In today’s American Banker, Stacy Kaper offers a thoughtful glance into the prospects for financial regulatory reform. Overtaken by other legislative priorities – most notably health care reform – that have occupied both the Administration and Congress over the past year, enactment of financial regulation reform has slipped into 2010. Some observers have argued for months that chances for meaningful reform have been fading, as the health care debate has dragged on and as the urgency of the financial crisis has moderated. The House of Representatives passed its version of a reform bill in December, entitled the “Wall Street Reform and Consumer Protection Act,” but the Senate Banking Committee continues to wrestle through disagreement regarding a number of aspects of Senator Dodd’s (D-CT) original draft bill. President Obama recently urged the Senate to act, declaring that reform is needed “as quickly as possible on behalf of the American people.”
The House product, which passed by a vote of 223-202, includes a number of critical components, such as the creation of the Financial Stability Oversight Council (FSOC), which would be responsible for monitoring and assessing systemic risk to the financial system as a whole, and the establishment of resolution authority – housed mostly within the FDIC – which would allow for the orderly dissolution of failing financial conglomerates, eliminating the “too big to fail” dilemma and, therefore, the need for future bailouts by the federal government. Also included in the bill is a fundamental reform of the way credit rating agencies are regulated, heightened regulation of the over-the-counter derivatives market, and the establishment of a Federal Insurance Office (FIO) within the Treasury Department, which would monitor the insurance industry from the federal level. On the floor, the full House adopted an amendment offered by Rep. Melissa Bean (D-IL), which resolved many – but not all – of the concerns with changes that had been made to the federal preemption language in the original Committee-passed bill.
While the passage of this bill is a positive step towards meaningful regulatory reform, some elements can and should be improved. For example, there are lingering concerns that the resolution authority, as written, lacks sufficient specificity and “toughness” to adequately shield taxpayers from exposure. One provision intended to incorporate market discipline into the resolution process allows the FDIC to impose a 10-percent “haircut” on secured creditors during the resolution process. This would likely have a devastating effect on the overnight “repo” market, and could introduce a new element of systemic risk by encouraging lenders to unwind their investment out of fear of losing the unsecured portion of the loan. The bill also calls for the pre-funding of a resolution fund by financial institutions with greater than $50 billion in assets. A pre-funding regime would likely increase moral hazard because markets would view it as extending open-ended aid to creditors and shareholders, and would divert as much as $150 billion from the financial system at a time when financial institutions are trying to raise capital cushions and when businesses and consumers need capital to spur economic growth and job creation.
The creation of the Consumer Financial Protection Agency (CFPA) also continues to raise concerns among a wide array of observer. While enhancing consumer protections is an essential aspect of the policy response to the financial crisis, such an agency, by its very nature, might not effectively serve the critical objective of improving consumer protection. There is a wide and varied range of consumer protection issues, and the creation of a new agency would monopolize the approach to these issues – one agency, one staff, one institutional outlook and posture. Sequestering consumer protection in a new agency would also separate consumer protection priorities from overall assessments of safety and soundness. An increased emphasis on consumer protections should be embedded within the DNA of each of the functional regulators, not isolated within the walls of a new single agency.
Lastly, the committee adopted an amendment which would give regulators the authority to preemptively dismantle and limit the activities of healthy, well-capitalized and well-managed financial institutions. Large financial institutions provide unique value to the U.S. economy, and, if signed into law, this provision could put U.S. businesses at a competitive disadvantage, and cause long-term harm to the U.S. economy and its job-creating capacity.
In the Senate, Banking Committee Chairman Dodd introduced a draft bill on November 10th. Committee members from both sides of the aisle raised concerns with a number of issues in the discussion draft. In an effort to address those concerns, and generate a product that will garner bipartisan support, Chairman Dodd has commissioned a number of working groups, pairing Committee members from each party to focus on questions surrounding derivatives, systemic risk and resolution authority, consumer protection, and executive compensation. While the results of these working groups are yet unknown, one conceptthat seems to have broad bipartisan support on the Committee is the idea of stripping all supervisory powers from the Federal Reserve. Despite the progress that the working groups have made, the Chairman has indicated that his Committee will likely not be able to pass anything until February at the earliest.
The Forum is particularly concerned with an emerging trend in both the House and the Senate toward unfavorable regulatory treatment of large financial institutions. Among the proposals under consideration either in the House or Senate are the following: limitation on the activities or break-up of healthy and well capitalized financial institutions, pre-funding a systemic resolution fund, basing assessments to the Deposit Insurance Fund on assets rather than deposits, and reinstating Depression-era Glass-Steagall restrictions on the ownership of investment banks by commercial banks. These provisions would inhibit job creation, reduce capital and credit, and in some cases, introduce new levels of systemic risk and moral hazard into the financial system.
Looking ahead to 2010, the Forum hopes to see a Senate product that builds on the favorable aspects of the House bill, and also addresses the lingering elements of concern. In the end, Congress must deliver to the President’s desk a piece of financial regulatory reform legislation that will ensure a financial sector that is effective and efficient, ensures institutional safety and soundness and systemic stability, promotes the competitive and innovative capacity of the U.S. capital markets, and protects the interests of depositors, investors, policyholders, and consumers. Given the importance of financial regulatory reform, the Financial Services Forum will continue to engage policymakers and be a thoughtful participant in efforts to achieve this critical goal.