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Financial Planning > Behavioral Finance

Point of View: Lawyer Mark Plotkin on Dodd Reform Bill

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Mark E. Plotkin discusses the possible effects of the financial-reform package now shaping up in Washington, D.C.

Will the passage of financial reform prevent a repeat of the recent financial crisis? And do you foresee a future crisis that is not envisioned by this legislation?

No package of financial reform enacted by Congress is going to prevent all financial crises. Financial crises and panics will happen periodically, as they have throughout U.S. history and world history.

The U.S. itself had at least four major banking crises before the Depression and has had several, albeit milder ones, since 1929. Most legislation addressing such events is necessarily retrospective in nature and fails to anticipate the possible sources of the next such crisis.

Generally speaking, U.S. bank regulators already have the tools they need to address future financial meltdowns that might resemble past events — regulators have long adjusted their capital and risk standards to take into account past problems, and the bank regulators could have been counted on to do this again in the wake of the recent financial crisis.

This is precisely what bank regulators do best — they learn from experience and apply those lessons to adjust the system in ways to lessen the prospects of future harm.

This is not the realm for politicians, who lack a nuanced understanding of the intricacies and economics of banking and bank regulation.

Where Congress can be helpful and insightful is in anticipating and averting future crises that could result from public policy choices made by the Congress and the White House.

The most glaring risk, from my view, for a future financial crisis results from the current spending spree by Congress and the Administration, resulting in spiraling deficits that threaten to cripple our economy and productivity in the future.

The current Congress and Administration are writing checks to be cashed on the backs of future generations, imposing a debt burden that may make it much harder for a future Congress and future regulators to address a future crisis.

Congress could more profitably be looking to ways to make American financial institutions more competitive abroad while reducing deficits at home.

Can another Lehman-style failure occur? Is such a “too-big-to-fail” crisis at least less likely?

I do think that another Lehman-style failure is less likely, primarily due to the assertion of greater jurisdiction by the regulators over such firms and the extremely cautious approach regulators now will take with respect to the Lehmans and the AIGs going forward.

The mechanisms available to regulators, including the ability to intervene earlier and to wind down institutions over time, are a positive contribution of the legislation, at least in theory. There remains, of course, the risk that an institution may be shut down prematurely out of an excess of caution.

But it is more likely that the largest institutions will enjoy a privileged status due to their large size and their special place in the system, and that they will receive regulatory attention and nurturing in a way that is not matched for smaller institutions.

That said, the likelihood of truly systemic risk coming from one or a few firms will not be as great as it has in the past. Instead, that systemic risk is going to be presented by debt and by deficits.

It also is worth noting that perhaps the key culprit most identified with triggering the financial crisis — the failure of subprime loans in a market of falling home prices — has been entirely unaddressed by Congress.

Will the bill eliminate bailouts?

No. There are too many financial institutions as well as non-bank financial firms that potentially could get into trouble.

It may reduce the likelihood of bailouts for the biggest firms based on their U.S. operations, but as those firms conduct business around the world, the reality is that our regulators and our Congress cannot hope to supervise the truly global operations of U.S. firms.

As we have seen over the past two years, mismanagement and financial errors can occur anywhere in the world, including in the most sophisticated economies. Future bailouts may be smaller or may be addressed largely to foreign operations in order to save a U.S.-based institution.

Having said that, the political will and appetite for future bailouts is almost certainly going to be far less than it has been in recent years.

Will it protect consumers from abusive lending practices?

There is nothing here to prevent consumers from abusive lending practices.

The establishment of a new consumer protection unit within the Federal Reserve simply adds another layer of bureaucracy to the existing consumer protection mechanisms available within the OCC, the Federal Reserve, the FDIC and the FTC.

The market didn’t seem to react well to the Dodd bill. Will the bill emerging from the House-Senate conference be more satisfactory to Wall Street?

I think I would be inclined to say that the conference version of the bill is likely to be less troubling, rather than more satisfactory, to bankers generally.

The House version is not much more palatable than the Senate version, but some of the worst excesses of the Senate version — including the Durbin and Collins amendments — should be addressed by Barney Frank’s staff.

By and large, the result will still be an excess of regulation at a time when the financial industry is still rebuilding.

Do you foresee any other notable effects of this legislative effort?

The legislation is going to prompt at least some U.S. financial services firms to look to relocate certain of their businesses offshore, outside the jurisdiction of U.S. regulators. Such discussions are already well underway within the U.S. financial community.

Mark E. Plotkin, a partner in the Washington, D.C. office of Covington & Burling LLP, has advised many of the nation’s and the world’s leading financial institutions on financial services regulatory matters for more than two decades.


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