Sunday, July 18, 2010

Finanical Reform at Last?

The Dodd-Frank Wall Street Reform and Consumer Protection Act (all 2300 pages) will be signed into law by President Obama on Wednesday, July 21, 2010. I will be blogging at length about the substance of the bill over the next 10 days or so, trying to highlight elements not covered well in the media. In general, the bill holds the potential to rein in Wall Street excess and hopefully prevent the next meltdown. Nevertheless, overall the bill is too little too late, and relies too much on regulators to regulate appropriately in defiance of the experience of the last 30 years when regulators led the march to re-imposition of discredited laissez-faire policies in the financial sector. Moreover, the bill largely leaves in place a financial regulatory sector that is proven to be subject to an inadequate legal structure that cannot resist special interest influence. There is no fundamental reform here that will change underlying political and legal dynamics. The issue of economic inequality, which according to Professor Raghuram Rajan played a foundational role in the entire crisis, fails to even warrant a mention.

According to a Wall Street Journal report, for example, the bill authorizes at least 243 rule makings, requires further study for 67 issues, and mandates 22 periodic reports. Clearly, Congress has simply kicked many issues down the road, to be resolved after the election largely by regulators subject to the same political pressure that got us into this mess.

Thus, the Federal Reserve, which really bent all the rules beyond recognition to bail out all kinds of financial firms that it deemed too-big-to fail is given the power to break-up firms to make sure they do not become too-big-to-fail under section 121. This is like putting a bartender in charge of an AA meeting. I will be expanding on this issue in my next posting but for today the point is the bill may rearrange the deck chairs a bit, but fundamentally leaves the same regulators in charge, subject to the same political pressures and realities.

Former Labor Secretary Robert Reich states the problem well:

"The American people will continue to have to foot the bill for the mistakes of Wall Street’s biggest banks because the legislation does nothing to diminish the economic and political power of these giants. It does not cap their size. It does not resurrect the Glass-Steagall Act that once separated commercial (normal) banking from investment (casino) banking."

Economist Daniel Kaufman argues:

"We should not totally rule out that some regulators may carry out appropriate actions at times. But we should be mindful that the vested interests in a system captured by ‘money-in-politics’ would tend to bias decision-making against such timely and tough regulatory actions. Congress did not dare to look into this issue."

By virtually all accounts, the regulatory implementation of the bill is paramount, and those interested in progressive reform should now prepare for an extended battle before the many regulatory agencies that now have the power to significantly repair the system. As former IMF Chief Economist Simon Johnson puts it: "Regulators can do a great deal, but they need political direction from the highest level in order to make genuine progress." The Obama Administration must move with a renewed sense of urgency before another shock to the financial system tips the system into a second downward plunge.

A very good start would entail working with the Fed immediately to identify which too-big-to-fail-bank should be broken up first under section121, so that the market ceases to provide these entities too much capital too cheaply right now. This would be a very important first signal.

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