Tuesday, October 23, 2012

Senator Warner Says 113th Congress Will Take Up Major Bi-Partisan Dodd-Frank Corrections Legislation

Senator Mark Warner, a key member of the Banking Committee, told the Bipartisan Policy Center that the 113th Congress should consider major and bipartisan Dodd-Frank corrections legislation. While Dodd-Frank broadly got things directionally right, said Senator Warner, there are at least 50 sections of Dodd-Frank he would like to change. The Senator added that, regardless of the outcome of the November election, the Dodd-Frank Act would not be repealed.  The repeal of Dodd-Frank would be extremely disruptive to the market, he warned, and would chill financial stability in the US and globally. The Banking Committee will revisit Dodd-Frank in a rational way, he promised. 

While Dodd-Frank only got the 60 votes needed to clear the Senate hurdle, he noted, many parts of the legislation received a much broader bi-partisan consensus. For example, he observed that Titles I and II setting up the Financial Stability Oversight Council (FSOC) and an Orderly Resolution Authority were embraced by 85 Senators.

That said, he added that there are lots of places in Dodd-Frank where Congress got it wrong. Historically, with any major piece of federal legislation, Congress never gets it entirely right the first time. But as imperfect as Dodd-Frank may be, he continued, the US acted in a comprehensive way and, as a result, financial markets are safer and banking institutions are stronger.

Specifically, when Congress revisits Dodd-Frank, he noted, more work must be done on transparency, derivatives, and the Volcker Rule. He called for a more principles-based Volcker Rule that is not as rules-based. He also said that many of the problems arising around swaps are due to regulatory overlap. The reality is that regulators protect their own turf, he observed. Congress and the regulators must also recognize the diversity of US financial institutions and not impose the same level of stringent regulations and capital standards on mid-size and smaller financial institutions that are applied to large global financial institutions.

Another concern is that FSOC is an imperfect creation with no independent entity or person in charge. FSOC has not become the arbiter of conflicting regulations that he envisioned it would be. It has not played the role of adjudicator of conflicting regulations. Perhaps it is because the Office of Financial Research created by Dodd-Frank has not functioned as a quasi-independent backstop to get data to the FSOC as he had hoped it would. There is still no permanent  OFR Director.

There are also continuing issues around FSOC designation of financial firms as systemically important, thereby subjecting then to stricter regulation. The Banking Committee knew that the designation process would be problematic, said Senator Warner.

He explained that Congress was confronted with two choices: 1) break up the largest financial institutions or put a cap on them (which Congress may revisit), or 2) designate systemically important financial institutions for more stringent regulation. Congress rejected the first choice because of a global trend toward larger financial firms; and Congress did not see the size of US firms as putting many of them in the global top 50. In addition, it would be difficult to impose and administer an arbitrary asset cap.

So, Congress decided to put a price on being large, in the form of higher capital standards, stricter leverage ratios, and convertible contingent capital. The capital standards component is working, he said, while the jury is out on contingent capital.

Finally, Senator Warner disagreed that Dodd-Frank institutionalized the too big to fail doctrine. Bankruptcy simply will not work in every circumstance for large, complex and sophisticated financial institutions. Thus, Title II sets up a process to make resolution so bad that no rational management team would prefer that route. The resolution authority should be the default of last choice, he emphasized, because under it the shareholders are wiped out, management is removed and there are clawbacks, and creditors and bondholders face haircuts.

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