The Tough Task of Financial Regulatory Reform: Those Ungrateful Banks

This week the Dow surged past 10,000 points. JPMorgan Chase and Citigroup reported earnings that exceeded analyst’s estimates. These are all positive indicators. However, structural and regulatory problems that caused the current financial crisis have remained unaddressed to this point.

The Obama Administration has proposed major overhauls to the financial regulatory system. In the past year taxpayer’s have provided vast sums of money to bailout banks. For the most part, these bailed out banks have been restored to profitability and are providing record compensation for their executives. In the midst of President Obama’s push to reform and overhaul financial regulations, guess who’s pushing back the hardest? If you said banks, you’re correct. Yes, the very industry that the federal government saved is lobbying the hardest to thwart overhaul and regulation of their industry.

This week, the Obama Administration voiced frustration with the banking industry. Administration officials noted that the banking industry is returning to a sounder footing because of government bailout, and that lobbying efforts to kill regulation run counter to the nation’s longer term interests. Valerie Jarrett, a senior advisor to President Obama noted: “We are disappointed by the lobbying of anyone in the financial industry against regulatory reform, considering the obvious need for change on that front.”

The banking industry misses the point. Some banks are reporting record compensation and a return to pre-financial crisis meltdown profits. This is the picture on Wall Street. On Main Street, unemployment is close to 10%. Foreclosures over the last year have jumped close to 30%. If Main Street is hurting Wall Street should be more conscious of that fact. Quite honestly, Wall Street, and banks and the financial services industry in particular, should be more thankful and grateful for the lifeline extended to them by taxpayer’s.

Keep an eye on the Sunday morning talk shows. The Obama Administration has promised to send a tough message to the financial services industry regarding the industry’s pushback on regulation. We shall see.

A New World Financial Order: G-20 Leaders Discuss International Regulation

On Thursday, the world leaders from the 20 most powerful countries (G-20) will gather in Pittsburgh, PA to discuss the matters affecting their respective countries. On the top of every leader’s list is financial regulation. Many are concerned that despite the harsh realities of failing economies, concrete reforms are likely to remain a distant prospect, primarily because the G-20 has no law-making power. EU Ambassador to the United States John Bruton stated that "G-20s don't make the detailed decisions ... But they can create the conditions…. for reforms.” However, any real reform will have to be drafted, adopted, and implemented by national authorities not the G-20.

President Obama and the leaders of Britain, Germany and France are expected to try to reignite the fervor of a year ago to regain momentum for international financial reform by raising the sensitive issue of executive compensation. There is recommendation that executive bonuses should be linked to the long-term performance of investment decisions and the financial condition of banks’ balance sheets to discourage short-term risk taking. Ambassador Bruton stated that “[t]here is a high level of anger in Europe about the fact that the remuneration packages have been designed to emphasize short-term returns." G-20 leaders will also recommend comprehensive regulation of the over-the-counter (OTC) derivatives markets, hedge funds, credit rating agencies and debt securitization.

When Lehman Brothers collapsed in September 2008, freezing world capital markets, the G-20 leaders were galvanized around one single point-- tighter financial regulation. Now its been a year later, economies are stabilizing with the help of their respective governments, markets are rebounding – in the U.S. the Dow Jones industrial average, is up approximately 50 percent since February – there is a light at the end of the tunnel (and it is not the proverbial train). The G-20 leaders have less of an impetus to “create the conditions” for international financial regulation reform.

The reality is to introduce tough new capital requirements for banks, at this time, may actually harm banks’ balance sheets because governments want banks to lend more to help spur economic recovery. Stephen Green, chairman of the British Bankers' Association and HSBC bank, wrote in a letter to British Prime Minister Gordon Brown that "[t]he simple fact remains that financial institutions cannot take steps to further increase the amount of capital they hold and at the same time lend that capital to businesses and consumers."

Debates on details and timing for reform are growing heated. The Financial Stability Board (FSB), the G-20's policy coordinating arm, last week cited "challenges in maintaining an appropriate balance and pace of regulatory reform." Europe is suspicious about a U.S. push for banks to adopt a leverage ratio. There is a worry in Europe that adopting a leverage ratio that goes beyond being just a "backstop" to Basel II would undermine the Basel rules. There is still no consensus on how to define a leverage ratio or what assets should be included.

Many nations have already pledged to take new steps to strengthen regulation of the global financial system. However, the continental Europeans and the United States have stressed different elements of reform. The European Union is pushing for restrictions on bankers' pay in order to eliminate what they see as perverse incentives that encouraged irresponsible risk-taking. The United States has put more emphasis on forcing banks to raise the quality and quantity of capital they have on hand to cover potential losses in an effort to better protect taxpayers from having to pay for banks' mistakes. Joe Engelhard, policy analyst at investment research firm Capital Alpha Partners stated that the G-20 might produce a consensus on capital standards, but it will take much longer to settle on "the exact levels of the new capital and leverage ratios and even longer to agree to the new liquidity regime."

The G-20 members are working on a framework for regulatory reform with firmer deadlines. Ultimately, though, it is up to national legislatures to follow through. The U.S. Congress is working on a proposal to overhaul financial regulation.

Lydie Nadia Cabrera Pierre-Louis
St. Thomas University School of Law

Corporate Behavior in the Face of Reform

Treasury Secretary Timothy Geithner has been aggressively peddling the Obama Administration’s plan to reform the financial industry in recent weeks. We as a nation, have a habit of experiencing an economic crisis and then passing reform after the fact in order to try to protect against its recurrence. Interestingly, we often fail to heed the calls for common sense reform or regulation prior to a devastating meltdown (I wrote a law review article warning against unregulated over-the-counter trading of derivatives back when Greenspan was telling Congress that large institutional investors would never leverage themselves to the point of financial failure), waiting instead to clean up the carnage after the fact. In fact, as criticized on this Corporate Justice Blog, often the carnage clean up rescues the malfeasors (recently in the form of government bailout and continuing excessive executive compensation) and leaves taxpayer citizens (the innocent party) shouldering the burden of the economic crisis.

To wit, the Securities Act of 1933 and the Securities Exchange Act of 1934 were both enacted in wake of the Great Depression. Sarbanes-Oxley was enacted in the wake of the Enron, WorldCom, Tyco scandals. Today, the momentum to pass regulatory reform is strong in wake of the devastating market crisis that we continue to feel and attempt to overcome. Still, the broken models that have proved ineffective continue to be used as the baseline for these reform efforts.

In response to the subprime mortgage meltdown, the Obama administration’s reform effort will seek regulatory control that includes (1) broadening the Federal Reserve’s authority to assess risks and overleveraged positions taken by financial firms and taking action to divert failure and (2) the creation of a consumer watchdog type of agency that would oversee mortgages, credit cards and other financial products. So, with Wall Street reform on the table, leaving aside the value or quality of the suggested reforms, what response can we expect from Wall Street and the financial industry in the face of these proposed reforms?

If history is any indicator, the response driven by corporate interests will be forceful and coordinated in an effort to defeat any new regulation or to significantly weaken it if the force of majority is too strong for reform (see Sarbanes Oxley, etc.).

As a point of comparison, Corporate behavior in recent weeks in response to health care reform and climate change legislation has been breathtaking in its audacity and truly underhanded in its application:


Corporate interests in the health care industry have undertaken a strategy of near mob mentality in coordinating efforts to hijack Congressional town hall meetings through astro turf lobbying firm “marching orders” designed to squelch conversation and open debate. As Congresspersons use the recess to openly debate and honestly describe the efforts to reform U.S. health care, a group of citizens will show up with the express purpose to shout down any attempts at an open conversation about changing a health care industry that works extraordinarily well for insurance companies (and their investors) but that is broken for large segments of American society.

Corporate interests in the energy industry hired lobbying firms that have recently forged letters from civil rights groups in an effort to defeat environmental reform. Several Congresspersons received letters ostensibly from the NAACP and a Hispanic Civil Rights organization pressing the representative to vote against climate change legislation, only to later learn that these letters were forgeries sent from a Capital Hill lobbying firm hired by industry corporations to defeat reform.

Corporate justice? With corporations in the insurance and energy industries using scorched earth tactics to defeat reform? The mountaintop (of reaching corporate justice) seems to be extraordinarily steep.