{"id":1751,"date":"2011-09-27T14:18:18","date_gmt":"2011-09-27T18:18:18","guid":{"rendered":"http:\/\/www.multiplier-effect.org\/?p=1751"},"modified":"2011-09-27T14:20:17","modified_gmt":"2011-09-27T18:20:17","slug":"where-the-action-is-on-financial-reform","status":"publish","type":"post","link":"https:\/\/blogs.bard.edu\/multiplier-effect\/where-the-action-is-on-financial-reform\/","title":{"rendered":"Where the Action Is on Financial Reform"},"content":{"rendered":"

In the case of a major reform like the Dodd-Frank Act, the attention spans of most journalists and opinion-mongers inevitably peak around the legislative battle, pronouncements are made in the aftermath, and then everyone moves on.\u00a0 But as articles<\/a> like this<\/a> remind us, so much of the action still remains to be played out, in the nitty-gritty of the rule-making process.\u00a0 To wit, a draft proposal that fleshes out the \u201cVolcker rule\u201d prohibitions on proprietary trading was recently released.\u00a0 The rule was intended to restrict banks\u2019 ability to make bets with their own capital, but the draft language in question suggests those restrictions could end up being fairly weak (due in part to a broader interpretation of the sort of \u201chedging\u201d that will be deemed permissible).<\/p>\n

This is just the beginning of the beginning for Dodd-Frank.\u00a0 Looking beyond these initial rule-writing stages, there is the further question of how the law and its provisions will hold up over time.\u00a0 Rules are only as good as the regulatory and enforcement structures that shape and govern them.\u00a0 That\u2019s not much of a catchy slogan (worst-selling bumper sticker of all time?), but it contains some critical truth.<\/p>\n

Jan Kregel (recently elected to the Lincean Academy<\/a>) highlighted these dynamics in his investigation of the origins and eventual erosion of Glass-Steagall, the New Deal-era legislation that separated commercial and investment banking (some regard the Volcker rule as a kind of tame, second-best alternative to a return to Glass-Steagall). \u00a0\u00a0In addition to tracing the history of the collapse of the 1933 law, Kregel argues that we cannot simply go back to a Glass-Steagall-style regime.\u00a0 (Read the policy brief here<\/a>; highlights here<\/a>.)<\/p>\n

While so much attention is paid to Gramm-Leach-Bliley (the Financial Services Modernization Act of 1999), Kregel demonstrates that the \u201cend\u201d of Glass-Steagall and of its restrictions on securities trading was a fait accompli<\/em> well before the much-maligned 1999 law had passed. \u00a0All of the action had already taken place through a series of rulings and interpretations by the Fed, the SEC, the Supreme Court, and lesser known bodies like the Office of the Comptroller of the Currency (see Kregel, on pp. 9-11 of the brief<\/a>, for a crisp summary of the key provisions that were weakened and effectively dismantled over time; particularly with reference to Section 16 of the 1933 law, the \u201cincidental powers\u201d clause; which Kregel refers to as the \u201cAchilles heel\u201d of Glass-Steagall).<\/p>\n

At a deeper level, and of great policy relevance to current discussions (as well as post-mortems) of financial reform, Kregel goes on to argue that there are serious challenges to reinstating Glass-Steagall-type separations between banking and securitization.<\/em><\/strong>\u00a0 The deregulation leading up to 1999 was, he argues, largely a response to a tension that emerged in the financial structure created by Glass-Steagall.<\/p>\n

The most important function of commercial banks is not deposit-taking, Kregel notes, but liquidity creation.\u00a0 And while Glass-Steagall gave commercial banks a monopoly over the former, it did not give them a monopoly over the latter. \u00a0Innovations in the financial sector (securitization, commercial paper, money market funds) essentially allowed investment banks and other financial institutions to crowd into commercial banks\u2019 liquidity creation function\u2014and moreover, to provide these liquidity-creating services at lower costs and with fewer restrictions than regulated banks.\u00a0 \u201cIn this environment,\u201d Kregel points out, \u201cthe monopoly protections placed on deposit business by the 1933 Act became a hindrance to the commercial banks\u2019 survival.\u201d (p. 5<\/a>)<\/p>\n

Competition from investment banks undermined commercial banks\u2019 business model and spurred them to expand their activities into new areas; an expansion that, aided and abetted by deregulation, ultimately contributed to the fragility of the system and the latest crisis.\u00a0 Note that this is not just a story about \u201cregulatory capture.\u201d\u00a0 It was the underlying competitive imbalance, brought on by innovation in the non-regulated financial sector, that spurred deregulation.<\/p>\n

The \u201clogic\u201d of Glass-Steagall, as Kregel puts it, ultimately fell apart and became untenable well before the law was formally scrapped.\u00a0 Any attempt to reinstate a Glass-Steagall-type segregation would need to address this structural problem.\u00a0 Without exercising vigorous monitoring and control of innovation in the non-regulated part of the financial sector, simply re-imposing 1933-style divisions would not work.<\/p>\n

Kregel suggests a number of potential, though as he admits partial, solutions to the problems posed if investment banks were to once again have an effective monopoly over securitization (\u00e0 la<\/em> <\/em> Glass-Steagall).\u00a0 Part of the challenge involves providing an alternative revenue source for regulated banks.\u00a0 One possibility here is to recognize deposit taking as a public service; to regulate it as a public utility, subsidized by a tax on nontransaction banks.\u00a0 Kregel also considers an approach that would affirm, as he puts it, \u201cthat the Constitution reserves the provision of currency to the government, and there is no reason for the major part of this obligation to be outsourced to the private sector.\u201d\u00a0 Kregel has in mind here a scenario in which wealth and transaction services are provided as a public service, doing away with the need for things like deposit insurance or the lender-of-last-resort function.<\/p>\n","protected":false},"excerpt":{"rendered":"

In the case of a major reform like the Dodd-Frank Act, the attention spans of most journalists and opinion-mongers inevitably peak around the legislative battle, pronouncements are made in the aftermath, and then everyone moves on.\u00a0 But as articles like this remind us, so much of the action still remains to be played out, in […]<\/p>\n","protected":false},"author":202,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[8,111],"tags":[],"class_list":["post-1751","post","type-post","status-publish","format-standard","hentry","category-financial-crisis","category-financial-reform"],"jetpack_featured_media_url":"","_links":{"self":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts\/1751","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/users\/202"}],"replies":[{"embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/comments?post=1751"}],"version-history":[{"count":5,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts\/1751\/revisions"}],"predecessor-version":[{"id":1756,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/posts\/1751\/revisions\/1756"}],"wp:attachment":[{"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/media?parent=1751"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/categories?post=1751"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/blogs.bard.edu\/multiplier-effect\/wp-json\/wp\/v2\/tags?post=1751"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}