Tuesday, 06/29/2010 - 9:39 am by Dean Baker
FinReg bill falls short, especially in not ending Too Big to Fail.
The final compromise bill approved by the conference committee on Friday will improve regulation in the financial sector. However, given the severity of the economic crisis caused by past regulatory failures, the public had the right to expect much more extensive reform.
On the positive side, the creation of a strong independent consumer financial products protection bureau stands out as an important accomplishment. Such an agency would have prevented some of the worst lending practices that contributed to the housing bubble. It will be important President Obama choose a strong and effective person, such as Elizabeth Warren, as the first head of the Bureau to establish its independence.
The requirement that most derivatives be either exchange traded or passed through clearinghouses is also an important improvement in regulation. However, important exceptions remain, which the industry will no doubt exploit to their limit.
The creation of resolution authority for large non-bank financial institutions is also a positive step, although the fact that no pre-funding mechanism was put in place is a serious problem. Also, the audit of the Fed’s special lending facilities, as well as the ongoing audits of its open market operations discount window loans, is a big step towards increased Fed openness.On the negative side, there is little in this legislation that will fundamentally change the way that Wall Street does business.
The rules on derivative trading will still leave the bulk of derivatives to be traded directly out of banks rather than separately capitalized divisions of the holding company. The Volcker rule was substantially weakened by a provision that will still allow banks to risk substantial sums in proprietary trading.
More importantly, there is probably no economist who believes that this bill will end too big to fail. The six largest banks will still enjoy the enormous implicit subsidy that results from the expectation that the federal government will bail them out in the event of a crisis.
Also, the fact that no regulators, most obviously Ben Bernanke at the Fed, were fired for failing to prevent the crisis leaves in place serious doubts about the structure of incentives for regulators. Cracking down on reckless behavior by politically powerful financial institutions will always be difficult for regulators. On the other hand, if regulators know that failing to crack down carries no consequences, even when it leads to disastrous outcomes, we can expect that regulators will have a strong bias toward ignoring reckless behavior.
It is possible that Congress may take stronger steps toward restructuring the financial sector, most obviously in the context of a
financial speculation tax. While this is not likely to pass at the moment, in the context of severe budget pressures, a tax that can raise $150 billion a year in revenue may look more appealing than most alternatives. Such a tax would do far more to restructure the industry than this financial reform bill.
Well, I found one economist who believes the "too big to fail" argument is bogus.
Krugman:
Too big to fail FAILI’m a big advocate of much strengthened financial regulation. One argument I don’t buy, however, is that we should try to shrink financial institutions down to the point where nobody is too big to fail. Basically, it’s just not possible.
The point is that finance is deeply interconnected, so that even a moderately large player can take down the system if it implodes. Remember, it was Lehman — not Citi or B of A — that brought the world to the brink.
And as far as I know, there never was a time when policymakers could have viewed the collapse of a major money center bank with equanimity.
They certainly were worried about systemic risk in 1982, when I had something of a front-row seat. There were fears that the Latin debt crisis would take down one or more money center banks — Citi, or Chase, say. And policy was shaped in part by the desire to make sure that didn’t happen. Bear in mind that this was in the days before the repeal of Glass-Steagal, before finance got so big and wild; the New Deal regulations were mostly still in place. Yet even then major banks were too big to fail.
So I think of the pursuit of a world in which everyone is small enough to fail as the pursuit of a golden age that never was. Regulate and supervise, then rescue if necessary; there’s no way to make this automatic.
The problems stemmed from the repeal of Glass-Steagall and the shadow financial system that grew out of that.
As for Baker's concern about derivatives trading, that's being
addressedAlso, though not quite as extensive, there is a tax on institutions, both in the bill and pending:
In the United States, the proposed $19 billion tax would cover the cost of implementing financial reform. President Obama is expected to sign the bill in July.
The tax would apply to banks with more than $50 billion of assets and hedge funds with over $10 billion in assets. It would be assessed based on how much risk an institution takes and is expected to raise $4 billion a year over the next five years.
In addition, Congress is considering a $90 billion "financial crisis responsibility fee" as part of President Obama's 2011 budget proposal. The so-called bailout tax would be paid largely by major financial institutions that contributed to the financial crisis, and were the biggest beneficiaries of extraordinary government actions.
linkStill, why would anyone vote against these reforms?
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