“You want to move at the point where people still have the memory of the trauma,” Tim Geithner explained recently when asked about financial regulation. Aware that the crisis is moving into a new phase, with the emphasis shifting from firefighting to working out how supervision should be restructured, America’s treasury secretary wants to seize the moment. He plans to unveil a comprehensive regulatory overhaul by mid-June. Barack Obama has said he wants to sign the changes into law by the year’s end.
In Europe, too, the pressure is on. “There’s no room for more delays,” José Manuel Barroso, president of the European Commission, said on May 27th when he unveiled a blueprint for reform of financial supervision. He announced plans to form two new grandly named institutions: a European Systemic Risk Council, which is supposed to provide early warning of possible risks, and a European System of Financial Supervisors, which would be a super-committee of regulators from across the European Union.
The goals of the two new institutions are admirable. Both are intended to correct a fundamental flaw in European bank regulation and supervision; namely, that although banks are free to operate across borders, they are supervised only by their home countries. Slack oversight by one country can, as the crisis has revealed, spread chaos across many. Yet it is not at all clear that the proposals have been thought through properly. “The European Commission is confusing speed with haste,” says Nicolas Véron of Bruegel, a think-tank in Brussels. “The governance, mandate and funding of these new authorities is not really addressed.” Britain, which has the biggest banking center, is particularly concerned about the proposed rules, which may cede aspects of the City of London’s banking supervision to Brussels.
In America, meanwhile, the plans taking shape face resistance, partly from the bankers they will shackle but even more from regulators and lawmakers. Bankers accept they will be forced to build up bigger capital buffers, which will crimp profitability, and that the liquidity of their balance-sheets will be policed more intensively. The regulatory net will be cast over the “shadow” banking network of hedge funds, money-market funds, and the like, to which much financial activity gravitated during the boom.
Big banks, however, still have enough lobbying power to ensure that not every decision goes against them. True, they are still licking their wounds after the recent passage of draconian credit-card reforms. But they are happier with the government’s proposals on derivatives, under which dealers will be able to continue peddling customized swap contracts away from exchanges, albeit with a higher capital charge.
As the crisis has deepened, American bankers have tempered their opposition to the idea of new rules that reduce the chances of another blow-up. “Would I accept regulation that slows innovation a bit and knocks three percentage points off my returns if it promised greater stability? Absolutely,” says the head of one large bank.
For some, more stringent regulation even has a silver lining. With tougher mortgage rules, banks will no longer have to lower their standards to compete with the industry’s unregulated parts. The survivors could also benefit from higher barriers to entry.
On the whole, Wall Street sees a welcome disconnect between the Obama administration’s rhetoric and its actions. The Treasury is “gradually learning” how to square the circle of showing that it understands the public’s anger on the one hand, and maintaining a dynamic financial sector on the other, says one bank lobbyist. Another test of its capacity to resist pitchfork-wielding urges will come in the next few weeks, when it is expected to issue guidelines on executive pay.
The stiffest resistance to change is coming not from Wall Street but from Washington, DC, where government officials, regulators, and congressional leaders are locked in turf wars and ideological battles. “Opinion has splintered. Everyone is fighting everyone,” says Bert Ely, a consultant on regulatory issues.
Even the main banking agencies are at odds with each other. Sheila Bair of the Federal Deposit Insurance Corporation (FDIC) and John Dugan, the Comptroller of the Currency, have fallen out over Ms. Bair’s deposit-insurance reforms. Mr. Dugan also opposes the FDIC’s push for sole authority to liquidate failing non-banks, as it already does with banks.
Worse, there is no consensus on the proposed systemic-risk regulator, which would identify and act on emerging “macro-prudential” dangers. The administration wants the Fed to assume the role, but many in Congress oppose this. Dick Shelby, an influential senator, has accused Mr. Geithner of using the crisis to hand the Fed unacceptable levels of power. Meanwhile, Ms. Bair has suggested that systemic regulation be done (or at least overseen) by a multi-agency council, an idea that is gaining traction even if others (including, again, Mr. Dugan) worry that such supervision-by-committee is a recipe for inaction.
An even bigger battle is brewing over the shake-up of existing regulators. No one doubts that the archaic, overlapping patchwork of agencies needs modernizing, with regulation refocused on a firm’s activities rather than its legal form. Reportedly, the White House is considering rolling the four banking-supervision agencies into one, though the idea is still in flux.
But an embryonic plan to create a super-regulator for consumer products, such as mortgages, credit cards, and mutual funds, is already encountering stiff opposition. The Securities and Exchange Commission (SEC), which would lose out in such a shuffle, has powerful friends on Capitol Hill, especially on the Senate banking committee that oversees the agency-and any overhaul would require congressional approval. Public pension funds have also joined together to lobby against a reduction in the SEC’s power.
Moreover, the economically rational may not be politically feasible. Though it would make sense to merge the SEC with the Commodity Futures Trading Commission, which regulates derivatives, Congress’s powerful agriculture committee would probably block the move.
Debate about other thorny issues, such as what restrictions to place on, or whether to dismantle, banks that are too big to fail has barely begun. Congressional leaders cannot even agree on whether to pass new rules in pieces or roll them up into one mega-bill.
All of which explains why pundits now expect to see few, if any, further financial reforms passed in 2009. Delay could play into the financial industry’s hands, to the extent that it reduces the likelihood of heat-of-the-moment laws like Sarbanes-Oxley, rushed through after the Enron scandal. But if measures that would increase stability fall victim to politics, everyone will be worse off.