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While these proposals are yet to be fully baked, on first blanch they seem balanced. This doesn't mean they are good or bad; it means they are not horrible from banking, brokerage, consumer, taxpayer, legislative and regulatory perspectives. That is to say, they could be much worse. A number of businesses and constituencies will be hurt, but none -- except the Office of Thrift Supervision -- will be demolished.
On reading the proposal, the banks seem to be left pretty much unscathed. But while large banks will not be broken up, they will suffer under tighter regulation, greater capital charges, increased compensation scrutiny, pressure to centrally clear over-the-counter products, greater post-trade asset-backed securities price transparency, pressure to migrate "standardized" OTC products toward exchange trading, increased global regulatory cooperation, and the creation of a whole new agency to vet and bless financial products targeted at individual investors: the Consumer Financial Protection Agency (CFPA).
While this new framework doesn't significantly challenge the large banks' business models, there are a number of little things that could turn out to be devastating, depending upon how they are implemented.
The most significant of these changes are the development of a systematic regulator, the reallocation of capital reserves, the development of the CFPA, and a little-noticed clause allowing the CFPA to restrict or ban mandatory arbitration clauses. While many of the issues raised in the plan will cause banks indigestion, these four open-ended developments could prove either lenient or restrictive, and depending upon interpretation could lead the industry in very different directions.
While I am not sure the Obama administration hit everything in sufficient detail, it did cover significant ground. In my research piece "The Future of Investment Banking: Subprime and Its Impact on the Industry," written in October 2008, I highlighted a number of issues that the regulators needed to address, namely: elimination of predatory financial products, reduced investment banking leverage, a realignment of the credit rating agency business model, the migration of OTC products to central clearing and toward exchange trading, and the separation of risk businesses from transactional agency-type businesses. All of these issues, with the exception of the separation of risky and non-risky banking businesses, appear to be addressed.
Could legislators have gone further? Yes. Are there calls that they haven't gone far enough? Righteously, yes. Are the banks balking at the onerous nature of these new regulations? Yes, of course. But will banks be alright? Absolutely.
Investors and the public want a greater level of institutional surety that the credit crisis or anything remotely looking like it will never happen again. Banks need to maintain their global competitiveness; but if change is too radical they will need to modernize significant investments in people, technology and infrastructure. Shareholders want profit. Regulators want jobs. And legislators want both their committee positions and campaign contributions. Everyone is right, and everyone is biased. That is what makes this so hard.
We live in an entangled financial ecosystem, where scale, inexpensive deposits, credit velocity, risk mitigation and leverage drive not just bank earnings, but how wealth is distributed, capital allocated and credit rationed, as well as how individuals survive -- not just in the U.S. but globally. And while it may be easy to say, "Burn it down," in reality I am not sure I would want to be the one signing legislation that could inadvertently either make the U.S. financial system (and hence the U.S. itself) uncompetitive or trigger another crisis.
We also need to remember that no matter how much we like or hate this new plan, it is just a proposal; and while it may look both extensive and incomplete, we need to see what happens once lobbyists attack it, the House and Senate grind it up, and the president signs what remains. And while it may look like Prego now, once it comes out of the sausage factory it may have a whole different taste.
