There was something anti-climatic about the recent financial regulatory financial reform passed by the Senate on May 20, I guess I expected more celebration instead we got a collective sigh. Is there real reform or merely cosmetic changes in response a clamoring public? Can the taxpaying public rest easy and feel confident that Congress has its back or does it need to look over its shoulder and keep a hand on its wallet because Uncle Sam is poised to pick its pocket again?
It wasn’t too long ago that financial regulation was a bad word. Big money and its political patrons claimed we needed to even the playing field with the international banks, allowing U.S. banks to compete without unnecessary constraints imposed by government regulators. In 1999 the slow repeal of the Glass Stegall Act was complete breaking down barriers that segregated bank activities. The environment was ripe for risk taking, cheap money and increasingly complex financial instruments.
Regulatory failures were a contributing factor to the financial meltdown. Financial firms created complex financial products that governmental oversight agencies were unable effectively monitor. The largely unregulated derivative market, lack of transparency and standards in the securitized loan market, deteriorating underwriting standards for mortgage loans, and credit rating agencies inability to rate the collateralized debt obligations consistently was obscured by rising home prices. The convergence of these circumstances blew up in the perfect storm resulting in the great recession. Adequate governmental oversight of banks and other financial and investment institutions might have thwarted or at least muted the severity of the recession.
It was not a matter of if we have regulatory reform, but what shape would it take. The Senate bill will be merged with the House bill and signed by President Obama on July 4th. The Senate bill creates a nine-member Financial Oversight Council consisting of the treasury secretary, Federal Reserve chairman, a presidential appointee with insurance expertise, heads of regulatory agencies and a new consumer protection bureau that would monitor financial markets and watch for threats.
Consumer protections will be monitored and enforced by a newly created agency with a base of operations in the Federal Reserve, not the FDIC. The group will have the authority to ensure American consumers get clear and accurate information needed to shop for mortgage loans, credit cards and other financial products and make sure hidden fees, abusive terms and deceptive practices are exposed and eliminated.
Large banks and financial institutions will not be broken up as some proponents had lobbied. Taxpayers can take some consolation knowing their tax dollars will not be used to bail out financial firms deemed too big to fail. A safe way to liquidate financial firms that threaten the economy will be established. Capital and leveraging requirements will make the cost of getting too big more prohibitive. The Fed will still have authority to allow system-wide support, but no longer bail out individual firms, Fannie and Freddie excluded. This stipulation is a big step in the right direction, but without clear parameters stipulating when and how firms may be liquidated, the potential for regulatory overstep is high.
The advanced warning system is a council that will identify and assess risks posed by large companies, complex financial products and activities before they threaten the stability of the economy. On the surface, the advanced warning system sounds like it will be the watch dog the U.S. consumer and the world financial system needs to calm jittery nerves and provide reassurance to those who lost faith in the system. Once again, without clear parameters and definitions, the potential for governmental abuse is high. What is the group’s mission statement and will it operate independently or will it be influenced by the politics of the day to put pressure on companies that have not been friendly to the party in power.
Reactionaries on the left wanted to completely reorganize the system, claiming the meltdown was proof Capitalism no longer works in the 21st Century. Sentiment such as, we need a governing body that has its hand in all private sector activities, is a misdiagnosis the problem. The system, though imperfect, still works. Create a hedge around financial activities and products and let the players have at it. A system allowing operators to focus solely on the next quarter, churn securities for no reason other than generating income on a transaction and cloak activities in secret, needs some checks and balances. The Transparency and Accountability for Exotic Instruments provision should be sufficient. Regulating derivatives, asset back securities, mortgage brokers and payday lenders by putting process and procedures in place should eliminate many abuses. Naked shorts should have been included, oh well.
The credit rating agencies failed by giving high ratings to collateralized debt obligations that were composed of sub-prime and Alt-A mortgages. New regulations will protect investors by demanding transparency and accountability of the credit reporting agencies. The banks will no longer be able to shop and choose the agency that gives their product the best rating. A board will be created that will assign a rating firm to the bank. Banks will be a large source of revenue of revenue for the ratings agency, so the potential for abuse will still exist.
Smartly, punitive taxes on profit and mandatory salary caps will not be implemented. Shareholders will have a non-binding say on executive compensation which may be a lever for providing pressure. Make it simple, your company makes money, exceeds expectations, compensation should be large. If your company tanks, making bonus for leading a downturn doesn’t make much sense.
Language in the bill states the laws that are already in place will be enforced. Oversight will be strengthened; regulators will be empowered 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. Herein lays the rub. Who will define what? The government does not have a stellar track record enforcing laws and regulations that are already on the books. Will the laws be ignored someday because they will be deemed discriminatory because they happen to affect a one group more than another?
Government has become so large with so much overlap; various agencies had become uncertain about their lines of authority, allowing the system to become riddled with loopholes. The Senates financial reform bill clearly delineates lines of responsibility. The FDIC will regulate state banks, thrifts and bank holding companies with assets under $50 billion. The OCC will regulate federal banks, thrifts and holding companies with assets under $50 billion. The Federal Reserve will regulate banks, thrifts and bank holding companies with assets over $50 billion. Banks with assets under $10 billion will be examined by the appropriate bank regulator and will be exempt for some of the higher fees larger banks will pay.
Will anything change? Future actions and behaviors can be predicted with a high degree of probability by looking at how individuals or organizations reacted in the past. Anytime the spotlight is focused on an individual/department/organization, short-term activity increases and minor advances are made, but the test occurs when the klieg light of public attention is focused on a new target. Laws will be updated, unethical but legal loopholes will be closed. The Fed is assuming more power, but how well will new regulations prevent future bubbles or excessive risk taking, depends to a large extent on enforcement. Look at past regulatory actions, the future ones will not be far off. Hopes are high, expectations are low.
http://banking.senate.gov/public/_files/FinancialReformSummaryAsFiled.pdf
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