The catch phrase “too big to fail” has been a clarion call for Washington lawmakers who are scrambling to re-regulate a financial industry that sent the global economy into a tailspin.
Right now, with Senate Banking Chair Chris Dodd, Connecticut Democrat, getting set to release his plan to collar the banks, the real question is whether his rambling overhaul proposal is too big to read.
At 1,136 pages, the “Restoring American Financial Stability Act of 2009” is a detailed attempt to tackle the multitude of alleged evils that triggered our rapid fall from financial grace. Printers and copiers from Wall Street to Washington’s “K” Street are working overtime as the throng of special interests gets set to loose its horde of lobbyists on the Capitol Hill.
Is This a Noose Tightener?
Among its high points, the bill would:
• Establish a Financial Institutions Regulatory Administration that would essentially handle all regulation of banks at the national level to unify the patchwork of regulations that currently cover the country’s commercial financial institutions.
• Create a Consumer Financial Protection Agency to regulate the entire spectrum of consumer financial products from credit cards to home loans.
• Set up a new oversight institution being dubbed the Agency for Financial Stability.
While all of these proposed reforms have their share of supporters and detractors, none is more fundamentally complex or arcane than Dodd’s proposed Agency for Financial Stability.
Chaired by a Senate-confirmed White House appointee, membership on this newest regulatory bureau would include the Treasury Secretary and Federal Reserve Chairman. Additional slots would be reserved for the heads of the new Financial Institutions Regulatory Administration, the Consumer Financial Protection Agency, the Securities and Exchange Commission, the FDIC (Federal Deposit Insurance Corp.), the Commodity Futures Trading Commission, and a final independent member picked by the White House.
This agency will be charged with identifying systemic risks to the economy, promoting market discipline, and responding to emerging financial hazards. It will have the power to require companies to face enhanced supervision. The board also will be able to write regulations setting risk-based capital, leverage, and liquidity requirements for larger companies.
Everyone from Fed Chair Bernanke to the talking heads on CNBC seems to agree that this latest financial meltdown largely occurred because regulators were asleep at the switch. Because regulators did not perceive the systemic peril posed by the unchecked risks being taken by the banks, they were unable to impose capital and liquidity buffers that would have prevented the crisis.
In 1999, Congress redrew Depression-era financial regulations when it repealed the Glass-Steagall Act that separated commercial depositor banks from investment banks. The removal of this regulatory partition gave rise to financial conglomerates involved in insurance, stock brokerage and commodity trading.
Crisis Could Have Been Avoided?
Supporters of this new regulatory scheme argue that had a group such as the one proposed been in place, the alarms could have sounded long before first tremors destabilized the financial markets. Several opponents of the Dodd proposal aren’t sure.
They contend that the massive failures of risk management within the nation’s financial firms still would have remained hidden even if such an agency had been operational. For example, both Bear Stearns and Lehman Brothers were firms without commercial banking divisions whose operations may not have fallen under the purview of this new oversight board.
Another camp, whose most vocal spokesman on Capitol Hill is Vermont’s Independent Sen. Bernie Sanders, is advocating alternative legislation that would not impose super-regulation on firms deemed too big to fail. Rather, it would force their breakup. In the House, Rep. Paul Kanjorski, a Pennsylvania Democrat, is preparing legislation that would limit the size of financial organizations.
Dozens of academics and Nobel laureate economists also have weighed in on this debate. Many have said that they are concerned with the distortion of risk that may result from the type of oversight and intervention being proposed. From their perspective, it is not just the thorny question of identifying which firms should be subjected to enhanced supervision, but whether that such governmental meddling would hinder normal market forces that regulate risk.
Although most mainstream economists have concluded that the White House and lawmakers had little choice other than to intervene in the financial markets through their multifaceted bailout programs, several now think that the erection of this governmental safety net has imposed a false sense of security among those firms who now believe they have been designated too big to fail. Instead of curtailing risk, these academicians contend that this new regulatory focus may embolden these firms because they know that the government will not let them fold.
Over the next several months, the press will likely focus most of its attention on the consumer protection features of this legislation. But the real philosophical battleground will revolve around how, or more aptly whether, any central government is suited to the task of indentifying and regulating those financial interests that may be too big to fail.
John Cohn is a senior partner in the Globe West Financial Group based in West Los Angeles. He may be contacted at www.globewestfinancial.com
