Up Front

Financial Reform in 2013 and What Could Come in 2014

Douglas J. Elliott

Reform of financial regulation continued with great intensity in 2013. U.S. regulators spent the year immersed in developing the detailed rules to implement the Dodd-Frank Act, as well as Basel III, the global accord setting minimum requirements for the safety margins of capital and liquidity at the banks. Progress by the regulators is often portrayed as unpardonably slow, but we must keep in mind the immensity of the task they have been handed and the totally unrealistic set of deadlines imposed by Congress. The fact is that we are dramatically transforming major parts of a very large and complex financial system. Further, the pieces of reform have to fit together, which requires a great deal of coordination. All of this takes time. That said, there are certainly turf battles and other bureaucratic and political obstacles that have slowed things down further, but that was always going to be a problem in the real world and it cannot be waved away with a magic wand.

The good news is that much has been accomplished in 2013, including important rules about derivatives markets, mortgage originations and securitizations, and the long-awaited promulgation of the details of the Volcker Rule to largely eliminate proprietary trading. Very good progress has also been made by the Federal Deposit Insurance Corporation, in cooperation with other regulators, in designing a solid approach to dealing with banks that run into problems in the future. The FDIC’s progress significantly reduces any risks from “Too Big to Fail” financial institutions, although more still needs to be done.

The big debate in 2014 is likely to be between two views of progress on financial reform. Most analysts, including me, broadly endorse the existing approach to reform, embodied in Dodd-Frank and Basel III, although everyone has disagreements to a greater or lesser extent with the specifics. However, there is a substantial minority who argue that real financial reform requires radical change. The three most common proposals for such radical action are: to break the big banks up into smaller pieces; to restore some version of Glass-Steagall to force banks to split between traditional commercial banks and those that focus on securities and derivatives markets; and to require very high levels of capital at the banks.

I believe all three of these extreme approaches are quite flawed and would hurt the economy, as I have discussed elsewhere. Luckily, none of them is likely to be passed in the current political environment. The danger is that one or more major new scandals in the financial industry could quickly change that political environment, causing Congress to seize on one of these proposals as a way to show the public that they are not in the pockets of the banks and are prepared to take bold action.

So, I am keeping my fingers crossed that 2014 will see yet more progress in the step-by-step implementation of sensible financial reforms without interference from radical actions that would do more harm than good.