Unusual dissension in Fed vote on Reg W exemption

The drama around yesterday's Fed decision to grant Morgan Stanley a 23A exemption makes the exemption a tempting target for criticism. But a minor factual error in Governor Bowman's statement defending the decision reveals critical context that puts the decision in perspective.

In case you missed it, the Fed Board voted 4-3 to approve an exemption letting Morgan Stanley move a significant trading operation from its European non-bank subsidiary to its US FDIC-insured bank. Such a transaction would usually be prohibited by the restrictions on bank transactions with their affiliates in the Federal Reserve Act's Section 23A. All three dissenters published separate statements alongside Bowman's.

This level of public controversy seems unprecedented. I can't recall there ever being a divided Board vote on a 23A exemption, let alone public statements of dissent. If anything, the exemptions are often decided by staff on delegated authority.

The last time there was notable public controversy around 23A exemptions was during the financial crisis of 2008. And you have to go back to 2008 to understand the full context behind the Morgan Stanley decision yesterday.

In defending the decision, Bowman pointed out that several other US banks already operate similar trading businesses in their FDIC-insured entities under the Fed's Regulation K, even while others operate them outside the bank under Section 4(k) of the Bank Holding Company Act (BHCA).

"Morgan Stanley initially chose section 4(k)," Bowman wrote, "but now believes Regulation K would be more advantageous"

But that's not exactly true. Morgan Stanley did not choose to put the operation outside of the bank under Section 4(k). The operation was already outside the bank when Morgan Stanley unexpectedly became a bank holding company over the course of one crazy weekend in September 2008.

In the emergency conditions that weekend, there was never any opportunity for Morgan Stanley to decide exactly which bank holding company legal structure this business would use. And, if the practices of other banks are any guide, the bank-chain structure may well be how Morgan Stanley would have structured the business had it already been a bank holding company when the business started -- or had it any time to think about corporate structure during the whirlwind weekend it became one.

The critics and dissenters are concerned about the precedent the approval sets, and the fact that it is being handled by order instead of regulation. But the full historical context suggests that this exemption might actually be -- believe it or not -- just residual cleanup from 2008.