Evaluating Key Aspects of Senator Dodd’s Revised Financial Reform Bill

Senator Dodd, Chairman of the Senate Banking Committee, released today his much-anticipated revisions to his financial reform bill. The changes, by and large, are an attempt to gain a measure of Republican support without losing a larger number of his fellow Democrats. The revisions reflect in part the results of an extended attempt by Senator Dodd to reach a comprehensive compromise with Senator Corker, a Republican on the Banking Committee. (Those discussions followed earlier failed efforts to develop a compromise bill with the ranking minority member on the committee, Senator Shelby.)

Overall, I believe the bill would represent a major improvement to the status quo, but political compromises significantly diminish its effectiveness compared to an ideal set of reforms. This note will focus on a few key aspects of the 1000+ page bill, including:

  • The approach to consumer protection
  • The new mechanism for “resolving” troubled financial institutions
  • The reshuffling of regulatory responsibilities

Likelihood of passage

Before discussing the policy issues, it is worth explaining my four reasons for continued optimism that comprehensive financial reform will be signed into law this year.

There is a reasonably wide consensus on the need for many of the reforms included in the bill. These less controversial points tend to receive little media attention because they are not the focus of ongoing fights.

Regulators have the authority to act on their own to put into place a number of the most important reforms, including some of the most expensive for the financial industry. For example, if there is no legislation this year, regulators will not wait for the next Congress to act (or choose not to act) before they raise capital and liquidity requirements. Further, they would likely impose a second tier of even higher requirements for the largest financial institutions, in line with the thinking of the Administration and of most legislative proposals.

The politics are very different than for healthcare reform. The public is demanding action, although the area is too technical for them to know exactly what they want. Further, they hate bankers with a passion at the moment and bankers are seen as the principal obstacle to passage of the bill. Thus, it is not clear that there are 41 senators who would be willing to stand up and filibuster a bill when that action would be portrayed as siding with the bankers.

Many leaders in the financial industry want to see a bill passed, in order to end the uncertainty and avoid some potentially very negative outcomes. In my view, the industry over-played its hand last year when it lobbied so hard, and effectively, on key points that it sometimes appeared that it could stop meaningful reform. Not only would this not be in the long-term interests of the industry, which needs a system less prone to failure, but it led to a backlash. Frustration reignited discussions of taxes on bonuses, spurred a proposed bank tax, and encouraged the Volcker Rule, a proposal to eliminate proprietary investment activities at the banks. This seems to have reminded the industry that there are many worse outcomes than the core proposals on the table. Equally importantly, the stock market is allergic to uncertainty and all of the leading financial firms are publicly traded. For that matter, it is frustrating and difficult for bank executives to plan when the basic rules are unclear.