#Long-Term Capital Management

As we noted last week, the Fed decided to issue some post-Archegos guidance telling big banks to watch their counterparty credit-risk exposures.  As a banker with all too much experience dodging risk bullets told me, this guidance followed lots of prior guidance saying the same thing after each big boo-boo – think Long-Term Capital Management more than two decades ago and follow the trail of Fed statements thereafter.  Each time, the Fed looks stern and banks say they’re sorry but soon go back to following the money, not the risk.  And, over and over, examiners fail to notice anything amiss until the amount of realized risk is impossible to ignore.  Interestingly, the Bank of England acted with the Fed but with far more force.  Unlike the Fed’s renewed “you better watch out” guidance, the BoE demanded an immediate review of prime-brokering, reports back to regulators, and senior-management pay cuts if flaws go unrepaired.  Thus, unlike the Fed, the Bank of England’s response to costly and thoroughly avoidable lapses has teeth.  Whether the British then bite anyone is another question – the record is not replete with supervisory success – but the difference should nonetheless be instructive to the Fed’s next supervisory vice chair.

This difference is just like that between telling a child that she’ll be sorry next time and ensuring that the kid immediately knows that bad actions have tangible, actual consequences.  One doesn’t have to beat the kid silly – indeed, of course one more than shouldn’t.  But, …