Obama's window dressing

US financial reforms Bill falls short of original aim

US President Barack Obama has signed into law the US Financial Reforms Bill. The debate on the Bill has been going on for quite some time now and, as usually happens in such politically charged debates, the original purpose and objective of the Bill has gotten lost in various compromises. It was important for Obama to keep his promise of financial reforms and so he came forward with an Act that introduces some reforms. Unfortunately, as is the case in most democracies with less-than-strong and visionary leadership, what one ends up with is very different from what one started with. For example, the Act does nothing to restrict the size of banks, a major objective of the original reform proposal. Admittedly, while the US could regulate the size of its own banks, it could do very little to cap the size of foreign banks. Since the US and foreign banks operate in the same global and national space, it is difficult to restrict the size of US banks if they are to compete with their bigger foreign counterparts. This once again highlights the necessity to coordinate financial market reforms across countries, something the emerging countries have been aware of ever since they were hit by the crisis they did not bring upon themselves.

The other objective, possibly less desirable but wanted by most people, was a restricted compensation policy for bankers. At the very least, it was expected that the fees of the top management would be structured in a manner that relates bonuses and fees to long-term bank performance indicators. While the Act requires shareholders to vote on executive fees, the outcomes of these votes are not binding on the bank management. In general, this is not a problem if there is market discipline. Unfortunately, financial markets and their institutions are notorious for following the herd and, hence, one is sceptical about the impact non-binding shareholder voting will have on executive pay packages.

Many of the derivatives and risk instruments traded by the banks prior to the crisis did not take place in standard markets. Consequently, there was little or no transparency regarding what the banks were up to. The Act requires standardisation and trading of derivatives in open exchanges. This will force banks to compete in volumes and customers will gain on both improved service and reduced price. However, which derivatives have to be placed in open exchanges is to be decided by the regulators. Given the experience during the most recent crisis, when the regulators were unable, or unwilling, to rein in the banks, leaving such things to them may not be very desirable. The flip side is if not regulators, then who? The banks themselves? Politicians? Of course, all this would have been unnecessary if the Act allowed banks to fail. This is politically infeasible, especially when banks are “too big to fail”. But since the Act does nothing to restrict bank sizes, one may only wonder how long this window dressing is going to last before the banks get back to their old ways of doing business.