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Financial Reform Legislation Moves Forward

The House and Senate have come to an agreement of financial reform, and it is stronger than I anticipated when the process first began. Here's a quick summary of the legislation:

The bill would give the government new power to oversee systemic risk and to shut down giant failing institutions (another AIG) in an orderly way. It includes a surprisingly strong "Volcker Rule,'' which almost prohibits banks, with their federally-insured deposits and special access to Fed borrowing, from engaging in proprietary trading. It sharply restricts the ability of banks to trade derivatives. It cleans up the whole business of derivatives by moving the trading into clearinghouses and onto exchanges where it will be transparent and properly capitalized.

And it creates a new consumer protection agency, albeit within the Federal Reserve, with the power to crack down on shady mortgages, credit card practices, payday lenders and other financial services.
However, although the legislation is stronger than I thought it would be, it's important to note that many of the new rules are written in a way that will depend upon the judgment of regulators and their inclination to crack down, or not, on particular behaviors. David Zaring sees it similarly:
With the Volcker Rule (limits on prop trading by banks) and the scaled back ban on derivatives trading, the devil is in the details, and by creating some exceptions to a blanket ban, Congress essentially gave regulators the power to give full, or no, content to these rules. That's either a punt or something that should terrify regulated industry.
With Obama's apparent lack of interest in filling key agency positions with qualified people -- there are many, many unfilled positions that don't even have a nominee -- it's not clear that there is the kind of emphasis from the top that will be required to reform these agencies and make them effective.

The biggest change that is needed is a shift in culture within regulatory agencies, one that could start by putting people in charge who actually believe in the need for regulation. Many of these agencies have had leadership that believes the market can take care of itself, and the outcome has been a minimalist approach to regulation and the capture of the agencies by industries they are supposed to be overseeing. It hasn't helped that many of the people in charge of regulation are former industry insiders.

All the laws in the world won't help if they aren't enforced. I am glad that the new legislation passed, and I think it is a step forward. But I believe that for the most part the rules and regulations that were needed to stop the housing bubble were on the books already. It wasn't lack of legislation giving regulators the authority they needed that was the problem. It the failure to believe that a big problem could happen due to an unjustified faith in the ability of markets to self-correct, and the failure to take the actions that might have prevented the crisis that are the most to blame for the regulatory failures. We can pass all the new rules and regulations we want, but until the culture within the regulatory agencies changes, the danger of another meltdown will persist.

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