July 12, 2015 / 11:02 PM / 4 years ago

COLUMN-Banking regulators heighten financial market risk

(Michael S. Piwowar is a Republican Commissioner on the U.S. Securities and Exchange Commission; J. Christopher Giancarlo is a Republican Commissioner on U.S. Commodity Futures Trading Commission. The opinions expressed are their own)

By Michael S. Piwowar and J. Christopher Giancarlo

July 12 (Reuters) - - During the 2008 financial crisis, the authors of this editorial were in unique positions to observe the near-collapse of our financial system. One of us was at the White House serving on the President’s Council for Economic Advisors and the other was a senior executive of a global operator of trading platforms for cash and derivatives financial products.

Almost seven years later, we now find ourselves serving as commissioners at the two federal agencies charged with regulating U.S. financial markets. As such, we constantly strive to identify and address risks in the markets. Sometimes this analysis leads to surprising and unfortunate conclusions, as is the case with current market conditions.

It is an unavoidable fact that one of the greatest potential risks to the financial markets is the work of regulators themselves.

The 2008 financial crisis had a devastating impact on nearly all aspects of our economy but one, the regulatory machine. In the aftermath of the crisis, policymakers seeking a simple narrative for how these events transpired claimed that financial markets, and the participants overseen by the capital and derivatives markets regulators, were the primary cause of the financial crisis.

This ill-informed assertion led to a misconceived solution: a massive increase in financial regulation. Some of this new regulation merely reflects the pet issues of special interest groups and has nothing to do with the underlying causes of the financial crisis. Other provisions seek to address problems that no longer exist and lack foresight or an appreciation for current market dynamics.

While condemning the actions of a three-letter insurance giant continues to make for a good soundbite, the two massive government-sponsored enterprises that fueled the housing bubble, contributed to the crisis, and received the largest taxpayer funded bailouts, have been conveniently ignored. Thus, despite the millions of dollars and innumerable man hours spent implementing the mountain of new regulatory mandates, real risks in our financial system persist unchecked.

One of the most damaging aspects of these new regulations is the dramatic impact that new prudential rules on banks are having on capital and derivative markets. Given the banking regulators overall lack of market expertise, it is not surprising that myriad new banking regulations fail to effectively account for their impact on markets and market participants. As a result, federal banking policies such as Basel III capital requirements, the Volcker Rule’s ban on trading, flawed derivatives trading rules, and edicts from global shadow regulators like the Financial Stability Board are placing the entire economy at risk by draining much needed liquidity from our markets.

Adequate trading liquidity is the life blood of successful financial markets that fuel our economy. Yet across our markets signs point to diminished liquidity, from the October 2014 Treasury flash crash to fractured trading liquidity in the global swaps markets. The next time our financial markets experience a sharp stress or shock, the cumulative effect of new banking regulations will likely be dramatic price fluctuations and the loss of trading liquidity that will be essential to the viability of many Main Street businesses.

One reason we face this current liquidity threat is the lack of coordination in new rules and the failure to assess the combined effects of banking and market regulations. The Dodd-Frank Act itself acknowledged this potential outcome. Its purported solution was to create and task the Financial Stability Oversight Council, or “FSOC”, with coordinating and identifying the risks associated with the imposition of hundreds of new rules and regulations.

In this role, as with so many others, the FSOC has been an unmitigated failure. Instead of seeking to rein in or calibrate potentially harmful banking regulations that could choke off liquidity needed to support resilient financial markets, the FSOC has wasted its time designating market participants as “too big to fail” in a transparent attempt to expand the perimeter of bank regulation. If FSOC truly concerned itself with potential sources of market risks, it would turn its gaze to the impact of regulations promulgated by the banking regulators who dominate the Council.

Of two things we are certain. First, a lack of forethought and market knowledge by banking regulators has put our financial markets at risk of a liquidity crisis. Second, if a liquidity crisis hits, the banking regulators will be the first to point fingers, blame financial markets and participants, and demand more control over them. Given the risks these regulators have already created, the only way to ensure the safety and efficiency of our financial markets is the press for less meddling from our banking counterparts, not more.

Michael S. Piwowar is a Republican Commissioner on the U.S. Securities and Exchange Commission; J. Christopher Giancarlo is a Republican Commissioner on U.S. Commodity Futures Trading Commission Editing by Alden Bentley

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