One year after the passage of Dodd-Frank, I invited some experts and those on the front lines to weigh in on what’s happened so far and what’s to come on financial regulation. Next, I talked with a New York financial lawyer who writes under the pseudonym Economics of Contempt. EoC spent over 20 years as an in-house lawyer at one of the big investment banks and has spent the majority of his professional life in and around US financial law. He has followed the Dodd-Frank rulemaking process very closely and blogs at Economics of Contempt.
Mike Konczal: It’s been one year since the Dodd-Frank Act passed. There are dozens of articles saying it’s going terribly, dozens saying we don’t know how it’s going, and even a handful saying progress is being made. How has the past year gone for financial reform and Wall Street?
Economics of Contempt: On the whole, I’d say it’s going pretty well. But part of the problem with assessing the Dodd-Frank rulemaking process is that most people think of “the regulators” as a single, coherent entity. The reality is that there are at least seven different agencies that are writing the regulations for Dodd-Frank, and within the main regulatory agencies, each rulemaking task is assigned to a different team of staffers and lawyers. Some of them are doing an excellent job, and some of them are doing a poor job. Of the proposed rules and final rules that have been issued so far, there are many more good rules than there are bad rules. (Sadly, most pundits like to to seize on one example and extrapolate out to “Dodd-Frank implementation” in general, which is beyond illogical.)
Unfortunately, it’s still too early to make any definitive pronouncements, simply because most of the major/consequential Dodd-Frank rulemakings are still outstanding. We have “proposed rules” for some of the major rulemakings, and most of those proposed rules are quite strong. The proposed rules for resolution plans (a.k.a. “living wills”), reporting requirements for hedge funds and private equity funds, and the capital and margin requirements for OTC derivatives all stand out as strong rules.
Of course, there have also been some disappointments. The Fed relented on interchange and raised the swipe fee cap from 12 to 21 cents in its final rule, which was disappointing. Treasury also exempted FX swaps and forwards from Dodd-Frank’s clearing and electronic trading requirements, which I wish they hadn’t done. But again, the good rules clearly outnumber the bad rules.
MK: The first stop on financial reform is dealing with Too Big To Fail financial firms. How is the process of making them less prone to collapse and more manageable to resolve coming along?
EoC: I think this is going well. We basically knew what the rules for the resolution authority were going to look like already — they were going to be very similar to the rules governing FDIC resolutions of commercial banks. The real movement in this space has been in the so-called “resolution plans” that the major banks have to submit (and regularly update). The proposed rule on resolution plans was very strong — it ensures that the FDIC will have all the information it needs when it comes time to actually resolve a major bank. That’s crucial, because a successful resolution of a major bank will have to be planned out in advance and be reasonably comprehensive. The proposed resolution plan rule also allows the FDIC and the Fed to identify any legal or funding structures that would cause problems in a future resolution, and gives the FDIC the authority to force the banks to restructure in a way that would make a future resolution easier.
The FDIC and the Fed were supposed to vote on the final rule for resolution plans earlier this month but ended up pushing the vote to next month. (I think the final rule just wasn’t finished in time, which is understandable.)
MK: There are a lot of articles saying that the Volcker Rule is, or will be, dead on arrival and easily avoidable for high-end financial firms. What’s your take?
EoC: I said from the outset that the Volcker Rule, as drafted by Sens. Merkley and Levin, would be way too easy to circumvent. There are simply too many loosely-drafted exceptions to the proprietary trading ban. The industry has definitely come around to my interpretation, and it’s true that most people in the industry don’t expect the prop trading ban to be effective in practice.
That said, I can’t claim vindication yet. The Fed hasn’t issued the proposed rules implementing the Volcker Rule yet (although they’re expected by the end of the summer). Until we see the Fed’s proposed rules, it’s impossible to say that the Volcker Rule is dead.
MK: Relatedly, bringing new kinds of transparency and accountability to the derivatives market was a major goal. How is progress there?
EoC: Progress is very good there. The CFTC and SEC have both proposed robust derivatives trade reporting rules — if anything, the CFTC’s proposed rule on post-trade reporting is a little too robust. The CFTC proposed a rule requiring that most swap trades be publicly reported immediately after they’re executed (the so-called “real-time reporting” requirement). Block trades and large notional swap trades would only be given a 15-minute delay under the CFTC’s proposed rule, which pretty much everyone not named Gary Gensler thinks is far too short a delay. I expect the CFTC to lengthen the delay in its final rule (and I suspect that was Gensler’s plan all along — cagey bastard), but the delay for publicly reporting block swap trades definitely won’t be longer than one day. I don’t know how you describe that as anything other than a win for Dodd-Frank.
Of course, some people will inevitably look at the lack of transparency in the derivatives markets today and declare that Dodd-Frank is a failure. But transparency is only achieved through robust reporting requirements, and designing and implementing a robust reporting regime (from scratch) takes time.
MK: What’s going on with the ratings agencies? Do they just get a free pass on everything?
EoC: Basically, yes. That’s easily Dodd-Frank’s biggest shortcoming. I wish I knew how to fix the rating agency problem, but I genuinely don’t. The rating agencies are so hard-wired into the financial system that it’s very difficult to experiment with untested reform proposals. That’s why Barney Frank balked at the Franken Amendment, which was a toy model masquerading as a reform proposal.
MK: When financial firms are lobbying against Dodd-Frank, what does it look like? Do they have receptive audiences? Are they coordinating well or throwing each other under the bus?
EoC: Lobbying in the rulemaking process is done primarily through comment letters and face-to-face meetings with regulators. Whether the audience is receptive, especially for face-to-face meetings, very much depends on the regulator who’s in charge of writing the particular rule. Sometimes they genuinely want to hear the banks’ feedback, and other times they have absolutely no interest in the banks’ grumbles. Typically, banks use face-to-face meetings to underscore what their top issues/concerns are and to make any arguments that rely on proprietary data. Hedge funds tend to favor face-to-face meetings so that they don’t have to detail their concerns in publicly available comment letters.
The big financial firms have been coordinating well with each other on some issues and throwing each other under the bus on other issues. Due to the sheer range of issues being addressed in the Dodd-Frank rulemaking process, this was inevitable. Big foreign banks have different incentives than big US banks on some issues (e.g., extraterritoriality), but they’re aligned on other issues (e.g., clearinghouse ownership). To be honest, I’ve seen more coordination between the major banks than I expected, but I think that’s primarily because the trade associations (SIFMA, Financial Services Roundtable, ISDA, etc.) have been so eager to get paid and stay involved.
MK: Worst case scenario: We wake up in November 2012 to President Bachmann and a Republican controlled House and Senate. Alternatively, the GOP just takes the Senate. Will enough of the muscle of Dodd-Frank be put into place so that it holds, or will a lot of it be able to be compromised quickly under any future Republican administration?
EoC: That is scary. If that nightmare scenario came to pass, I suspect that some very important pieces of Dodd-Frank would stand a decent chance of getting repealed. Republicans would obviously go after the CFPB first. The other measures I’d expect them to target would be the regulation of “systemically important financial institutions,” the Volcker Rule, and the derivatives end-user exemption.
MK: During the financial reform debates, there was a group of people who thought Dodd-Frank wasn’t going far enough. In general, they were dubious about rule-writing and regulators, how well resolution authority could work in an international world during a crisis moment, loopholes for derivatives and thought that the size of the largest firms made those firms too dangerous, politically and otherwise. We’ve tended to be on opposite sides of this debate. For the “Dodd-Frank hasn’t gone far enough” group, what’s something that has happened that has proven them wrong, and something that has happened that has proven them right?
EoC: As you say, the “Dodd-Frank didn’t go far enough” crowd tends to think that one of the main reasons why the major banks should be broken up is that they have a dangerous amount of political power. I think that the big banks’ political power, especially after the crisis, is massively overrated by pundits, and I think the interchange vote proved this. The big banks spared absolutely no expense in trying to roll back the Durbin Amendment (i.e., the interchange rules). The big banks mounted an all-out, eight-month lobbying campaign against the Durbin Amendment, and they even had the powerful community banks on their side. But they still lost the vote. (Yes, the Fed compromised in its final rule by raising the swipe fee cap to 21 cents, but that isn’t what the banks wanted and wasn’t what their lobbying campaign was aimed at. They wanted the Durbin Amendment gone, and they were rebuffed.)
Now for something that’s proven my side wrong. I think it’s fair to say that my preferred regulatory regime relies fairly heavily on the regulators. The past year has, unfortunately, proven that you can’t always count on regulators having adequate funding to perform at the level envisioned by my side.
MK: Others have been worried about the relative power of the financial sector in our country. People worry about “financializaton” from the point of view of entrepreneurship, relative focus and power of economic sectors, a focus at the top instead of the bottom, short-term-ism, etc. A decade from now, how will Dodd-Frank have changed the political economy of the country? Is it way too early to tell, or is it just not relevant to how Dodd-Frank is working?
EoC: A decade from now, I think Dodd-Frank will have changed the political economy in the sense that it will make high finance less profitable and less attractive to talented employees — but the changes will be at the margin. One of the problems with lamenting the “financialization” of the US economy is that no one ever explains what they would consider a successful de-financialization. Finance is a global industry and US financial institutions provide significant financial services to foreign investors. It’s also fair to say that the US has a comparative advantage in financial services. So given that comparative advantage, and the global nature of the financial industry, where is the line between a healthy US financial industry and the unhealthy “financialization” of the US economy?
So coming back to Dodd-Frank, I think that it will inevitably reduce the financial industry’s share of the economy, simply because it will make the industry less profitable. But will it achieve the “de-financialization” of the US economy? That depends on how you define a successful de-financialization. I haven’t spent enough time looking at the numbers to have a fully articulated view on the appropriate size the US financial industry, so I’m afraid I’ll have to give a terribly unsatisfying answer: I don’t know.