2006, foreshadowing the full report, “this would be devastating for both our city and nation.”
To avert such disaster, Schumer and Bloomberg counseled urgent action. The first problem to fix was the overly harsh regulation of Wall Street. As they wrote in their op-ed, “While our regulatory bodies are often competing to be the toughest cop on the street, the British regulatory body seems to be more collaborative and solutions-oriented.” The full McKinsey report, made public two months later, elaborated on this danger: “When asked to compare New York and London on regulatory attractiveness and responsiveness, both CEOs and other senior executives viewed New York as having a worse regulatory environment than London by a statistically significant margin.”
A specific risk posed by America’s overly strict financial regulators, McKinsey warned, was that their approach was driving the highly desirable derivatives business abroad. “Europe—and London in particular—is already ahead of the U.S. and New York in OTC [over the counter—which is to say difficult for regulators to monitor] derivatives, which drive broader trading flows and help foster the kind of continuous innovation that contributes heavily to financial services leadership,” the McKinsey report cautioned. “‘The U.S. is running the risk of being marginalized’ in derivatives, to quote one business leader, because of its business climate, not its location. The more amenable and collaborative regulatory environment in London in particular makes businesses more comfortable about creating new derivative products and structures there than in the U.S.”
Moreover, the report sounded an alarm about the future. America’s overly zealous regulators were on the verge of another colossal mistake: they were planning to raise capital requirements for U.S. banks, a measure McKinsey warned was unnecessary and would weaken the country’s financial champions in the fierce global competition for business. “U.S. banking regulators have proposed changes that would result in U.S. banks holding higher capital levels than their non-U.S. peers, which could put them at a competitive disadvantage,” the study said. These tougher new requirements were unnecessary, in McKinsey’s view. Instead, the report advocated a more sophisticated approach that took into account the economic environment. “This application also ignores some of the changes in capital requirements that occur as a result of economic cycles,” the report argued. “In a strong economic environment, for instance, capital requirements in a risk-based system should actually decline.”
Read with the benefit of hindsight, the Bloomberg/Schumer/McKinsey report is a parody of hubris. The overall concern with overly harsh U.S. regulators, a year before regulatory laxity permitted the worst financial crisis in three generations, is clearly absurd. The specific fears are even more specious. Alarm about a U.S. regulatory environment that was unduly restrictive of derivatives—those were the very financial instruments at the heart of the crisis. Worry that new capital requirements would be unnecessarily onerous—when it turns out that higher capital requirements were precisely what the banking system needed. Had Michael Moore set out to write a satire about the shortsighted greed of U.S. financial and political elites, he could not have invented better examples.
The arguments in the report are so wrong that it is easy to mock McKinsey, the author, and Bloomberg and Schumer, the sponsors. But what is really striking is how bipartisan and transatlantic the consensus within the Anglo-American financial and political elite was on the ideas in the study. Bloomberg is an independent; Schumer is a Democrat. Eliot Spitzer, the erstwhile sheriff of Wall Street as New York’s attorney general and then governor of New York State, joined Bloomberg and Schumer at the press conference announcing their report and broadly supported its conclusions. Two days before Bloomberg and Schumer took to the op-ed pages of the
Hank Paulson, the Republican Treasury secretary and former chairman and CEO of Goldman Sachs, traveled to New York a few weeks after these twin editorials to give a speech to the Economic Club of New York on “The Competitiveness of U.S. Capital Markets” in which he praised the Bloomberg/Schumer op-ed as being “right on target.” To make his point that Americans were in danger of overregulation, Paulson approvingly quoted a Democratic predecessor as secretary of the Treasury and fellow former Goldman Sachs chairman, Bob Rubin: “In a recent speech, former Treasury secretary Bob Rubin said this about regulation: ‘Our society seems to have an increased tendency to want to eliminate or minimize risk, instead of making cost/benefit judgments on risk reduction in order to achieve optimal balances.’”
A final U.S. contribution from the department of irony. A few weeks after the Schumer/Bloomberg op-ed had been published, one captain of finance wrote a letter to the editor to support their fight against “overregulation.” He was John Thain, then the CEO of the New York Stock Exchange. Two years later, Thain, by then CEO of Merrill Lynch, was forced to sell the nearly hundred-year-old firm to Bank of America at a fire sale price because of a financial crisis caused in great measure by inadequate regulation.
Across the ocean, the elite consensus was equally strong. A few days after the McKinsey study was released in New York, Sir Howard Davies, the director of the London School of Economics, former head of Britain’s top regulator, the Financial Services Authority, and former deputy governor of the Bank of England, opined, from the snowy slopes of Davos, that Bloomberg had “set a cat among the snow eagles this week.” The New York mayor, Sir Howard argued, was absolutely right: the American capital markets “are losing market share relentlessly against London.” The English peer’s fear was that in order to level the global playing field, the United States would try to impose its overly onerous regulatory approach on the rest of the world: “The Americans, as we know, are famously generous people, and they are even prepared to export their regulations, free of charge to the rest of the world.”
From Sir Howard’s perspective, the danger as viewed from Davos in 2007 was that the Republican administration of George W. Bush would seek to force the rest of the world to adopt America’s unnecessarily tough regulation of its financial sector. But Sir Howard held out the hope that Britain’s Labour government and its famously brainy economic duo of Prime Minister Gordon Brown and his Harvard- and Oxford-trained adviser, Edward Balls, would defend Great Britain’s superior “light-touch” regulatory approach against the Yanks. Sir Howard’s column is titled “Balls Must Save Us from U.S. Regulatory Creep.” Of Davos, he reports: “Gordon Brown patrolled the conference corridors, ready to explain that the London markets, like the NHS [the National Health Service], are safe in his hands. In this territory, he has a good story to tell.” (Incidentally for Sir Howard, the future embarrassment of having written this opinion piece would turn out to be a lesser example of the personal dangers of buying into the worldview of the global plutocracy. On March 3, 2011, he resigned as director of the LSE because of the embarrassment he had caused the school by accepting a ?1.5 million donation from Saif Gadhafi, son of the dictator, and agreeing to a ?2.2 million deal to train Libyan civil servants. Sir Howard had also been a paid adviser to Libya’s sovereign wealth fund.)
Once you get beyond how jarringly wrong all of these bold-faced names were, and how uniform, bipartisan, and international their consensus, you notice the epistemological wrong turn at the center of their mistake. The premise of this entire 2006–2007 conversation about the regulation of U.S. financial markets was that you learn whether your rules are working by asking the banks upon which they are imposed. Here’s how McKinsey described its methodology: “To bring a fresh perspective to this topic, a McKinsey team personally interviewed more than 50 financial services industry CEOs and business leaders. The team also captured the views of more than 30 other leading financial services CEOs through a survey and those of more than 275 additional global financial services senior executives through a separate on-line survey.” There’s a nod toward other points of view—“to balance this business perspective with that of other constituencies, the team interviewed numerous representatives of leading investor, labor, and consumer groups”—but it is a token effort compared to the meticulous attention focused on the bankers. And, like asking children whether they are satisfied with their bedtime, or surveying workers to find out whether they are paid enough, the results of the McKinsey investigation were entirely predictable.
The paradox, of course, is that these captains of finance were not only wrong about what was best for America—they were wrong about their own self-interest, too. I happened to interview John Thain on September 16, 2008, the day after he sold Merrill Lynch. On the Street, the deal itself was widely viewed as a masterstroke, particularly compared to Dick Fuld’s failure to find a buyer for Lehman Brothers a few weeks earlier. But Thain was anything but triumphant. We met in the Wall Street office whose $1.2 million redecoration would soon become infamous. I was blithely unaware of the million-dollar splendor of the furnishings, but I could see that Thain, who was normally precisely turned out and glowing with health, looked tired and discombobulated. “I totally understand why Dick Fuld couldn’t do it,” Thain told me when I asked him why he had been able to sell his bank but Fuld had not.
