Anil Kumar Satapathy
The pendulum of economies is now swinging back to a condition of state control from erstwhile days of free market, all thanks to the global financial crisis. Even the outright neo liberals now agree that there should be some sort of regulation at the financial market to prevent the 2008-model crises. No wonder that it’s the US, the Mecca of free-market capitalism a few years back, which is leading the struggle against unregulated financial markets.
A few days ago the US Senate passed a bill on banking reforms (Restoring American Financial Stability Act of 2010), which has been initially hailed as “historic”. The bill is a major initiative to regulate the financial industry in 80 years since the Glass-Steagall Act, which separated commercial and investment banking in 1933.
Notably, the Senate bill has to be merged with a measure passed in December by the House of Representatives (Wall Street Reform and Consumer Protection Act of 2009). A House-Senate conference committee will do that and give final touches to the bill before sending it to President Obama for signing. The final version could differ from the House and Senate bill.
The bill is an outcome of the financial crisis, which opened a can of worms. The sub prime crisis started in the US grew into the worst financial crisis since the Great Depression and pulled down a number of financial institutions, including the US investment giant Lehman Brothers.
The preceding months saw deep introspection around the world about the causes of the meltdown. Big bankers and market speculators came in for sharp criticism for their practices which were eventually blamed for the financial crisis.
Since then, there have been calls from various quarters for strong regulatory provisions to prevent similar crises in future.
The current bill must be looked at from this perspective and was one of the key promises of President Obama.
The bill aims to rein in Wall Street giants whose practices culminated in the 2008 meltdown.
According to the bill, which is yet to be made public, a mechanism will be in place to watch out for risks in the financial system and create a method to liquidate large failing firms.
The Senate bill provides for an "orderly liquidation" process, instead of bankruptcy. This is to avoid a repeat of 2008, when the US administration launched costly taxpayer bailouts of firms such as AIG.
Also, authorities could seize large firms in distress and put them in Federal Deposit Insurance Corp (FDIC) receivership, with liquidation required as the next step.
Notably, shareholder and creditors have to bear losses and not taxpayers as is the case today. Authorities could also fire the management of the ailing firm. The FDIC’s costs would be covered by sales of the liquidated firms’ assets and, in case of shortfalls, fees slapped on other large firms.
Also a new consumer protection agency is in the pipeline that will tackle "abusive" mis-selling of mortgages, credit cards and other loan products.
However, banks and other financial institutions have cautioned that this will in future create hurdles and may lead to ban on certain items.
The most controversial are the rules on the unregulated USD 615-trillion over-the-counter derivatives market. As per the current suggestions, over the counter derivatives have to be traded on exchanges or cleared through central counterparties. This will oblige banks to spin off some of their derivatives trading activities into separate entities – which the Federal Reserve and Treasury had opposed.
(Derivatives are instruments that let companies hedge interest-rate risks or changes in commodity prices. They are also used for speculation.)
The bill proposes one Financial Stability Oversight Council of regulators chaired by the Treasury Secretary. The new body will identify risks in the financial system.
If implemented, the US companies will face stricter capital, leverage and liquidity requirements and will have to draw up plans to ensure an orderly wind-down should they fail.
The government can also seize and wind up a large financial institution if it runs into difficulties and poses a risk to the wider financial system.
Will it prevent another crisis?
The bill has been hotly debated world-over and many have already pointed out its flaws.
In an article, the New York Times pointed out many loopholes in the bill. “The House bill would force some trades into a clearinghouse but would allow far too many exemptions. The Senate bill is stronger. It’s probably too strong, in fact. It effectively bans many big firms from trading the most lucrative type of derivatives. That’s not so different from a ban on subprime mortgages, which, of course, also helped cause the crisis,” said the paper.
Also, the US Federal Reserve had been severely criticised for its role leading up to the financial crisis. Empowering it with a whole new range of new powers would not guarantee that the Fed would successfully prevent another crisis.
On the bailout front, there were some criticisms too.
According to analysts, a permanent tax on banks could be a better option than setting up a fund for bailing out falling giants.
“Undoubtedly there will be further problems, it’s just the nature of business and the financial business in particular. But this will avoid some significant problems and limit the impact of others,” Harvey Goldschmid, a former SEC commissioner, has commented on the bill.
Similarly, CNN has slammed the bill over mortgages and rating agency provisions.
“The Senate bill -- and a similar House measure -- would do much to make the financial markets safer and fix many of the problems that arose. But it falls short of fundamentally changing the way that financial institutions do business,” it said.
On the bailout front, the Senate bill suggested that government will recoup the amount from the industry after the crisis is over. This is like punishing the survivors for the mistakes of someone else.
Despite the huge claims of the Obama administration, many analysts remain sceptical about the bill. Is it a big step, or just a baby step is the key debate. In either case, one has to admit that the bill has changed the rules of the game.