The belated passage of the US financial regulation Bill has drawn to a close one chapter in the saga of attacking systemic risk and stabilising the shaky economy. But it also opens the next sequential chapter on implementation and walking the words. If there is a lesson to be drawn from the failure of American public sector oversight in averting the crash of 2008, it is that mere existence of laws on paper does not guarantee enforcement until they pass through the prism of regulatory agencies that have to act in good faith.
The reform?s final version?harmonised between the Senate and the House and christened as the Dodd-Frank Bill?leaves technical minutiae to the discretion of old and new rule-making bodies. Only broad brush strokes of general principles have been laid down in the 2,319-page Bill, throwing the follow-up ball into the court of government agencies that do not enjoy public confidence owing to their sullied past.
At the apex of the new regulatory pecking order is the Financial Stability Oversight Council, which will be headed by Treasury secretary Timothy Geithner. Its overriding powers to spot and curb companies and toxic instruments that threaten the rest of the American economy do worry Wall Street because more financial firms and products will now come under the state?s supervisory scanner. Yet, financial tsars have plenty to cheer because the council has been awarded the right to veto, by two-thirds majority, rules created by a new entity called the Consumer Financial Protection Bureau. Consumer protection is a radical idea, as it subjects the entire financial sector to a litmus test of whether it is harming average Americans through predatory lending, misinformation or fleecing. The bureau, one of the most fought over elements in the reforms package for over a year, has separate financing and an independent director to vest it with some autonomy from the US Federal Reserve Board. But the ?ber-regulatory council can annul any of the bureau?s rules that are deemed to be hurdles to ?soundness? of the financial system. With the present US Treasury secretary leading a long list of old Wall Street hands at the helm of the council, there is a strong likelihood that consumer protection rules will not be allowed to overreach and block profitability of banks.
Already, macroestimates from pundits predict that the Dodd-Frank law and related regulatory overhauls will cut the financial industry?s short-term profits by 11%. The NYT recently disclosed that JP Morgan, one of the stars that emerged unscathed from the mayhem of 2008, is apprehensive that Dodd-Frank?s restrictions on proprietary trading and derivatives will cost it ?billions? of dollars. CEO Jamie Dimon is also apparently anxious that the stricter regulatory regime might deliver ?another setback? to the ?jittery economy?. The argument that a highly profitable Wall Street is necessary for the US economy to rebound is going to remain the main intellectual fulcrum on which the post-legal regulatory battles will be played out. New revelations of the AIG bailout of 2008 confirm that Geithner, who was the head of the Federal Reserve Bank of New York when the insurance giant caved in, orchestrated a massive ?corporate welfare? heist by ensuring that Wall Street biggies like Goldman Sachs were made whole at the taxpayer?s expense. Geithner?s logic in transferring public wealth to rescue AIG?s insured banking partners was that a ?catastrophic failure of another financial firm? (after Lehman Brothers and Bear Sterns) was unacceptable ?at that perilous moment?.
How certain can one be that another perilous moment is not on its way in the not-too-distant future? Despite the promise of Dodd-Frank to impose strict capital reserve requirements and usher in robust governmental power to dissolve financial firms through a ?resolution authority?, market analysts are predicting that nothing in the rule books will stop Goldman, JP Morgan, Citi or Morgan Stanley from growing bigger and even more systemically consequential.
Harvard economist Kenneth Rogoff?s coauthored master-piece of financial history, This Time is Different, conveys that regulation can turn draconian only when crisis is deep and the political will is strong, i.e., not in the long run. Wall Street?s giants are not losing sleep over Dodd-Frank, but rather preparing to exploit its gaps and weaknesses by reorienting internal teams and units towards new products that will escape whatever regulatory zeal might kick in over the near term.
Obama reassured financial firms on the eve of Dodd-Frank?s entry into force that they had ?nothing to fear? unless they were indulging in fraudulent excesses. Since the definition of what is unhealthy and where the buck stops is not static, Wall Street insiders are expressing muted optimism that they will eventually ride out of this storm like water overflowing a dam. In the Obama administration (and even more so in any future Republican regime), there are few takers for the MIT economist Simon Johnson?s contention that financial capitalism is ?potentially dangerous to societies?, offering few broad benefits but incurring ?large and frightening costs?.
The conventional wisdom that contemporary finance must grow for the ?real economy? to prosper has not dimmed in the corridors of power. That leaves a huge sigh of relief on Wall Street, which can keep arguing that imprisoning it with clutches and watchdogs will ultimately shackle economic recovery.
The Institute of International Finance, a global trade association of investment and commercial banks, claims in its lobbying briefs that Dodd-Frank and its offspring of rules could erase 3.1% of US GDP. Absent alternative models for recharging the limping US economy, Wall Street is again readying to reap the benefits of its supposed indispensability.
The author is associate professor of world politics at the OP Jindal Global University