The debate about financial industry overhaul is dragging on as Congress argues, and the industry fights, everything from better oversight of derivatives (cure the credit default swaps problem) and consumer protection (cure the lax lending standards problem) to a resolution authority for bad banks (cure the “too big to fail” problem).
To get some insight into what’s before Congress at the moment, Julie Segal, staff writer, talked to Oliver Ireland, partner in the Washington, D.C. office of Morrison & Foerster. Ireland’s practice focuses on retail financial services and bank regulatory issues including consumer protection rules, the Gramm-Leach-Bliley Act privacy provisions and the Fair Credit Reporting Act.
Do the proposals within Senator Chris Dodd’s bill institutionalize “too big to fail” as some critics have said?
If we prefund a fund for the purpose of resolving nonbanks, as the Dodd bill would, that fund may well encourage regulators to use that fund for that purpose. This can be viewed as institutionalizing “too big to fail” and may go too far in that direction. However, “too big too fail” is really a misnomer for the need to stabilize markets in times of stress or panic. Recognition of the need to be able to stabilize markets in times of stress dates from the Bank of England in the 19th century. This ability is critical to the financial health of market economies.
Does the Volcker Rule really address a systemic risk or is it a piece of populist legislation?
To the extent that more liquid markets are more prone to panics and bubbles in practice, the Volcker Rule would address systemic risk, but I am not aware of any data that confirms that view. In theory, a more liquid market that includes speculators might be more stable as speculators seek to profit from irrational swings in the market.
How is outsize compensation addressed within the legislation? Will CEOs salaries really come down as a result?
The amount of compensation is a populist issue. Whether a particular compensation program rewards the taking of unreasonable short term risks is a different issue. Among other things, the Dodd bill would limit “excessive compensation” at bank holding companies. Depending on how this provision is applied it could well reduce compensation levels at these organizations.
How effective do you think the proposals for financial institutions to keep a piece of securitizations on their books will be in pushing them to create less risky securities?
I don’t know what effect this provision will have on market stability. It should increase the costs of securitization and may limit the overall amount of securitization by any one entity. The idea of addressing potentially risky securitizations has some appeal given the performance of some of these assets in the recent crisis, but I don’t think that enough attention has been paid to the best way to maximize the benefits of, and at the same time, control excessive risks in, securitizations, or similar funding transactions.
Congress is debating alternatives to bankruptcy court for financial firms. How effective have the bankruptcy courts been in dealing with the Lehman Brothers failure?
I think that a resolution authority that is more attuned to market stability might be a preferable choice over the bankruptcy courts for resolving large financial institutions in times of market stress. Such an approach may have benefits even without prefunding resolution costs.
