HAS WALL STREET BEEN PUT BACK IN ITS CAGE?


By: Dr. Lynn Reaser

Two years ago, the Dodd-Frank bill was signed into law to prevent another financial collapse that nearly engulfed the world in 2008.  Today, two years after the historic legislation was enacted, 400 rules remain to be written by 20 regulatory agencies.  Even as the specific rules are being written, firms such As BlackRock and KKR are moving even faster to avoid the regulatory net as part of the so called “shadow banking” system.

The Federal Reserve Bank of Atlanta hosted a conference last week, titled, “Financial Reform:  The Devil’s in the Details.”  Indeed, that is true.  Whether financial risk can truly be controlled in Wall Street remains to be seen.

Federal Reserve Board Chairman, Ben Bernanke, indicated in his remarks at the conference that regulation has risen as a priority for the Federal Reserve to the same level as monetary policy.  This represents an historic change in direction and focus for our central bank.  Mr. Bernanke also indicated that the Fed may try to conduct regulatory policy on a counter cyclical basis in the same way as it conducts monetary policy.

This will be no mean feat.  “Leaning against the wind” by tightening monetary policy when the economy is overheating and easing policy when the economy is cooling has always been difficult as turning points are very hard to identify.  “Leaning against the wind”, such as by imposing higher capital requirements, higher down payments, or more stringent “stress tests” at the peak of a cycle may also be difficult as bubbles in various markets are not always obvious.

Sheila Bair, former Chairman of the Federal Deposit Insurance Corporation (FDIC), spoke of the importance of not making rules overly narrow and detailed.  Financial institutions can often find ways to skirt even the most specific rules.  Rather, it would be better to define more general principles that can encompass changing conditions and innovations.

My view is that we have not eliminated the risk of another financial crisis.  There are still institutions on Wall Street that are “too big to fail.”  Large banks are successfully lobbying to prevent regulations they view as particularly harmful.  Meanwhile, many small banks will not be able to endure the costs of more intense regulation.  The view of regulators that they will be able to gauge all of the macroeconomic risks in a timely fashion and take appropriate countercyclical steps appears overly optimistic.

In sum, regulation is unlikely to prevent Wall Street abuses.  An embracing of ethical principles and a greater reliance on trust is what we need.

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