There are many valid reasons to be angry with bankers, and supporters of Senator Chris Dodd’s (D–CT) latest rewrite of his financial regulatory bill, the Restoring American Financial Stability Act, have mentioned them all. Americans have heard all about greedy bankers, huge bonuses, shady accounting practices, and outright greed. But the reason for this rhetoric is nothing less than an attempt to seize control of the financial services industry and to micromanage it.
Unfortunately, if this ploy succeeds, the result would be an all-powerful bureaucracy that would do little to address the real problems in the industry and actually make future crises—and bailouts—more likely. The first step has already been taken after the Senate Banking Committee amended the 1,336-page original text with a 114-page manager’s amendment and sent the bill to the full Senate after a 22-minute markup on March 22.
The Consumer Financial Protection Bureau
According to the media, the most controversial issue is Dodd’s decision to create a Consumer Financial Protection Bureau (CFPB) within the Federal Reserve rather than creating a new independent agency. The new CFPB would have its own staff, autonomous rule-making authority, and the ability to examine financial institutions with more than $10 billion in assets.
It makes little difference where the agency is housed if, as Dodd proposes, it is effectively a completely independent agency that can ignore questions about whether its proposals could destabilize the industry. The bill approved by the Senate Banking Committee enhances those concerns, because although safety-and-soundness regulators would be able to appeal draft CFPB regulations that could endanger the stability of the financial system, they would not have the ability to veto them in advance.
A Permanent TARP for Failing Financial Institutions
The Senate Banking bill proposes to create a new $50 billion fund to be used in “emergencies” to close or restructure failing financial institutions or those perceived as being in danger of default. This fund is certain to be used for bailing out any politically significant financial institution and is nothing less than a permanent TARP program.
If the Treasury, Federal Reserve, and FDIC agree, failing financial institutions would be turned over to the FDIC for resolution. Three bankruptcy judges must also agree, but this appears to be more window-dressing than any substantive requirement, since the closing or restructuring would be handled by the FDIC and not through bankruptcy courts.
Despite rhetoric about using bankruptcy for most failures, the draft makes it clear that this is to be handled through a bureaucracy subject to political pressures, since the bill also does not include language adapting the bankruptcy process to the special needs of complex international financial institutions.
A far better approach would be to create a special section of the bankruptcy code and use it to handle the failures of all major financial institutions. In addition, the FDIC has neither experience with complex international financial failures nor the expertise to handle the failure of these financial institutions.
An Extremely Powerful Financial Stability Oversight Council (FSOC)
Dodd’s bill would create a new nine-member council of regulators designed to identify and protect the overall financial system against the kinds of threats that appeared in 2008. The bill would allow this new entity to “draft” any financial institution that it deems a risk to the overall financial system into regulation by the Federal Reserve and then enable the Fed to order that financial institution or any other to break itself up, stop selling certain products, or even go out of business.
The FSOC would “recommend” to the Fed that it increase rules dealing with capital standards, liquidity, leverage, risk management, and a host of other areas. It could also require major financial services firms to have a pre-existing plan for closing the firm in the event that it runs into trouble. Unfortunately, these extensive new powers would not in themselves make the system safer, and the uncertainty about how they would be applied may actually destabilize the financial system. Instead of open-ended regulatory powers, Congress should use higher capital and liquidity standards to strengthen the financial services system.
Even More Power for the Federal Reserve
Ironically—since the debate started with a stated desire to trim back the regulatory powers of the Federal Reserve—the Senate Banking bill ends up giving it even greater powers over major financial services firms than it has now (even though it does strip the Fed of its jurisdiction over small banks). Although the new council of regulators is given the power to recommend and approve Fed actions, the actual power to design and implement such actions goes to the Federal Reserve.