Living Like It’s 1931

Law professor Frank Partnoy questions whether the regulatory reform bill under debate in Congress will be enough to move the economy toward prosperity.

The calendar says 2010, but Frank Partnoy believes that in certain respects, we’re living like it’s 1931. That was a transitional year between the 1929 stock market crash and the passing of two transformative securities laws, in 1933 and 1934, that established a regulatory body for public companies, mandated widespread financial reporting, and created antifraud remedies.

Seven decades later, optimists would like to believe that the regulatory reform bill in Congress will mark the beginning of better days for the U.S. economy. But Partnoy, a University of San Diego law and finance professor and longtime follower of regulatory reforms, thinks 2010 will likewise be considered a transitional time. “We’re still in the middle of the ball game in terms of regulatory response,” he told CFO in a recent interview.

In Partnoy’s view, the regulatory response to the financial crisis thus far has been “muddled.” Congress is plodding through more than 1,500 pages of reforms that will affect various areas of the U.S. financial system. The reforms include a new government authority to prevent financial institutions from becoming too big to fail, a consumer protection agency, regulations for the derivatives market, and even some measures that could be deemed antiregulation (such as a provision that would exempt the smallest U.S. publicly traded companies from getting an audit opinion on their internal controls).

The bill is expected to be finalized at the end of this month. Around the same time, Partnoy will speak about the new regulatory reforms and their resemblance to past reforms at the upcoming CFO Core Concerns Conference, to be held June 27-29 in Baltimore. An edited version of CFO’s recent interview with Partnoy follows.

How can we assess whether the new legislation will be successful?
The only way we’ll know is to wait and hope. If we could go back in time a few years with these proposed rules, would the crisis have been prevented? The answer is no. Congress is considering more than 1,500 pages of reform, but most of that is not directed at problems that would have prevented the crisis.

What piece of the legislation do you most hope will survive the process?
The most crucial part is the removal of regulatory references to credit ratings. I have my fingers crossed that it will pass. Participants in the financial markets need to stop relying on Moody’s and S&P.

Partnoy quote

Why isn’t a similar proposal by the Securities and Exchange Commission to end the practice good enough?
The SEC doesn’t have the power to change a statute; Congress does. And many of these references extend beyond the securities area, outside the purview of the SEC. In addition, it’s important for Congress to fire a shot across the bow of all regulators to let them know that it’s not appropriate to rely on ratings. It’s the kind of reform that needs to come from the top, and that means Congress.


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