The Financial Reform Bill


Remarkably enough, bearing in mind the size of the bill (call it 2,300 pages) and the inordinate amount of time needed to pass it, the financial reform that the Senate sent to the president's desk on Thursday is only one more marker on a long and winding road.

The bill leaves multiple regulators with wide discretion across a range of critical issues. The argument over precisely what the new rules will be is barely getting started. Some of the most important questions -- such as the amount of capital financial firms will have to set aside -- are scarcely even addressed. Again and again, the bill calls for studies to be undertaken. No matter how these open issues are resolved, unintended consequences will come thick and fast. The whole thing is unfinished work with a vengeance. Nonetheless, better this than nothing.

The biggest and most valuable ideas in the bill are the Financial Stability Oversight Council and the new early resolution authority. Concerning the first, formal system-wide oversight was lacking in the old regime, a fatal flaw. It is good to have a single entity charged with that role, even if the entity is a panel of representatives from many different agencies. A much simpler structure would have been preferable for many reasons -- not least, it would have made international co-operation easier (more on this in a moment) -- but failing this the new oversight body is still a big improvement.

Early resolution authority is the bill's main defense against "too big to fail". The idea is to have the FDIC apply a pre-emptive liquidation procedure, like the one it currently uses for banks, to any systemically important financial firm that looks headed for collapse. The idea has been controversial, but it seems to me indispensable. The lesson of Lehman cannot be unlearned. For the foreseeable future, the authorities will not let an institution of that kind fail: unfortunately, the earlier effort to resolve the problem of moral hazard, by denying Lehman support, has enormously compounded it.

And I fear that breaking the biggest institutions into smaller pieces, as many of the bill's critics wanted, would have been a partial answer at best, as well as costly in other respects. Assume no super-banks. Even then, what regulator is going to risk a repeat of Lehman and its consequences? Planned pre-emptive intervention looks a better bet -- though, as elsewhere, the details matter. How well this will work in practice, or whether it will work at all, we are going to find out.

I expect less of the consumer-protection side, because the underlying trade-offs are so politically fraught. Dodd-Frank lays out a broad mandate for the new Consumer Financial Protection Bureau, and confers broad powers. That is all very well. Good politics too, I expect, for the time being. But wait till the new regime bites.

The law is silent on how the consumer protection agency should balance the directly competing goals of greater safety and wider access to finance. As Raghu Rajan argues (see my review of Fault Lines), the political push to widen access to credit, especially housing credit, was a crucial contributor to the crisis. The politics of acces to credit has not gone away. Let's suppose the new bureau succeeds in reducing outright fraud (of which there was plenty) and patent recklessness (of which there was more); a difficult trade-off still remains. If the agency significantly shrinks the availability of credit for low-income borrowers, it will not stay popular with the politicians who have championed it for very long. Therefore, it will not significantly shrink the availability of credit.

The bill makes progress on derivatives -- seeking to get them standardized and traded on exchanges. This is the right idea, but, as Douglas Elliott explains in a note for Brookings, the plan is again pretty vague.

Congress, appropriately, left a great deal to be decided by the regulators in this area. They will need to determine the rules for when a derivative is considered standardized enough that it must be traded on an exchange and/or cleared through a central clearinghouse. Indeed they may even be called on to make decisions on specific derivatives at times, especially until the rules are clear to everyone. They will also need to set the rules determining the collateral that derivatives counterparties must put up on over the counter (OTC) trade, as well as the capital required by banks and their affiliates on those trades. These choices will significantly affect the cost and attractiveness of derivatives, which matters a great deal given the importance of these instruments in our financial system.

Beyond that, the law will make derivatives clearinghouses far more critical than they have been, which also means that careful attention will have to be paid to regulation of those clearinghouses. (In practice, these will be institutions that are "Too Big to Fail", increasing the priority of careful regulation, since the taxpayer could be on the hook in an emergency.) There has been talk, for example, that the major derivatives dealers could be required to give up ownership or governance rights in derivatives clearinghouses, since they may have an incentive to make it harder for those entities to compete with OTC activities.

Whatever happened to the "Volcker rule"? It's there, after a fashion: banks will have to end their proprietary trading. But quite what "proprietary trading" means is unclear. The bill anticipates a series of exemptions. Volcker says you know it when you see it. Hmm. We'll find out.

Elliott's note rightly draws attention to the international dimension. Following the debate in Congress, you might imagine that the rest of the world does not exist. It's a nuisance, but it does. One of the things weighing on regulators as they work out the meaning of the new law and choose how to implement it will be the implications for the competitiveness of US finance -- or, conversely, the opportunities for regulatory arbitrage. Congress is deluding itself if it thinks the US can set the stringency of its financial regulatory regime unilaterally. Getting effective co-operation is vital. This is where the bill's timidity in simplifying the US regulatory structure -- actually, the bill complicates it -- is such a disappointment. The more complicated the organization chart, the more difficult it will be to work with other governments.

Jump to comments
Presented by

Clive Crook is a senior editor of The Atlantic and a columnist for Bloomberg View. He was the Washington columnist for the Financial Times, and before that worked at The Economist for more than 20 years, including 11 years as deputy editor. Crook writes about the intersection of politics and economics. More

Crook writes about the intersection of politics and economics.

Get Today's Top Stories in Your Inbox (preview)

Sad Desk Lunch: Is This How You Want to Die?

How to avoid working through lunch, and diseases related to social isolation.

Elsewhere on the web

Join the Discussion

After you comment, click Post. If you’re not already logged in you will be asked to log in or register. blog comments powered by Disqus


Where Time Comes From

The clocks that coordinate your cellphone, GPS, and more


Computer Vision Syndrome and You

Save your eyes. Take breaks.


What Happens in 60 Seconds

Quantifying human activity around the world



More in Business

Just In