The new financial regulation bill

NEW REGULATORY AUTHORITY: Gives federal regulators new authority to seize and break up large troubled financial firms without taxpayer bailouts in cases where the firm's collapse could destabilize the financial system. Sets up a liquidation procedure run by the FDIC. Treasury would supply funds to cover the
up-front costs of winding down the failed firm, but the government would have to put a "repayment plan" in place. Regulators would recoup any losses incurred from the wind-down afterwards by assessing fees on financial firms with more than $50 billion in assets.

OVERALL A GOOD PROVISION, ALTHOUGH THE ACTUAL INCIDENCE OF THESE FEES IS TRICKIER THAN THE DESCRIPTION INDICATES.

FINANCIAL STABILITY COUNCIL: Would establish a new, 10-member Financial Stability Oversight Council, comprising existing regulators charged with monitoring and addressing system-wide risks to the nation's financial stability. Among its duties, the council would recommend to the Fed stricter capital, leverage and other rules for large, complex financial firms that are judged to threaten the financial system. In extreme cases, it would have the power to break up financial firms.

I'M NOT ENTHUSIASTIC, THOUGH PERHAPS IT WILL JUST BE A WASH.  NONETHELESS IT REFLECTS A BAD AND DANGEROUS ATTITUDE ABOUT WHAT REGULATORS ARE CAPABLE OF.

VOLCKER RULE: Would curb propriety trading by the largest financial firms, though banks could make de minimus investments in hedge and private-equity funds. Those investments would be limited to 3% or less of a bank's Tier 1 capital. Banks would be prohibited from bailing out a fund in which they are invested.

IT'S HARD TO TELL WHAT ACTUAL RESTRICTIONS WILL BE IN PLACE AND MOST LIKELY THERE WILL BE MAJOR LOOPHOLES.  YOU DON'T HAVE TO HATE THIS PROPOSAL — RECALL THE POPULARITY OF "NARROW BANKING" PROPOSALS IN THE 1990S AS A KIND OF SECOND-BEST REFORM, CONSIDERED BY MANY MARKET-ORIENTED ECONOMISTS.  FURTHERMORE IF MARKETS ARE PRETTY LIQUID, KEEPING THE BANKS OUT OF THESE MARKETS MAY NOT HARM MUCH AT ALL.  STILL, I'LL PREDICT THIS DOESN'T DO ANY GOOD.

DERIVATIVES: Would for the first time extend comprehensive regulation to the over-the-counter derivatives market, including the trading of the products and the companies that sell them. Would require many routine derivatives to be traded on exchanges and routed through clearinghouses. Customized swaps could still be traded over-the-counter, but they would have to be reported to central repositories so regulators could get a broader picture of what's going on in the market. Would impose new capital, margin, reporting, record-keeping and business conduct rules on firms that deal in derivatives.

I WAS AN EARLY PROPONENT OF THIS IDEA MYSELF, BUT LATELY I'VE STARTED TO WORRY ABOUT HOW WELL CAPITALIZED THIS CLEARINGHOUSE WILL NEED TO BE.  I'LL STILL COUNT IT AS A NET PLUS, BUT I DON'T THINK WE'VE THOUGHT IT THROUGH VERY WELL.

SWAPS SPIN-OFF: Would require banks to spin off only their riskiest derivatives trading operations into affiliates, in a late-night compromise struck to scale back a controversial provision championed by Sen. Blanche Lincoln (D., Ark.). Banks would be able to retain operations for interest-rate swaps, foreign-exchange swaps, and gold and silver swaps among others. Firms would be required to push trading in agriculture, uncleared commodities, most metals, and energy swaps to their affiliates.

THE DEVIL IS IN THE DETAILS.  MAYBE THE AFFILIATES ARE NOT "TOO BIG TO FAIL" BUT WHAT REALLY MATTERS ARE THE COUNTERPARTIES ON THE OTHER SIDE OF THE TRANSACTION.  WE STILL BAILED OUT LTCM, REMEMBER THAT?

CONSUMER AGENCY: Would create a new Consumer Financial Protection Bureau within the Federal Reserve, with rulemaking and some enforcement power over banks and non-banks that offer consumer financial products or services such as credit cards, mortgages and other loans. The new watchdog would have authority to examine and enforce regulations for all mortgage-related businesses; banks and credit unions with assets of more than $10 billion in assets; pay day lenders, check cashers and certain other non-bank financial firms. Auto dealers won a hard-fought exemption from the Bureau's reach.

WE'LL SEE.

PRE-EMPTION: Would allow states to impose their own stricter consumer protection laws on national banks. National banks could seek exemption from state laws on a case-by-case, state-by-state basis if a state law "prevents or significantly interferes" with the bank's ability to do business – a higher bar than federal regulators currently must meet to pre-empt state rules. State attorneys-general would have power to enforce certain rules issued by the new consumer financial protection bureau.

THIS SHIFTS THE WORDING OF THE LAW, BUT DOES IT CHANGE THE POLITICAL EQUILIBRIUM?  AGAIN, "WE;LL SEE."

FEDERAL RESERVE OVERSIGHT: Would mandate a one-time audit of all of the Fed's emergency lending programs from the financial crisis. The Fed also would disclose, with a two-year lag, details of loans it makes to banks through its discount window as well as open market transactions – activity the Fed currently doesn't disclose. Would eliminate the role of bankers in picking presidents at the Fed's 12 regional banks. Would also limit the Fed's 13(3) emergency lending authority by barring the central bank from using it to aid an
individual firm, requiring the Treasury Secretary to approve any lending program and prohibiting the participation of insolvent firms.

A MISTAKE, BUT THIS COULD HAVE BEEN MUCH WORSE.

OVERSIGHT CHANGES: Would eliminate the Office of Thrift Supervision, but after a fight, the Fed retained oversight of thousands of community banks. Would empower the Fed to supervise the largest, most complex financial companies to ensure that the government understands the risks and complexities of firms that could pose a risk to the broader economy.

OVERALL I AM PRO-FED AND SO THIS PLANK COULD HAVE BEEN MUCH WORSE, FORTUNATELY WE HAVE NOT REALLOCATED FED POWERS IN A MAJOR WAY TO LESSER REGULATORS.

BANK CAPITAL STANDARDS: Would set new size- and risk-based capital standards, including a prohibition on large bank holding companies treating trust-preferred securities as Tier 1 capital, a key measure of a bank's strength. Would grandfather trust-preferred securities for banks with less than $15 billion in assets, enabling them to continue treating the securities as Tier 1 capital. Larger banks would have five years to phase-out trust-preferred securities as Tier 1 capital.

IT'S BASEL III WHICH WILL REALLY MATTER AND WE SHOULDN'T EXPECT MUCH FROM THAT FORUM.  WE'RE DROPPING THE BALL ON A MAJOR ISSUE.

BANK FEE: Would mandate the Oversight Council to impose a special assessment on the nation's largest financial firms to raise up to $19 billion to offset the cost of the bill. The fee would apply to financial institutions with more than $50 billion in assets and hedge funds with more than $10 billion in assets, with entities deemed high risk paying more than safer ones. The fee would be collected by the FDIC over five years, with the funds placed in separate fund in the Treasury and would not be usable for any other purpose for 25 years, after which any left-over funds would go to pay down the national debt.

THIS IS FOR PR, SO THE POLITICIANS CAN CLAIM TAXPAYERS WON'T BE ON THE HOOK AGAIN.  RIGHT.  ALSO, STUDY TAX INCIDENCE THEORY AND GET BACK TO ME.

DEPOSIT INSURANCE: Would permanently increase the level of federal deposit insurance for banks, thrifts and credit unions to $250,000, retroactive to January 1, 2008.

ALREADY DONE, SO TO SPEAK.

MORTGAGES: Would establish new national minimum underwriting standards for home mortgages. Lenders would be required for the first time to ensure that a borrower is able to repay a home loan by verifying the borrower's income, credit history and job status. Would ban payments to brokers for steering borrowers to high-priced loans. 

DEVIL IS IN THE DETAILS.

SECURITIZATION: Banks that package loans would, broadly, be required to keep 5% of the credit risk on their balance sheets. Would direct bank regulators to exempt from the rules a class of low-risk mortgages that meet certain minimum standards. Regulators could permit alternative risk-retention arrangements for
the commercial mortgage-backed securities market.

WASTE OF TIME.  YOU CAN JUST AS EASILY ARGUE THE PROBLEM WAS INSUFFICIENT SECURITIZATION.  AND HOW HAVE SIMILAR RULES WORKED OUT FOR THE SPANISH?

CREDIT RATING AGENCIES: Would revamp the credit-rating industry, establishing a new quasi-government entity designed to address conflicts of interest inherent in the credit-rating business after the SEC studies the matter. Would also allow investors to sue credit-rating firms for a "knowing or reckless" failure to conduct a reasonable investigation, a lower liability standard than the firms were lobbying to get. Would establish a new oversight office within the SEC with the ability to fine ratings agencies and empowers the SEC to
deregister a firm that gives too many bad ratings over time.

THE BEST EQUILIBRIUM IS TO HAVE DISCREDITED RATINGS AGENCIES, NOT REVAMPED AND REREGULATED AGENCIES.

INVESTMENT ADVICE: Would give the SEC the authority to raise standards for broker dealers who give investment advice after the agency studies the issue. Would permit, but not require, the SEC to hold broker dealers to a fiduciary duty similar to the standard to which investment advisers are held.

COULD EASILY END UP MEANING NOTHING.

CORPORATE GOVERNANCE: Would give shareholders of public corporations a non-binding vote on executive pay and "golden parachutes," and would give the SEC the authority to grant shareholders proxy access to nominate directors.

COULD EASILY END UP MEANING NOTHING.

HEDGE FUNDS: Would require hedge funds and private equity funds to register with the SEC as investment advisers and to provide information on trades to help regulators monitor systemic risk.

COULD EASILY END UP MEANING NOTHING.

INSURANCE: Would create a new Federal Insurance Office within the Treasury Department to monitor the insurance industry, recommending to the systemic risk council insurers that should be treated as systemically important. Would require the new office to report to Congress on ways to modernize insurance
regulation.

I AGREE WE SHOULD NOT TRUST STATE-LEVEL REGULATORS WITH FIRMS SUCH AS AIG, BUT LET'S HAVE MODEST EXPECTATIONS ABOUT WHAT THIS OFFICE WILL ACHIEVE.  IT PROBABLY WOULDN'T HAVE STOPPED THE AIG DEBACLE EITHER.

  -By Victoria McGrane, Dow Jones Newswires

THE BOTTOM LINE: THE GOOD PARTS OF THE BILL AREN'T NEARLY AS GOOD AS THEY SHOULD BE, AND THE BAD PARTS BECAME MUCH BETTER WITH TIME.  THE BIGGEST OMISSIONS ARE SIMPLE AND TOUGHER RESTRICTIONS ON LEVERAGE AND REFORM OF THE MORTGAGE AGENCIES.  OVERALL CONSIDER THIS A VICTORY FOR THE STATUS QUO AND YOU SHOULD REALIZE THAT THE UNDERLYING PROBLEMS HAVE NOT BEEN SOLVED.

Comments

Tyler, do you know anyone familiar with the history of finance and in particular with the history of financial regulation that has read all the 2,000 pages?

...has read all the 2,000 pages?

What does it matter whether a one page law or a 2000 page law is passed given the hundreds of thousands of pages of law, and the history of the nation and the world that forms the body of law. After all, the Iraq "war" resolution was about 1 page with preamble and front and back matter. Do you think that everyone read that one page and understood the implications of it, other than a few people like Sen Byrd, and Sen Kennedy? Maybe those protesters marching in the streets had read the one page and understood it better than those voting on it?

"The bill we’re getting may be a mere hodgepodge, and that is after the biggest financial crisis since the Great Depression."

It's a good effort and better than nothing, but, as you say, it's disconcerting that this is what we get after narrowly avoiding a Debt-Deflationary Spiral. It's hard for me not to conclude that we'll be back where we were prior to these reforms very soon, and congratulating ourselves that we won't make the same mistakes again, since we're so much wiser.

Lenders would be required for the first time to ensure that a borrower is able to repay a home loan by verifying the borrower's income, credit history and job status.

Actually, it would restore the requirement to verify income and assets; when Fannie Mae was fully government, verification was mandatory for mortgages to be sold to the government or insured by the government. And as the government Fannie Mae drove the mortgage business until the 70s when private mortgage insurance was tried again, and with State usury laws and prohibitions on predatory lending, who would finance mortgages without verification?

The problems with large numbers of fraudulent mortgages began with the lax verification in the 80s, and the widespread view it wasn't needed since 2000 because private mortgage and debt insurance was readily and cheaply available.

I remember trying to get auto loans, fee based charge cards, and mortgages in the 70s, and it was a hassle even though I had great cash flow - paying in cash and having lots of savings and having a good job, just didn't seem to satisfy the suspicion I might not repay the loan. It was humbling trying to convince bankers I was worthy.

Mulp, I'm glad to hear that you're sane and happy. Please read the 2,000 page bill and if you have any coment based on the history of finance and the history of financial regulation and share it with me and other financial experts.

The long-term issue is easy credit made up for a lot of wage stagnation. It'll be interesting to see how that plays out.

E.Barandiaran: If Arg beat Germany and Chile beat Brazil, Arg & Chile might play. Divided loyalties for you. I hope Chile wins. Of course it's all economic psychology. Germany is high on the austerity crusade that gives it new world stature. England is biting the floor of debt binging. Argentina is happy that last week it successfully *robbed* its creditors. But, sorry, with Argentina it's always pride before the fall!

I WAS AN EARLY PROPONENT OF THIS IDEA MYSELF, BUT LATELY I'VE STARTED TO WORRY ABOUT HOW WELL CAPITALIZED THIS CLEARINGHOUSE WILL NEED TO BE. I'LL STILL COUNT IT AS A NET PLUS, BUT I DON'T THINK WE'VE THOUGHT IT THROUGH VERY WELL.

Who's this "WE" Kemosabe? Maybe I'm totally off base, Tyler, but I really don't think the actual writing of this legislation took into account the thoughtful reflections of you and Arnold Kling.

Michael, don't worry. I know what soccer is about so my loyalty is always with Argentina. On economics, don't worry about Argentina's creditors because they earned good money despite what has happened in the past 8 years. And of course the fact that the old debt has now been "paid" doesn't mean that the government will not do it again --actually, they are trying hard to do it but export prices are still high so the tax revenue from exports is also high. The Kirchners will have to spend a lot of money to win the 2011 presidential election.

I wonder how many pages of the bill are the result of carve outs for the Tea Party's big victory, Scott Brown, who is demanding the regulatory pork for Mass banks and hedge funds?

How about a return to the financial regulation of the 60s? A return to Regulation Q which defined each type of the financial transaction and the limit on interest rates. I remember how the complaint was the too low interest rate on savings, an outrageously low 4% for banks and 4.5% for S&Ls, and SEC regulation combined with bank regulation that even the most restrictive money market funds of today as illegal banking.

Unless a GI or some other special group, buying a house was easy: 20% down and mortgage and taxes below 35% of your past 3-5 years income.

The rules from the 30s were chipped away at in the late 60s, more rapidly in the 70s, and then the jack hammer was taken to them in the 80s onward, with the first crisis occurring in the mid-80s and festering until Bush supported bailing out the banks circa 1990.

And by the way, if there was one bill that most contributed to the current crisis, it was the 2000 page bill that was crafted by the Republicans in mid December 2000 in conference and then voted on a day later without anyone having time to read the bill, which was totally different than what either house passed, and then voted on so Congress could adjourn for the holidays. That bill was driven by conservatives, to serve conservative's business supporters, so for conservatives to object to this bill based on its length, just look at the deals that Scott Brown, the Tea Party win, so see the integrity and consistency between what conservatives say and what they do.

Thanks for such a great post and the review, I am totally impressed! Keep stuff like this coming.
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