WASHINGTON — President Barack Obama signed into law Wednesday an overhaul of banking and Wall Street regulations that he says will end many of the practices that sent the U.S. economy into the worst recession since the 1930s...The legislation gives the government new powers to break up companies that threaten the economy, puts more light on the financial markets that escaped the oversight of regulators and creates a new agency to guard consumers in their financial transactions....
To a burst of applause, the president said: "Because of this law, the American people will never again be asked to foot the bill for Wall Street's mistakes." "There will be no more tax-funded bailouts ... period," Obama added, noting that if a large financial institution should fail, the new laws provide the ability to wind it down without endangering the economy. He also said that lawmakers will still need to "make adjustments" to the rules as the financial system adapts to the changes....
The president argued that a crippling recession was primarily caused by a breakdown in the financial system that cannot be allowed to happen again. "I proposed a set of reforms to empower consumers and investors, to bring the shadowy deals that caused this crisis into the light of day, and to put a stop to taxpayer bailouts once and for all," Obama said to supporters. "Today, thanks to a lot of people in this room, those reforms will become the law of the land."
--"Obama signs broad reform of financial regulation into law," msnbc.com/Associated Press (7.21.10)
More, I think sincere concern and a sense of responsibility have weighed on legislators and regulators alike. And if it has taken more time than many of us may have wished, it has been to examine and work through legitimate differences of opinion about what is most important and how best to address and structure needed laws and regulations. Yes, there were clear differences of opinion between the Republicans and Democrats, and differences among the members of each party. These are difficult, complex issues, and finding the right balance between deterrence and limitations of potentially dangerous practices or behavior, on one hand, and facilitate robust, creative and efficient markets, on the other, is no mean feat--especially when trying to anticipate the unknown. And there were present some unconstructive aspects of today's polarized political climate. No mean feat, indeed.
And what we did get is really quite a lot. We have needed limitation and regulation of the use of derivative instruments, even if the banks managed to moderate it. We have consumer protection, even if the banks have succeeded in locating it within the Treasury Department, rather than a separate agency. And we have a process for government management, break-up or liquidation of too-big-to-fail financial institutions, but only when they begin to fail, and without the $50b industry pre-funding. Yes, it is an unproven approach for deterring irresponsible behavior by the largest financial institutions, or winding them down if they fail, but for now it will likely suffice. And there is much more.
Here is a summary of the highlights of the bill compiled by the Senate Committee on Banking, chaired by one of the legislation's principal authors, Senator Chris Dodd:
Restoring American Financial Stability
Create a Sound Economic Foundation to Grow Jobs, Protect Consumers, Rein in Wall Street, End Too Big to Fail, Prevent Another Financial Crisis
HIGHLIGHTS OF THE NEW BILL
Consumer Protections with Authority and Independence: Creates a new independent watchdog, housed at the Federal Reserve, with the authority to ensure American consumers get the clear, accurate information they need to shop for mortgages, credit cards, and other financial products, and protect them from hidden fees, abusive terms, and deceptive practices.
Ends Too Big to Fail: Ends the possibility that taxpayers will be asked to write a check to bail out financial firms that threaten the economy by: creating a safe way to liquidate failed financial firms; imposing tough new capital and leverage requirements that make it undesirable to get too big; updating the Fed's authority to allow system-wide support but no longer prop up individual firms; and establishing rigorous standards and supervision to protect the economy and American consumers, investors and businesses.
Advanced Warning System: Creates a council to identify and address systemic risks posed by large, complex companies, products, and activities before they threaten the stability of the economy.
Transparency & Accountability for Exotic Instruments: Eliminates loopholes that allow risky and abusive practices to go on unnoticed and unregulated - including loopholes for over-the-counter derivatives, asset-backed securities, hedge funds, mortgage brokers and payday lenders.
Federal Bank Supervision: Streamlines bank supervision to create clarity and accountability. Protects the dual banking system that supports community banks.
Executive Compensation and Corporate Governance: Provides shareholders with a say on pay and corporate affairs with a non-binding vote on executive compensation.
Protects Investors: Provides tough new rules for transparency and accountability for credit rating agencies to protect investors and businesses.
Enforces Regulations on the Books: Strengthens oversight and empowers regulators to aggressively pursue financial fraud, conflicts of interest and manipulation of the system that benefit special interests at the expense of American families and businesses.Obviously, this is a summary that describes purposes and legislative results without discussion of stronger proposals diluted of rejected. Still, it provides a clear sense of how much good work was accomplished by a congress generally plagued with bitter partisan disagreements. Not perfect, as we have noted; it could be strengthened in many ways. And yet it provides so much badly needed reform to the American financial and banking system, and protection to all Americans.
But how do others view the new reform legislation? One of the opinions I usually consult is that of The Economist, almost always direct and fair. Here's their assessment of the legislation:
The 2,319-page Dodd-Frank Wall Street Reform and Consumer Protection Act...tackles almost every aspect of American finance from municipal bonds to executive pay. Its success, however, rests on a simple question: does it make another crisis significantly less likely?
[B]y itself, this bill is an incomplete remedy (see article). Much depends on how American regulators implement its provisions. Congress left several meaty matters for later, including the crippled mortgage giants, Fannie Mae and Freddie Mac. And even more is riding on how the Basel club of international banking supervisors compel banks to raise their buffers of capital and liquidity.
Start with what the bill gets right. Though the financial crisis was global, it originated in America's uniquely fragmented financial system, overseen by a patchwork of federal and state regulators. Dodd-Frank missed its chance to eliminate that patchwork, but offers decent alternatives. It creates a council to advise regulators on emerging threats. It consolidates oversight of consumer financial products, from mortgages to credit cards, in a single agency. And big financial firms that aren't banks can be yanked into the embrace of the Federal Reserve.
Though a secondary player in the crisis, derivatives are a perennial candidate for causing the next one because they add opacity and leverage to the financial system. Most derivatives that now trade dealer-to-dealer will be traded on public exchanges. That will lessen the risk that one dealer's failure brings down others. An extreme proposal to stop banks trading derivatives has been mercifully scaled back. (The Volcker rule, limiting banks' ability to trade on their own account, also seems likely to hurt Wall Street profits less than some feared.)
The most important provision is the resolution authority under which federal regulators can seize any financial company whose failure threatens the financial system, and quickly pay off secured creditors while imposing losses on shareholders and unsecured creditors. This is an improvement on the status quo. Such resolution authority already exists for banks, but for other companies like Lehman Brothers and American International Group, regulators face a dreadful choice of either bailing out the company and its creditors or letting it go bankrupt. Yet in its zeal to protect taxpayers, Congress has made the resolution process so similar to bankruptcy that counterparties and lenders may still choose to abandon a troubled firm to avoid losses. Other steps are still needed: for example, regulators should create a new ring-fenced group of creditors who would be exposed to losses in resolution. But the horrible truth is that the effectiveness of any such body will be discovered only when a real crisis occurs.
Still a work in progress
In America Dodd-Frank's actual impact will depend greatly on how regulators like the Fed and the new consumer agency enforce its provisions. The risks cut two ways. Banks and their lobbyists may persuade regulators to interpret the new rules in the friendliest possible way to Wall Street, as they did before the crunch: the treatment of the ratings agencies, which seem to live a charmed life, will be a good test. In the opposite direction, regulators may overreach—stifling innovation which, for all its recent excesses, has over time been a force for good.
At the G20 Mr Obama boasted of "leading by example" on financial reform. In fact, Dodd-Frank is too idiosyncratically American and too incomplete to be a true template for others. And his claim that it would keep a financial crisis like the one the world just went through "from ever happening again" is bound to prove wrong. Yet imperfect though it is, the reform is proof that even a government as fractious as America's can move with impressive speed when the motivation is there.
Less than a complete or glowing endorsement, The Economist nonetheless acknowledges the scope and importance of the work done in unique and difficult circumstances. They allow that it is indeed a "decent start."--"A Decent Start," The Economist (7.1.10)
Too Big to Fail & Busting Up Banks
Among those most intensely debated issues was dealing effectively with the "too-big-to-fail" issue. A proposal rejected was "busting up the banks" now; that is, separating different, mutually-compromising lines of business in large financial firms. This was a proposal strongly advocated by many respected commentators, a proposal for which I shared sympathy. But it was not a deal breaker: the compromise approach agreed to has merit and potential, and there was just too much else at stake.
But if the compromise approach passed has merit and potential, it still leaves the many large financial institutions structurally unchanged. Those institutions will still likely take every risk the law and regulations arguably allow--and there will still be a likelihood of future crises of one sort or another, to one extent or another. And so it is understandable that many raised the refrain, "If it is too big to fail, it is too big to exist!" It is understandable, too, that they would prefer healthier markets with many more truly competitive smaller participants, rather than the less competitive, market-controlling oligopolies that so predictably evolve, that serve consumers less effectively, less fairly (and, without government help, would often predictably fail).
So let's pause to review some of the thinking on breaking up large financial institutions. Here are excerpts from a representative review in a recent Newsweek article:
Smaller Is Better
There's a very simple way to curtail the power of the big firms that helped cause the crisis: break them up. The recent crisis highlighted the "too big to fail" problem. The collapse of Lehman Brothers and the resulting cardiac arrest of the global financial system revealed that many institutions had become so large, leveraged, and interconnected that their collapse could have systemic and catastrophic effects.
The ranks of the TBTF club contain few traditional banks. Most belong to another species: big broker dealers like Morgan Stanley and Goldman Sachs; AIG and other insurance companies; government-sponsored enterprises like Fannie Mae and Freddie Mac; and hedge funds like Long-Term Capital Management. While the crisis left fewer such firms intact, those remaining are often larger, thanks to the consolidation that followed the panic.
Not only are such firms too big to fail, they're too big to exist, and too complex to be managed properly. They should be pushed to break themselves up. One way of doing this would be to impose higher "capital-adequacy ratios," which is a fancy way of saying that these institutions should be forced to hold enough capital relative to all the risks posed by their different units. This requirement would reduce leverage and, by extension, profits. The message: bigger isn't better.
[Are big banking or financial firms esssential, or even worth defending?]
For their part, the TBTF firms consider themselves essential to the world economy. Thanks to their scale, we're told, they offer "synergies" and "efficiencies" and other benefits. The global economy can't function without them, they say.
This is preposterous. For starters, the financial-supermarket model has been a failure. No CEO, no matter how adept, can manage a global institution that provides thousands of kinds of financial services. The complexity of these firms, never mind the exotic financial instruments they handle, makes it mission impossible for CEOs—much less shareholders or boards of directors—to keep tabs on every trader.
Even nominally "healthy" firms like Goldman Sachs pose a threat. Not that you would know it listening to the firm's CEO, Lloyd Blankfein, who in early 2010 defended handing out record bonuses by claiming, "We're very important. We help companies to grow by helping them to raise capital. Companies that grow create wealth. This, in turn, allows people to have jobs that create more growth and more wealth. We have a social purpose."
Spare us. Like other broker dealers, Goldman Sachs has a long history of reckless bets and obscene leverage. It was at the center of the investment-trust debacle that exploded in 1929, ushering in the Great Depression. It spent the succeeding decades operating in a relatively prudent fashion. But that changed in the late 1990s, when Goldman went public. Since then, it has helped inflate speculative bubbles, ranging from tech stocks to housing to oil. After the SEC eliminated leverage restrictions for investment banks, Goldman's leverage ratios soared to all-time highs, making it vulnerable when the crisis hit.
Like its competitors, Goldman was up to its neck in risky securitization, and while it's true that it saw the subprime bust coming earlier than others, its survival has little to do with its savvy. It lived through the crisis because the federal government propped it up again and again. All told, Goldman probably took upwards of $60 billion in direct and indirect help, then took even more after converting to a bank holding company, when it got access to TARP funds.
Yet its close brush with annihilation doesn't seem to have left its ringleaders chastened. They've wriggled free of restrictions on compensation by returning the TARP funds. Now they're back to pursuing high-risk proprietary trading strategies. For these reasons, Goldman should be broken up.
Glass-Steagall
In the wake of the recent crisis, distinguished thinkers like former Fed chairman Paul Volcker have argued for a return to the Glass-Steagall legislation of 1933, which separated commercial banking from investment banking. This firewall eroded in the 1980s and 1990s, finally disappearing altogether in 1999. The result was the current system, in which a firm like Citigroup or JPMorgan Chase can be a commercial bank, a broker dealer, an insurance company, an asset manager, a hedge fund, and a private-equity fund all rolled into one. That meant banks with access to deposit insurance and lender-of-last-resort support pursued high-risk activities that resembled gambling more closely than banking.
Returning to Glass-Steagall would be good but not good enough. What we need is a 21st-century version of the legislation that creates new firewalls. It would move beyond a simple separation between commercial and investment banking and create a system that can accommodate—and separate—the many different kinds of financial firms now in existence, as well as curtail the sort of short-term lending that made the financial system "too interconnected." Accordingly, commercial banks that take deposits and make loans to households and firms would belong in one category; investment banks would belong in another. Investment banks would be forbidden to borrow from insured commercial banks via the short-term, overnight "repo financing" that proved so fragile during the recent crisis.
Returning to Glass-Steagall would be good, very good. You would think we could at least have turned back the clock to that wiser time of sounder policy when Glass-Seagal helped maintain more financial system order and discipline, more accountability. You'd think so, but no. Obviously, we failed to reinstate Glass-Steagall in any form at all. And any other legislative proposals to separate functionally incompatible banking businesses--or, "bust up the banks"--failed as well.
Big financial institutions and big banking is what we still have--better regulated big banking, thank God for that, but big banking that continues to expose us to risk of yet another unanticipated financial crisis in the future. Of course, that's a risk that cannot be completely removed. There is always the unknown, the next period of regulatory complacency or fiscal irresponsibility, the next manifestation of unrecognized, unpredictable systemic risk. Yet, we should embrace our opportunities to reduce it wherever it is recognized, shouldn't we?
But this time the banks were too strong and influential, as were their allies in the congress. It's just commercial reality, and political reality, too. A deal could not be done if anything like Glass-Steagall were to be included. And as we first discussed, there was just too much else that was too important in this financial reform bill to place it all at risk over this compromise approach to "too-big-to-fail." Another day, perhaps. For today, we must be relieved to have the bill that was passed, and a process for the government-managed restructuring or liquidation of financial institutions that do fail. It's much better than what we had.
Writing Regulations, Enforcing the Law
But there is yet one more important phase of this financial reform process to be negotiated: rule making and enforcement. Before we can enforce the legislation, its many unclear areas or delegated rule-making must be addressed by executive department regulations. These legislative and interpretive regulations provide yet another opportunity for congressional and special interest lobbying to influence the final interpretation of the rules to be enforced. And then the regulators have to be organized, trained, charged and deployed to enforce them. We still have a way to go before we can indulge that final sigh of relief. This msnbc.com/Associated Press article lays out the next steps:
WASHINGTON — In the end, it's only a beginning....The legislation gives regulators latitude and time to come up with new rules, requires scores of studies and, in some instances, depends on international agreements falling into place. For Wall Street, the next phase represents continuing uncertainty. It also offers banks and other financial institutions yet another opportunity to influence and shape the rules that govern their businesses.
In hailing the bill's passage in the Senate on Thursday, Treasury Secretary Timothy Geithner acknowledged that implementing the new law will take time. "But we are determined to move as quickly as we can to provide clarity and certainty," he said.
Among the first impacts of the bill...will be the immediate creation of a 10-member Financial Stability Oversight Council, a powerful assembly of regulators chaired by the treasury secretary to keep watch over the entire financial system. The Obama administration has one year to create a new Bureau of Consumer Financial Protection. Congress will keep its eye on that agency, eager to see whom Obama chooses as its director. The agency will have vast powers to enforce regulations covering mortgages, credit cards and other financial products. One of the first post-passage issues to come back to the Senate will be the appointment of a director for the consumer agency...
But while the oversight council and the consumer bureau might bloom swiftly, other central provisions of the bill will take time, in some cases years, to take root. The consumer bureau, for instance, has as long as 30 months after it is created for its regulations on predatory lending to take effect. The legislation calls for a two-year study before regulators write rules on how risk-rating agencies should avoid any conflict of interest with the firms whose financial products they assess.
The Fed has until April to derive standards to measure the fairness of fees charged by banks to merchants for customers who use debit cards. And regulators will have to fine tune the broad restrictions in the legislation for the complex derivatives market. Key will be determining what firms and corporations will face new restrictions.
The U.S. Chamber of Commerce counts more than 350 rules that the legislation directs regulators to write. Senate Banking Committee Chairman Christopher Dodd, an author of the bill, says the legislation gives regulators a specific blueprint to follow. "This bill directs the regulators to do things," he said in an interview. "We leave to the regulators how best to achieve the goals, but the goals are clear. Congress is not a regulator."
In many instances, regulators already have embarked on rule-writing. The SEC, for instance, has been working on rules that would impose the same professional standards on stockbrokers and dealers that are imposed on financial advisers. The legislation insists that the SEC conduct a study first.
Hailing the bill Thursday, Fed Chairman Ben Bernanke said the central bank is also ahead of the game, "overhauling its supervision and regulation of banking organizations." Regulators also will have to figure out how to implement new standards for how much capital banks should hold in reserve to protect against losses. The legislation requires rules in 18 months.
But the U.S. is also part of international negotiations on what global capital standards should be, and those could move more slowly. "I am very confident with the strong hand that this (legislation) gives us, that we will be able to bring the world with us," Geithner told reporters Thursday.
--"Now the real work on financial reform begins," by Jim Kuhnhenn, Associated Press, as reported on msnbc.com (7.18.10)
So, the basic laws are passed and the legislative intent recorded. That's the good news. Yet, we're only, say, 70% of the way there. Material damage could still be done behind the scenes in the remaining regulatory and enforcement processes. So buckle up, Pilgrim, there are a few more laps to run, a few more skirmishes to fight. It could easily be another two years or more before most of the rules are written, longer before they are properly enforced.
And meanwhile, environmental legislation is shaping up and the table is being set for immigration reform. That, on top of TARP, stimulus, and health care reform already completed but demanding continuing attention. And then there's the upcoming mid-term elections. It will be easy, sometimes necessary, to direct more attention to the new initiatives than follow up on still important earlier ones. But we have to hope it can all be managed well, don't we? Exciting, but challenging times.
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