[Just added: One UPDATE near end.]
Senate Banking Chairman Chris Dodd released his own financial reform legislation today (discussion draft here). It is similar to the House effort lead by Barney Frank and the White House’s own plan; where are the places to watch to see how they conflict, which is where a lot of the debate going forward will be?
How Many Regulators?
Under Barney Frank’s plan the Office of Thrift Supervision (OTS) will be taken apart, but the rest of the regulatory infrastructure will be kept in place. New powers to designate Too Big To Fail firms will be handled by a Financial Oversight Council, which is a group of all the leading regulators, and once designated, extra scrutiny and oversight of these firms will be handled by the Federal Reserve. How public this list of firms will be, and whether a firm on the list will likely be rewarded or penalized by the market, is up for a lot of debate.
Under Dodd’s plan, he would take all of the bank regulators and merge them into one single regulator called the “Financial Institutions Regulatory Administration.” There are roughly 4 regulatory agencies overseeing Federal banking currently, and this would reduce it to one. This is a development that seemed very unlikely 5 months ago – here’s Tyler Cowen thinking of reasons against consolidation (after the Obama administration signaled it wasn’t going to go down this route), and me arguing for consolidation.
As for Too Big To Fail: Dodd would create a “Agency for Financial Stability”, similar in some ways to Frank’s Financial Oversight Council. Some details:
b. This agency would identify systemic risks to the economy, promote market discipline, and respond to emerging risks.
c. It will have the power to require companies to face enhanced supervision.
d. It will also be able to write regulations setting risk-based capital, leverage, and liquidity requirements for larger companies.
When it comes to deciding who poses systemic risks the bills are similar; the big difference is in who enacts the increased supervision. Let’s say, as a hypothetical, that a large financial firm has piled into short tenor debt in such a way to leave them vulnerable to a bank run. In Frank’s plan, the Federal Reserve handles increasing capital reserves and other regulatory burdens; in Dodd’s plan the Agency itself handles it. So it is a shift away from giving the Federal Reserve more powers.
The Consumer Financial Protection Agency goes through in a similar fashion to Frank’s plan. It’s worth noting that, as far as I read reports from DC, Senator Richard Shelby, the banking committee’s top Republican, and Dodd failed to reach a consensus over the CFPA and this is what is the major hurdle. It’s possible that they disagreed on a whole variety of items, but to hold up reform of the financial sector on this one point strikes me a necessitating a better rationale than what I’ve heard from the anti-CFPA side.
It is encouraging that this is here. Stopping this has been a rallying point for financial interests; it’s their version of a “public option” rallying point in co-ordinating a lot of different financial service industry interests. The U.S. Chamber of Commerce dumped $2 million+ dollars with a large campaign to kill this proposal – complete with a webpage with the subtle address of stopthecfpa.com, in case you didn’t know what their opinion was. Blue Dog Democrats, led by Melissa Bean and the New Democrat Coalition, tried to give this a serious run by weakening and watering down the language, but have been largely ineffectual. So some kudos are deserved to Frank and Dodd for keeping this alive as best they can, even if we are losing ideas like the vanilla option.
It appears that the costs of resolving large institutions will go to the surviving firms. From what I understand, like the original Frank plan, firms with over $10bn in assets will have to pay to clean up the costs of a failed TBTF bank after the fact. This is designed to encourage moral hazard; someone else has to clean up after you. Frank’s plan has changed to create a FDIC like fund for firms to pay into up front; it is likely that the Dodd plan, or whatever final version, will go a similar way.
This funding part is likely to be a central point of controversy. Here’s Adam Levitin (h/t):
Thus in most failures of too-big-to-fail institutions, the government will have to provide funding for the resolution, and this makes the resolution a political issue. For this reason alone, I think we are kidding ourselves if we believe that we can regularize the resolution of systemically important institutions. It would be great if we could regularize too-big-to-fail resolution, but I don’t think it is possible to come up with any set of rules that we won’t break at the first sign of them creating distributional results that we do not like.
And this regularization problem scales terribly as the size of the institutions themselves grow, and any returns-to-scale numbers that can be found from the banking sector needs to be resolved against this.
The Dodd bill is strong in a lot of areas that the Frank bill doesn’t go. [UPDATE: The Frank Bill does include a version of each other these; Hedge Funds, Ratings Agencies and Compensation Reform. I’m curious about the differentials in the ratings agencies approach – Will the Dodd plan cement in the situation we have?]
– Hedge Funds worth over $100m will be required to register with the SEC.
– Creates an Office of Credit Ratings at the SEC, which will be tasked with enforcing higher levels of disclosure, and will maintain a right to deregister an agency. I haven’t heard many really great ideas for how to solve the problems with the credit rating agencies; there may not be a ‘there’ here in this bill, but hopefully this will allow a better solution down the road.
– Strengthening shareholder rights through requiring an independent compensation committee as a prerequisite for listing on an exchange. Requires polices for public companies that allow the clawback of executive pay if financial statements turn out to be inaccurate.
I’ll update this if it turns out my reading of the bill is incorrect, but I believe this is an accurate summary. It’s possible that this plan is purposefully strong up front so layers of it can be sliced off as the bill goes forward. Let’s hope it keeps the best parts. More as the week goes on and I get a better read.
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I think (p. 84) that the Financial Stability Agency can decide that a given firm threatens the stability if the system and force it to break up. Whether that authority would ever be used is another question.
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Terrific breakdown Mike. We appreciate it out here.
“This is designed to encourage moral hazard; someone else has to clean up after you.”
The moral hazard is there whether the payment comes after the resolution or before it. “Someone else” has to clean up after failed commercial banks too (i.e., other commercial banks) — a commercial bank doesn’t care who has to pay for its failure, just as long as it’s not them.
By using a pre-paid FDIC-like fund to pay for the resolution of a TBTF bank, you lose the ability to make financial institutions pay according to how much they contributed to the failure. So if anything, a pre-paid FDIC-like fund creates more moral hazard than a post-failure assessment. Sheila Bair is only demanding a pre-paid fund because (a) she needs the money, and (b) a pre-paid fund would greatly increase her power.