More on Dodd’s Financial Reform Plan

Some excellent additional thoughts on the Dodd plan from Felix Salmon, Kevin Drum, and Ezra Klein.

Also – Daniel Indiviglio has been taking apart the bill piece by piece in several blog entries; he did a similar eight part series on the Frank bill – indexed here – that is worth the 10 minute read if you want to know the details at a fine level.

I don’t know if it’s practical for the Federal Reserve to not be involved in regulating Wall Street. I suppose you could end up with a situation where the single ““Financial Institutions Regulatory Administration” regulator works closely but separately with the New York Fed, but that seems unlikely to work in practice. The call for the banks not to pick the regulators of the regional Federal Reserve branches strikes me as a massive improvement though.

Yglesias had a post a while ago about crude measures with regulation:

But I think this is an important point — in just the areas where we’d most like effective regulation, we’re sort of unlikely to get it. If traders are likely to overestimate the effectiveness of their risk models, then regulators are prone to those exact same errors. Where does this leave us?

Brooks, I think, thinks it leaves us just as skeptical of regulation as we were before we took the behavioral turn. I think it arguably leaves us somewhere else. It leaves us with an appreciation of crude measures rather than hubristic efforts to get the regulations precisely right….

At the same time, this rule, for all its arbitrariness, has the virtues of being clear and largely self-implementing. It doesn’t depend on anyone’s discretion being used wisely or honestly, and it doesn’t depend on anyone’s calculations being right…The best you can hope from a regulatory regime is that it will be a satisficing solution wherein some fairly crude rule will improve on the outcomes generated by the unfettered market. When that’s not the case, we may as well let the market go unfettered even though that, too, will be somewhat sub-optimal. But at the same time when we’re looking at a regulatory regime that seems to be working okay, and the regulated parties start saying we need tweaks x and y and z and oh there’s no danger there we should be very suspicious. We shouldn’t count on being to fine-tune our results to perfection, we should either lean in with a heavy hand or else stay away.

Decisions are about tradeoffs, and I always watch for the tradeoff between satisficing solutions, hard rules that will be clear and harder to game but presumably sub-optimal, and solutions that allow for greater flexibility but require greater discretion and wise judgement on the part of regulators, and I tend to side with the first.

Once banks make it onto the To Big To Fail list in Frank’s plan, the Federal Reserve will handle them on a case-by-case basis, shifting them across a series of four ratings. It’s possible that they will use satisficing solutions in these cases; it is also possible that they will not. The FIRA will (from the document): “prescribe such regulations and guidelines, and issue such orders, as FIRA determines to be appropriate to carry out this title, and the powers, authorities, rights, and duties transferred to FIRA under this title”, so not much help there.

But if the rationale for the FIRA is to have a super-FDIC, or an FDIC with a larger charter, the regulation may fall on the clear rule side of the regulatory burden. Hopefully in the next week we’ll learn more about how the FIRA will be run.

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One Response to More on Dodd’s Financial Reform Plan

  1. Not the Mike You're Looking For says:

    I still find this “resolution authority” troubling, though there seems to be a precedent in the Continental Illinois insolvency (http://en.wikipedia.org/wiki/Continental_Illinois). I’d love to hear your thoughts.

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