The 2,500 page long Dodd-Frank Financial Regulatory Reform Bill has passed through the United States Senate. The bill will now be signed into law by President Barack Obama. It signals a halt to the deregulatory process that the U.S. financial system has experienced for almost fifteen years. It promises to strengthen consumer protection. In principle, it raises bank capital requirements, requires more collateral and margin requirements, enables a regulator to act against a very large and risky bank, and more.
These are overdue reforms. Warts and all, and considering the political realities of legislative deals, having this bill is better than continuation of the regulatory vacuum. But, it is not a comprehensive systemic solution. This watered down bill will not effectively reverse the massive financial deregulation that took place, nor will it fully assure that the financial system will be effectively supervised and regulated so to avoid another systemic crisis.
Despite the length of the document, the regulatory reforms in this bill are vague. Congress was reluctant to specify clear and detailed regulatory code into the bill. This means that the detailed homework in defining, detailing and interpreting the broad regulations is being passed on to the regulators. They will have enormous latitude and discretion in specifying these regulatory details, and in interpreting them during implementation. And the notion of ‘regulator’ ought to be viewed broadly here, since they also include senior political appointees in government, such as the Treasury secretary, who will wield enormous influence in the regulatory reshaping, interpretation and implementation.
If recent history and our empirical work are any guide, such latitude and discretion handed to regulators and politicians in government can be very costly because of the likelihood of regulatory (or ‘state’) capture by powerful financial institutions. Recent debates on this financial reform bill tend to focus on technical aspects, largely ignoring the politically sensitive issues surrounding the power of money and influence in politics with its perverse effect on financial regulation and its implementation.
Thus, I ask: how will politicians and regulators in government have the wherewithal to withstand pressures from Wall Street enabling them to make timely and tough decisions to break a very large bank (when the risk to the systemic so warrants)? And even if a regulator dares to do so, how will it be implemented given the international ramifications of such an action?
We should not totally rule out that some regulators may carry out appropriate actions at times. But we should be mindful that the vested interests in a system captured by ‘money-in-politics’ would tend to bias decision-making against such timely and tough regulatory actions. Congress did not dare to look into this issue.
In this context, errors of omission in this bill are noteworthy. Freddie Mac and Fannie Mae, the quasi-public housing finance behemoths that important culprits in the financial crisis, have been spared. Yet again, lawmakers carefully avoided addressing these institutions, which in the past have exerted undue financial largesse on politicians to influence them so that they could operate in a financially irresponsible fashion.
More broadly and understandably, given the interests of lawmakers and political realities, the bill is silent on the pervasive and pernicious role of money in politics influencing the whole regulatory system. Furthermore, the bill does not clearly re-erect a wall between traditional deposit banks and investment banking, which prevailed since the Glass-Steagall Act was enacted in 1933 until it was repealed in 1999.
Not that the U.S. is alone in facing challenges in regulatory reforms; progress is even more questionable abroad: witness the time lags, lack of coordination and consensus on regulatory reforms among EU members, the U.K., the IMF and the Financial Stability Board (FSB). This matters also for the effectiveness of the U.S. regulatory reforms since a modicum of coordination and harmonization across international financial centers is required. It may be years until Europe gets its act concretely together on this. Worse, the way the Basel Accord is being watered down right now due to lobbying pressure by banks may further erode the impact of the U.S. Regulatory Reform Bill on U.S. banks.
Thus, daunting challenges remain and need to be addressed head on, otherwise this bill will not substantially enhance the stability of the financial system or alter the behavior of financial institutions.
Paradoxically, this bill may have an impact on oil and gas companies. In fact, in ending on a positive note, let me focus on a little noticed side initiative within this bill which nonetheless is of high relevance for global development and anti-corruption efforts. There is a resource transparency provision in the bill spearheaded by Senators Lugar and Cardin (supported by many others).
The provision mandates oil, gas and mining companies registered with the Securities and Exchange Commission (SEC) to publicly disclose the tax and revenue payments made to any government and requires that they disclose how they ensure that their payments do not fund armed groups in some countries. The information disclosed by these companies will be independently audited.
Even if it was an obscure aside for many, this is a commendable provision to enhance transparency in the extractive industries and many resource-rich governments. There are two priorities next on this important front. First, transparency provisions ought to apply about full disclosure of the contracts signed between industry and governments as well. And second, in the near future these mandated transparency reforms in the extractive industries ought to also be rolled out to security exchanges in financial centers in London, Frankfurt and elsewhere.