That plan became tougher last January through two additional provisions. Mr. Obama, adopting an increasingly populist stance against banks and bankers, proposed to tax banks through a “Financial Crisis Responsibility Fee” to reduce their risk-taking, recoup taxpayer funds from the costly and unpopular bailouts and finance the cost of future bailouts. The second provision, in two parts, was aimed at closing the loopholes that had enabled banks to trade risky financial derivatives, such as credit default swaps, which had landed them in deep trouble, by limiting the scope and scale of banks.
In the first part, banks, if they were to collect government-insured deposits and access the Federal Reserve’s discount window, would no longer be permitted to own, invest or sponsor hedge funds, private-equity funds or engage in proprietary trading for their own accounts. Labeled the Volcker Rule, after a former Fed chairman and the head of Mr. Obama’s Economic Recovery Advisory Board, this would only partially revive the Glass-Steagall Act of 1933, repealed in 1999. This law had been enacted after the Great Depression, as part of the New Deal, against universal banking by separating commercial and investment banking. In the second part, to prevent further consolidation of the financial system and to fight the too-big-too-fail syndrome, banks would be subjected, besides the existing caps on their deposits to no more than 10 percent of the national deposits, to limits on non-deposit funding such as short-term borrowing in financial markets. This would stop the growth but not shrink the existing sizes of banks. Both parts of the second provision, as well as the first provision, took big banks by surprise, which lobbied fervently as part of their concerted efforts to soften the overall regulatory reform’s restrictions on their structures and operations.
In the final analysis, despite the zealous lobbying by the financial services sector and the vehement opposition by the Republican Party, President Obama got in the bill about to become law most of what he had wanted in his “white paper.” He had to give up his proposed tax on banks but did manage to impose on them the Volcker Rule, although in its diluted and delayed version. The bill enables regulators to supervise almost all financial instruments from simple mortgages to complex derivatives such as credit default swaps and collateralized debt obligations. It imposes tougher capital and liquidity requirements and leverage restrictions on banks. It also restricts their ability to engage in proprietary trading in risky financial instruments, such as derivatives, and to invest in hedge and private equity funds, according to the diluted Volcker Rule.
It gives resolution authority to the government to seize and operate any troubled financial institution, not just banks, to prevent contagion and minimize systemic risk, and liquidate it if insolvent. Finally, it creates an autonomous Consumer Financial Protection Bureau within the Fed, whose regulatory power is greatly expanded and strengthened, to protect borrowers. But the bill ignores the critical role played by the giant now government-owned mortgage insurance and securitization institutions Fannie Mae and Freddie Mac as instruments for pushing to the extreme politicians’ economically dubious pet idea of universal home ownership, prior to the US subprime mortgage meltdown. It also fails to address clearly and directly the most basic “too-big-to-fail” problem of the large financial institutions, especially within the shadow banking system, and perhaps magnifies it, implying even costlier taxpayer funded future bailouts, according to some opponents of the bill. (“Shadow banks” are non-bank financial intermediaries that engage in maturity and liquidity transformation with households and businesses but without the access to central bank liquidity, such as the Fed’s discount window, and government credit guarantees, such as federal deposit insurance, that traditional banks have.)
Although the complex bill, HR 4173, which requires rare both legal and financial expertise for its full understanding, is a long one at 848 pages, according to its final version posted on the US Government Printing Office’s website, it is vague in terms of how it is to be implemented. So, it requires the now more powerful but still balkanized US regulatory agencies -- despite the formation of the 10-member Financial Stability Oversight Council, chaired by the US Treasury secretary -- to translate its general provisions into several hundred specific detailed rules and giving them a great deal of latitude in its application. They include the rules to be applied by the Commodity Futures Trading Commission, jointly with the Securities and Exchange Commission, in its oversight of the $615 trillion over-the-counter (OTC) derivatives market. Not surprisingly, the financial services sector will now be heavily lobbying the regulators, as well as the Congressional committees that will be making the many inevitable technical corrections to the bill, to shape those specific detailed rules in their favor as much as possible.
This bill cannot prevent all possible financial crises; no bill can, given human nature. Due to its sweepingly wide scope, the bill includes, despite its many shortcomings, some long overdue regulatory changes that could help increase financial transparency, reduce systemic risk and instability. But whether it will help prevent or even significantly mitigate a crisis similar to the one we are still coping with remains to be seen, especially in the absence of an agreement within the G-20 on effective global financial reform.
