The lack of transparency in financial markets was a significant contributor to the 2008 financial crisis. The risks of toxic securities were hidden behind layers of complexity, and the credit rating agencies tasked with making the bottom line transparent to buyers had crippling conflicts of interests.

On the institutional level, the tangled balance sheets of the critical dealer banks were a major contributor to the market freeze that occurred in late 2008. Uncertainties regarding opaque over-the-counter derivatives, complex interbank relationships and “toxic asset” exposures were such that counterparties simply refused to deal with major banks at the center of the system, and the markets froze. Regulators also clearly lacked understanding of bank risk exposures both during the crisis and in the years leading up to the crisis when intervention could have been effective

At the heart of the transparency problem was and is the complexity of the shadow banking system, in which credit is intermediated through extensive securities market relationships. The balance sheets of traditional banks could be understood by examining the underwriting of their loans and their relatively limited set of funding sources. But modern universal banks have a tangled web of securities exposures involving enormously complicated derivatives commitments, short-term funding collateral and elaborately structured securities.

The shadow banking problem is far from solved. But recent financial reforms contain numerous elements that could improve the availability of critical data. However, it’s still far from clear that all of these initiatives will be properly implemented.

What’s more, the ability to integrate and interpret this flood of new data is still lacking. It’s an open question whether all this raw data will result real knowledge that will help both regulators, market participants and the public understand the financial system more effectively.

Here are some of these initiatives:

Derivatives market transparency: For market participants, trading facilities will now offer real-time data feeds for the trading of standardized swaps. Transparency to market participants is still lacking for so-called over-the-counter swaps. For regulators, new swaps data repositories should massively increase the information available to regulators on all swaps.

Transparency of banks: The newly approved international Basel rules contain a list of new bank disclosures that are meant to update the traditional “call report” and 10-K to give more information on the activity of dealer banks. Depending on implementation, these disclosures have  the potential to significantly improve information available to market participants. New accounting rules should also reduce the ability of banks to conceal assets off balance sheet.

On the regulatory side, banks are now required to submit “living wills” to regulators detailing how they could be resolved in the event of financial difficulties. These should greatly improve regulators understanding of bank internal structure. However, their current public versions offer little to no transparency to market participants.

New tracking of credit exposures will also improve regulators’ understanding of interrelationships in the banking system, and regulators at the New York Federal Reserve are working to improve information on securities lending markets. Regulatory stress tests have also improved the effective transparency of bank activities to regulators, as these stress tests require tracing out relationships that may not be visible on the balance sheet alone.

Securities market transparency: The Securities and Exchange Commission has issued new rules on disclosure requirements for asset-backed securities. New SEC rules for credit rating agencies are designed to improve the reliability of ratings information and thus the transparency of securities, although the SEC has apparently rejected radical reform and the effectiveness of its proposed rules seems highly doubtful.

In addition, the new common securitization platform being designed by the federal housing agencies could radically increase the availability of loan-level data for mortgage-backed securities, and possibly simplify and standardize the structure of asset-backed securities as well. One of the few areas of consensus in the reform debate is the desirability of improving the standardization of mortgage-backed securities to make them more transparent for investors.

Overall financial system transparency: The new Office of Financial Research has the ability to amass information centrally to map out areas of stress in the financial system, and also has various legal powers to improve information standardization and accessibility in the markets.

But despite the impressive number of initiatives in progress, it is doubtful that the financial markets are much more transparent to even sophisticated users than they were five years ago. Only a small amount of the new data is available to the public as opposed to regulators. And even regulators, with full access, have great difficulty making sense of the data.

The experience of the so-called “London Whale” demonstrates the continuing limits of regulators’ ability to truly understand bank operations. Richard Berner, the director of the Office of Financial Research, recently admitted that regulators were far from a clear understanding of the nature and location of systemic risks. Data gaps continue to exist, and lack of standardization even in the data that is available makes it hard to use analytically.

Much more work must be done to turn data into real understanding. Besides problems with the data itself, too little is available to the public, even in aggregated form. Along with particular initiatives, regulators need to think about how to engage market analysts, academics, and the public in “crowdsourcing” a better interpretation of the financial system.

— Marcus Stanley

Originally published on USNews.com.

Eleven new House members sit on the Financial Services Committee. All 11 voted last month for a bill that would “blow a hole” in the derivatives reforms adopted after the 2008 crisis, as CFTC Chairman Gary Gensler put it.

Here’s another interesting fact about those 11 freshmen: according to Politico’s latest analysis of Federal Election Commission data, they raised an average of $322,012 in campaign contributions during the second quarter of 2013 — “$100,000 more than the $221,633 average hauled in by all House freshmen.”

“The strong cash hauls by the freshman committee members highlight the fundraising benefits of sitting on a panel that oversees Wall Street and other parts of the deep-pocketed financial services sector,” Politico’s M.J. Lee observes.

Claiming first and second place on the roster of House freshmen were Representatives Tom Cotton (R-Ark.), at $611,341; and Patrick Murphy (D-Fla.), at $530,963. Cotton, as Lee points out, is believed to be weighing a Senate run next year, while Murphy faces a tough reelection race. — Jim Lardner

In its short life, the Consumer Financial Protection Bureau has taken steps to rid the mortgage market of loans designed to self-destruct; shielded military families against various financial scams; warned auto lenders against practices that jack up the price of credit for African-Americans, Latinos, women or seniors; returned nearly half a billion dollars to consumers cheated by credit card companies; and begun to tackle a host of other problems, including predatory payday loans, excessive bank overdraft fees, abusive debt collection practices and the plight of students and families trapped in high-cost private education loans.

It has set out to do its job, in short, and has thereby earned a spot in the cross-hairs of some of the worst elements of the financial services industry and its friends on Capitol Hill.
“If I had my way, we wouldn’t have the agency at all,” Senate Minority Leader Mitch McConnell, R-Ky., reminded an audience of bankers several months ago. McConnell has not had his way. Yet. But three years after the CFPB was approved by Congress and affirmed by the president, to the applause of a large majority of voters regardless of party, McConnell and nearly all his fellow Republican Senators are out to squelch it – by refusing to confirm a director unless their demands are met.

There is thankfully little sign of a willingness to yield on the part of the White House or the Senate as a whole right now. But since paying ransom is always tempting in a hostage situation, it is worth examining the so-called “commonsense reforms” put forward by McConnell & Co., and asking what they would actually do to the CFPB.

“Reform” No. 1: Its director would be replaced with a five-member commission appointed by party leaders. These bodies have a track record of quarrelsomeness and reluctance to stand up to corporate power; moreover, in dysfunctional times like the present, they tend to wind up with only four confirmed members who can’t agree on much of anything. And with a committee in charge, it becomes much harder to hold individuals accountable for their decisions and actions.

“Reform” No. 2: The CFPB would have to come to Congress every year for its funding, rather than continue to receive a small, capped share of the budget of the Federal Reserve, where the agency is housed. Each of the other bank regulators – the Fed, the FDIC and the Office of the Comptroller of the Currency – has some form of independent funding as insulation against political shenanigans. By contrast, the two non-bank financial regulators that already fall under the appropriations process, the SEC and CFTC, have faced massive problems.

Under an exemplary chairman, the CFTC has made admirable progress in reining in the crazed derivatives trading that nearly crashed the world economy in 2008. Yet, as a reward for that success, Chairman Gary Gensler has seen his agency starved for resources and bullied by industry-coddling legislators. And for good measure, the CFPB faces…

“Reform” No. 3: Its actions would be subject to majority-veto by a committee of traditional bank oversight agencies. In short, consumer protection would once again be dictated by the sort of old-school bank regulators who, in the name of protecting the “safety and soundness” of the financial system, have been chronically unwilling to lay down rules that would mean even a modest dent in bank profits. (Their safety-and-soundness record hasn’t been so hot lately, either.)

It is perhaps relevant to note that the 43 Senators vowing to block a vote on a CFPB director have collectively received nearly $143 million in campaign contributions from Wall Street and the financial and real estate industries – a sum untold multiples greater than any money to be had from the consumer, civil rights, labor, senior, small business and other groups arrayed on the other side of these issues.

Of course, the influence of money is hard to prove in a court of law (as opposed to a court of common sense), but the effect of the senators’ proposed “reforms” is clear: by undermining the authority and independence of the CFPB, they would be a godsend to the megabanks and storefront loansharks that this invaluable agency has had the nerve to go after.

Do the 43 senators believe their high-minded talk about bringing more “accountability” or “transparency” to the CFPB? It’s hard to see any evidence of that. A host of federal agencies, including (in the banking realm) the Office of Comptroller of the Currency and the Federal Housing Finance Authority, are led by single directors, while most of the financial watchdogs have independent funding. Yet the  senators who object to these characteristics in the CFPB’s case have failed to evince a comparable desire to “reform” any other such agencies. In fact, some of the them explicitly favored a single director for the the FHFA, arguing that it would be more effective that way.

Nor, for the most part, have they questioned the qualifications of the CFPB’s current director and director-nominee, former Ohio Attorney General Richard Cordray. Since his recess appointment in January 2012, Cordray has won praise from consumer advocates and bankers, and, indeed, from senators on both sides of the aisle. “I think you have done a wonderful job so far in carrying out your duties,” Senator Tom Coburn, R-Okla., told him at a senate hearing a few months ago. Just the same, Coburn is among the 43 vowing to block a vote on Cordray or any other CFPB nominee.

What they have against this agency is, it would appear, neither its structure nor the person nominated to lead it, but its mission as the first and only financial watchdog charged with the primary mission of protecting consumers instead of banks. And that’s what we will lose if the 43 Senators get away with their shabby scheme.

UPDATE: Senate Majority Leader Harry Reid, D-Nev., filed for cloture on the Cordray nomination, among others, today. — Jim Lardner

Originally published on USNews.com.

Harry from Massachusetts thought his son Ari, a 21-year-old infantry soldier, had been bilked by the company that financed his purchase of a truck. Besides paying an 18 percent interest despite his good credit, Ari was talked into a package of dubious extras, including a “comprehensive” insurance plan that didn’t cover several major components. Every month he was hit with monthly processing fees that weren’t even listed on his statements.

Ari was left with a monthly payment of $700 – more than 70 percent of his take-home pay. To add insult to injury, the lender that put him in this fix had the nerve to promote itself as a “proud” provider of “educational services” as well as credit to “our active duty customers.”

Harry reported his son’s plight to the Consumer Financial Protection Bureau. It looked into things, and ultimately saw a problem affecting not just Ari, but other borrowers as well. Last week, the Bureau ordered the lender’s two parent companies, U.S. Bank and Dealers’ Financial Services, to return $6.5 million in what it characterized as ill-gotten gains generated by hidden fees and overpriced add-on services targeted at service members. The order also stops U.S. Bank from requiring borrowers to repay their auto-loans through the military allotment system, the source of some of the undisclosed fees.

The CFPB was created after the financial crisis to bring basic rules of fairness and transparency to the world of lending and consumer finance. The Dodd-Frank financial reform law that created it also specifically required the bureau to receive consumer complaints, and doing so is an important part of its work. More than 120,000 people have communicated with the Bureau by submitting formal complaints through its online Complaint System, reporting, among other things, their unhappy experiences with loans and other financial products. And others have, like Harry, used the “Tell Your Story” feature on their web site.

Here is the bureau’s process for dealing with complaints, which can be submitted online or by phone: Once the bureau receives a complaint, it contacts the relevant company. The company has two weeks to acknowledge the complaint and a limit of two months to respond to all but the most complicated issues. Companies may provide monetary or non-monetary relief (by fixing a credit score, for example), give an explanation or they can deny that there was a problem that needs fixing. Consumers can follow the progress of their complaints online and offer comments throughout. They can also let the bureau, and the public, know if they think the company’s response was reasonable or not good enough.

Meanwhile, the bureau puts data on the complaints it receives into a public database that includes tools for filtering and sorting by categories, such as product type, company, resolution status and whether or not the consumer was satisfied with the response. We think they should also make consumers’ actual descriptions of the problems they run into public (with the complainers’ consent, and without personal information), and are urging them to do that in the future.

In any case, anyone can go to the database and see what problems others have encountered with particular products or institutions, and how problems have been resolved. They can learn from bad experiences and take note of good ones. Researchers can look for patterns of problems and solutions. And, as they did with Harry and Ari, the CFPB can use the complaints as one of its tools for understanding the consumer financial marketplace, spotting and investigating problems and taking action to make the market function more fairly and transparently.

The more people are aware of and use the complaint system, the more useful it will become. At the start, the system could only take credit card-related complaints, but now it has been expanded to include a variety of financial products including car loans, bank accounts, mortgages and student loans. More categories are on the way and the “Tell Your Story” feature remains a more free-form alternative for sharing all kinds of consumer experiences.

The good news about Harry and Ari’s story, and about the complaint system as a whole, is that someone in Washington is finally starting to pay attention to what citizens and consumers have to say about what it’s like to navigate the consumer financial system – and is taking steps to improve it. That is exactly what the Consumer Financial Protection Bureau was created to do.

The bad news is that too many in the financial services industry and their lobbyists and allies on Capitol Hill liked things just the way they were before, and continue to do everything in their power to keep the Bureau from succeeding at its job, including preventing the confirmation of a director to lead it. That needs to change. — Mitch Margolis

Mitch Margolis is an intern with Americans for Financial Reform, a coalition of more than 250 civil rights, consumer, labor, business, investor and other groups working for a strong, stable and ethical financial system.

This piece originally appeared on USNews.com.

In the Dodd-Frank financial reform law, Congress tried to put some minimal restrictions on the Federal Reserve’s powers to bail out Wall Street – but it doesn’t look like the Fed is interested in cooperating. Three years after the agency was instructed to specify new bailout rules “as soon as practicable,” the Federal Reserve still hasn’t done so.

The moral hazard created by bailouts for irresponsible financial behavior is an issue central to financial reform. During the 2008 crisis, the federal government provided unprecedented amounts of assistance to Wall Street, and provided it on extraordinarily favorable terms. The $750 billion Troubled Asset Relief Program authorized by Congress got the most attention, but TARP was just the tip of the iceberg.

Almost a year before TARP, the Federal Reserve began to use its emergency powers under Section 13(3) of the Federal Reserve Act to provide low-interest loans to Wall Street. Over the two years from 2007 to 2009, some $16 trillion in emergency lending flowed through Federal Reserve facilities. At the peak of the Federal Reserve’s emergency bailout, some $1.5 trillion per day was being loaned to various Wall Street and foreign banks.

The Federal Reserve’s use of its emergency powers went far beyond any historical precedent. Section 13(3) of the Federal Reserve Act, which permits the Federal Reserve to do emergency lending to businesses under “unusual and exigent circumstances,” was passed in 1932 during the depths of the Depression. The context differed profoundly from today – for example, policymakers were concerned that in some regions with extensive bank failures, businesses might lack banking services altogether. The original 13(3) also contemplated that emergency powers could be used to lend directly to businesses, instead of simply to financial interests. But even during the Great Depression, the use made of these emergency powers was strictly limited, with less than $2 million in loans made over four years.

While it’s somewhat accepted for central banks to provide some emergency assistance during times of financial stress, the Federal Reserve’s use of its emergency powers went well beyond normal principles of central banking.  Since the 19th century, those principles have called for lending on a temporary basis and at a “penalty rate” – that is, at an interest rate above the prevailing market rate.

The use of a penalty rate means banks which need assistance would have an incentive to self-cure and would bear part of the costs of their rescue. As researchers have documented, the Federal Reserve blatantly violated these principles, extending massive loan programs for a period of years and providing heavily subsidized assistance at rates far below the market rate.

In a compromise, the Dodd-Frank law permitted the Federal Reserve to retain broad emergency lending powers, but placed new limitations on their use. Under Section 1101 of the law, emergency lending must be secured by good collateral and may only be performed through programs with “broad based eligibility” that are limited to “solvent” companies and are not designed to assist a single failing bank. Lending programs also must be terminated in a “timely” manner.

While the restrictions sound good in theory, the legislative language is far too broad and vague to provide an effective check on the Federal Reserve’s emergency powers. The meaning of a “solvent” institution or “good collateral” is often in the eye of the beholder. And a program with “broad based eligibility” can easily be structured to be especially beneficial to holders of a selected class of assets – for example, a program that allowed financial institutions to convert toxic securities into cash could be seen as “broad based,”  since anyone holding such securities would be eligible.

For that reason, Section 1101 also required the Federal Reserve and Treasury to immediately write regulations setting out the exact policies and procedures governing its emergency lending programs. In fact, the Fed was required to propose these regulations “as soon as is practicable.”

But the Federal Reserve seems to be simply ignoring this requirement. Today, three years after the bill was enacted, regulations still haven’t been proposed. The delay isn’t because good rules would be particularly complicated to write. For example, a restriction on emergency lending to a strictly limited time period – say, 90 days – would automatically tend to restrict assistance to financial entities which are actually solvent and have good collateral. That’s because a solvent institution that faces temporary liquidity problems due to market disruptions should be able to find private sector funding over a relatively short time period, while a truly insolvent institution could not.

Clear and forceful rules to limit future Federal Reserve bailouts are necessary to address the expectations created by recent experience that the government may pick up the tab for irresponsible Wall Street behavior. Unfortunately, the Federal Reserve’s inaction on these rules undermines confidence that it’s serious about obeying the new restrictions. It’s past time for them to put the rules in place. Sens. Sherrod Brown, D-Ohio,  and David Vitter, R-La., have introduced new legislation that – along with significantly increasing capital requirements for big banks – would also place far stronger limitations on Federal Reserve emergency assistance. The longer the Federal Reserve delays, the stronger the case looks for doing so.

  — Marcus Stanley

Originally published on USNews.com.