In the early days of the economic crisis, there was pressure to enact reforms on bank and financial institutions, but the initial urgency has slowed and partisan tensions have grown. Senator Chris Dodd’s (D-CT) early attempts to reach a middle ground between Republicans and Democrats faltered, and his financial regulation legislation passed in a Senate committee without a single GOP vote. Democrats are hoping to capitalize on the momentum gained by the recent passage of health care reform to revive the financial reform legislation, which could be the next bill that arrives at the White House without Republican support.
On March 31, Douglas Elliott answered your questions on the financial regulations bill awaiting a vote on the Senate floor, and on the chances of its final passage after Easter, during a live web chat with POLITICO’s David Mark.
12:34 David Mark: We're chatting today with Doug Elliott of Brookings, a former investment banker and expert on financial regulation. Welcome, Doug.
12:35 David Mark: The financial reform bill being pushed by Senate Banking Committee Chairman Chris Dodd (D-Conn.) would place a proposed consumer protection agency under the Federal Reserve. Is the Fed the appropriate place for such a consumer organization?
12:37 Douglas Elliott: I would prefer to see a stand-alone, independent consumer protection agency, but, unfortunately, that's not what we're going to get.
12:38 Douglas Elliott: The Republicans and the banking industry are concerned about an agency that would create too much bureaucracy and possibly stop good products from being sold, throwing out the baby with the bathwater.
12:39 Douglas Elliott: The compromise will almost certainly be that the agency resides within the Fed, or another regulator, and can be overridden by a supermajority of the other regulators, but has very substantial independence otherwise.
12:39 [Comment From Jim Collura: ] What is the likelihood of the Dodd Bill being passed - either as is, or in some variant?
12:39 Douglas Elliott: You can never be sure of anything in politics, but the probability of passage of a comprehensive reform bill this year is quite high.
12:40 Douglas Elliott: The politics are very different than for healthcare. The public very much wants something to be done, although it is too technical for them to judge the details well. They also hate bankers with a passion, which means that there may not be 41 Republican Senators brave enough to filibuster the bill even if they disagree with it.
12:41 Douglas Elliott: In addition, many of the industry leaders strongly want some resolution this year and would encourage a reasonable set of compromises. It is bad for their busineses and stock prices to have so much uncertainty.
12:42 Douglas Elliott: Also, there is considerably more agreement on key points than often appears in the media. The areas of agreement are naturally not what one writes about. for the most part.
12:42 Douglas Elliott: Finally, many of the most expensive changes for the banks can be put through by regulation anyway, so stopping the bill doesn't gain as much for the banks as one might assume.
12:42 [Comment From Bill in VA: ] Does the legislation address the "Too Big to Fail" issue? How should that issue be addressed?
12:43 Douglas Elliott: The legislation addresses "Too Big to Fail" to some extent, but there is no easy way to solve the problem without creating more damage, so those who are highly concerned about the issue may not be happy with the bill.
12:44 Douglas Elliott: The bill would put a number of burdens on the biggest financial institutions, partly to make them safer and partly to make it more expensive for them to be that big, thus encouraging them to be smaller, if they can do their business sucessfully that way.
12:45 Douglas Elliott: The biggest institutions will have significantly higher capital requirements at the end of the day and will bear the burden of premiums for a new resolution fund to deal with future failures. (Smaller banks will be exempt from paying.) Also, the proposed Financial Crisis Responsibility Fee would solely hit the larger institutions.
12:45 [Comment From Heather Booth: ] What is your estimate that we will pass a bill strong enough to stop the next crisis? One that has independent consumer protection? One with real derivatives reform (clearing and exchange trading)? One with real resolution authority?
12:47 Douglas Elliott: I don't believe that any form of regulation can stop all future crises, no matter what the politicians are saying. Crises result from human mistakes and herd instincts. They will always be with us. The real goal is to make them significantly less frequent and substantially less troublesome when they do appear. We can handle something like the savings and loan crisis or the, even less troublesome, crisis with Long Term Capital Markets (a hedge fund) much less painfully than a terrible crisis like what we just went through.
12:48 Douglas Elliott: The good news is that, in my view, the legislation would get us about two-thirds of the way to where we'd like to be, which is a very good outcome for any political system on an issue that is this complex, and is certainly a good outcome for our troubled system.
12:50 Douglas Elliott: You point to several important issues. I think we'll get a consumer protection agency that is considerably better than the system we have now, but which falls short of what the administration proposed. Simiarly, the derivatives legislation will be a big step forward, but will also fall short of what I think is a good set of proposals from the administration. And don't get me started on the resolution authority issue. It's extremely complex, but I'm not happy with where it looks like we'll end up, although even that will be better than where we are now.
12:50 [Comment From Patrick Smith: ] What specific provisions in the current bill have the GOP so hesitant to back reform? It would seem to be political suicide to not jump on the "punish Wall Street" bandwagon.
12:51 Douglas Elliott: Good question. There are hundreds of issues in the 1,300 page bill, but I think there are two that the Republicans are most focused on. The rest seem to be areas where compromises can be reached, especially because they are so technical.
12:52 Douglas Elliott: First, the consumer protection agency is one where Republicans will lay down on the tracks if they have to. They see the agency as a potential disaster that will be very bureaucratic and make it difficult for banks to do ordinary business. That's why I think the eventual compromise will move considerably in their direction, as I described earlier.
12:54 Douglas Elliott: Second, the Republicans do not want the adminstration's proposed enhanced resolution authority to deal with large, troubled non-banks, like AIG or Lehman or Bear Stearns, last time around. They want to stick with normal bankruptcy law for non-banks, rather than having the FDIC hold the kind of almost dictatorial powers that it does over actual banks. They recognize there may have to be a few exceptions where systemically important non-banks receive a different treatment when they hit the wall, however they want to make this very punitive, in order to avoid bailouts.
12:56 Douglas Elliott: Politically, the good news for the bill is that Dodd has essentially accepted their suggestions. In terms of policy, the bad news is that, for a variety of reasons, I believe this is the wrong approach. I'm afraid that it is being set up to be so onerous that it may be unusable in the next really severe financial crisis, in which case we'll be left using ad hoc solutions again, like we did with the TARP this time.
12:56 [Comment From Wells Frice: ] Many mid-size banks got into trouble that do not have any material exposure to trading activities as well as very large firms, and yet they were able to be absorbed. What ever happened to what I thought was a Fed rule about less than a maximum of 10 percent of market deposits required for any merger?
12:57 Douglas Elliott: There were only a few cases where an institution with a 10 percent market share of deposits took over a significant institution in a merger or acquisition. My understanding is that the takeovers in each case were of a thrift, which does not fall under the rule for bank deposits. It's kind of a technicality. I expect the Fed would have waived the 10 percent rule or gotten Congressional approval to do so, if it had been needed.
12:58 [Comment From Terry Magness: ] There seems to be some ambiguity regarding the Volcker Rule. How do you see this playing out in the legislation?
12:59 Douglas Elliott: Ah, the Volcker Rule. While I applaud the intent to avoid banks taking excessive investment risk, I believe that the actual proposal is a terrible way to do it. This is relevant, since a large majority of analysts feel the same way, reducing its chance of adoption a great deal. For its part, Congress is really annoyed about having the administration pass up many months of opportunities to push for something like the rule and then suddenly deciding it was an important thing to do. It looked political and it was not well received by Congress.
1:01 Douglas Elliott: As a result, the Volcker Rule will be gutted. It will be in the legislation, so that the president is not embarassed by his own party. However, the regulators, who don't like the rule either, will be asked to study it and implement it as makes sense. In a nutshell, it's not going to happen in any serious way.
1:01 [Comment From Mark Johnson: ] It seems that momentum for reform was strong right after the economic crisis began, but it stalled. Now it's starting to heat up again - why?
1:03 Douglas Elliott: I think the industry lobbyists overplayed their hand at the end of last year. They appeared to have the potential to stop the bill altogether, despite its strong political appeal and the true necessity for some reform. What this ended up doing is spurring the administration to even stronger proposals, such as the Volcker Rule and the bank tax. This seems to have awakened many of the opponents to the realization that they could do worse than a reasonable bill that contained some compromises on key issues.
1:03 [Comment From Dan: ] What aspect of financial reform do you think the media has failed to focus on, but should be paying more attention to?
1:06 Douglas Elliott: I love the question. I believe that the single most important set of reforms is one of the least controversial. Banks will be required to hold more capital to protect against errors and accidents. Capital is the difference between the value of the assets owned by the bank and the liabilities that they owe. It's like equity in a house. The more you have, the tougher a problem you can handle without being crushed. Similarly, banks will be required to keep significantly more liquidity, meaning that they need to hold more cash and things they can quickly convert to cash. This would have helped Bear and Lehman by giving their more time to raise capital or otherwise solve their problems. Higher capital and liqudity requirements will make a big difference to the system's safety, but it's a complex set of issues for the media to try to explain.
1:07 Douglas Elliott: I should add that the big financial institutions will have even higher capital requirements, which will help protect against the need for taxpayer bailouts.
1:07 [Comment From Martina: ] Even if no legislation makes it through Congress, is there action existing regulators and/or the Obama administration can and should take?
1:08 Douglas Elliott: Yes, the capital and liquidity requirements that I just described could be put in place by regulators quickly if they wanted. They've had the luxury of waiting for Congress to officially encourage them, since few people want to increase the capital requirements - which will discourage lending - until we come out of the current credit crunch.
1:08 [Comment From Tony Brush: ] Where do you think we will end up on resolution authority?
1:10 Douglas Elliott: I think we'll end up with a resolution authority as shown in the Dodd bill. Banks are already covered by an effective resolution mechanism run by the FDIC. Non-banks would stay with the current bankruptcy process, except for a very few that would be so obviously systemically important that they would need special treatment. Those firms would be required to be liquidated at the end of the process. I think the approach is much less effective than the administration proposal, but at least it would be better than what we have now.
1:10 [Comment From Mike Allen: ] Is Wall Street going to try to stop reform?
1:12 Douglas Elliott: Wall Street (and the main street banks) are torn. There are some reforms that they do want, others that they recognize are important even though they'll be costly, and there are others they oppose. Even if the bill is more negative than positive in their view, which is not true of all of their views, some of them still want it passed in order to get past the uncertainty, so they know how to run their businesses.
1:12 [Comment From Debra Perry: ] Does the revised Financial Reform bill include any provisions regarding the oversight or role of credit rating agencies?
1:13 Douglas Elliott: Yes, rating agencies would be subject to greater SEC oversight. More importantly, they will have a higher standard of legal liability, which should make them more careful in the future. Neither of these feels that satisfying, but it is very hard to design anything more that doesn't do harm rather than good.
1:13 [Comment From Kerry Clark: ] What's the single most important policy change that should be made to protect the financial markets and the economy from another disaster?
1:14 Douglas Elliott: From my point of view, the singlest biggest need is for higher capital and liquidity requirements. These address the core problems that get banks into trouble. One nice thing about them is that you don't have to know what kind of mistakes or bad luck created the problem, having more capital will help, no matter what.
1:15 [Comment From Eric: ] Dodd's bill came out of the Senate committee without a single GOP vote - some say that may have been a tactical mistake on the part of the Republicans. What do you think?
1:16 Douglas Elliott: I think the Republicans probably played it right politically. The smart thing now would be for them to strike a deal with Dodd on all of the issues in contention and then give him some Republican votes on the floor of the Senate. What I think would be really stupid would be to make a big deal filibuster attempt, which they could well lose anyway.
1:16 [Comment From Cheryl: ] In your opinion, if the bill is passed will it put the United States at a disadvantage? Should the United States wait for other countries to pass reform, or at least do it at the same time?
1:18 Douglas Elliott: International coordination is important, but I don't believe that we should wait for global agreement before passing the bill. The proposals fit in well enough with the international discussions and the political momentum for reform here in the United States is too important to waste, even though the need for policy changes is not urgent, just very important. (That is, I'd hate to see nothing done in the next few years, but if I could have my perfect bill pass in 3 or 4 years, I'd be fine from a policy point of view.)
1:20 David Mark: We're going to wrap a bit early today. Thanks for joining us.