The old maxim among regulators holds that the more the regulated whine about what you’re imposing on them, the better you’re doing.
In that case, the Obama administration must be doing a wonderful job on regulatory reform of the US financial system. Everyone, it seems, is critical of the Restoring American Financial Stability Act, which was passing through the Senate as Euromoney went to press.
Banks have been urging the administration to get on with this quickly because the very uncertainty over regulatory reform is beginning to harm them. But it took the dramatic announcement of the SEC’s fraud allegations against Goldman Sachs in April to silence political opposition to reform and bring bipartisan support in Congress.
It is a huge, 1,300-page bill. One wonders if more than a handful of people have read it all. Clearly there is something in it for everyone to object to. As well as imposing new rules on different markets, the bill aims to overhaul the entire structure of regulation and the bodies that enforce it.
The American Bankers Association moans that the new consumer protection agency the bill sets up puts too much burden on banks, which are heavily regulated already, rather than focusing on non-banks which, the association rather boldly claims, primarily caused the financial crisis.
The White House explains that the new agency will for the first time provide federal oversight of both non-bank companies and banks in the mortgage market and protect borrowers from unfair, deceptive or other illegal mortgage lending practices. The implication is that mortgage brokers rather than borrowers themselves bear responsibility for loans that couldn’t be afforded and that led to the sub-prime crisis.
The American Chamber of Commerce also dislikes the new agency for its capacity to cast any small business that charges customers in more than four instalments as a non-bank financial company over which it can exercise wide-ranging powers.
But if the new agency merely improves initial loan underwriting standards across the system, it will have been worth creating. Failure on this damns existing regulators and the nation’s central bank.
There is a bigger question, though, about the bill’s success in reshaping regulatory oversight so as properly to cover the US financial system. As it now stands, non-banks and the securitization market provide much more credit to companies and individuals than banks themselves do.
The bill sets up a new financial stability oversight council with responsibility to gauge risk across the system and its many regulatory silos and market participants. This is an eminently sensible aim. But gaps remain. The collapse of Lehman Brothers briefly threatened a seizure of the whole financial system when one money market fund broke the buck due to losses on Lehman paper and the entire mechanism for large corporations and banks to fund through short-term bills sold to money market funds almost collapsed.
The SEC revised new rules in January to shorten the average duration of assets at money market funds from 90 days to 60, increase daily cash liquidity requirements to 10% of funds’ size, limit investments in illiquid and lower-rated paper and require publication of net asset values with a 60-day lag so as to disclose to investors the relative riskiness of funds’ investments.
None of this seems enough to reduce the systemic vulnerability to money market funds at a time when banks are facing both much higher liquidity and capital requirements.
And there are other uncertainties that will prevail long after the bill is passed. Chief among these: does the new mechanism for winding down large firms really end the moral hazard around too-big-to-fail banks?
Opponents say the bill enshrines bailouts through a new $50 billion fund to manage such wind-downs. That criticism looks plain wrong. Banks will be taxed to provide that $50 billion. The real question is whether that would be enough to tide over one or more large banks through the initial crisis of confidence accompanying a collapse that would engulf the system. Equity and more importantly debt investors might well assume that the implicit put to taxpayers still exists even if the bill is passed. That is an uncomfortable proposition for everyone.
Critics worry that at worst such a large and complex bill risks making funding and capital formation harder and more costly for good companies while not making the system much safer.
Most bankers Euromoney speaks to understand and even welcome much of what the legislation contains, including the wind-down procedures that should, in theory, end the assumption of too big to fail. That should allow big banks to continue to operate a diverse set of businesses. In the economic recession that followed the financial system crisis, many large banks have only covered losses in their retail divisions from wholesale trading and investment banking profits. The Volcker rule looks like a dead duck.
