “Not the first time IMF has succumbed to pressure from politicians.”

A recent FT editorial as well as story indicated that the IMF’s Independent Evaluation Office found that the “IMF repeatedly succumbed to political pressure from European governments during the eurozone debt crisis”.

This is not the first and only case in which the International Monetary Fund has been manipulated by politicians, and it certainly is far from the worst.

The full letter is available at

Hanke on Currencies and Economics…

CFS special counselor and Johns Hopkins professor Steve Hanke penned an extraordinary piece – “Remembrances of a Currency Reformer: Some Notes and Sketches from the Field.” The piece chronicles his successes and experiences (over 21) as a currency reformer. Many of the episodes highlight the productivity of Steve’s longstanding collaboration with CFS senior fellow Kurt Schuler.

“Remembrances of a Currency Reformer” sheds light on currencies, challenges related to making policy, and the IMF. Steve offers unique insight into decisions in Indonesia, Argentina, Russia, Bulgaria, etc.

Last – and definitely not least – Steve offers five rules that have guided his research. They include:

– The 95% Rule,
– The Plumbing Principle,
– The Repetition Rule,
– The Patience Principle, and
– The Numero Uno Rule – Mrs. Hanke.

My brief and rule headings barely skim the surface. The full paper is available at

EMSAC Considers Recommendations on Trading and Disclosure

The SEC Equity Market Structure Advisory Committee (“EMSAC”) considered recommendations made by a subcommittee that examined investor disclosures, trading halts and trading reopenings.

The EMSAC Market Quality Subcommittee made a number of recommendations regarding halts and reopenings in individual stocks and in the market generally. The subcommittee recommended that the exchanges make every possible effort to open all stocks at 9:30 a.m. following a trading halt. The subcommittee noted problems with reopening less liquid securities.

The EMSAC Customer Issues Subcommittee suggested that the SEC:

  • benchmark and monitor investor confidence in U.S. equities market structure by testing the clarity of disclosures on a representative sample of individual investors; and
  • modify Regulation NMS to require that meaningful execution quality and order-handling disclosures be provided to retail investors.

In a public statement at the meeting, SEC Commissioner Michael S. Piwowar stated that he had “previously challenged the notion that the [SEC] should ‘promote investor confidence,’ because it is not part of [the SEC’s] core mission and is a nebulous concept.” However, Commissioner Piwowar affirmed that he “completely agree[d]” with the Customer Issues Subcommittee’s proposal concerning investor testing, “not because it could improve investor confidence, but because it could facilitate investors making informed choices about investment venues, strategies, and products.”

Lofchie Comment: The recommendations offer a lot to consider about the ways that markets function and investor disclosure works. Trading firms should review the various statements carefully regarding the proposed procedures for stopping and restarting trading generally and in individual stocks. The customer disclosure issues might not be controversial in substance, but firms should consider whether the requirements concerning those issues will be difficult operationally.

As a matter of regulatory philosophy, the distinction made by Commissioner Piwowar between boosting investors’ confidence and increasing their “understanding” (which he described as “skepticism”) is important. Given the variety of forces that affect it, market behavior is innately incomprehensible, and attempts to control those forces can backfire or have unintended consequences. For that reason, the government’s effort to control market behavior in order to inspire investor confidence is a losing game. To play that game is to instill false confidence in investors, and that confidence will be shaken doubly when it is disappointed. As in love, so in the marketplace: It is better to know that things can go wrong than to have one’s overconfidence encouraged.



Lofchie on Financial Reform Platforms

When considering financial regulation (and regulation generally) and their expressed attitudes towards the financial system, the two platforms are positioned almost diametrically in opposition. It is necessary, therefore, to say something about the parties’ views of the role that government should play both in providing employment and in the role of private enterprise. The Republican platform is based on the standard position that private enterprise is to be strongly encouraged and is generally preferable to governmental enterprise. By contrast, the Democratic platform is largely about governmental spending and enterprise; including, for example, government spending on infrastructure: drinking water and waste systems, climate change initiatives, education, industrial energy efficiency, broadband networks, health care, child care, care for the aged, housing, supporting groundbreaking research and so on. The Democratic platform supports such spending not only at the federal level, but also at the state and municipal level. While the summary above does not fully include these spending initiatives, it would not be possible to assess the Democratic position on financial regulation and the direct conduct of financial activities by the government without that context.

The focus of this discussion is on financial regulation. The Republican platform, provides little in the way of ambitious new plans. It is, at its core, completely skeptical of regulation, describing all of it as a “tax.” This is obviously not true: good regulations are necessary for growth because they keep market participants honest. Advocating for the abolition of the Internal Revenue Service, as the platform does at one point, seems to be a wholly unserious proposition. That being said, it is all a matter of perspective. If one believes that our current system of financial regulation is more in need of pruning than of fertilization, then such unseriousness is a bit of welcome relief from the unseriousness of our current debates.

The Democratic platform, by contrast, is breathtaking in its ambition. It is not possible to ignore the extent to which the Democratic platform envisions a substantial replacement of the private financial system by government-owned financial enterprises. A notable example: the platform advocates the idea that the Postal Service should provide “basic” banking services. While the only such service that is expressly mentioned is check cashing, the platform strongly suggests that such services would also include deposits and lending. In addition, the platform would establish an “independent, national infrastructure bank” to, among other things, “provide loans and other financial assistance for . . . multi-modal infrastructure projects.” (What in the world does that mean?) Then there are also the half dozen or more other loan and investment services for which the platform makes provision. The platform seems to intend that the Postal Service would enter into direct competition with community banks. It would seem to be the strong, albeit implicit, belief of the drafters of the Democratic platform that the government would be successful in not only community banking but in a whole range of investment banking-type activities.

The Democratic platform spends a fair amount of time demonizing all those who work in financial services as part of a hostile and criminal operation. Perhaps those who are in government should be a bit more modest given that the number of senior government officials who have been convicted of financial crimes is fairly substantial. That said, the supposedly corrupt “revolving door” between financial regulators and the financial industry seems to be overstated if not completely fictional. Where is the evidence that anyone at the SEC has been negatively influenced by their previous job? Whether or not the authors of the draft platform have any genuine goal in that regard, the effect of the assumption will be the same: preventing knowledgeable individuals from working for financial regulators. If being ignorant of how markets work should be considered to be such an asset, then perhaps financial regulators should be selected randomly from the phone book (though a lottery drawn from a list of academics might yield even more candidates with this particular asset).

Much of the detail of the Democratic platform is either unserious or intellectually incoherent. What does it mean to protect the independence of the Federal Reserve Board, but to make it more representative? If the Board is to be more “representative”; i.e., reflecting the popular will, what is the purpose of its independence? Likewise, is it absolutely necessary that “every Republican effort to weaken” Dodd-Frank must be stopped – i.e., that it is wrong to reassess the 2,000-page statute after six years of operation in order to gauge its failures and successes? Does anyone really believe that Dodd-Frank is such a perfect work of art that any attempt to revisit its contents is a form of desecration? The politicization of every issue makes it impossible to have a rational discussion about financial regulation.

Interestingly, there are some areas of agreement between the Democrats and the Republicans in their political platforms. Both express skepticism of international trade (both single out China) and both are opposed to “too big to fail” (which seems to be the regulatory equivalent of supporting the baking of apple pie).

It is perhaps unfair to critique political platforms given the general understanding that they are for the most part meaningless monologues that will be ignored by the soon-to-be elected officials. Nonetheless, even if they are not directly actionable documents, they do influence the parameters of the debate that is to come, and thus it seems appropriate to treat the documents as significant.

Republican Financial Reform Platform Summary

The Republican platform position is highly critical of Dodd-Frank for “establish[ing] unprecedented government control over the nation’s financial markets,” forcing “central planning of the financial sector” and creating “unaccountable bureaucracies” that have “killed jobs.” In general, the Republican platform describes financial regulations as “just another tax” and states that Americans should “consider a regulatory budget that would cap the costs federal agencies could impose on the economy in any given year.” In particular, Republicans would:

  • abolish the Consumer Financial Protection Bureau or subject it to congressional appropriation;
  • “advance legislation that brings transparency and accountability to the Federal Reserve, the Federal Open Market Committee, and the Federal Reserve’s dealing with foreign banks”;
  • (regarding “too-big-to fail”) “ensure that the problems of any financial institution can be resolved through the Bankruptcy Code”; and
  • endorse prudent regulation of the banking system to ensure that FDIC-regulated banks are properly capitalized and taxpayers are protected against bailouts.

The Republican Platform criticized the Dodd-Frank Act:

Rather than address the cause of the crisis — the government’s own housing policies — the [Dodd-Frank Act] extended government control over the economy by creating new unaccountable bureaucracies. Predictably, central planning of our financial sector has not created jobs, it has killed them. It has not limited risks, it has created more. It has not encouraged economic growth, it has shackled it.

Democratic Financial Reform Platform Summary

The Democratic platform position on financial regulation begins with an endorsement of Dodd-Frank. The Democrats state that they will “vigorously implement, enforce and build on the landmark Dodd-Frank financial reform law” while “stop[ping] dead in its tracks every Republican effort to weaken it.” When addressing the financial industry, a term used interchangeably with “Wall Street,” the Democrats aver that it is marked by “greed and recklessness” and that it is “gambling trillions” for the benefit of a “handful of billionaires.” To combat this, the Democrats would “support stronger criminal laws and civil penalties for Wall Street criminals who prey on the public trust” and would support “extending the statute of limitations” to prosecute such people.

The Democrats propose to:

  • support the Department of Labor’s new fiduciary rules;
  • “oppose any efforts to change the CFPB’s structure from a single director to a partisan, gridlocked Commission” and “oppose any efforts to remove the [CFPB’s] independent funding and subject it to the appropriations process”;
  • “nominate and appoint regulators and officials who are not beholden to the industries they regulate”;
  • “crack down on the revolving door [sic] between the private sector . . . and the federal government,” and “ban golden parachutes” [payable to those leaving private industry to work in government];
  • “limit conflicts of interests by requiring bank and corporate regulators to recuse themselves from official work on particular matters that would directly benefit their former employers”;
  • “bar financial service regulators from lobbying their former colleagues for at least two years”;
  • adopt an “updated and modernized version of Glass-Steagall”
  • impose a “financial transactions tax on Wall Street to curb excessive speculation and high-frequency trading,” although the platform does “acknowledge that there is room within our party for a diversity of views on a broader financial transactions tax”; and
  • “defend the Federal Reserve’s independence,” but also “reform the Federal Reserve so that it is more representative of America as a whole, and . . . fight to make sure that executives at financial institutions are not allowed to serve on the boards of regional Federal Reserve banks or select its members.”

The Democratic Party emphasized its determination:

Democrats will not hesitate to use and expand existing authorities as well as empower regulators to downsize or break apart financial institutions when necessary to protect the public and safeguard financial stability, including new authorities to go after risky shadow-banking activities.

The Democratic platform envisions not only a continuing expansion of financial regulation, but also seems to promote the idea that government should play a very major role as a direct provider of financial services.

As a provider of financial services, the federal government would:

  • expand the powers of the Postal Service so that it may offer “basic financial services such as paycheck cashing”; and later, the platform again emphasizes that the Democrats “believe that we need to [provide additional banking services] by empowering the United States Postal Service to facilitate the delivery of basic banking services”;
  • create an “independent, national infrastructure bank that will support critical infrastructure improvements” and “provide loans and other financial assistance for . . . multi-modal infrastructure projects”;
  • continue to support the interest tax exemption on municipal bonds . . . to encourage infrastructure investment by state and local governments;
  • defend the “Export-Import Bank”;
  • “provide direct federal funding for a range of local programs that will put young people to work”;
  • “provide targeted funding and support for entrepreneurship and small business growth in underserved communities”;
  • “double loan guarantees that support the bio-based economy’s dynamic growth”; and
  • expand “federal funding for New Markets Tax Credit, community development financial institutions, and the State Small Business Credit Initiative.”

Industry Groups Urge SEC to Amend Reproposed Rule on Incentive-Based Compensation

The Managed Funds Association (“MFA”), the Alternative Investment Management Association (“AIMA”) and SIFMA told the SEC that its proposal concerning incentive-based compensation arrangements imposed restraints that exceeded the intent of Section 956 of the Dodd-Frank Act. Section 956 requires U.S. financial regulators to issue rules prohibiting excessive compensation arrangements that encourage inappropriate risk taking at Covered Financial institutions.

In their comments, MFA and AIMA recommended that the proposal should:

  • explicitly exclude non-proprietary assets in the final rule;
  • exclude (i) certain assets that may appear on an adviser’s balance sheet from the calculation of that adviser’s assets for purposes of the asset thresholds, (ii) assets that are invested or otherwise remain in a fund managed by an adviser, and (iii) assets that are held in or set aside for deferred compensation arrangements from the adviser’s assets, in order to determine whether the adviser exceeds one of the thresholds set out in the rules;
  • clarify that only assets from an adviser’s investment advisory business should be included in the calculation of the adviser’s assets for purposes of the asset thresholds in the proposed rules;
  • exclude advisers that rely on the foreign private adviser exemption;
  • exclude investment advisers that are charitable organizations or advisers to church plans or, at the very least, minimize the rules’ effect on them;
  • permit a registered commodity trading advisor (“CTA”) to count only the pro rata portion of its assets in a ratio that is based on the portion of its investment adviser business, as compared to its CTA business, for purposes of the asset thresholds in the rules; or, alternatively, provide a limited exclusion from the definition of “investment adviser” solely for purposes of the incentive-based compensation rules for advisers that are exempt from SEC registration;
  • provide a clear provision in the final rules specifying that payments tied to ownership interests will not be deemed incentive-based compensation under the rules;
  • permit an investment adviser to determine its assets based on an average of multiple dates in a calendar year;
  • require the asset threshold to be adjusted periodically for inflation and the growth of capital markets; and
  • involve coordination between the SEC and the Internal Revenue Service regarding the relationship between the proposed rules and the tax consequences of those rules for covered institutions and covered persons, which would permit covered financial institutions to consider (i) a covered person’s tax situation in setting their incentive-based compensation, and (ii) the after-tax resources of the financial institution in implementing the deferred compensation arrangement.

In a separate comment letter, SIFMA suggested that the SEC proposal should:

  • balance principles-based guidance and prescriptive rules in order to advance the tenets of the Dodd-Frank Act, Section 956;
  • limit the definition of “covered persons” to apply only to those who expose institutions to risk;
  • limit the coverage of incentive-based compensation programs only to those that could encourage inappropriate risk-taking by carving out broad-based arrangements and de minimis compensation; and
  • reflect business structure, risk and governance factors in its approach to consolidation.

SIFMA emphasized that greater flexibility is necessary:

[T]he Reproposed Rule includes a comprehensive framework of often inflexible requirements. Because it will be promulgated and enforced by six independent agencies, once finalized it will be unusually difficult to adjust. It may significantly impact the financial services industry for a long time, through many business cycles and evolutions in the financial markets.


Lofchie Comment: A disproportionate number of individuals who are paid less because of rules like the ones in this proposal happen to work and pay taxes in the New York metropolitan area. New York politicians should consider the negative effect that targeting the financial industry can have on the local economy. Perhaps the localized impact would not matter if such rules made for good public policy. Unfortunately, government-imposed pay rules are a purely political calculation and not based on economic rationality.