Financial reform in America

Almost there

Chris Dodd’s bill is the closest yet to a workable bank reform

THE process has not been pretty, but Barack Obama is drawing closer to getting the overhaul of the financial system that he has been seeking. On Monday March 15th Chris Dodd, chairman of the United States Senate’s Banking Committee, launched a proposed bill that would grant regulators new powers to impose an orderly shut-down of failing firms and to sniff out and squelch the risks that brought on the financial crisis.

The proposal is Mr Dodd’s second, and hews more closely than the first to what Mr Obama’s Treasury Department had originally wanted and to the bill that the House of Representatives has already passed. In particular, the Federal Reserve will keep a role in regulating banks. Just as important, Mr Dodd’s proposal holds out the hope of winning enough Republican votes to become law.

The causes of the financial crisis are countless, and Mr Dodd’s 1,336-page bill seems to aim something at all of them, from credit-rating agencies’ fantastical AAA-ratings to derivatives. Its fate, though, rests on two controversial provisions, one dealing with big, risky firms, and another with consumer products.

In the first, Mr Dodd would create a Financial Stability Oversight Council, composed of regulatory chiefs, that can designate any big firm as systemically important enough to be regulated by the Fed. If such a firm got into trouble, the Fed, the Federal Deposit Insurance Corporation and the Treasury, with the approval of three bankruptcy judges, could impose an “orderly liquidation” on it.

Such a resolution mechanism has long existed for banks but not for other big financial companies or for bank holding companies like Citigroup, the parent of Citibank. This, in theory, would spare officials the dreadful choices they had to make in 2008 between whom taxpayers would bail out (Bear Stearns, American International Group) and who would fail (Lehman Brothers, Washington Mutual).

An unpleasant process

Conservatives and Republicans, with good cause, fret that any firm designated as systemically important will be assumed “too big to fail” and thus able to borrow more cheaply than its competitors, eventually becoming so big and risky that collapse is inevitable. In response Mr Dodd made the resolution process far more unpleasant than either the House or Treasury proposed, tantamount to being liquidated in the bankruptcy court.

Unfortunately, this glosses over crises’ ugly realities. Politicians don’t let big financial companies fail for two reasons. One is connectivity: if one firm fails it could bring down others exposed to it. The other is contagion: if investors lose their shirts on one firm, they will flee any others that look like it, precipitating their collapse. In a severe financial crisis the new process “will be too terrifying for politicians and bureaucrats to use”, predicts Douglas Elliott of the Brookings Institution. Instead, they will fall back on the ad hoc measures they used in 2008.

Mr Dodd also proposes a Consumer Financial Protection Bureau that could write and enforce rules for a broad range of financial products, from car loans to ATM fees. For banks, that job is now done by bank regulators. For non-banks, from payday lenders to mortgage brokers, it is in theory done by state and federal consumer agencies, but in practice usually by nobody. Democrats believe that bank regulators put bank stability ahead of consumer protection and have made an independent agency their central goal. Banks and Republicans just as adamantly believe the agency would become a self-justifying bureaucratic force, killing off legitimate products and so circumscribing banks as to undermine their health.

Mr Dodd’s compromise is to place the agency inside the Federal Reserve, though its director would be a presidential appointee. The bureau would have to consult with bank regulators, who could appeal against its decisions to the new oversight council.

Like the Treasury and the House, Mr Dodd leaves largely intact America’s ridiculous cluster of overlapping regulators: the four main bank regulators become three. The Fed will lose some authority over smaller banks while retaining it over large bank holding companies. It also includes politically motivated loopholes: banks with less than $10 billion in assets will be spared the attention of the Consumer Financial Protection Bureau, though they are hardly paragons of virtue. They have, for example some of the highest overdraft fees, says Michael Calhoun, president of the Centre for Responsible Lending, a consumer-advocacy group.

Despite such flaws, Mr Dodd’s bill deals with the most important weaknesses exposed by the crisis. Can it become law? Despite his compromises Mr Dodd failed to get any Republicans to support the bill, though Bob Corker of Tennessee and Judd Gregg of New Hampshire might be enticed to vote for it with a few modest concessions. Richard Shelby, the senior Republican on the banking panel, groused that his party has been given only a week to form an opinion on a 1,336-page bill. Even if enough Republicans vote for it to meet the 60-vote filibuster-proof margin, they may withhold support when the bill is then amended to eliminate differences with the House version, notes Taylor Griffin, a political consultant.

Mr Dodd, who retires at the end of the current Congress, has staked his legacy on financial reform. If he fails, it won’t be for want of trying.