The 7 Biggest Surprises from Dodd's Bill

I think one last post should suffice about Senate Banking Committee Chairman Christopher Dodd's (D-CT) new financial reform proposal (.pdf) -- for now. When markup starts (and supposedly ends) next week, there may be more to say about amendments that pass and fail in committee. But for my seventh post on the topic (links to the others below), I thought it might be useful to comment on what I found most surprising about his version of financial regulation. Some of this will serve as a summary for points I've made before, but a few I have neglected to mention until now.

Consumer Financial Protection Bureau Director's Power

Despite the fact that the most talked-about aspect of Dodd's CFPB is his decision to place it in the Fed, I think it's also probably the least interesting. As far as I can see, the CFPB would be essentially independent, even if its staff would share office space with other Federal Reserve personnel.

Instead, I found the most surprising aspect of Dodd's CFPB the power he would provide to its director. The U.S. Chamber of Commerce did a good job in illuminating this criticism of Dodd's version yesterday. The House version would have the agency's power much less concentrated, with group of appointed commissioners in place to take on some of the responsibility for doing the regulating. With Dodd's version, the director would do all the hiring, decide how to spend the budget and presumably have a huge impact on the regulation.

The Council's Two-thirds Standard

Another difference between what the House and Dodd propose for systemic risk regulation is the difficulty that their respective councils would have in making decisions. In deciding to subject a firm to systemic risk regulation or breaking big ones up, the House bill would only require a simple majority of the council to vote in favor. Dodd's would require a two-thirds majority for both tasks. As I said, I think the difficulty in achieving a majority would ideally be based on how controversial a decision is being made. So for systemic risk regulation I like a simple majority, but for break-up, two-thirds is probably prudent.

Fed "Strengthening"

Dodd's bill manages to give the Fed a great deal more power than his original proposal in November would have. Now he's conceded that the Fed should do most of the systemic risk regulation. He even hands it the CFPB, though it will be held at arm's length. Yet at the same time he appears to want to rein in the Fed a bit. Those aspects of his plan, he amusingly titles "Strengthening The Federal Reserve" in his summary.

I didn't see several of these proposals coming. For starters, it's interesting that he hopes to add "financial stability" as a specific duty the Fed must aim for. Even though the Fed has sort of implicitly tried to smooth economic cycles over the past few decades, it has never explicitly been ordered to pop or prevent bubbles.

Dodd's desire to prevent bank employees, past or present, from acting as directors of the Federal Reserve is also not an idea I had heard being loudly shouted in Washington before. While I think it's sensible insofar as these individuals could favor their own banks' interests with a role in the Federal Reserve, I also worry about losing their market expertise and experience entirely. These people are in the trenches, so you don't want them to stay away from the central bank altogether. Perhaps this proposal could be changed to simply recommend that bank employees not have any voting power, but can sit on Fed boards as non-voting members.

Finally, the idea that the President should appoint the New York Fed president is kind of strange. Sure, that's an important role, but I have to ask the counterfactual question here: would the banking industry have fared any better during the financial crisis if President Bush had appointed the NY Fed president? I sort of doubt it. Indeed, Geithner was considered by President Obama to have performed so admirably during the crisis that the President made him Treasury Secretary. As the appointments become more driven by politics, I worry that the Fed's independence could also suffer.

Small Resolution Fund

This is another one I noted: Dodd only wants his bank resolution fund to be $50 billion, while the House version calls for $150 billion. Past experience suggests that $50 billion won't get you very far in a deep financial crisis. It's unclear why Dodd picked such a low number, but I think the House's $150 billion is probably closer to what would be needed.

No Specific Leverage Limit

I did my best to fully absorb Dodd's 1,336 bill, and as far as I can see, Dodd has no specific leverage limit proposed for banks. The House bill does -- it calls for a maximum of 15 to 1 leverage for financial holding companies subject to systemic risk regulation. I've written before about the importance of leverage requirements. Hidden leverage in the banking system was one of the direct causes of the crisis. If leverage would have been more transparent and lower, the banking system would have been far more stable. I was surprised to see Dodd overlook this and be so vague on his proposal's treatment of leverage.

Bank Supervision Changes

Another interesting feature of Dodd's new draft is his hope to take smaller bank regulation away from the Fed. He would delegate the regulation of state banks, thrifts and bank holding companies of state banks with assets below $50 billion to the FDIC. The Office of the Comptroller of Currency would get the national banks, thrifts and holding companies that fall within that same size cap. The Fed would get what remains, which is about 40 large banks. As far as I can tell, the House version doesn't seek to do anything like this.

A Seemingly Irrelevant Derivatives Section

Finally, in his summary of the proposal, Dodd says that a new derivatives section is still being worked on. It might not be completed by the time Dodd wants the bill out of committee and onto the Senate floor. I don't believe it's particularly common for a seemingly incomplete bill to be quickly swept out of committee onto the Senate floor, but that's likely what would happen here if Dodd gets his way. The committee would vote for the bill with a derivatives section that Dodd himself admits will probably be replaced.

While these seven aspects were perhaps the most surprising, I could have named other eyebrow raising features of Dodd's proposal as well. In general, however, it really did manage to trace over the House bill on most of the significant aspects. While some of the details of the two versions differ, I suspect that if the Senate does pass a version of Dodd's proposal, they will be easily reconciled. I would predict that many of these surprises, consequentially, will drop out between now and when Congress votes on a final version.

To read my other posts related to Dodd's proposal, please see:

Initial Thoughts on Dodd's New Financial Reform Proposal
Dodd's Bureau of Consumer Financial Protection
Comparing Financial Stability Oversight Councils
Chamber Stands Against Consumer Financial Protection Bureau
Non-Bank Resolution Process: House v. Dodd
Ron Paul on the Dodd Proposal's Treatment of the Fed