“An Inherently Public-Private Partnership”: Introductory Reflections on Financial Sector Regulation in the US and EU since the Advent of the Crisis

As we’ve noted previously, at this year’s AALS Annual Meeting the Section on European Law will join with the Section on Financial Institutions & Consumer Financial Services in co-sponsoring a joint program entitled “Taking Stock of Post-Crisis Reforms: Local, Global, and Comparative Perspectives on Financial Sector Regulation.”  The program will take place on Friday, January 3 at 10:30 am at the New York Hilton Midtown.  In what I hope will be an enticement for section members to attend, below are some introductory remarks with which I plan to open the discussion. I look forward to seeing many of you there.

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Together with the chair of the Section on Financial Institutions & Consumer Financial Services, Saule Omarova (UNC School of Law), let me welcome you to this morning’s panel, “Taking Stock of Post-Crisis Reforms: Local, Global, and Comparative Perspectives on Financial Sector Regulation.”  I am Peter Lindseth (UConn School of Law), chair of the Section on European Law.  It is our pleasure to co-sponsor this morning’s joint program with the Financial Institutions Section.

The aim of this panel, as the title suggests, is to “take stock” of reforms in financial-sector regulation since the advent of the crisis. Our perspective will be resolutely comparative and, we hope, “transatlantic” and indeed “global.”  As the call-for-papers put it, “[t]he financial crisis of 2008 was truly a global crisis, and the world continues to face a wide range of post-crisis economic and political challenges.”  Not least of these is the continuing quest for the right institutional mechanisms as well as the right regulatory and enforcement strategies to promote political and legal accountability in the financial system, whose sound operation is of obvious high public importance.

For many of us in the European Law Section, the study of risk regulation in the financial sector takes us distinctly outside our comfort zone. But the question of financial-sector regulation, I would submit, touches on issues that should be deeply familiar to anyone who has closely followed the process of European integration – indeed, the evolution of modern governance more generally – over the last several decades. 

As our two discussants today (Anna Gelpern and Bob Hockett) put it to me recently, regulation of the financial sector is “an inherently public-private partnership.” If we were to cast this in terms more familiar to Europeanists, we would say that financial-sector regulation is an example of “network” and “multilevel” governance in which significant amounts of regulatory authority, for better or worse, has seeped beyond the confines of individual nation-states.  In these circumstances, the question of accountability – legal, political, even moral – becomes acute.  The regulator’s role, whether in terms of macro-supervision of systemic risks or micro-prudential supervision of individual firms, becomes daunting.  Enforcement of regulatory norms is an ongoing challenge.  Coordination among regulators at various levels of governance becomes crucial.

Although the papers this morning speak more directly to the US rather than the European experience, they were selected precisely because they address general concerns that lend themselves to a broader comparative discussion. We will begin with Art Wilmarth (GW Law School). Wilmarth’s paper focuses on Citigroup as a “case study in managerial and regulatory failures” in a global too-big-to-fail (TBTF) bank. This paper, however, is merely the first installment in a broader comparative project that, when completed, will include similar studies of two additional TBTF banks, both of which are based in Europe.  The first is the Royal Bank of Scotland (RBS), the UK giant that resulted from the merger with NatWest in 2000.  The second is UBS, the Swiss global financial services company that resulted from the merger of the Union Bank of Switzerland and the Swiss Bank Corporation in 1998.  Wilmarth’s analysis, in its almost relentless litany of repeated losses, scandals, legal violations, and regulatory failures, presents a cogent challenge to the “universal banking” model on which Citigroup, RBS, and UBS have been built.  It is an excellent point of entry into our discussion.

Our second paper is from Hilary Allen (Loyola-New Orleans College of Law). Allen’s piece tries (in part) to answer a question posed originally by Matt Taibi in a Rolling Stone article in February 2011: “Why Isn’t Wall Street in Jail?”  The typical answer (in fact, Taibi’s answer) is that the financial sector has captured politicians and regulators, who are thus more inclined to protect the sector rather than hold it to account. (This is a familiar claim in the European context as well, particularly at the national level, with its penchant for “national champions” and politically-connected regional and local banks – for example, Spanish cajas or German Landesbanken – that have been major sources of instability.)  Allen argues, by contrast, that destabilizing behavior in the financial sector has been less a consequence of “dishonesty or untrustworthiness (which provide the justification for criminalizing most white collar offences), [than of] more indirect failure[s] of other-regarding behavior.” If this is in fact the case, it would not necessarily be inconsistent with the capture thesis.  Allen’s paper is nevertheless a reminder of how difficult it is to disentangle financial regulation from the realm of morality plain and simple.

Our final paper, from guest-presenter Sabeel Rahman (the Reginald Lewis Fellow at Harvard Law School), is also concerned with moral judgment, raising questions about the social value of certain forms of financial activity and how best to regulate them.  Rahman explores two paradigms for financial regulation that have competed with each other in the US over the last century. The currently predominant approach is, according to Rahman, “managerial,” entailing heavy reliance on insulated expert regulators to formulate and enforce rules.  In practice, however, Rahaman claims this reliance on expertise has too often resulted in what he calls an “overeager deference to financial innovation as an unqualified good.” The rival approach, which was in favor in the US in the early part of the twentieth century but has since been eclipsed, reflects deep reservations about the value of many forms of financial innovation.  This second approach thus focuses on “structural” constraints on the size and powers of financial firms, as manifest in such laws as the now-repealed Glass-Steagall Act.

As Rahman’s analysis suggests, history matters.  And it is on this level, in particular, that the European experience has something important to teach.  Without sensitivity to history, for example, it is impossible to understand the peculiar structure of the emergent European “banking union,” perhaps the most significant regulatory initiative to come out of the Eurozone crisis (aside from supranational surveillance of national budgets).  The US has had the three pillars of a federal banking union in place since the New Deal: a common bank-supervisory regime, a common resolution authority, and a common system of deposit insurance.  The EU, by contrast, is struggling to recreate some (but not all) aspects of those pillars in the midst of the current crisis. 

The European Central Bank (ECB) will soon gain supervisory authority over Europe’s largest banks (some 130 or so) but the remainder (some 6000 banks) will remain under national supervision, many of which – like the aforementioned Spanish cajas or the German Landesbanken – are principal actors in the current crisis. European finance ministers recently agreed to a common bank-resolution mechanism, but it is important to note that closures will remain subject to an effective national veto, while recapitalization will depend heavily on creditor “bail-ins” in order to protect the public fisc.  The agreement provides for an extremely limited, supranationalized fiscal backstop that will only come into effect in a decade (based on a common fund paid for by the banks themselves).  Until that time, however, national budgets will remain on the hook – there will be no Europeanized fiscal burden-sharing for the so-called “legacy costs” of the crisis.  And as for the third pillar of a workable banking union – a common regime of deposit insurance – that has proven to be a bridge too far, again because of too great a risk of fiscal burden-sharing between the so-called core (lead by Germany) and the Eurozone periphery (Greece, Ireland, Portugal, Spain, and Italy).  Consequently, deposit-guaranty schemes will remain a national obligation, subject to certain common rules.

The result is a still-deeply fragmented European monetary union, with variable country-specific risks and interest-rate differentials.  The negotiations over Europe’s emergent “banking union” reflect, I would suggest, a deeper dynamic that has shaped the structure of European integration over the last half-century. In this dynamic, certain kinds of regulatory power (e.g., monetary policy, bank supervision) have proven capable, at least in part, of delegation to supranational institutions.  However, other powers (i.e., ones that demand strong democratic legitimacy like taxation, spending, and borrowing) have remained fundamentally national. There is a crucial irony that emerges out of this dynamic, at least with regard to the “banking union”:  Although the purpose of the “banking union” in the Eurozone was purportedly to break the so-called “sovereign-bank link” (i.e., the burden on national budgets to provide the ultimate fiscal back-stop for banks, and the burden on banks to buy sovereign debt), in fact the “banking union” has arguably ended up reaffirming that link, again contributing to the fragmentation and renationalization of the European market for financial services.

For our first discussant today, Anna Gelpern (Georgetown), this reaffirmation of the “sovereign-bank link” is hardly surprising.  In several articles/chapters that she is currently finalizing, Anna has been exploring the “persistence and perverse effects” of what she calls the “dysfunctional marriage” between banks and governments.  We’re hoping that, in her comments today, she might set out some of her insights regarding that seemingly unavoidable linkage, both with regard to the US and the Eurozone.

Our second discussant this morning, Bob Hockett (Cornell Law School), has been thinking about another dimension of the problem – the role of central banks, monetary policy, and the provision of credit – as an aspect of the “inherently public-private partnership” that is financial regulation.  Bob will hopefully elaborate on that crucial function, particularly given some of the peculiar features of the ECB vis-à-vis a “normal” central bank like the Fed.

And with that, let us know turn to the speakers ….