The idea was to create a premier U.S. data powerhouse that would be
a National Weather Service for financial storms, with
up-to-the-minute information on transactions and the analytical
juice to anticipate where systemic risks were quietly growing.
Their pitch worked. The Office of Financial Research was created
within the Treasury Department, part of sweeping reforms in response
to the worst financial crisis in decades.
But more than three years since the passage of the 2010 Dodd-Frank
law, it is struggling to stay relevant.
Its first formal study, which found possible risks posed by the
activities of asset managers like BlackRock Inc and Fidelity, was
panned by many as ill-informed and ripped to shreds by the industry.
The office must compete for top minds on a lower pay scale than some
other agencies. And crucially, other regulators are hesitant to
share data and expertise.
Even some of the office's key backers criticized its early work. The
office, or OFR, needs a turnaround to avoid becoming a second-class
bureaucratic operation, succumbing to regulatory turf wars and
becoming unable to spot a brewing financial crisis.
"In order to be effective, OFR must have data integrity and
thorough, accurate analysis," said U.S. Senator Jack Reed, a Rhode
Island Democrat who drafted the legislative language that created
the research unit.
"The office has to raise its game," Reed said of the asset
management report.
Its director, Richard Berner, a former economist at Morgan Stanley
and Mellon Bank, wants time. He told Reuters the OFR is still new
and recruiting top talent.
The agency has roughly 185 staff members, and Berner hopes to have
300 in 2015. Its fiscal 2013 budget, financed through fees on big
banks, is about $78 million.
The office takes annual looks at simmering stability risks and,
observers say, has made progress tracking financial transactions.
"Now that we are starting to get some critical mass on the research
side, the data side and the technology side, the progress is coming
faster," Berner said in an interview. "The accomplishments are
substantial."
ACADEMIC THEORY
The idea for the research office took shape at a February 2009
conference on statistics in bank regulation. Participants decided
regulators lacked the data to anticipate the 2007-2009 crisis and
needed a research powerhouse, said Arthur Small, an economist who
joined the group shortly after the conference.
"We felt a great sense of urgency," Small said, to make sure the
idea got into the Dodd-Frank law.
One member gave the 2009 presentation at the American Enterprise
Institute, and the group spoke with Martin Gruenberg of the Federal
Deposit Insurance Corp, Neal Wolin, then a top official at the U.S.
Treasury, and others. Senator Reed of Rhode Island pushed to get the
research office into the law.
Dodd-Frank gave the office two major tasks. One is to standardize
financial transaction data so regulators can eventually monitor
asset bubbles as they form.
The other is to support the Financial Stability Oversight Council,
or FSOC, a group of regulators that watches risks. OFR studies are
meant to inform the FSOC's policy decisions.
EARLY BATTLES
The OFR's first big project came in 2011, when the FSOC wanted to
know if the activities of asset managers posed risks to financial
stability.
These firms buy stocks and bonds on behalf of investors and,
together, handle trillions of dollars in assets. If the FSOC dubbed
a manager "systemic," it would face costly mandates to rely less on
debt and be regulated by the Federal Reserve.
At the time, the OFR was understaffed and had few in-house markets
experts. The Federal Reserve Bank of Boston loaned the OFR a staffer
with asset management expertise to help out, a Boston Fed spokesman
said.
Economists from all of the federal regulators also agreed to
participate in early-stage meetings to develop the report, except
the U.S. Securities and Exchange Commission. Its economists did not
respond to email invitations or attend at brainstorming sessions,
even though the SEC is the industry's main regulator, two people
familiar with the matter said.
The SEC did not participate early on because it had limited
resources, and officials there were also skeptical about the
office's level of experience, two other people said.
But when the OFR eventually circulated drafts, SEC lawyers tried to
edit the report. They thought it showed little understanding of the
industry, three people told Reuters.
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The OFR toned down and shortened the final report in September 2013,
several people said, but the study raised concerns about managers
borrowing to boost returns or crowding into the same assets at once.
SEC officials remained unhappy and asked for public feedback on the
study, a sign of criticism in regulatory circles.
The asset management industry said it was misleading and
inaccurate.
Berner has since said the SEC was involved "from beginning to end."
"Their fingerprints are on the report as well," he said at a recent
event in Washington.
SEC Chair Mary Jo White asked about the kerfuffle at a November
conference, said the SEC shared expertise. But "at the end of the
day, it is obviously the OFR's study," she said.
A spokesman for the SEC declined to comment beyond White's public
comments.
Data sharing has been a wider problem.
It took the OFR nearly two years to access Federal Reserve data on
overnight funding methods, or "repo" loans, that regulators think
fueled the financial crisis, a person familiar with the matter said.
The Fed took so long because it wanted to ensure the data would be
secure, the person added.
The Fed, which declined to comment, is notoriously careful about
sharing bank data lest it accidentally become public. It requires
memoranda of understanding, or MOU, detailing safeguards for
sensitive data.
The OFR now is early into a similar effort to get data on annual
stress tests run by the Fed. Dodd-Frank directed the OFR to weigh
the efficacy of the tests, which consider how banks would fare in a
crisis. But it does not have the Fed data yet.
"The OFR should do whatever it takes to gain access to the data
collected by the Federal Reserve, the Office of the Comptroller of
the Currency and the Federal Deposit Insurance Corp to execute the
Dodd-Frank mandated stress tests," the office's outside advisory
group wrote in August.
Berner said the office would seek an MOU with the Fed to share the
data, but to date it has not made a formal request.
EARLY GOING
The office is still in its early stages, and many of its supporters
remain optimistic about the office's potential.
They point to the OFR's work on an international effort to create
unique identifiers for financial institutions that would be used
like barcodes to track activities.
"My analysis is that without the OFR, that probably just wouldn't
have happened," said Small, the economist who helped push for the
office. "That's a first, critically important step in making the
financial system machine-readable."
But the OFR is also still working to staff up and, at times,
struggles to compete for talent within the government.
The Fed, which has huge cachet among economists looking for
government experience, launched its own research unit around the
same time as the OFR. It pays better, too.
The OFR's advisory panel said a PhD making around $200,000 a year at
the Fed would get less than $120,000 at the OFR. The OFR needs to
boost pay, the outside group said, or "it is doubtful that the OFR
will be able to attract the talent that it needs to fulfill its
research mission."
Berner said the office's pay practices are evolving, and it is
"making the changes we need to make" to hire more.
Still, the unit needs more top-tier talent and critical data if it
is to spot the next crisis before it lands.
"The OFR has a strong potential. It's unencumbered by regulatory
responsibilities. It has funding. It has access," said Andrei
Kirilenko, a former chief economist at the Commodity Futures Trading
Commission who is now at the business school for the Massachusetts
Institute of Technology.
"But for a variety of operational reasons, it seems to have not been
able realize its potential," he said. "I'd really like to see this
office succeed and have it become a center of excellence for
systemic risk."
(Editing by Karey Van Hall, Martin Howell and Eric Walsh)
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