Since passage of the Dodd-Frank Act in 2010, the financial industry has been dealing with an almost unstoppable wave of regulatory reforms. Most, if not all have been designed to prevent a repetition of the problems that followed the failure of AIG and Lehman Brothers in 2008. Now, after the U.S. election of a conservative majority in two (and soon to be all three) branches of the U.S. federal government, many bankers feel that a huge regulatory weight is about to be lifted. Some bankers expect a reversal of the drive toward reforms, perhaps even repeal of Dodd-Frank. That’s not going to happen, at least not without a lot of work.
Although there may be receptive listeners in government, it will take more than a supportive administration to ease the pressure for reforms. The nation has been repeatedly told that the financial industry brought the economy to the brink. Reform is now expected by Main Street voters. A new narrative must be formulated before the conservatives can delay imposition of the final rules, much less repeal the most restrictive measures.
Bankers must show, for example, how the liquidity impact of the net stable funding ratio is affecting the ability of companies to provide jobs to American workers. They must also explain whether they can self-regulate in ways that prevent the unchecked spread of leverage. Even Wall Street voters believe that investment banks created structured finance vehicles without consideration or even an awareness of the systemic risks that accelerated the credit crisis. And bankers must present their rebuttal arguments to comport with the realization that the earlier,
reactive reform process was forced to rely on flawed economic models[1] that have now been discredited. Perceptive economists have come to believe that those flawed models misdirected the reform process and led to severe unintended consequences. That misdirection can’t be allowed to happen again.
The financial framework in the United States must be formulated within a regime of Enlightened Regulation. However, this should not lead simply to laissez-faire deregulation. As a country, we will have a much greater political problem if lax new rules stimulate economic growth but fail to correct the popular perception of uncontrolled systemic risks. The problem at that point will not merely be economic. At that point, both major U.S. political parties will have tried to contain the risks while encouraging growth – and each will have failed. And that will not be good, either for the elected conservatives or for the electorate itself.
So, what is to be done?
Fortuitously, it seems that the
Financial Stability Board (FSB) has offered a solution. The Switzerland-based FSB has called for papers to review the beneficial, as well as unintended consequences of the reform process. This is a unique opportunity for leaders in the global financial industry to present the conceptual basis of an enlightened regulatory regime based on sound econometric models, to replace a regime which is seen to be largely reactive to the problems of the past.
If the financial industry can make a strong case that reforms can be redirected, then bankers will find legislative and supervisory staffers who support regulatory strategies that encourage capital formation and emancipate local labor. The time has arrived to take advantage of this once-in-a-career opportunity.
[1] Republished with permission from the
RMA Journal