August 20, 2012 / 4:35 PM / 5 years ago

Breakingviews: Lawsky affair rekindles U.S. regulatory arb risk

(This column appears in the August 20 edition of Newsweek magazine. The author is a Reuters Breakingviews columnist. The opinions expressed are his own. )

Superintendent of the Department of Financial Services Benjamin Lawsky listens to New York Governor Andrew M. Cuomo speak during a cabinet meeting in Albany, New York October 12, 2011. REUTERS/Hans Pennink

The usher shouting “Fire!” in a crowded movie theater should see flames before sending patrons stampeding for the exits. If the danger is real, he emerges a hero. A false alarm gets him fired. After all, he is the regulator of the cinema, ensuring the audience’s safety, shining light in the darkness, shushing moviegoers and, if absolutely necessary, clearing the seats.

So what kind of usher is Benjamin Lawsky? Don’t be ashamed if you’ve never heard of him. Even in the ambit of financial regulation, the New York State Superintendent of Financial Services was a nobody until last week, when he wangled a $340 million settlement from Standard Chartered, the UK bank with operations across the Far East, for facilitating allegedly illegal Iranian money transfers. Now he’s a known quantity in bank boardrooms from New York to London to Singapore.

To the tar-and-feather Wall Street brigade, Lawsky is a hero. The narrative goes like this: the dashing young regulator stood up to a “rogue institution” doing business with one of America’s sworn enemies. The bank’s executives ignored warnings that it breached U.S. sanctions. When faced with the evidence, one even replied: “Who are you to tell us, the rest of the world, that we’re not going to deal with Iranians?” In short, Lawsky was the good usher, exposing the miscreants throwing Junior Mints from the balcony and sounding the alarm.

And boy did he set bells ringing. The bank’s shareholders freaked out. So did fellow regulators looking into the Iranian dossier. Treasury Secretary Timothy Geithner found out about Lawsky’s threat to revoke StanChart’s banking license from the newswires. The Federal Reserve, worried that might cause a run on a bank that handles $230 billion of daily trades, donned its hardhat and conducted checks every few hours on StanChart’s deposits and cash positions.

Now, if the Fed and Treasury were dragging their heels, isn’t it right that Lawsky sprang into action? And, anyway, shouldn’t another arrogant, bonus-happy bank take it on the chin? Well, perhaps. But a central lesson of the financial crisis was the need for regulators to better cooperate and share information. Working at cross purposes creates opportunities for what’s known as “regulatory arbitrage,” whereby banks circumvent regulations by exploiting rivalries among their various overseers.

That’s why Washington’s financial watchdogs, and the New York banking authority, reached a memorandum of understanding two years ago that they would refrain from front-running each other on criminal or civil actions. The idea was to assemble the facts jointly before going public, or to use the cinematic analogy, to ensure flames are licking at the stage curtain before causing a panic. Lawsky may have been right to brand StanChart a rogue. But it takes one to know one.

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