Bank monitor Patrick Parkinson's intellectual backflip on policing derivatives has skeptics worried
When the definitive chronicle of America's Great Recession is written, Patrick M. Parkinson will merit more than a footnote. Rewind to the late 1990s. Federal Reserve Chairman Alan Greenspan wanted derivatives kept free of government oversight. He relied on Parkinson, then a midlevel manager in the Fed's division of research and statistics who was especially knowledgeable about how derivatives worked, to help make his case. As Parkinson told Congress in 1999, it was "unnecessary" for the government to supervise over-the-counter derivatives because the companies that trade them "are quite adept at managing credit risks and are more likely to base their investment decisions on independent judgment."
They won the fight when a Republican-controlled Congress passed the Commodity Futures Modernization Act of 2000. "[Parkinson] understood all of the complex derivatives, their pros, their cons, and their difficulties," Greenspan told Bloomberg BusinessWeek. Seven years later, derivatives played a central role in igniting the worst recession in half a century. After a year of emergency interventions, temporary backstops, and stimulus spending, Congress and the Obama Administration are at work on legislation to permanently fix the financial system.
And Parkinson? He's had a change of heart—and been promoted. Fed Chairman Ben Bernanke in October put Parkinson in charge of monitoring the nation's biggest banks as the director of the Banking Supervision & Regulation Div. Parkinson also spent part of last year helping the White House produce a new road map for financial regulation that forces many derivatives to trade on open exchanges or regulated electronic systems. That plan would give the Fed the role of super-regulator of the most important financial companies—a position Parkinson will hold if Congress approves.
His critics are dumbfounded. "We're not only putting the fox in charge of the henhouse," says Lynn Turner, the chief accountant at the Securities & Exchange Commission from 1998-2001, "we're giving him a bottle of barbecue sauce."
To others, Parkinson could be the ideal bank supervisor. President Franklin D. Roosevelt, they point out, installed Joseph P. Kennedy Sr., who made millions in the 1920s by taking advantage of uninformed investors, unregulated markets, and the absence of insider trading rules, as the first head of the SEC.
Brooksley Born, the former chief of the Commodity Futures Trading Commission, is giving Parkinson the benefit of the doubt. She crossed swords with him when she opposed the 2000 act, which kept the instruments trading in unregulated, opaque markets and triggered the explosive growth of contraptions like collateralized debt obligations.
Born sought to use existing commodities laws to regulate derivatives after seeing the role they played in the collapse of Long-Term Capital Management, a Greenwich (Conn.) hedge fund. At the time, Parkinson stunned her when he first contended that the CFTC had no authority to supervise over-the-counter derivatives. While Born lost that battle, she now praises his work on the Obama financial reform plan, calling the proposal on derivatives "an enormous step forward."
Parkinson, who has a PhD in economics from the University of Wisconsin, admits his faith in self-policing markets was misguided. "Obviously, the shortfalls in market discipline weren't something that developed just in the last three years," he says. "We had overestimated all along."
John Dearie, executive vice-president of the Financial Services Forum, a Washington trade group for the CEOs of large financial firms, says it's understandable "and even admirable" that a civil servant like Parkinson would rethink his views. "As John Maynard Keynes famously said, 'When my information changes, so does my conclusion,' " says Dearie.
In an interview with Bloomberg BusinessWeek , Parkinson described his foxhole conversion. As a staff adviser to Bernanke in 2008, he closely witnessed both the Fed's rescue of Bear Stearns and American International Group (AIG) and Lehman Brothers' collapse into bankruptcy. Money-market mutual funds with investments in Lehman-issued debt, for example, lost value overnight; the venerable Reserve Primary Fund actually "broke the buck," in which the value of a share fell below the longtime standard of $1.
Parkinson quickly fashioned a Fed guarantee to backstop the money-market funds, in which millions of Americans had invested their savings even though they weren't guaranteed like bank deposits. The guarantee worked, and the funds were saved.
Assistant Treasury Secretary Michael S. Barr, who worked with Parkinson and other officials to craft the Obama regulatory plan, says that Parkinson provided "invaluable" advice, especially on derivatives. One of the unabashed liberals at the Treasury, Barr says Parkinson is "a skeptic" rather than an ideologue.
Running the bank examination division at the Fed hasn't been a plum assignment. Parkinson's new offices on K Street are a downgrade from his digs in the Fed's Constitution Avenue headquarters overlooking the Lincoln Memorial. His unit, which has about 3,000 staffers still weary from criticism that they failed to oversee Citigroup (C), Bank of America (BAC), and other bailed-out firms, is being revamped so it has a better window on such activities as consumer lending, commercial paper, securitized loans, and mortgages. The Fed's new examination process builds on the stress tests of the biggest banks conducted to much acclaim last year. Examiners will also be looking at new risk factors and plan to do their reviews with an eye on the broader banking system rather than just individual banks.
At first, Parkinson resisted officials' pleas to run the group. The Milwaukee native, whose father, grandfather, and great-grandfather were all locomotive engineers, was nearing 30 years at the Fed. He wanted to retire and pursue his passions, including bird-watching. Parkinson now seems happy to have let the binoculars wait. At the division's holiday party, staffers sang a rendition of The Twelve Days of Christmas, with a final twist: They changed the last line of "A partridge in a pear tree" to "A director with a PhD." Parkinson, who could pass for a svelte Santa Claus, sang along.
Return to the Special Report Table of Contents