Thursday, 25 March 2010

Finishing the Job

Two and a half years into the crisis, we are at a defining moment in the debate about the financial reform. On Monday, the U.S. Senate Banking Committee approved the Senator Dodd draft legislation to overhaul the U.S. financial regulatory system. Besides its many important elements, the Dodd bill has two overarching objectives: to end “too big to fail” and to protect consumers from abusive financial services practices.

The ways those objectives are achieved spurred a number of controversies. According to the draft, the Bureau of Consumer Financial Protection (CFPB), which was initially envisioned by the Obama Administration to be an autonomous, independent watchdog, is to be housed within the Federal Reserve. Consumers themselves, living with an impression of the Fed’s apparent failure to regulate the banking system resulting in massive bank bailouts by the taxpayers, are finding the Fed’s revived authority misplaced. Market participants point out that the consumer protection objective may not always be consistent with the Fed’s primary task of maintaining the safe and sound banking system.

Ending “too big to fail” has caused a significant shift in how large money center banks and financial companies are view by investors. Both S&P and Moody’s have commented on a possibility of credit rating downgrades of certain financial institutions if an implicit government backing is removed. In turn, sell-side analysts promptly conducted an analysis concluding that a few U.S. largest banks’ short-term credit ratings may be reduced below “the highest rating category” effectively cutting those institutions from accessing the money markets.

Taking into account that the same banks provide financing for municipal markets and brick-and-mortar companies often through asset-backed commercial paper programs, some unintended consequences the bill might be well beyond of what politicians are expected.

The Dodd bill might be an interesting document to look at for all those interested in paradoxes of financial regulation. The 1,336-page draft can be accessed here:



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