Matt Levine comments on the trend to file required financial documents when municipalities issue bonds:

The SEC found that between 2010 and 2014, the 22 underwriting firms violated federal securities laws by selling municipal bonds using offering documents that contained materially false statements or omissions about the bond issuers’ compliance with continuing disclosure obligations. The SEC also found that the underwriting firms failed to conduct adequate due diligence to identify the misstatements and omissions before offering and selling the bonds to their customers.

Sampling the individual settlements brings up a lot of due diligence errorslike this:

Respondent acted as either a senior or sole underwriter in a municipal securities offering in which the official statement essentially represented that the issuer or obligated person had not failed to comply in all material respects with any previous continuing disclosure undertakings. In fact, certain of these statements were materially false and/or misleading because the issuer or obligated person had not complied in all material respects with its previous continuing disclosure undertakings. The offering in which the official statement contained false or misleading statements about prior compliance was

• A 2011 negotiated securities offering in which an issuer failed to disclose that it filed an audited financial report on the MSRB’s Electronic Municipal Market Access system 499 days late, and failed to file the required notice of late filing.

That is: Municipalities issue bonds. When they do that, they promise to file current financial statements in a publicly accessible way. Sometimes — quite frequently, it seems — they forget to do that, or stop doing it, or whatever explains being a year and a half late with the financials. Then they want to issue new bonds. As part of issuing the new bonds, they again promise to file current financial statements, and also promise that they’ve never been late on their financials in the past. Even though in fact they have been 499 days late on their financials in the past. And somehow neither the issuer, nor the underwriters, nor the buyers of the bonds notice that this isn’t true.

That is an obvious failing of due diligence and the underwriters should definitely be in trouble. But I’m kind of more worried about the fact that the municipality here was 499 days late on its filings, and no one noticed, or at least, no one cared enough that it was hard to sell the bonds in the future. And there are lots of cases like this; here’s one with an issuer who “filed three annual financial reports which were between two and 50 months late.” One gets the rather strong impression that no one is reading these filings, and that the whole disclosure system for issuing municipal bonds might be more or less ignored.

by William Haefell, The New Yorker

Reserve Governor Daniel Tarullo spoke about “Capital Regulation Across Financial Intermediaries”:

The scope and nature of a firm’s liabilities provide the justifications for capital requirements regulation. Differences in liabilities can, accordingly, sometimes warrant different capital requirements for portfolios of similar assets across firms. At the risk of packing too much into these introductory points, let me also note that an emphasis on a firm’s liabilities is related to, but not synonymous with, an emphasis on its activities. Thus, for example, simply deciding that an intermediary provides mostly commercial banking services or insurance products does not fully answer the question of what its capital requirements should be.

There is a lot here, including on prudential regulation of asset managers, but I particularly liked this:

When concerns are raised about regulatory arbitrage or a level playing field, they are usually in the context of a similar asset being held, or a business activity conducted, by financial firms with different regulatory structures. My discussion today would suggest that attention must be paid to the liability structure of the different firms before deciding whether the asymmetric regulatory treatment is prudent or an invitation to the propagation of new financial risks.

This is it seems to me the core question of financial regulation. There are assets. They are risky; they might go down in value. Someone bears the risk of those assets. If regulation tends to push that risk into entities that are funded with short-term debt from investors who expect it to be money-good, that leads to potential crises. If regulation tends to push that risk into entities with long-term equity-like funding from investors who knowingly bear the risk, that is the best it can do. You can’t get rid of risk, but you should try as much as possible to keep it from being funded by short-term debt with no capital buffers.  Tartullo Speech

Last week the chief executive of UBS told all the bankers who work for him that henceforth UBS chief says it is ok to make honest mistakes.
A culture in which everyone was petrified of taking risks, Sergio Ermotti said, was not in the interests of the bank or its clients.

How mature, came the response. How refreshing to hear a bank chief acknowledge that risks need to be taken and honest mistakes will sometimes be made.

The point is that “This mistake-loving nonsense is an export from Silicon Valley, where ‘fail fast and fail often’ is what passes for wisdom,” but that it is inappropriate in the banking context. Tech is an industry of moving fast and breaking things. Finance is an industry of moving fast, breaking things, being mired in years of litigation, paying 10-digit fines, and ruefully promising to move slower and break fewer things in the future.”

Of course there’s a reason that Ermotti said what he said. A workplace culture of experimenting, taking risks, being unafraid to try new things, not being harshly penalized for messing up is nicer than one of zero-tolerance striving for boring perfection. That’s why people want to work at tech startups and are less keen on working at banks these days. Regulators want to turn banks into utilities — boring and mistake-free — but the bankers look back on their mistakes with nostalgia.

Deutsche Bank prepared to fire traders for Libor manipulation. “Thank you for making yourself available for this call today,” it begins, and then “We have decided that your employment agreement should be terminated with immediate effect by reason of your gross misconduct,” which is the way to do it. Rip the band-aid right off; don’t mince any words about exactly how gross the misconduct was.

Harold James writes:  So far, the Volkswagen scandal has played out according to a well-worn script. Revelations of disgraceful corporate behavior emerge (in this case, the German automaker’s programming of 11 million diesel vehicles to turn on their engines’ pollution-control systems only when undergoing emissions testing). Executives apologize. Some lose their jobs. Their successors promise to change the corporate culture. Governments prepare to levy enormous fines. Life goes on.

This scenario has become a familiar one, particularly since the 2008 financial crisis. Banks and other financial institutions have enacted it repeatedly, even as successive scandals continued to erode confidence in the entire industry. Those cases, together with Volkswagen’s “clean diesel” scam, should give us cause to rethink our approach to corporate malfeasance.

Promises of better behavior are clearly not enough, as the seemingly endless number of scandals in the financial industry has shown. As soon as regulators had dealt with one case of market manipulation, another emerged.

The trouble with the banking industry is that it is built on a principle that creates incentives for bad behavior. Banks know more about market conditions (and the likelihood of their loans being repaid) than their depositors do. This secrecy lies at the heart of financial activity. Polite analysts call it “management of information.” Critics consider it a form of insider dealing.

Banks are also uniquely vulnerable to scandal because many of their employees are simultaneously behaving in ways that could influence the reputation, and even the balance sheet, of the entire firm. In the 1990s, a single Singapore-based trader brought down the venerable Barings Bank. In 2004, Citigroup’s Japanese private bank was shut down after a trader rigged the government bond market. At JPMorgan Chase, a single trader – known as “the London Whale” – cost the company $6.2 billion.

What these repeated scandals show is that apologies are little more than words, and that talk about changing the corporate culture is usually meaningless. As long as the incentives remain the same, so will the culture.

The Volkswagen case is a useful reminder that corporate wrongdoing is not confined to the banking industry. There were incentives in the automobile industry to game the system. Everyone knows that actual fuel economy does not correspond to the numbers on the showroom sticker, which are generated by tests carried out with the wind blowing from behind or on a particularly smooth road surface. Anyone who has stood next to a diesel vehicle could tell that it was smellier than cars powered by gasoline.

There are two important similarities between the scandals in the finance industry and at Volkswagen. The first is that large corporations, whether banks or manufacturers, are deeply embedded in national politics, with elected officials dependent on such firms for job creation and tax revenues.

The second similarity is that both industries are subject to multiple regulatory objectives. Regulators may want banks to be safer, but they also want them to lend more to the real economy.

The regulation of automobile emissions faces a similar problem. As regulators’ focus turned toward limiting global warming, there were tremendous incentives to manufacture vehicles that produced fewer greenhouse-gas emissions,

As the Volkswagen crisis so vividly illustrates, we need more than corporate apology and regulatory wrist slapping. It is time for a sustained discussion about how to craft regulations that provide the proper incentives to achieve the objectives we truly desire: economic and social wellbeing. It is only when that discussion takes place that we will get the banks, cars, and other goods and services that we want.

Dean Starkman writes”  Anat Admati, a professor of finance and economics at Stanford’s business school, is an unlikely player in Washington, D.C.’s financial-reform scene.

The 58-year-old Israeli-born economist arrived at Stanford in 1983 with an interest in mainstream financial issues and a firm belief that markets — with their unique ability to assign a price to risk and channel capital to its most efficient use — were a powerful force for good.

The 2008 financial crisis upended that faith. She turned her gaze to the industry at the center of the crisis: banking.

Admati made waves on the national financial-reform scene in 2013 with the book “The Bankers’ New Clothes: What’s Wrong With Banking and What to Do About It,” co-authored with economist and banking expert Martin Hellwig.

She argues that requiring banks to rely more on shareholders’ money instead of borrowing funds would increase stability, harness market forces to deter risky behavior and lead to a smaller, safer system as banks pulled back on bets that didn’t make financial sense.

Her arguments have drawn fierce pushback from the banking industry, but got the attention of financial policymakers.   Dean Starkman Interviews Anat Admati