James Pethokoukis

Politics and policy from inside Washington

U.S. financial reform is still a matter of faith

April 19, 2010

The timing of the Securities and Exchange Commission’s suit against Goldman Sachs may sway a few doubters. But U.S. financial reform is still a matter of faith. That’s one reason for the partisan bickering. Preventing future government bank bailouts relies heavily on Wall Street believing new rules will be enforced and failures will be allowed.

For skeptics, though, the current Senate bill leaves enough wiggle room to induce doubt.

On paper, Democrats have a case to support their convictions. Their bill gives regulators new authority to wind down non-bank financial institutions. Tougher new capital and leverage requirements, as well as limits on risky activities, are supposed to make failures much less likely. A $50 billion bank-financed pool would fund resolution costs — though this whole idea may yet be dropped.

The trouble is, teetering banks and their creditors might still assume that while not too big to sue — as Goldman can attest — Uncle Sam would still think them too big and interconnected to fail. And that’s the problem for many Republicans. The bill tends to favor discretion over hard and fast rules. While the feds would have the authority to shut down institutions, for instance, they wouldn’t be required to do it. History hints that regulators and politicians will continue to be tempted to rescue banks in a crisis.

And those new rules on capital, leverage and risky activities will be spelled out only later by a new systemic risk council. The government would be able to guarantee financial firms’ debt without any automatic triggering of the resolution process. And it’s still fuzzy how the challenge of winding down cross-border obligations and operations would be met.

There’s an argument for leaving less to officials’ discretion. If the threat of liquidation isn’t credible, banks will operate — and investors will treat them — as if a government backstop still existed.

If the Democrats’ reform bill passes in its current form, believers might then look for signs that it’s working. One would be that big banks can no longer fund themselves so cheaply. Especially since the recent crisis, big banks — with, say, more than $100 billion in assets — have been paying less interest on deposits and debt than smaller brethren.

If that too-big-to-fail subsidy doesn’t narrow significantly, Republicans would be justified in calling for a reform revival.

Comments

I do not think the so called educated who run these so called financial institutions should be allowed to continue running them.
There is no need for a program, billions to be squandered,Tsars, or some useless legislation that does not benefit “We the People.”
These executives should have the same scrutiny a $5.00 an hour employee has to to tolerate.
I think people who steal should go to prison.

Posted by Anna123 | Report as abusive
 

Canada was voted by the IMF as having the best banking system in the WORLD. Why doesn’t the USA just adapt the straight-forward and non-partisan rules that Canada has in place, and work, so we can move forward. Why are we always trying to re-invent the wheel — only to have the wheels fall off our economy every few years. Sooner rather than later the world is going to permanently turn its back on the fraudulent financial products coming out of the USA.

Posted by JJWest | Report as abusive
 

JJWest: Praise from the IMF should usually be regarded with suspicion. That said, adapting the Canadian banking system to America might be more difficult than imagined. Canada’s banking system is dominated by five very large institutions that operate everywhere in the Dominion, followed by some regional banks and a large number of very small local credit unions. Some international banks – chiefly HSBC – have a strong presence here as well. Would Americans be happy with a small number of gigantic banks – they’d have to be gigantic to cover all of the US – dominating the landscape? What about too big to fail? I think the real key would be simplifying regulation. Canadian banks, all of them, are overseen by one federal regulator only, the Office of the Supervisor of Financial Institutions (OSFI). That’s it. Nothing at the provincial level. On the other hand, American banks are overseen by the Fed and what appears to be a confusing array of federal and state regulators, all with their own budgets and turfs to protect. Would these groups willingly give up their poweer and perqs to simplify and strengthen bank regulation at the federal level? That, I believe, is the real problem, one not given to populist speech-making.

Posted by Gotthardbahn | Report as abusive
 

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