Grading Financial Regulatory Reform

This morning, we learned of a huge compromise in regulatory reform. The expectation was that no one was happy with the bill, but the politicians, who all get to go home to the voters and say “Well, at least we passed something.”

Overall, I give this a C minus: There are simply too many Fs to give them a much higher grade. Let’s look at what was passed and grade each section of reform:

TOO BIG TO FAIL:  Grade: F

The new regulation does not directly address either the repeal of Glass Steagall or TBTF. The crisis legacy is a financial services sector that is highly concentrated with dramatically reduced competition. The six largest financial firms — combined assets: $9.4 trillion — will still dominate the industry.  Too-Big-to-Fail remains the law of the land.

MORTGAGE UNDERWRITING STANDARDS: Grade A

Establishes new minimum underwriting standards for mortgages. No more no doc, NINJA, or Liar loans. Lenders must verify income, credit history and job status. Would ban payments to brokers for steering borrowers to high-priced loans. Of all the regulatory changes passed today, this seems to be the only one that, if in place a decade ago, would have prevented (or at least dramatically reduced) the crisis.

NEW REGULATORY AUTHORITY:  Grade:  C+

Gives federal regulators new authority to seize and break up large troubled financial firms without taxpayer bailouts; creates a sector rescue fund from banks with > $50B in assets. The time to assess this fee is before a crisis, not after — when banks need every penny of capital.

LEVERAGE:  Grade: F

Inexplicably, all of the new regulations fail to reduce leverage rules today .

FINANCIAL STABILITY COUNCIL:  Grade:  B-

10-member Financial Stability Oversight Council to address system-wide risks to stability, with the power to break up financial firms.  Oh, and about that leverage thingie? Directs them to look into it.

Question: Why not address leverage NOW, instead of kicking it down the road? Is Congress really THAT cowardly?

CREDIT RATING AGENCIES: Grade:  F

Sets up a quasi-government entity to address conflicts of interest. Allow investors to sue credit-rating agencies. Establishes new SEC oversight office. Retains Oligopoly; Fails to open ratings to more competition. Considering that the ratings agencies were the prime enablers of the crisis, this failure is shameful.

DERIVATIVES:  Grade B+

Moves most derivatives to exchanges, routed through clearinghouses,e etc.  Customized swaps remain OTC, but have reporting requirements. New capital, margin, reporting, record-keeping and business conduct rules for firms that deal in derivatives. Failed to overturn CFMA.

VOLCKER RULE: Grade A-

Curbs propriety trading by FDIC insured depository institution. Would not have rpevented this crisis, but addresses the moral hazard of banks in the future due to the bailout.

CORPORATE PAY: Grade F

Give shareholders a non-binding vote on executive pay. No clawback provisions. Does not address imposing liability on management for excess risk taking, corporate collapse or taxpayers bailouts.

FEDERAL PRE-EMPTION OF STATE BANKING RULES: Grade C+

Overturns OCC tool John Dugan Federal pre-emption of state regulations. states to impose their own stricter consumer protection laws on national banks. National banks can seek, and will likely receive exemptions from state laws, undercutting this entire law.

DEPOSIT INSURANCE: Grade B-

Permanently increases FDIC for banks, thrifts and credit unions to $250,000. Fly int he ointment: Congress failed to fund this, although the FDIC will be covered by taxpayers if and when they run out of cash . . .

CONSUMER AGENCY: Grade D+

The new Consumer Financial Protection Bureau is a half decent idea, but the exemption for Auto Dealers — the typical family’s 2nd biggest purchase is a car — is unconscionable.  Putting the agency inside the Federal Reserve is beyond idiotic.