Financial reform in America: The hand of Dodd
The Senate bill is finally published
Mar 18th 2010 | WASHINGTON, DC | From The Economist print edition
Dodd bandages things up
[Greg Ip] CHRIS DODD, the soon-to-retire chairman of the Senate Banking Committee, has staked his legacy on overhauling America’s financial regulations. If he fails, it won’t be for lack of trying.
On March 15th Mr Dodd unveiled a sweeping proposal to rearrange the duties of America’s financial regulators while creating new powers and authorities to sniff out and squelch the risks that brought on the financial crisis. This is not the first reform blueprint: the House of Representatives has passed its own bill, the Treasury issued proposals last year, and Mr Dodd himself had already unveiled one, aborted draft of the Senate bill. This version, however, is the first to reflect substantial input from Republicans, whose support is necessary to reach the 60-vote margin needed in the Senate for the bill to become law.
The causes of the financial crisis are countless, and the 1,336-page bill takes aim at most of them, from credit-rating agencies to derivatives. But the two most sensitive proposals are its plans to deal with big, risky firms, and the creation of a new body to protect consumers.
To curb risks to the financial system, Mr Dodd would create a Financial Stability Oversight Council composed of regulatory chiefs who can designate any big financial firm as systemically important. That would put it under the eye of the Federal Reserve. Republicans have justifiably worried that designating any firm as systemically important would encourage markets to assume it is too big to fail, making it cheaper for the firm to borrow.
Mr Dodd’s bill seeks to make size unappealing by requiring firms with more than $50 billion in assets to fund a resolution kitty to deal with failing firms, also worth $50 billion. And it opens the door to the adoption of Barack Obama’s “Volcker rule”, which would restrict banks and other Fed-regulated financial companies from proprietary trading and sponsorship of hedge funds and private equity.
More importantly, Mr Dodd has also made the resolution process deeply unpleasant. If a failing firm were deemed a threat to the system, the Fed, the Federal Deposit Insurance Corporation and the Treasury, with the agreement of three bankruptcy judges, could impose an “orderly liquidation” on the firm, forcing shareholders and unsecured creditors to take losses. Such a resolution mechanism has long existed for banks but not for other big financial companies or for bank-holding companies.
It may prove unworkable, of course. The threat of being wiped out in bankruptcy could cause creditors to flee both the troubled firm and any firms like it, precisely the sort of panic the resolution regime is meant to avoid. “In a severe financial crisis it will be too terrifying for politicians and bureaucrats to use” the new process, predicts Douglas Elliott of the Brookings Institution. Instead, he says, they will resort to ad hoc measures as they did in 2008.
Less important but much more controversial is the issue of consumer protection. Democrats want to take that job away from bank regulators and give it to an independent agency. Republicans fear such an agency would kill off legitimate products and circumscribe banks’ financial health. Mr Dodd’s clunking compromise is to place a Consumer Financial Protection Bureau inside the Fed (where it gets a chunk of the Fed’s budget), make its director a presidential appointee and allow the oversight council to overrule its decisions.
There are other compromises, too. Mr Dodd had originally planned to merge America’s four overlapping bank regulators into one. He has given up that laudable fight. Just the hapless Office of Thrift Supervision will disappear. The Fed will lose authority over smaller banks—a move it opposes—while retaining it over large bank-holding companies. The bill also includes politically motivated loopholes: banks with less than $10 billion in assets will be spared the attention of the new consumer-protection bureau, though they are hardly paragons of virtue. They have some of the highest overdraft fees, says Michael Calhoun of the Centre for Responsible Lending, a consumer-advocacy group.
Despite Mr Dodd’s contortions, no Republicans have yet said they will support the bill. Modest concessions may entice Bob Corker of Tennessee and Judd Gregg of New Hampshire to vote for it. But the final product could then be unacceptable to liberal Democrats. And if Mr Dodd shifts left to bridge the gaps between his bill and the House’s, any Republican support could quickly melt away. With time running out before attention turns to mid-term elections in November, Mr Dodd’s place in history is still in the balance.