Sen. Chris Dodd (D-CT), looking for a capstone to his 30-year career in the Senate, unveiled his vision for financial regulatory reform this week. The chairman of the Senate Banking Committee has long been dogged by claims that he’s in the pocket of the financial industry and hedge funds, but his plan is a robust effort to address the systemic issues that led to the 2008 financial crisis. While it’s far from perfect, the Dodd proposal is a good one that could be made even better with a few tweaks.
A robust Consumer Financial Protection Agency (CFPA) is vital. Concerns over creating a whole new bureaucracy have to be balanced against developing a consumer watchdog agency that has teeth to rein in subprime mortgages, hidden banking fees and the like. I got to hear Sen. Mark Warner (D-VA) talk about this with Sen. Bob Corker (R-TN) at a panel sponsored by the National Journal, where they described striking that balance by housing the CFPA in the Fed. The new autonomous agency would get Fed funding for its activities but would not fall under its oversight. That responsibility would fall on a CFPA director appointed by the president and confirmed by the Senate. This should give it enough independence from the financial institutions that fund the Fed to make the agency a real force for protecting consumers.
However, as described in the bill, the CFPA would exempt some lenders from oversight. An improvement would be to follow President Obama’s lead and create a CFPA that covers retail activities from all financial entities, including small banks, auto loan and mortgage originators (like Countrywide or GMAC), and payday lenders. The Department of Defense got military personnel protected from such lenders four years ago, finding that such loans “undermine military readiness, harm the morale of troops and their families, and add to the cost of fielding an all-volunteer fighting force.”
The Dodd bill includes the so-called Volcker rule, limiting the scope of bank activity, which I’ve argued before won’t make a real difference in prop trading, as banks can mask it behind market-making and client trading. However, the excess leverage tax in the Volcker rule — if properly beefed up — will discourage firms from becoming Too Big Too Fail (TBTF). And where the bill as envisioned doesn’t seem to rein in behemoths like Citi or Bank of America, increasing the capital requirements on overly large firms is a relatively easy fix, if the political pressure from bank lobbyists can be overcome.
The bill looks to wind down TBTF through a special financial panel of bankruptcy court, which would allow systemic risk overseers — envisioned in the bill as comprised of representatives from Treasury, the Fed and the CFPA — to take vulnerable firms into receivership and liquidation in times of crisis. The FDIC would manage a $50 billion fund that banks would pay into to provide liquidity in these situations. As envisioned, the treasury secretary petitions the court, the financial firm in question responds, and the court has 24 hours to decide. But a decision can be appealed to a Court of Appeal and then the Supreme Court, a process that could take up to 30 days. In a financial era in which multibillion dollar institutions like Merrill Lynch and Lehman Brothers can evaporate over the course of a weekend, giving management 30 days in which to stonewall means that an orderly wind-down as the new rule envisions is unlikely.
We’re waiting to see what will come from Sens. Jack Reed (D-RI) and Judd Gregg (R-NH) on derivatives, but the existing language encourages increased transparency and centralized clearing for standardized derivatives (the maligned CDS’s and the like) and increases margin requirements for non-standard derivatives. All trades being reported will help regulators understand the evolution of the financial system better.
The inclusion of a non-binding shareholder vote on executive pay will give shareholders a greater role in compensation. While it won’t solve the “heads I win, tails you lose” problem of Wall Street’s bonus structure, it will give outsiders more say on pay and hopefully check the worst excesses.
Like the CFPA and the chairman of the Fed, the proposed legislation would also make the New York Fed presidency a White House appointment. That role, which was vital at the height of the 2008 crisis when now-Treasury Secretary Tim Geithner held it, and was central in previous crises, like the LTCM meltdown of 1998, has long been seen as beholden to Wall Street. A presidential appointment would increase its independence form investment banks.
As presented, the Dodd bill has its flaws — in addition to the ones mentioned above, others have argued that political realities have compromised the force of the bill, and because it hasn’t addressed leverage, the seeds of an asset-bubble-driven crisis like the most recent one are still there. It’s true, as Sen. Dodd said when he announced the bill: “This legislation will not stop the next crisis from coming. No legislation can…” But this bill — with improvements — can give regulators the tools they need to address future crises in a more proactive manner.