First Impressions: A Legislative Dud from Dodd
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On Monday, Senate Banking Committee Chairman Christopher Dodd released a 1,136 page financial regulatory overhaul proposal. At a press conference to unveil the “discussion draft,” Chairman Dodd said that this was “not a time for timidity.” Yet Dodd’s proposal amounts to a reshuffling of the deck chairs, and skips over some of the most critical issues related to the stability of the U.S. financial system.
The bill is similar to the proposals put forward by the Treasury Department and the legislation that has been passed out of the House Financial Services Committee. However, it contains a number of important differences. First, it consolidates bank regulators into a single “Financial Institutions Regulatory Administration” (FIRA). Importantly, this move would strip the Federal Reserve Board of its supervisory responsibilities for bank holding companies, prevent the Fed from making emergency loans to financial firms, and eliminate the thrift charter. Second, the bill establishes an “Agency for Financial Stability” with an independent chairperson and members that include the heads the Fed, Treasury Department, SEC, FDIC, CFTC, FIRA, and the newly-created Consumer Financial Protection Agency (CFPA). This Agency would assume the “super regulator” role that many had envisioned for the Fed. Third, the bill proposes to create the CPFA, which would be managed by a five-member board, and any proposal would need to win majority support for approval. This is an effort to assuage bank concerns that the CPFA as proposed by the Administration would vest the CPFA Director with too much authority.
As with previous efforts, the bill has some rather glaring weaknesses. First, the bill deals with the credit rating agencies by expanding their legal liability. Section 932 of the bill provides for civil rights of action against credit rating agencies that “knowingly and recklessly” failed to conduct due diligence. While the reform of the credit rating agencies is a complex policy issue with many moving parts, this proposal is misguided. Charles Calomiris recently discussed this issue regarding a similar proposal by Rep. Paul Kanjorski and concluded the following:
First, in some instances the proposal strangely would provide for “joint liability” of ratings agencies, meaning that each could be held liable for actions by another. Second, it creates no objective standard for Nationally Recognized Statistical Ratings Organization (NRSRO) performance on which to base potential legal liability. Third, because it relies on legal liability, it would entail a wasteful litigation process that would create huge new legal risks for rating agencies, rather than the straightforward penalty function that I propose for all rating agencies that choose to provide ratings as NRSROs.
Second, the bill makes much of its efforts to consolidate regulators at the federal level, but takes large steps in the direction of fragmenting the actual regulations governing banks. Subtitle D of Title X ensures that federal consumer protection law does not preempt more onerous state law. Instead of operating under a single system, financial firms will be operating under a single minimum standard with each state free to write its own rules. This will create a regulatory burden for firms, as they try to comply with a patchwork of state regulations.
The bill fails to address the future of Fannie Mae and Freddie Mac. While reasonable people differ on the extent to which the actions of Fannie and Freddie caused the financial crisis, leaving out Fannie and Freddie from a “discussion draft” about financial regulatory reform is akin to having a discussion of global imbalances with no mention of China, or the Little Rascals with no mention of Spanky.
Finally, the bill authorizes the Secretary of the Treasury to seize a systemically significant financial institution near default, yet fails to spell out what this means to creditors and counterparties. As long as the “resolution authority,” as it’s called, is a black box with no specific language to require least-cost resolutions, imposing market discipline on large financial firms will be a herculean challenge. This looks like a system to make bailouts more efficient, with the costs borne by surviving firms, through special assessments. For large creditors to integrated financial holding companies, the message is crystal clear: they are still very likely to get bailed out. In aftermath of a bailout tsunami, the objective of a bill that purports to overhaul the financial system can't just be efficiency. The Financial Times summarized the situation well today: “chewing over the structure, rather than the content, of proper regulation is a step backwards in a process where the sheer volume of material, let alone the intricacies of policy, has become baffling. The regulatory response to the crisis is lagging horribly behind the recovery – whatever your accent.”