Skeptics may doubt that any government agency can competently monitor complex Internet fi rms. But legislation has already set one
to work on a far harder problem: assessing the overall state of U.S.
fi nancial markets. While a company like Google is a closed system, with standards of or ga ni za tion imposed from the top, fi nance in-volves transactions between entities. Nevertheless, the Dodd- Frank Act of 2010 empowered an Offi ce of Financial Research (OFR) (sometimes called “The CIA of Finance”) within the U.S. Depart-ment of the Trea sury to improve regulation by illuminating the overall state of fi nancial markets.98
Like intelligence agencies that have broad investigative powers to spot threats, the OFR collects and analyzes details of fi nancial transactions in order to spot “systemic risk” (that is, patterns of bets that threaten to undermine the entire fi nancial system). It can keep its analyses private, share them with other regulators, or open them to the public, within certain statutory and constitutional limits.
This is a delicate balancing act. If the OFR tries to reveal too much of the data it collects to the public at large, affected fi rms could bog it down in lengthy court proceedings over confi dentiality. If it discloses too little, it risks being dismissed as yet another lapdog of Wall Street.
But what ever its per for mance in detecting systemic risk, the OFR promises one benefi t to future historians: permanent archives of fi -nancial decision making that might otherwise get lost in a maelstrom of business mergers, takeovers, and IT system “upgrade.”
OFR analysts focused on mea sur ing fi nancial risk, liquidity, and the potential that the failure of a “systemically important fi nancial institution” might spark a chain of defaults. Privy to some of the most sensitive data in fi nancial markets, the OFR can send early warnings to fi nancial regulators. By assessing the state of the fi nancial system as a whole, it should provide a critical new source of knowledge to regulators long kept in the dark. The OFR is serious about its work, fully acknowledging that fi nance recordkeeping may have to change to promote systemic stability:
The data simply may not exist in the form needed for monitor-ing purposes. In that case, the Offi ce [must] defi ne data require-ments, evaluate the feasibility and diffi culty of obtaining the data, identify the best way to fi ll the gap, and develop a collec-tion strategy. If the data do exist, they may not be accessible due to confi dentiality, privacy, or data- sharing limitations. The data
may be inadequate because they are not detailed enough for analysis, focused on the wrong items, too limited in scope, or of poor quality. In addition, the data may be impossible to compare or aggregate because of a lack of data standards.99
The last point— about data standards— is a diffi cult one; it has also plagued regulators in other fi elds, like health care. When the Obama Administration promoted the gathering and exchange of health information in 2009, many worried that the resulting data could never be aggregated and analyzed for public health purposes.
But health care regulators are using an elaborate package of incen-tive payments to improve interoperability among electronic health record systems.
The OFR, by contrast, has no money to lure fi nance fi rms to adopt uniform standards. It can urge the various fi nancial regulators it ad-vises to try and nudge the sector toward some common standards.
The OFR itself is now setting standards known as Legal Entity Iden-tifi ers. These would set a consistent name or number for the entities engaged in various fi nancial transactions, and are no doubt valuable:
when a large fi nancial fi rm can have hundreds of ad hoc subsidiaries and “variable interest entities,” regulators need to be able to quickly map who owns what.100 But with derivatives’ draf ters slicing and dic-ing risk and reward, modern fi nance threatens to make basic own-ership information irrelevant; if, for instance, Citibank “owns” a small fi rm, but has swapped the fi rm’s net income for an interest- bearing bond, who really loses if the fi rm fails to generate income? And this is a very simple example: derivatives can get far more complex, with risks and rewards shifting on the basis of unforeseeable events.
Other regulators are trying to help here.101 CFTC and SEC staff conclude “that current technology is capable of representing deriva-tives using a common set of computer- readable descriptions[, which]
are precise enough to use both for the calculation of net exposures and to serve as part or all of a binding legal contract.”102 As with the SEC’s Consolidated Audit Trail,103 which tracks trading, the idea here is to develop methods not merely for real- time monitoring of troubling developments, but also for red- fl agging the most prob-lematic trading strategies.104
However ambitiously American fi nance regulators may set stan-dards, their efforts are compromised by the internationalization of major fi rms, which plead that any stringent national standard for recording information may make it harder to do business over-seas. They want to wait for international coordination— a pro cess that could take de cades. Or they could simply move their trading overseas.
If the proliferation of tax havens is any guide, there are plenty of places willing to bend (or end) rules to lure fi nance business.105 A small, hopeful step toward improving government understanding of fi nancial fl ows happened when Congress passed the Foreign Ac-count Tax Compliance Act (FATCA). Thanks in part to a series of embarrassing investigations into tax havens by Senator Carl Levin, that law targets illicit income.106 But there is little reason in princi-ple why its auditing requirements could not be expanded to encom-pass a larger view of fi nancial fl ows. Just as we need to know where shadowy data brokers’ data is coming from, and where it (and the inferences drawn from it) are going to, we need to have a much bet-ter sense of where funds are fl owing from, and where they (and the income they generate) is going to.
An adviser to the Tax Justice Network once said that assessing money kept offshore is an “exercise in night vision,” like trying to mea sure “the economic equivalent of an astrophysical black hole.”107 The most fundamental tool of tax secrecy is separation: between persons and their money, between corporations and the persons who control them, between benefi cial and nominal controllers of wealth. FATCA helps reconnect all those fragments. It requires for-eign fi nancial institutions (FFIs) to report fi nancial information about accounts held by American citizens, or pay a withholding tax.108 Congress enacted FATCA in response to the problem of in-ternational tax evasion. Too many U.S. citizens were using offshore accounts to avoid paying U.S. taxes, reminiscent of the fi nancial fi rms who locate dozens of shell companies in “secrecy jurisdic-tions” to defl ect the attention of auditors or regulators.109 FATCA is shaping up to be a major advance in tracking global money fl ows.110
Tax havens may seem like an outlier in the global economy, a problem well outside the run of ordinary business. But tax havens
are among “the most powerful instruments of globalization,” criti-cal to many business strategies.111 Shell company networks can be structurally similar to the webs of entities used by tax evaders.
FATCA requires that FFIs report both on accounts held directly by individuals and on interests in accounts held by shell entities for the benefi t of U.S. individuals. It also covers foreign entities with sig-nifi cant United States own ership.112 The law shifts the responsibil-ity for reporting from the taxpayer to fi nancial institutions. It hits those FFIs where it hurts, penalizing them monetarily if they do not report.113 FATCA also requires participating FFIs to with-hold on payments to nonparticipating FFIs, which is supposed to create a divide between compliant and noncompliant entities.114 Isolating noncompliant fi rms should also be a central goal of fi -nance regulators.