Friday, July 16, 2010

Reform Passes But Six Banks With More than $9 Trillion in Assets Still Dominate

After an economic crisis that pushed the banking industry to the brink of collapse, froze credit markets, and led to $700 billion in taxpayer bailouts, the toughest set of market rules since the Great Depression will soon become law, with Senate passage of the legislation hours ago. The bill will promote financial stability by improving accountability and transparency in the financial system, improve oversight, bolster consumer protection, and reform the derivatives market, amongst other things. Sounds pretty good so far, right?

Well, when you consider President Obama's 90-page white paper that he proposed back in June 2009 grew to a 2,300-page bill due to the addition of lobbied provisions that no doubt diluted the Bank Act considerably, one has to wonder if the bill tackles the rot at the very core of our financial system. The overhaul won’t shrink banks deemed too big to fail, and it leaves intact a financial industry dominated by six banks with more than $9 trillion of combined assets.

Yet, at the end of the day, essentially nothing in the entire legislation will reduce the potential for massive system risk as we head into the next credit cycle. -- Simon Johnson
While the reform has now been passed, it leaves plenty of unanswered questions:
“Although we agree that there needs to be careful consideration and application of the legislation, the outcome in the short run seems to be that banks continue to conserve capital and maintain excess levels of liquidity while they await the final rules. This could have the effect of dampening economic growth and delaying the economic recovery, until there is a clearer picture of where some of these major issues will shake out,” CreditSights says.

Moreover, it is not convinced that the bill does enough to correct the problems in the financial industry that led to the crisis in the first place. CreditSights argues that the bill doesn’t do enough to improve the credit risk assessment process, and does not address the frequent power imbalance between the front office exposure originators/traders and the back-office risk managers. It also worries that the new oversight bodies are comprised of regulators and central bankers who missed the red flags leading up to the crisis in the first place.
Raters and regulators must be independent of, and possess the authority needed to gain the respect of the banksters, otherwise financial reform is meaningless.

The deregulation of the last 30 years has all but destroyed the the banking reforms and size caps on the banks imposed in the 1930s. However, The Kanjorski Amendment , part of the Dodd-Frank bill gives federal regulators the right and the responsibility to limit big banks and break them up if and when they pose a “grave risk” to financial stability.

So, while regulators can be very effective in curbing the abuses that led us to the brink of financial collapse in 2008, they must have the power to instill the fear of severe consequences should the banksters step out of line.
“The key lesson of the last decade is that financial regulators must use their powers, rather than coddle industry interests.” --Representative Paul Kanjorski,

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