The Dodd Bill: Generally Very Good

I like a very great deal of Chris Dodd’s proposed regulatory reforms, and overall the Dodd bill is, I think, a significant improvement on Treasury’s proposals. A good place to start is the discussion draft, but there’s a great deal going on here (the full bill is 1,136 pages), so expect lots more details to emerge in the coming days and weeks. In general I’m a fan of it, although I have reservations about the new Agency for Financial Stability, and the reduced powers at the Fed.

The heart of the Dodd bill involves setting up three new agencies: the Financial Institutions Regulatory Administration, the Agency for Financial Stability, and the Consumer Financial Protection Agency. The last — the CFPA — is if anything a beefed-up version of the agency envisaged in Treasury’s proposal, and it’s a very good idea. But the first two are new.

The Agency for Financial Stability is the agency charged with monitoring systemic risk — a job which under Treasury’s proposal would be given to the Federal Reserve. On this I think I have sympathy with Treasury: the Fed in general, and the New York Fed in particular, is better placed to monitor these risks than a brand-new agency with no direct ability to supervise banks or to break them up. A giveaway appears on page 3 of the discussion draft:

The Agency for Financial Stability will identify systemically important clearing, payments, and settlements systems to be regulated by the Federal Reserve.

Clearly, the Fed is going to play a necessary role here, and it’s not exactly rocket science to identify key clearing and settlement systems. So why take that job from the Fed and give it to powerless technocrats in Washington? Similarly, on page 5, the discussion draft says that

The Federal Reserve will continue to play a key role in assessing financial stability and have guaranteed access to financial institutions and any needed information.

That does seem to me to be somewhat duplicative in terms of what the Agency for Financial Stability is meant to be doing.

The Dodd bill is also big on trendy concepts like contingent capital and living wills, none of which have ever been shown to work in practice. It’s so sure, in fact, that it can mandate a way in which the FDIC can “unwind failing systemically significant financial companies through receivership” that at the same time it places an outright ban on the Fed stepping in to bail out a failing institution.

I fear this is dangerous. Yes, it would be great if all of this worked as planned. But that never happens, in the heat of a crisis, and I’m not a huge fan of cutting off the optionality we currently have at the Fed. By all means put in place the contingent capital and the living wills and the FDIC as the first best option for resolving a bank in crisis. But there’s no harm in keeping the Fed as a backstop if none of that works.

The Financial Institutions Regulatory Administration, on the other hand — the new single bank regulator — is a great idea. As the discussion draft says, it

combines the functions of the Office of the Comptroller of the Currency and the Office of Thrift Savings, the state bank supervisory functions of the Federal Deposit Insurance Corporation and the Federal Reserve, and the bank holding company supervision authority from the Federal Reserve.

About time too. For political reasons, the state banking system, governing community banks, will remain in place; I also note that the discussion draft says nothing about the NCUA, and I wonder whether that too is somehow politically impossible to fold into the new agency.

The Dodd bill is great on derivatives regulation, giving the SEC and CFTC broad powers to force markets onto exchanges where they can pose less systemic risk. Any trades not taking place on an exchange will be penalized with margin and capital requirements: a very good idea.

I also like the way that the Dodd bill forces hedge funds with more than $100 million in assets — the potentially dangerous ones — to register with the SEC. Investment advisers looking after less than that will be left to state supervision, which is also a good idea, in terms of not stretching the SEC too far.

There will also, finally, be an Office of National Insurance, within Treasury. About time too!

The Dodd bill is good on regulating credit rating agencies, and also on executive compensation, although I worry a bit about the way that companies will be asked to compare executive pay to stock performance. Executives have control over how their companies perform internally, not over how much outside investors are willing to pay for their stock. But that’s a niggle: over a five-year time period, you’d expect a company which had shown significant improvements internally to also have done well in the stock market.

I’m a big fan, too, of eliminating different standards for broker‐dealers and investment advisers, and holding any broker who gives investment advice to the same fiduciary standard as investment advisers. Makes perfect sense to me.

Banks who securitize loans are going to be forced “to retain at least 10% of the credit risk”; I haven’t looked at the full bill to see what exactly that means, but it’s good in principle. And there will also be lots more regulation of the municipal-bond market, which is long overdue.

The worry, of course, is that if the Senate ends up passing anything like this, it’s going to be very hard to reconcile with something more along Treasury’s lines coming out of the House. But even the vague possibility that Treasury’s plans will end up being strengthened rather than weakened has to be heartening.

Comments

[Robert Mart...:]

Felix,

This bill does a good job on regulating large hedge funds, holding brokers to a fiduciary standard, and regulating derivatives (by penalizing trades placed off of an exchange).

Unfortunately the biggest risk remains unchecked: Bailouts. With the exception of Lehman, large firms learned during the financial crisis that the government will bail them out. Bailouts create a culture of excessive risk taking, and the costs are eventually borne by the taxpayer.
Rob

Nov 10 04:20 PM

[reveigel@ms...:]

The heart of the bill, 3 new agencies. That is where I stopped. We do not need more government agencies, more government control and more expense. It is a bad bill, period.

Nov 10 06:57 PM

[Curious Bys...:]

Indeed, had the agencies we had not been corrupt and obtuse in the first place, this mess could've been avoided. Much like the Patriot Act, this is government nonsense just to look like they are actually doing something other than sitting on their thumbs like they were when this was being created. No more government...

Nov 10 07:56 PM

[THofler:]

I had to laugh about the "not stretching the SEC too far" part. This is the organization that couldn't be bothered to check with the DTC to see if Bernie Madoff had actually made any of his claimed trades. And this after numerous accusations of fraud had already been made.

Nov 10 10:28 PM

[Steve in Gr...:]

I think we need one Federal regulatory agency for each U.S. citizen. God knows what we might be up to. We should be watched closely.

On Nov 10 06:57 PM [e-mail] wrote: "The heart of the bill, 3 new agencies. That is where I stopped...."

Nov 10 10:29 PM

[KJP712:]

Looks like political grandstanding by Dodd before an election year.Where were these reforms a few years ago when they were needed? Creating more Federal agencies is not the way to go and looks like a tired attempt at creating activity during a tight Senate campaign.Maybe the footsteps of Peter Schiff are starting to get louder as the sprint to the election finish line draws closer.This has all the makings of a very interesting Senate election battle.

Nov 11 12:16 AM

[John Bowman:]

Sounds like a "planned" economy to me.....just like the one halfway 'round the world which is so successful and most of it's citizens are in a drunken stupor sipping vodka all day long trying to forget their misery.

Next on the agenda: five year plans.

Nov 11 12:33 AM

[JudeJin:]

regulations written by the bureacrats won't work! the best regulation is to let the bad firms fail!

we only need one regulation: the market principles.

anything else is just more interventions to protect the existing establishments.

the worst is yet to come!

Shame On America!

Nov 11 01:45 AM

[paxjds:]

The FED cannot or should not regulate or oversee the banks in any way. The FED is really part of the Banks, they are bankers. You don't put criminals in charge of their probation or law enforcement to arrest themselves. It is madness that Dodd or Congress would want to give the FED more powers. The Fed needs to be abolished.
Between the FED, Wall Street, Bankers, and Congress, look at the mess we are in. We need an Attorney General to arrest all of them, prosecute and convict them, and throw them all in prison for ten years. Oh yes, The Attorney General needs to be jailed also for dereliction to duty.
Throwing trillions of dollars at these crooks to try to bail out the mess is madness. Only a pathological narcissist would think of such a scheme. Hitler, Stalin, and there cronies live on through their minions in the above mentioned crooked power bases. God help the world, as there is no longer a USA under God to come to the rescue anymore.

Nov 11 03:42 AM

[leonb105:]

They may think it's vodka, but it is really "Victory Gin" . . .


On Nov 11 12:33 AM John Bowman wrote:

> Sounds like a "planned" economy to me.....just like the one halfway
> 'round the world which is so successful and most of it's citizens
> are in a drunken stupor sipping vodka all day long trying to forget
> their misery.
>
> Next on the agenda: five year plans.

Nov 11 09:46 AM

[bobbybutte:]

Congress needs to reform THEMSELVES with members holding 10,000 of cash in their freezer and repealing glass steagel

when dodd shows his loan documents and is investigated then maybe we can take what he says serious

Nov 11 09:52 AM

[jarco:]

Think about it. The answer is: Chris Dodd and Barney Frank.

And the question is: " "Name two politicians who know the least about financial systems".

Three "new" agencies? What's wrong with one reconstituted agency? At least they'll share the same computer data bases. Now we'll have three who don't talk to one another at 4 times the administrative (read that civil servants or as we say in the beltway - retired in place) head count.

Nov 11 10:21 AM