Now that we know that the president will not be someone who pledged openly to repeal Dodd-Frank, it's time to look forward to the agenda for the next four years. One thing is certain: The job of reforming Wall Street is far from finished. The most profitable investments for the big banks continue to be Washington lobbyists chipping away at reform and litigators challenging every major rule in court.
I see three topics on the agenda: Unfinished Business; Defending Won Territory; and New Initiatives. A few of the major agenda items for each are described below.
The single most important holdover from the Dodd-Frank implementation process is completion of the Volcker Rule regulations. Unlike other financial reform that curbs activities, the Volcker Rule prohibits federally insured banks from engaging in specific business lines: proprietary trading and investment in hedge funds and private-equity funds. It should have been completed in July, but the war of words and influence over the all-important exceptions from the general prohibitions dragged on until the election intervened. The final scope of these exceptions, a complex subject to say the least, will determine the nature of banking by "too big to fail" institutions in the years to come.
The other major bank prudency initiative, bank capital and leverage requirements, is also to be completed by the regulators. As with the Volcker Rule, the proposed regulations include some excellent provisions and some that cause progressives to shake their heads in disbelief. Final rules, in both areas, will complement one another. Whether this will lead to a prudent banking system is yet to be seen.
The CFTC must complete work on the rules governing the transparency of derivatives trading. Perhaps anticipating the election, a draft final rule was just circulated that works fairly well, all things considered. Adoption would fill in a major gap in the regulatory regime for derivatives.
Defending Won Territory
Industry groups have attacked adopted regulations in court. They have relied most heavily on the cost/benefit analyses required of the regulatory agencies. Several things need to be done to secure the regulations that have been wrenched out of the system at the cost of much blood, sweat, and tears. First, the three vacancies on the D.C. Circuit Court must be filled by the administration. It is now top-heavy with Republican appointees, and the opinions so far on regulatory reform should make conservative opponents of judicial activism blush with shame.
In a related matter, pending legislation transferring cost/benefit analyses to a centralized administration department, the Office of Information and Regulatory Affairs, must be defeated. Though it sounds benign, it is a sheep in wolf’s clothing. OIRA’s mission is quantitative analysis, and many of the costs and benefits are not readily quantifiable. The legislation is a clever ruse to create a quagmire for regulatory initiatives.
The Commodity Futures Trading Commission’s jurisdiction and responsibilities exploded with the passage of Dodd-Frank. The markets the CFTC regulates are enormous, and it must oversee complex and massive derivatives operations of registered dealers. Yet its budget has been frozen as the Republicans have insisted on cutting it. The agency has asked for only $100 million more to cover its massively expanded workload. Something must give if the CFTC is going to get its work done.
But as important is the leadership at the CFTC and the Securities and Exchange Commission. Mary Shapiro may well depart as SEC chair, notwithstanding her protestations to the contrary. And Gary Gensler is serving as CFTC chair as a holdover appointment. Gensler is a key figure. The high quality of his work can be measured by the animosity directed at him by opponents of financial reform. He must retain a major role in financial regulation through reappointment or appointment to an even more significant position. Senate approval will be a bloody fight, but it will also be a showcase for the positive aspects of financial reform. He is a knowledgeable and effective leader. The administration should see support of him as an opportunity to flush out the venality of right-wing obstruction to regulation of the banks.
Finally, cross-border regulation is a work in progress. Guidance will soon be provided, but much needs to be done to assure that the U.S. financial system cannot be damaged by activities abroad as the banks shop for venues with the weakest regulations.
Financial regulation needs to move on from Dodd-Frank implementation. It was a minor miracle that the law was adopted. But it covered only the barest minimum of problems in the financial sector. The industry still suffers from massive and costly distortions that evolved over three decades of deregulation. These pose a clear and present danger of repeated crises, but they also drain productivity from the economy. In effect, the financial system exacts a huge tax that transfers wealth from the middle class to the financiers.
The major areas that must be addressed are:
- High-frequency trading, the use of super computers and advanced algorithms, often to manipulate the markets;
- Money-market mutual funds, the enormous pools of money susceptible to depositor runs in a time of stress (which actually occurred in 2008, requiring a Fed bailout); and
- Data systems to enable the regulators to monitor activity around the world so that they can adapt to the rapidly changing markets.
This is part one in a series called New Rules for Wall Street. This week, we'll make the case for what should be on the financial-reform agenda in the next four years.