« Defense Spending and Deficit Reduction | Main | Why are the Fed's Options Still under Review? »

Wednesday, July 21, 2010

Master's Forum on the Dodd-Frank Financial Reform Bill

This is mostly to let those of you who might be interested know about the Conglomerate Blog's Master's Forum on the Dodd-Fran financial reform bill. Here are a few examples taken from recent posts in the long series of posts on this topic. (These are lawyers, so much of it is from a legal perspective. Also, I don't necessarily agree with everything that is said in the examples below or in the discussions more generally):

Dodd-Frank Forum: I Give It a B, by Brett McDonnell: Erik asks us how we would grade the Act as a whole, and whether we would have voted for it. I seem to be more of a supporter than most posters here: I would certainly have voted in favor, and I give it a solid B. Unlike Renee, I think there is a big picture story which helps identify the core provisions. After decades of deregulation, our financial system has become unstable as players loaded up on leverage and untested innovations, leaving the system vulnerable to episodes of panics and deleveraging which can bring down the entire economy. There are two complementary stories of leverage and systemic risk. The too big to fail story focuses on financial giants whose failure would rapidly spread to dozens of other connected firms. The shadow banking story focuses on the ways that markets like repo, commercial paper, and money market funds resemble banks, with short-term debts financing long-term assets, and hence become subject to runs. A major side story is the housing market, where the main bubble that led to the panic occurred. There, securitization and abusive credit products helped create the dubious debts which eventually ignited the system.

The core provisions for addressing system instability are Titles I and II. We addressed the banking system in the 30s with 3 main elements: deposit insurance, FDIC resolution authority, and increased banking supervision. There's no explicit insurance in Dodd-Frank, but the bailouts suggest that the federal government stands ready to prop up a failing financial system. Title II replicates something close to FDIC resolution authority for a broader range of financial institutions. One element of Title II that I really like is its push to punish the officers of failed companies, through firing and restitution. That may go a decent way to mitigate the moral hazard caused by the bailouts. Title I extends supervision, including regulation of leverage, to a broader range of companies. It should at least cover the too-big-to-fail companies. It doesn't break them up, but it does direct regulators to impose heavier burdens on those companies, and gives them the power to break them up if they believe doing so is needed for financial stability. ... Title IV (hedge fund advisers) should at least give regulators more information about what is happening in many companies within the shadow banking system. Title VII address another important source of financial instability, swaps with their counterparty risks that create doubts throughout the system. The creation of derivative clearinghouses is likely a good idea, although it creates its own risks, and as always the devil is in the details.

Dodd-Frank also addresses the problems in the housing market. Title X creates the Bureau of Consumer Financial Protection. ...

Those core provisions strike me as serious attempts to address the main problems that the crisis has revealed. There was even more moaning about the banking and securities acts of the 30s, but they created a regulatory framework that helped bring the longest period of financial stability in American history. ... We have a vast, unstable financial system which no one really understands in anything like the depth required to adequately regulate it, and yet unregulated it is likely to drive us into a Second Great Depression one of these days (and there's no good reason to think that the First Great Depression is as bad as it can get). There are no good alternatives available. Given all that, I think Dodd-Frank is quite a reasonable stab at an impossible task. ...

By contrast:

Dodd-Frank Forum: “I’ll Have the Meatless Entrée, Please”, by Kim Krawiec: The administration and lawmakers are busy congratulating themselves on the “historic” Dodd-Frank legislation, the “toughest financial reform” since the Great Depression. Sure . . . if historic is synonymous with long, costly, needlessly complex, and likely to have little impact on systemic risk, moral hazard, or the financial market opacity that exacerbated the financial crisis.

Not all of the bill’s provisions are bad, of course, and some may even be good (though much will depend on implementation). And there is little doubt that the legislation will significantly change the regulatory landscape and business operations of every financial institution and many commercial companies doing business in this country.

But I join the chorus of those who believe that the bill largely fails to address the root causes of the financial crisis and the financial system weaknesses exposed by it; grants discretionary authority to regulators to perform acts already within their existing powers, such as identifying systemic risks (which they did not use before the last crisis, and are not likely to use before the next one); punts the bulk of meaningful issues to regulators; and fails to address at all items that should have been at the top of Congress’ reform list (such as the credit rating agencies and Fannie and Freddie). ...

Here's another example:

Dodd-Frank: Only You Can Prevent Ponzi Schemes, by Christine Hurt: So, in the interview portion of our financial reform pageant, Erik asked me as a follow up to my Dodd-Frank & Madoff post:
Christine: What grade would you give to the Dodd-Frank provisions designed to make sure the SEC doesn’t drop the ball with future Madoffs? ...

I hate to say this, but I think Ponzi schemes are inevitable..., con artists will always be there to offer you unbelievable returns. Regulating against human nature is impossible. We have murder laws, but we'll always have murder. So, the question is can any regulation help the SEC spot the Ponzi scheme before people lose money.

First, Ponzi schemes aren't really illegal until someone doesn't get their money back. Perhaps the schemes (like Madoff's) where he claims to make an investment and then doesn't do anything at all could be prosecuted prior to its collapse, but it would be hard to do. Or, if someone holds himself out as something he isn't -- broker, investment adviser, etc. or offer an unregistered security. Sometimes the SEC finds an ongoing scheme and in investigating, gets the target to obstruct justice or make a false statement, but usually someone has to lose money and complain about it first. So, pretty much someone has to lose money before we can step in and prosecute. So, it's hard to write any new SEC procedures that will prevent at least some loss. ...

Madoff was ... able to continue for a long time because he was an insider and human nature made the SEC investigators not suspect him. Most garden variety Ponzi schemes are by industry outsiders, and the SEC is very good about prosecuting those low-hanging fruits. Will regulation make SEC individuals rise above human nature? No, but now experience will educate investigators to look out for insiders as well as outsiders. ...

Ponzi schemes will always pop up as long as their are people who want to make high returns in a quick period of time. Human nature makes the victims look past red flags, particularly with affinity fraud. Regulation can't really do much about that.

One more:

Dodd-Frank Forum: Who Benefits from the New Resolution Authority?, by Michelle Harner: Like many, I am skeptical that the Dodd-Frank Act accomplishes much of anything. It does provide nice photo ops and plenty of ammunition (on both sides of the political spectrum) for the mid-term elections. It also reminds us of the lobbyists' ability to influence legislation (see, e.g., Gordon’s post here and reference to auto dealer exemption here). But does it fix all, or even some, of what contributed to the financial crisis?

Given the number of contributing factors and the breadth of the legislation, I am just going to say a few words about one piece of this puzzle—the resolution authority granted the federal government under the Act. ...

As a last example:

Dodd-Frank Forum: What Ever Happened to Criminal Sanctions?, by Lisa Fairfax: I ask the question not because I believe they are warranted, but rather because we have been discussing comparisons between this new Act and Sarbanes-Oxley and those comparisons got me thinking about one striking difference between the two acts in terms of the emphasis on criminal sanctions. With Sarbanes-Oxley, there was a lot of discussion about the need for personal accountability, which ultimately translated into a push for increased liability for corporate executives, and hence provisions imposing enhanced criminal penalties related to various frauds, including sanctions for executives' false certification of financial reports. This time, such a push has not been a central focus of reform efforts. In fact, even though this new Act uses the term "accountability," it does not even have the same connotation as it did under Sarbanes-Oxley. Which raises the question, why not? Here are some possibilities. ...

    Posted by on Wednesday, July 21, 2010 at 12:34 PM in Economics, Financial System, Regulation | Permalink  Comments (9)


    Feed You can follow this conversation by subscribing to the comment feed for this post.