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First take on Dodd’s financial regulations

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Senator Chris Dodd on new financial regulations legislationEver since Sen. Dodd announced his financial reform plan, I’ve been waiting for a good analysis of it. Steven Pearlstein, of the Washington Post, wrote a scathing article today on the bill.

Wading through the 1,336-page “chairman’s mark” of the Senate’s financial regulatory reform bill, my initial reaction was the same as the Senate Republican leader’s response to any Democratic initiative: Put this sucker aside and start over.

Don’t get me wrong — I’m all for clever compromise, but this one looks like the proverbial camel concocted by a committee that set out to design a horse.

Unfortunately, Mr. Pearlstein’s story on the bill fell short of any real analysis. Not being satisfied and wanting to know what actually was in the bill, I downloaded the Reform Summary: FinancialReformSummary231510FINAL.

Overall it sounded pretty good which caused me to wonder why Pearlstein was against it. So, I wandered around to all of my favorite economists websites, hoping for a better analysis. Financial Times explains it, from the perspective of the Fed’s role.

The Fed would lose oversight of banks with less than $50bn in assets in a bill by Chris Dodd, chairman of the Senate banking committee, which was introduced this week and will go to a mark-up next week.

“It makes us essentially the ‘too-big-to-fail’ regulator,” Mr Bernanke told a congressional hearing. “We don’t want that responsibility. We want to have a connection to Main Street, as well as to Wall Street.”

The $50bn threshold is a compromise from Mr Dodd, offered after his earlier proposal to remove all of the Fed’s bank supervision was roundly rejected by the Treasury, the Fed and some senators.

Paul Volcker, the former Fed chairman, appeared alongside Mr Bernanke to describe the idea of hiving off all of the bank’s oversight as a “grievous mistake” that would harm the conduct of monetary policy and financial stability by limiting the Fed’s understanding of the financial system.

In another article, FT reports on the objection by the U.S. Chamber of Commerce and big banks against the Consumer Financial Protection Bureau (CFPB) which, under the current proposal, will be housed in the Fed with independent powers to protect consumers and investors and with a permanent budget.

“In every case consumer protection has the edge and will trump safety and soundness and I think that is backwards,” said John Dugan, the comptroller of the currency, at an American Bankers Association conference.

Mr Dugan, whose office regulates national banks, said a Consumer Financial Protection Bureau proposed in Mr Dodd’s financial regulation bill, which was published on Monday and is to be revised next week, was too strong.

However, Mike Konczal has a good start analysis of the bill on his website, Rortybomb, in his analysis of the resolution authority.

Resolution prevention

Think of resolution authority as a relationship between deterrence, detection and resolution.

Ideally we’d like to be able to detect firms that are going to fail beforehand, and use the financial sector’s regulatory powers to push them back on a stable path. So resolution isn’t just about failing a firm, it’s about taking steps to tell a firm that they must take action to become safer before they are resolved. This is what regulation at commercial banks do all the time – they create limits and caps and explicit capital ratios. The fact that if they fail, the government will detect it and force changes acts as a deterrence – if they are going to get caught, why even bother?

This was the argument between bankruptcy and resolution authority – Republicans thought that if you just made the resolution above painful enough, through an ugly bankruptcy, that would be enough to force deterrence, and we wouldn’t even really have to bother with detection. The problem is that financial bankruptcies have externalities for banks that have no problems, as well as crushing the lending channels our real economy needs to grow and survive. And the parachutes are so golden, reputation incentives don’t see to do the trick. And the payoffs are so asymmetric and the books are so easily cooked, shareholders can’t bring disclipine. And so on. This is why we need regulation, specifically regulation to expand this pattern from commercial banks to the largest financial firms.

Of particular interest – and somewhat cynical humor – is Konczal’s What would Goldman Lobbyists Hate About the Financial Reform Bill?

I want to approach it from a different angle: What would an investment bank hate about this bill, and lobby hard to change? I actually read this bill as if I was a Goldman Sachs lobbyist, looking for all the sections that I hated and made a list of what items I needed to lobby hard on to kill or modify.

My final verdict, by the time I got to the end? If I was a Goldman lobbyist, I’d probably shrug and go “eh, pass it.”

What’s there to object to? More practically, what’s this bill really going to do? I really couldn’t find anything outside of two items that nobody expects to be effective anyway, and one I’m doubting will get passed.

Overall, the bill, so far, sounds pretty meek and makes only weak reforms of a financial system that nearly brought down the world economy. Some of the reforms, which the Chamber of Commerce and Banks really hate, deal with shareholder rights to vote on compensation and election to the board of directors as well as the CFPB. I can understand why big banks, like Goldman, Chase, Citi, and BofA, would hate these regulations, but why does the Chamber of Commerce hate them? After all, most of these regulations not only help consumers in general, they help to protect small to mid-sized businesses. But maybe small to mid-sized businesses are less important to the Chamber than big banks.

Of course, Senate Republicans are already on the attack, wanting to weaken even further or defeat Dodd’s bill entirely. I understand that Republican objections are politically motivated – how can they win back Congress and the White House if Democrats successfully pass legislation that protects consumers and investors? – but here’s the big question: how do they dare put party politics ahead of the health of our financial system and the well-being of every business and American family in the United States?

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