The Dodd-Frank Wall Street Reform
and Consumer Protection Act 2010, a response to the 2008 financial crisis is
considered to be the most important financial reform since the Glass Steagall
Act of 1933, a legislation signed by Roosevelt to end the Great Depression of
the late 1920s. This study critically analyses the Dodd-Frank Act and attempts
to answer the fundamental question as to whether the Act is an improvement or
an impediment, given its protractive length and intractable complexity. The GSA
which was distilled in less than 50 pages transmuted America’s financial
architecture and now serves as the most convenient historic benchmark of
financial impregnability. The DFA is over 2000 pages long and ironically, the
extra pages diminish, rather than enhance the law’s effectiveness. While the
Act seems to be a step in the right direction, it does not seem to have gone
far enough. This is followed by global implications of Dodd-Frank Act in the
context of international harmonisation, cross border insolvency and the
prospect of internalising risks that speculative investments impose on society
through Pigouvian taxation.
Table of
Contents
I.
Introduction
II.
Socio-Legal Approach: a Reasoned choice
III.
Literature Review
a. Legislative History in Context
b. Title VI: Section 619- The Volcker
Rule
c. Title VII—Section 752- International
Harmonization
d. Cross-border Insolvency: a Pertinent
Nexus
IV.
Analytical Discourse
a. As strong as your weakest link
b. Title XIV: Mortgage Reforms: A proxy
measure of Impregnability?
c. The good, not so good and vaguely
obscure
d. Regulatory dynamics: A Socio-legal
Panorama
V.
Legal implications of Tax laws and Prospective Alternatives
a. General Discourse
b. Professional Services-Interview
Insights
VI.
Limitations
VII. Conclusion
VIII. Acknowledgements
IX.
References
X.
Appendix
I.
Introduction
The
world is at the pinnacle of economic uncertainty. Despite the prowess in
technology, economic growth is far from similar to that during the industrial
revolution. Financial innovation has been misdirected towards the demise of
business ethics. Global economies are is at the verge of another collapse that
is building up like the tension under tectonic plates (before an earthquake
strikes) waiting to find an outlet of release. The course of history followed
this path in the roaring twenties before the Great depression and then again in
the first decade of the 21st century. History has repeated itself in
the political and financial arena. Unfortunately, legal responses have not gone
far enough to offset such oddities. While previous catastrophes of historic
proportions were met with radical legal amendments, current reforms are visibly
verbose, effectively impotent and ethically lukewarm in the face of adversity.
This essay dissects the most important sections of the DFA using the
socio-legal approach drawing insights from various tools of analysis from the
social sciences. Since the DFA is only 5 years old and many of its provisions
are still not in place due to implementation deadlines being postponed, there
is little case law that backs the deductions of this essay (though the literature
is ample). The absence of a an established academic framework in this subject
has made it a challenge to pursue,
however, this has also given the author an opportunity to develop
original analysis stemming from primary readings of the DFA, backed by logical
deductions informed by financial industry professionals, legal practitioners
and economists. This essay seeks to make valuable contributions to the small
but growing body of socio-legal perspectives on the Dodd-Frank Act.
One of the few constants in the USA is the
presence of frequent financial crisis since its declaration of independence.
However, the post 1930s phase of the twentieth century enjoyed regulatory
strength which was empowered by the law and enabled financial impregnability of
the USA. This paper unfolds a theoretical framework to shed light on the rise
and fall of America’s legal prowess in the context of International Financial
Law with insights into how landmark changes in the law can change the course of
economic history. Implementation of Section 619 or The Volcker Rule of the DFA
requires a historical perspective on the Glass-Steagall Act, intended to reveal
how practical politics consists of denying or ignoring salient facts to exert
its influence on legal frameworks. On July 21st 2015, The
Dodd Frank Act celebrated its 5th anniversary but there wasn’t much
reason to celebrate ‘results day’
being postponed is a good enough reason to rejoice. The dismal reality of
modern financial architecture is that it is inherently complex and structurally
fragile. The history of financial regulation points to the Banking Act of 1933
being the best historical benchmark for financial impregnability. It elucidates
how any diversion from this benchmark will eventually spiral into a financial
turmoil. Economists anticipate that another wave of financial catastrophe is on
its way and the 2008 response to the financial crisis, i.e. the Dodd-Frank Act
is not the rock that will be able to withstand it. This thesis explains why. In
1929, the sheer terror in the eyes of bankers was that of a potential financial
collapse. The general adherence to the unspoken rule of having to finance
institutions that are too big to fail led to bankers losing money and taxpayers
losing even more money.
Franklin
D Roosevelt saw through the mist that clouded general perception. On June 16th
1933, the Banking Act of 1933 was approved and a landmark legislation was set
in motion to change the financial history of the USA. Financial architecture
was largely in place until the law was repealed in 1999. Deregulatory
influences began in the 60s and 70s in what was known to be the efficient
markets paradigm (EMP), which stood for the notion that market prices reflect
fundamentals. Undisputedly, it is now understood that the former view was
flawed. In fact, this has been the turning point for disciplines within the
socio-legal approach that deviate from standard assumptions of analysis. In his
book entitled ‘Predictably Irrational’,
Dan Ariely, a behavioural economist explained why standard assumptions in
economics are prone to fail and that markets do not always get it right. This
is why the financial industry saw a pivotal change in general perception when
Greenspan confirmed this view in admitting that he was mistaken as the chairman
of the Federal Reserve in assuming that markets are inherently self-correcting.
It was later revealed that his governance at the central banks was heavily
influenced by Ayn Rand’s philosophy of all systems being free of government
intervention.
The 2008
shock to the system should have given adequate reason to walk in the intrepid
footsteps of Roosevelt in the 1930s. However, as Georg Hegel once said, history
teaches us how we never learn from it. George Santayana added that those who
cannot learn from it are doomed to repeat it. The Dodd Frank Act has not learnt
much from history and is on the verge of repeating it. The course of economic
prosperity was reversed as the Glass Steagall Act was repealed by the Gram
Leach Bliley Act which sought to“enhance competition in the financial
services industry by providing a prudential framework for the affiliation of
banks, securities firms, insurance companies, and other financial service
providers, and for other purposes”. Note that the wording of this purpose statement
stems from the assumption that financial services will remain anti-competitive
so long as the Glass Steagall Act is in place. This was the first mistake.
Second, it is enabling exactly what was happening before the Great Depression.
History has taught us the impact of bad legislation but there is not much to
tell us about the impact of ‘confusingly
verbose’ legislations which is exactly what the Dodd Frank Act appears to
be. The four regulatory objectives that the Dodd
Frank Act (DFA) seeks to achieve are: (i) market confidence, (ii) financial
stability, (iii) consumer protection and the (iv) reduction of financial crime. The
DFA seeks to promote the financial stability of the United States by improving
accountability and transparency, ending too
big to fail (TBTF) and protecting taxpayers and consumers from abusive
financial services practices. The DFA’s strengths include an
emphasis on banning proprietary trading, stress testing, creation of research
bodies such as the Office of Financial Research (OFR), the Act has several
weaknesses. The DFA neither simplifies supervision of its research or
consumer-protection oriented bodies and nor does it solve the regulatory
arbitrage problem. It does not go far enough in terms of regulatory
requirements for nonbanks. The overly complex and uneven nature of the
regulation is outworked into weak supervision of financial malpractices and
excessive regulation of others. Another shortcoming of
the DFA is that it neither advances the quality of supervision of its
supervisors and nor does it provide the required governance when the
application of regulation becomes arbitrary.
This essay begins by explaining the history of financial
regulation in the United States in the relevant socio-political context
followed by an investigation of the socio-legal scholarship about the
effectiveness of the DFA in ensuring financial impregnability. An analytical
discourse, inclusive of a critical and supportive stance is then presented to
form a systematic framework of knowledge that is intended to incline the
reader’s views in favour of the assertion that the Dodd Frank is an
unexceptional piece of legislation that borders on being a mediocre response to
the 2008 crisis. The DFA could have gone further but did not go all the way to
ensure financial impregnability. This paper gives special emphasis to Section
619 that proposes a ban on proprietary trading and on Title VII (section 752)
of the DFA that advances greater transparency and accountability in Wall
Street. Both sections give a good understanding of how far the DFA has gone
already but also how much further it could have gone from here. Section V (of
this essay) also explains the regulatory dynamics at play by assessing the DFA
using a Law and Economics theory of regulation
and blending these insights with an analytical revisit to the Volcker Rule
followed by a defence of the soft-law aspects of the DFA to assert that
non-binding rules do have the potential to be more coercive than hard-binding
law. Despite this has not been the case with the DFA, it is an important aspect
that must be taken into consideration. Section VI A. (of this essay) discusses
the legal implications of tax law that might be implemented in the near future
to fill the gaps that the DFA has left in the regulatory architecture. There is
a brief discussion about insolvency regulations followed by tax-intensive
solutions for future rule making. Section VIB.gives a practical dimension to
our analysis by insights derived from two professionals in the finance
industry. Section VII discusses the limitations of this study and section VIII
concludes.
This research is highly relevant and arguably the most
important topic in International Financial Law, given the course of recent
events and the fact that the decade since 2008 is expected to be the defining
regulatory decade in history. Note that this is not necessarily a positive
attribute because, while the prospect of safeguarding people’s best interests
and tax payer money is unquestionably good, the alternative of spiralling
deeper into another crisis by virtue of deceptively worded laws is now a real
possibility. The repeated failure of Basel Accords is no longer sparking
solution driven debates but distress driven arguments leading to opinions and
academic perceptions being skewed to please the influential.
Methodology: Socio-Legal
Approach: A Reasoned Choice
The Socio legal approach will be adopted for the purpose of this
dissertation because it bridges the divide between law and sociology, social
policy, social psychology and economics (Salter,
2007). These disciplines will form the core elements of this
dissertation which makes the Socio legal approach an apt choice. This legal
dissertation aims to provide a complete coverage of its topic in a wholesome
way and seeks to explain the existence of the gap between ‘law in books’ and
‘law in action’ (Salter 2007). This shall be achieved by considering what the
Dodd-Frank Act intends to achieve on paper and what the most practically
feasible outcome is. Both considerations will complement one another in that
the first blends the interaction of hard law and soft law (given the dual
nature of the DFA) our analysis and the second considers the behavioural impact
of binding law on market participants. United
States will be the focus of our analysis, however, given the interconnectedness
of the financial system, selected financial centres in Europe shall also be examined
to enable a well-rounded perspective. United States has been chosen as the
centre of this analysis because it was the epicentre of the financial crisis in
2007 and the great Depression of 1933. The USA gives a fairly good
representation of the western world’s financial architecture. There will be
occasional parallels drawn to the United Kingdom. These parallels will not be
comparative, but complementary coming under the purview of the broader theme of
this research. Such analytical digressions will be made only to bolster overall
arguments, not to substitute them.
II.
Literature Review:
a. Legislative History in Context
The
assertion that the Dodd Frank Act is a political act in legal clothing is
gradually gaining momentum. The Act has been subject to political infighting
lubricated by well-funded lobbying efforts on behalf of the biggest banks. The
course of America’s regulatory history is indicative of the influence of
questionable political and monetary motives and the DFA is no exception to this
historic pattern. A post-1930s flashback would offer compelling reasons to
believe this. Having traced the roots of the Wall Street Crash of 1929 (also
known as Black Tuesday), Ferdinand Pecora (1968) learnt how legal chicanery enabled bankers to
remain in the darkness of non-disclosure to breach their fiduciary duties in
plain sight. The crash followed a speculative bubble in the late 1920s, but its
cause was the collapse of an unregulated banking system (Friedman and Schwartz, 2008, p. 443). Black Tuesday marked the end
of the Roaring Twenties
and also the beginning of a decade long depression that unleashed a wave of
economic despair. The Pecora investigation, backed by President Roosevelt
sought to uncover the causes of this collapse (Ritchie,
1977). Upon examining high profile witnesses, including the nation’s
most influential bankers and stockbrokers, it was revealed that banks were
involved in a wide range of abusive practices that included a variety of
conflicts of interest such as underwriting of unstable securities to clear off
bad debts. The hearings galvanised broad public support for banking and
securities laws. The Pecora Commissions findings lead to President Roosevelt
signing the Glass Steagall Bill into law. The Glass Steagall Act (also known as
the Banking Act of 1933) separated investment banks from commercial banks. In
the following year, the US Congress then instated the Securities Act of 1934,
which formed the SEC to regulate stock exchanges.
The
Glass-Steagall separation of commercial and investment banks was incorporated
in four sections of the Banking Act of 1933. Jointly, sections 16, 20, 21 and
32 prevented commercial banks from (i) dealing in non-government securities for
customers, (ii) investing in non-investment grade securities for their own
benefit, (iii) underwriting or distributing non-governmental securities and (iv)sharing
employees with companies involved in similar activities. Before the 1930s,
there was light regulation of the financial industry. The GSA led to America’s
financial architecture being unscathed until Professor Eugene Fama published
his Ph.D thesis in the 1965 advocating the efficient-market hypothesis
suggesting that financial markets do not need regulatory intervention by
governments because markets are inherently self-correcting. The efficient
markets hypothesis or efficient markets paradigm (EMP) emerged as a prominent
theory that gained the strong academic support. As its anti- interventionist
views gained momentum, so did the view that speculative bubbles were merely
‘anomalies’ and that deregulation was the key to foster competition and enhance
economic efficiency. All it took was a flawed ideology that snowballed itself
over time and led to shrewd justification of the morality of greed in the guise of enhanced competitiveness. The
phrase ‘morality of greed’ refers to
the moral appeal of the 1960s dictum that ‘markets always get it right’. The
oxymoron offers a convenient way of explaining that unconstitutional
legislations can make their way to the Congress disguised as ethically
acceptable and socially beneficial laws. By 1999, the EMP had transformed
itself from a dangerous idea to multiple hearings in Congress in the 1990s and
finally to the repeal of the Glass Steagall Act. Without the laws enforced by
the GSA, the American economy was no longer impregnable to the risks exposed by
securitisation and investment banking. The GSA was repealed by the enactment of
the Gram-Leach Bliley Act which sought to make the American economy more
competitive. This legal failure lead to an economic collapse followed by a corrective
legislation (DFA) which is the longest piece of financial legislation in the
United States. The DFA established multiple agencies to improve consumer
protection, which might seem to be beneficial at first glance, but it brings
the legal complexity of overlapping jurisdictions and conflicting objectives of
regulatory authorities (See Appendix II. d).
It
has now five years since the passage of the Dodd Frank Act 2010, however the
law is far from being fully implemented (U.S. Government Accountability Office,
2013). In November 2013, at the time of writing, 280 Dodd Frank rule making
deadlines were passed. Of the 280 deadlines, 170 have been missed (61%) and 110
(39%) have been met with finalised rules. In addition, regulators have not
released proposals for 60 of the 170 missed rules (Davis, 2013). Apart from
this, there are 118 other rulemaking requirements without a deadline for a
total of 398 rulemaking requirements. Of there, 41% have been met with
finalized rules. Rules have not yet been proposed to meet 121 (30% of the
required rules. One can speculate as to whether 40% of the rules that are
finalised are the hardest or the easiest 40%.
There
are four key reasons impeding effective implementation of the Dodd-Frank Act.
(i)Brand new institutions (ii) Complicated rule writing (iii) Global
implications and (iv) Regulatory overlaps. First, DFA created multiple brand
new institutions form the scratch. The SEC was five new offices. The CFPB hired
a thousand new members of staff. Having this many new employees in its first
two years meant that the CFPB was an organisation with no institutional memory,
precedents or established way of doing things which explains why it missed most
of its deadlines. Second, it seems to be almost impossible to write rules that
Dodd Frank requires. The original bill was 848 pages and for every page of the
bill, 16 rules have been written-and the rulemaking is only 40 percent
complete. The rules are much longer than the bill because they include needed
definitions, clarifications, exceptions and exemptions. If Dodd-Frank mandates
were easy to put into practice, the rules would be shorter. The Volcker rule
serves as a good example. In the Dodd Frank Act, the rule was 11 pages long
(Schultz, 2014, p. 226). However, in November 2011, four agencies (of five) in
charge of writing the rule jointly put forth a proposal nearly 300 pages long.
The Volcker Rule grew from an 11 page idea to 300 pages because it asks
regulators to do something that is quite difficult in practice. The Volcker
Rule prohibits banks from engaging in proprietary trading (Whitehead, 2011) but permits bank holding
companies to engage in market making and risk management and to execute trades
for customers. In practice it is very difficult for regulators to differentiate
between these activities (Wilmarth Jr, 2010).
One needs to ask a few key questions. First, if a bank makes a market in a
security, is it allowed to be more aggressive on the buy side when it is
bullish on the security? Is that speculation or market making? Enforcing the
Volcker Rule requires us to determine a bank’s motives for trading, and that is
difficult to do.
Apart
from the perplexity in distinguishing motives, another reason why rulemaking is
taking a long time is that it has global implications even though U.S.
regulators do not have global authority. For instance, non-U.S. firms may be
required to register as major swap participants if they enter into enough swap
contracts with “U.S. persons”, so foreign financial firms will try to avoid
this designation by refusing to trade with US. firms. This may impede liquidity
in the swaps market. Further, complications may arise in treatment of
subsidiaries. For instance, the Japanese subsidiary of Goldman Sachs would not
be considered a U.S. person and could trade swaps freely in other countries.
The
fourth reason for the delayed process of writing the Dodd Frank Act is that
more than a dozen regulatory firms are involved in the rule making process. In
many cases, their jurisdictions overlap, and in some cases, they are jointly
writing rules. These agencies include the CFTC (Commodity Futures Trading
commission), the SEC (Securities and Exchange Commission) and the FDIC (Federal
Deposit Insurance committee) along with several other regulatory committees.
b. Title VI: Section 619- The Volcker Rule
The
Volcker rule is widely considered to be a remake of the 1933 performance by Senator Carter Glass.
Glass had strong ideological antipathy to mixing commercial and investment
banking and had trying to limit the activities of commercial banks for more
than two decades (based on a theory of credit called the ‘real bills doctrine’
that currently has no adherents. Glass got his opportunity in 1933 when he used
a logroll strategy to incorporate his prohibition into the Banking Act of 1933
(Schultz 2014). Similarly, Paul Volcker got his opportunity to turn back the
clock a bit after the 2008 financial crisis in an atmosphere that was hostile
to banks. In retrospect, it is well understood that underwriting is a core
function of large banks but this not only took a financial catastrophe but a
round of regulatory negotiations and lengthy in-depth analysis.
The
potential costs of Volcker rule (Schultz 2014, p.64) start with its potential
effects on markets. It is established in the academic community that
proprietary trading must not be distinguished form an activity such as market
making. While the two activities are not observationally different, they
reflect different intent, which is unobservable. Therefore, the risk is that
Volcker Rule will end up prohibiting banks from engaging in market making.
Unsurprisingly, Schultz (2014, p.128) maintains this anti-regulatory stance in
asserting that ‘Universal banks’ must
be allowed to exist. Richardson also holds that the Volcker rule is a threat to
the continuing global importance of US banks and capital markets. This view is
based on the notion that banks are losing money due to regulation and that the
money lost is not worth safeguarding the economy from another crisis. This view
might be superficially different but is fundamentally similar to the efficient
markets paradigm propagated in the 1960s and 70s. The idea grew into the repeal
of the Glass Steagall Act which then led to the demise of ethics in banking.
One
of the popular critiques that the Volcker Rule is subject to is that it will
increase risk by decreasing diversification. This is more cleverly worded than
logically understood, therefore holding much deceptive influence. The argument
is that regulators will no longer allow banks to invest in certain securities
which will increase volatility of their portfolio. Richardson (2014, p. 119) considers this to be a bad argument
because it confuses idiosyncratic with systematic risk. In a crisis, we are
concerned with systematic risk when it emerges. When proprietary trading is
undertaken, the total risk (i.e. idiosyncratic and systemic) might be
decreased, but the amount of systematic risk is not decreased.
Title VI is intended to make improvements in the regulation
of bank and savings association holding companies and depository institutions.
It is comprised of 28 sections, of which Section 619 is about the ‘prohibition on proprietary trading and
certain relationships with hedge funds and private equity funds’. The
Volcker rule is one of the key provisions of the Dodd Frank Act, even though
the pertinent clause is only 165 words long, with key points covered in 40. The
(Economist, 2015b) reports that banks are now
effectively banned from two activities: proprietary trading and ties (through
investment and relationships) to hedge funds and private equity. The Volcker
rule has forced Goldman Sachs to close down two proprietary trading operations
and likewise for JP Morgan. So far as compliance is concerned, every time a
bank buys or sells a security, it is in effect taking part in a proprietary
trading as per section 619. This requires bankers to judge not only the assets
and liabilities, but also the intention associated with any transactions.
Whether this upheaval is worth it or not is a complication for the Dodd Frank
Act as a whole, but not for a Volcker rule in particular. The Office of the
Comptroller of the Currency (OCC) conducted a cost-benefit analysis revealing
that the benefits of the Volcker Rule at this point are largely unquantifiable
but include better supervision, better risk management, greater safety, fewer
conflicts of interest and the hope of avoiding another global catastrophe. Compliance
costs are often cited by bankers as the biggest hindrance to business. This is
because monetary benefits associated with deregulation lead them to ignore the current
state of affairs which indicate that regulation is the price of financial
freedom (see Gary 2011 and Tarullo (2012)).
This does not refer to the free markets ideology propagated by Greenspan or his
fellow bankers. Rather, financial freedom is the ability to exercise required
transactions on a day to day basis with transparency that ensures fairness and
legislations that ensure consumer protection. The general public is unaware
about the dynamics of financial markets and are easily lulled into devious
tactics which are legally exercised by bankers to exploit customers (as seen
during the sub-prime mortgage crisis). The OCC’s annual supervision costs will
rise by $10m, which is only a fraction of what banks are willing to pay as
settlement offers in case they are accused of financial crime and are guilty. On
the positive note, the inventory of securities has rapidly declined. In
addition, there are other benefits that are hard to quantify but do exist
nevertheless. Steeper compliance costs do cost more for big banks but they also
drive out competition from smaller firms. There is also the added benefit of
big bank losses in a crunch with some constraints on market liquidity. The Economist (2015b) reasons that investors usually require higher return to
compensate for holding less liquid securities, raising the cost of capital for
some companies and making it harder for others to raise money. In light of this,
it is likely that trading shifts to unregulated firms in the shadow banking
sector. Hence, effectively instead of extinguishing financial risks, the so
called ‘reforms’ may just lead to financial risks being much harder to spot.
c. Title VII—Section 752-
International Harmonization and Basel Accords
Title VII Wall Street Transparency
and Accountability
This
title consists of two subtitles that deal with regulation of swaps. Subtitle A
deals with the regulation of OTC swaps and Subtitle B deals with the regulation
of security based swap markets. Title VII imposes exchange trading for
derivative contracts. Along with exchange trading, it also imposes new capital
and margin requirements, reporting obligations on OTC swap dealers and major
OTC swap participants (Anand 2011, p.63). Swap dealers and participants would
be required to clear swaps through a clearinghouse to execute centralised
transactions. Title VII exerts its influence by levelling the playing field for
community banks by prohibiting the Federal Reserve or the FIC from assisting
depository institutions involved in swap markets. USA is leading the regulatory
reform and is promoting such a level of market discipline globally.
Section
752 of the Dodd-Frank Act calls for International Harmonization in order to
promote effective and consistent global regulation of swaps and security-based
swaps. This happens to be in line with Section 1a (39) of the Commodity
Exchange Act which requires consultation from foreign regulatory authorities on
establishment of a consistent global standard of regulatory control. Section
752 also calls for promotion of effective and consistent global regulation of
contracts of sale of a commodity for future delivery and options on contracts. Greene and Potiha (2012, p. 271) report this
extraterritoriality as a highly controversial aspect of US financial
regulation, especially with respect to the Volcker rule. In fact, through
section 929, the DFA allowed the SEC and DOJ extraterritorial jurisdiction. In
a supreme court case: Morrison v. National Australia Bank, 561 U.S. 247 (2010),
there were concerns about NAB’s purchase of a mortgage servicing company,
headquartered in Florida. The plaintiffs argued that the fact the alleged fraud
occurred in Florida meant that it should be subject to US securities laws.
However, defendants argued that since alleged fraud related to trading
Australian securities, US securities did not apply. An exhaustive analysis of
such co-ordination failures is beyond the scope of this essay, but aspects of
DFA’s global impact will be discussed in Topic VI b. with insights from a
telephone interview with Mike Heelan, Partner at a London based wealth
management firm.
Basel Accords, G20 and the DFA
This section looks at how other countries may
adopt some provisions of the DFA, understand its impact on US banks, and relate
the Act to the European debt crisis, Basel III and G20. The DFA includes a new
set of firms in the regulatory architecture that intend to curb the harmful
effects of the crisis. The Act is considered beneficial for financial
stability, though there are objections about how effective its elements really
are. Its influence is channelled through market instruments like capital
requirements, returns, leverage, risk taking, transparency and innovation in
both small and large banks. US banks have particularly tight restrictions and
limitations on financial activities while other countries follow quite a
liberal model in comparison. Leading world economies such as Germany, UK and
Switzerland are still operating under the universal banking
model (Saunders and Walter, 1994) and
might not be ready to implement the DFA just yet despite America’s persistent
nudges to do so. This has already given rise to global inconsistencies between
world economies. Regardless of the time it takes for global markets to respond
positively to these provisions, one can safely say that America is at the
forefront of global financial reform (Pope and
Lee, 2013). Moral hazard and risks faced by large financial firms are
now blocked by the Volcker Rule. Section 619 also inhibits banks from growing
locally to merge assets and get involved in acquisitions. Larger banks do not
face such restrictions because they are at an advantage due to benefit
programme in place should they face bankruptcy in high investment-risk
situations (Anand 2011, p.118). Adoption of such a rule could potentially
weaken global competitiveness of a country and/or clash with rules governing
financial industries of other counties. Besides, the merger and acquisition
provisions of the DFA can curb the realisation of other countries’ dreams to
establish megabanks.
The Dodd Frank Act has had a radical shift in
its treatment of non-US investment advisors. There were exceptions about non-US
advisors registering with the SEC which have now become far more restrictive.
The exemptions were sought after because registering with the SEC would make it
more expensive to conduct business. Moreover, non US investment advisors that
do register with the SEC are required to manage books and keep records, follow
compliance procedures and establish a code of ethics alongside insider-trading
policies and procedures (Anand 2011, p.118, 123). Given the US regulatory reforms and global
inconsistency with these rules, global regulatory architecture faces a great
deal of uncertainty (Packin, 2013). In
addition, the sovereign debt crisis in Europe has directly affected the
American and European banking industry. Since there is no consensus on the peak
default rates in certain products, uncertainty pervades the banking sectors of
both continents (Koehler, 2011).
Basel Committee changes are being implemented
at a glacial pace, given the need to understand the impact of raising capital
requirements before global implementation takes effect (Coffee Jr, 2011, Lee, 2011). The G20 summit insisted other nations
joining the financial reform regime and
also discussed the restrictions imposed by the Volcker Rule. Anand (2011)
reports the finding that the Volcker Rule affects local markets is short-lived
but implementation to international markets might decrease foreign investments
in local stock and derivatives markets significantly. Europe and The United
States are divided on the issue of currency rate management. Correspondingly,
it is observed that this difference exists in policy approaches toward fiscal
austerity measures and has outworked itself into the G20 Toronto Summit
regulatory reforms (in June 2010) which saw the USA, UK and Germany in favour
of financial tax whereas Japan, Canada and Brazil were clearly opposed to it.
The DFA has affected investment companies
indirectly but strongly. The Act also restructures the SEC and its management
so that the SEC can provide more effective oversight in the context regulatory
framework. While the DFA lacks jurisdiction over mutual funds, it establishes
the investment advisory committee under the SEC to address matters regarding
general SEC requirements and investor protection. The SEC also has the
authority to enforce compliance against investment companies found in breach of
fiduciary duties.
This is expected to be enhanced given SEC’s
newly organised enforcement division and ability of senior staff to get tough.
For private fund advisors, the Dodd-Frank Act requires the SEC to conduct
studies to evaluate standards of care in advisor client relationships instead
of creating fiduciary standard provisions. The SEC will also be required to
submit a report comparing regulatory standards for broker-dealers with those
for investment advisors (Anand 2011, p.125). The SEC should also explore the
financial literacy of retail investors, specifically regarding mutual fund
shares.
The DFA brings enhanced transparency regarding
derivatives and enables regulators to manage individual counterparty
transactions and mitigate systemic risks. OTC Derivatives came under a series
of changes which affected economies involved in hedging transactions that could
impact investment strategies in the short run as well as in the long run.
Moreover, the DFA extends provisions within the Sarbanes-Oxley Act with respect
to non-US public accountancy firms. New regulations are intended to make the
financial industry experience see-through changes in individual models
which could be examined and assessed by market participants with much more ease
than before.
The Dodd Frank Act permeates its influence through many aspects of the
banking industry including returns, innovation, capital requirements, risk
taking and leverage. Other countries are still reluctant to catch up on
regulatory reform since the Act raises the regulatory bar to a new level for
mortgages and derivatives. The major unintended consequence of the DFA at this
point is global inconsistency which allows large financial institutions to fail
and hedge funds to collapse. In the long run, however, this could be seen as
beneficial for the public, given that their funds are safeguarded from being
exploited.
d. Cross-border
Insolvency: a pertinent nexus
Regulatory Overlapping and Cross border insolvency
There
is indirect link between the DFA and cross border insolvency issues that are
relevant to this study. Having instituted the Orderly Liquidation authority
which requires firms to have an adequate stock of capital, its functions are
not dissimilar from managing insolvency proceedings (see White et al. (2013, p.
174)). The European structure for protection of creditors has encountered and
undergone a momentous transformation in recent years. With increasing financial
interdependence worldwide, there has been a sharp surge in insolvencies. In
order to address this rapid spread of cross border insolvencies, international
organisations have made many efforts to enhance international cooperation. The
most notable among these is the UNCITRAL model Law on Cross Border insolvency
passed by the United Nations Commission on International Trade Law (UNCITRAL)
in 1997. Seven years later, the United States followed suit by its own analogue
of UNCITRAL, known as the famous Chapter 15. The EU Regulation came in May 2002
and unlike the Model Law, EU Insolvency Regulation was never intended to apply
to nations outside of the EU. The broad goal of the EIR, like UNCITRAL was to
make administrative procedures for cross border insolvencies more efficient.
However, given the globalisation of financial transactions, the globalisation
of financial regulation is inevitable. The EIR gives automatic recognition to
cross-border insolvency proceedings within the EU and establishes rules
regarding when courts have the authority to open proceedings related to
insolvency.
The
EIR has provisions which deal with the prevention of forum shopping. Such
provisions are largely missing from Model Law. This essay supports the view
that creditors that are similar must be treated similarly across borders
(Lastra (2011) and (Wessels et al., 2009)). In case of prejudice or
differential treatment, justification by overriding public policy objectives
and, if appropriate adequate compensation will be required.
Some
individuals mistakenly consider cross border insolvency as a topical phenomenon
given the array of significant corporate insolvencies over the last few
decades. In fact, it is a phenomenon firmly rooted in the history and the
development of international financial law (Smart, 2008, p.1 ). Insolvency
matters related to international co-operation date back to the 19th century
which is when cooperation was a hit or miss and was often dampened by the
inflexibility of reciprocity requirements (Lastra, 2011, p.188). Solomons v
Ross was a landmark case in the
mid-nineteenth century, where Bathurst J made it clear that English courts were
prepared to recognise foreign insolvency proceeding taking place in the
domicile jurisdiction of the debtor. This was done to avoid confusion and
conflict which would arise if creditors were allowed to circumvent, by relying
on legal rights available in England. Similar legal developments in other
European countries led to a fascinating history of insolvency and bankruptcy
proceedings.
Bankruptcy
laws in ancient Rome allowed for debtors to be imprisoned or put to death if a
debt for which a judgement was given remained unpaid for thirty days (Wessels
et al., 2009, p.3). In the middle ages, execution of assets for the benefit of
creditors was commonplace. In fact, the word ‘credit’ comes from the Latin word
‘credere’ which means to put one’s trust in someone. The Italian proverb
‘Fallitus ergo fraudator’ meant bankrupt, implying that debtors were crooks
(p.5). The perception of debtors as criminals was typical until relatively
recent times. In the mid-1800s, debates around slavery, imprisonment for debt
and bankruptcy coupled together leading to the widespread abolition of
imprisonment for debt and the development of federal bankruptcy law (See Man,
2002, cited in Wessels, 2009, p.8). This paved the way for the Bankruptcy Act
of 1898 which focussed on the rehabilitation of the financially failed and
reinvigoration of economic synergies. These policies ‘were largely recodified’
(Wessels et al., 2009, p.8) in 1978 with the adoption of the Bankruptcy Code
and its famous Chapter 11 which permits reorganisation under Bankruptcy laws of
the United States. The journey from indebtedness being treated as a moral
failure to now being treated primarily as economic one, while controversial, is
interesting to say the least. This very discourse could spiral into notions
about behavioural attributes related to bank-lending that fed the recent global
debt crisis itself. Without further digression, one important point the reader
must be aware of is that bad lending was the origin of the liquidity crisis,
which upon development led to what we call a ‘solvency crisis ’.
Bankruptcy’
is the word on the street during financial turmoil. Bankruptcy reforms are
aimed at preventing the abuse of the bankruptcy process. The only safeguard to this happens to be
bankruptcy judges themselves. Bankruptcy laws give judges almost complete
discretion whether to allow a sale to go forward or not (Skeel 2010, p.171).
However, this is in sharp contrast to discretion in other contexts, which are
nearly always constrained. For instance, a bankruptcy judge must ensure
adherence of a company’s proposal with 16 different requirement that the plan
must satisfy before approval. The great irony in this case is that unfettered
discretion can effectively become no discretion at all. Consider a hypothetical
situation with a debtor and lender, where the debtor (company in financial
distress) is desperate for cash. The lender insists that the debtor obtains
approval of the proposed loan soon as the company files for bankruptcy. If the
lender also wants to buy the debtor’s assets, he can leverage his position by
threatening to pull the plug and withdraw funding. In such a situation,
although judges theoretically have complete discretion, in reality, they have
very little, especially if the threat is credible. A similar situation arose
when the government intervened as the lender of Chrysler and GM making similar
threats, putting bankruptcy judges in ‘impossible positions’, as Skeel (2010, p.172)
puts it. Such issues could be resolved by simple reforms to prevent the
government from using sham sales to restructure companies. Mark Row, a
professor at Harvard suggested a proposal to forbid a company from using the
bankruptcy sale provision to sell its assets subject to the clause that half of
the debt of the buyer will be held by creditors. Skeel (2010) propounds that
such a rule would plug the hole in bankruptcy laws.
Skeel explains the
understandable temptation to repeal the Dodd-Frank Act given the unintended
consequences of a government-bank partnership being forged, hence laying the
foundation of future unintended consequences. However, this would be a mistake
since parts of the legislations are genuine improvements and limited repeals
are deemed to have slim chances of being effective. Skeel advocates a response
that looks for opportunities to bring market actors and rule-of-law principles
back into picture in an era that will be defined by government regulation.
Bankruptcy will be at the centre of public attention like never before.
Interestingly, all the rule-of-law virtues are embedded, but are subverted at
key points in Dodd-Frank, specifically in reference to systematically important
financial institutions (North and Buckley, 2012).
The fundamental changes needed would require less than 1% of the pages required
by the Dodd-Frank and would yet be a giant leap toward a more balance and
stable regulatory framework.
V. Analytical
Discourse
a.
As strong as
your weakest link
Despite
the prohibition imposed on the Fed from making single company loans, investment
banks could easily circumvent this restriction via the broad-base program which
could be established so long the bank just happened to benefit a systematically
important firm that was on the verge of a default. The run-up to the crisis led
to such unprecedented levels of regulatory creativity during the crisis. This
is one of the examples demonstrating how the Dodd-Frank provides the government
with new platforms to partner with large banks. It is easy to assume that after
all this, taxpayers were safe. However, this is a premature deduction, given
Skeel’s assertion that while a privately funded bailout does not directly
implicate the taxpayer funds, it has many of the same pernicious effects. Packin (2013) identifies a similar loophole in
the Dodd Frank Act is in its ‘Living will’ provision (Section 165, a) which
requires companies to be closed down in an orderly manner in case they spiral
into financial distress. The provision loses its clout since the requirement
applies only to companies that have formally been designed to be systematically
important. In addition, Skeel maintains that managers are unlikely to develop
serious and realistic plans (as part of living wills) unless regulators are
unusually vigilant.
Skeel
(2010, p.142) admits that controlling systemic risk is one thing that the DFA
may be able to do ‘tolerably well’. That said, it will do so by smuggling
bailouts into the resolution regime. The DFA has two sets of rules that tackle
the FDIC resolution of ordinary banks (Baird and
Morrison, 2011). The first is a special set of rules for derivatives
known as qualified financial contracts (QFCs) and the second is broad
discretion for the FDIC to fund almost anything it wants. Let us consider a
simulation to understand how the DFA would deal with systemic risk. Suppose
that a systematically important institution like AIG in 2008 filed for
bankruptcy. Theoretically, all its counterparties could cancel their contracts
at the same time and if everyone sold their collateral at once, it would drive
down asset prices and make the existing crisis even worse. The DFA addresses
such risks by putting the counterparties’ right to cancel their contracts on
hold for some time. During this time, the FDIC has the decision as to whether
the contract is repudiates or counterparties are paid in full. The FDIC’s
choice is ‘all or nothing’ which means that it could either repudiate all the
contracts or none of them. The DFA allows the FDIC to buy a (financially)
distressed company’s assets to guarantee its debts. The Dodd-Frank authorises
the FDIC to harness the borrowing power of the US Treasury to finance such
interventions. Skeel (2010, p.145) propounds that if there is any virtue to
this money pot, it is the FDIC’s flexibility to prevent systemic crisis. The
vice, nonetheless, would be the FDIC’s sweeping authority invites interventions
that that are essentially bailouts. FDIC decisions are initially funded by the
treasury and Dodd-Frank does try to limit taxpayers’ responsibility in funding
the FDIC. Such provisions make ‘Dodd-Frank’ enthusiasts celebrate the end of
taxpayer-funded bailouts. While this is a step in the right direction, Lissa Lamkin (2011, p. 80) warns that it is perhaps
too early to celebrate and convincingly argues (in agreement with Skeel (2010,
p.145)) that we may still see bailouts outside the resolution regime and while
FDIC interventions may have many of the same damaging effects as a bailout, it
just won’t be a taxpayer-funded bailout.
With
many rules yet to be written (see appendix II b), one must exercise caution in
trying to ascertain the effectiveness of the Dodd Frank Act. Notwithstanding
the challenges posed by incomplete legislations, even after the rules have been
written, one can anticipate significant challenges in congress proceedings and in
court, given the historic patterns of snail-paced procedures before
finalisation of legal amendments. For
instance, the House of Representatives voted to roll back the swaps push-out
rule causing severe delays in enforcing financial stability. In addition,
financial institutions and practices will evolve to circumvent Dodd-Frank
regulations. This calls for a more drastic change in the law. Instead of having
over 2000 words of complicated jargon, one could go back to the Banking Act of
1933 in effectively separating investment and commercial banks. The problem is
that regulators are trying to look for a solution that pleases everyone,
therefore leading to a framework that is so complicated that it no longer
remains a framework, but a non-binding guideline at best and an abstraction at
worst. Human nature is such that if an individual is told that he must not
cross a line, he will cross it until and unless the line is encircled by a wall
with barbed wired. This expression is a simplification but it serves as a
convenient benchmark in asserting that human beings are prone to making errors
contrary to optimal outcomes to society as a whole. This aspect of the
dissertation focuses heavily on the law and economics approach of regulation
blending unique insights from behavioural economics and legal outlines from
original legislations and acts. The legal aspect of this dissertation relies
more heavily on the wording and outworking of the original acts because there
are not many landmark cases in the field of American Financial Law, given that
the law has only been existence for five years and has not even been completely
written yet. Notwithstanding the DFA’s present infancy, future research could
provide an analytical account of government proceedings and court hearings in
relation to financial crime and the writing of the Dodd-Frank Act.
Nathan
(2015) asserts that antifraud laws already address the abuses and certain
conflicted transactions, hereby insisting that Section 621 of the Dodd-Frank
Act which prohibits conflicts of interest in asset backed securities is
unnecessary. Abacus, a CDO created by Goldman Sachs &Co., became a symbol
of a corrupt system when it became known that Goldman and Fabrice Tourre, a
Vice President at its correlation desk had assisted a hedge fund in designing
the security to fail. A full analysis of ways that DFA impact the financial
industry is beyond the scope of this paper and could fill an entire treatise.
We shall only discuss elements relevant to our analytical discourse. These are:
(i) Section 621(ii) Section 619 and (iii) Section 941. Title VI, Section 621 of
the Dodd-Frank Act states that ‘an underwriter or initial purchaser of any
asset backed security shall not, at any time for a period ending on the date
that is one year after the date of the first closing of the sale of the asset
backed security, engage in any transaction that would involve or result in any
material conflict of interest with respect to any investor in a transaction
arising out of such activity.’
This
law is progressive in that it recognises that certain traditional investment
banking activities are unlikely to harm investors. This provision makes
exceptions for the following: (i) hedging transactions designed not to make
money for the bank but instead to reduce the risk caused by a separate trade
(ii) underwriting and (iii) market-making, meaning buying from customers who
want to sell and selling it to customers who want to buy without any
expectation of profit or loss from the transaction. Though the proposed rules
are fifty pages long in entirety, they fail to precisely define a ‘material
conflict of interest’. Nathan (2015, p. 621)
justifies this, in agreement with the on grounds that any definition might be
over or under inclusive due to the inherent complexity of securitised markets.
As an alternative, the SEC proposes a test which suggests that a party has a
material, and, therefore prohibits conflicts of interest if: (1) the party
concerned benefits from adverse performance of sn underlying security and if (2)
the party controlling the selection of assets in the security will receive
benefits from a third party with an interest in the adverse performance of the
security and allowed that third party to help select these assets. It is
substantially likely that a reasonable investor would take this into account in
making an investment decision. In short, the proposed rule prohibits what was
formerly illegal only if undisclosed (see Appendix IVb. for legislations linked
to non-disclosure).
Section 619 and 941
Since
many consider securitisation to be part of the key causes of the financial
crisis (see Stout (2011)), it has been
addressed by multiple sections within the Dodd Frank Act. A comprehensive
discussion of all those sections is beyond the scope of this paper.
Nonetheless, we shall discuss two sections that particularly stand out: Section
619 and Section 941. In fact, the final text implementing the rule, known as
the ‘Volcker Rule’ runs to roughly 1000 pages. This paper only examines
provisions prohibiting conflicts of interest and the exceptions from the
proprietary trading rule. Since
regulators have already begun interpreting exceptions in Section 619 and 621
are worded similarly, it is important to understand the way these have been
applied under that rule, where rulemaking has yet to be completed.
The
Volcker Rule proscribes proprietary trading by banking entities subject to
certain exceptions, which, like the exceptions to Section 621, allow an
otherwise prohibited trade if it is for the purpose of underwriting,
market-making, or risk-mitigating hedging, along with other minor exceptions.
This implies that under Volcker rule, proprietary trading while generally
prohibited, is allowed if the trade falls under a recognized exception. That
said, there is a backstop prohibition against conflicts of interest, meaning if
activity that would otherwise fall into an exception results in a conflict of
interest, it remains prohibited. The conflict of interest backstop in the
Volcker rule, unlike Section 621, allows issuers to “cure” their conflict of
interest by either disclosing the conflict prior to engaging in the transaction
or using informational barriers within the firm to prevent it from benefitting
from this conflict.
Note
the ineffectiveness of the law considering that the conflicts prohibition in
the Volcker Rule is, in a way, the inverse of Section 621. The Volcker Rule
allows hedging or market making unless those activities result in a conflict of
interest not cured through disclosure or information barriers. In contrast,
Section 621 prohibits conflicts of interest unless they fall into a listed
exception like market making or hedging and does not allow issuers to remedy
their conflict through disclosure or information barriers.
Section
941, also referred to as the risk retention provision adds a new section to the
1934 Act requiring creators of asset backed securities like CDOs to put “skin
in the game” by retaining at least five percent of the credit risk for any
security they create. This is a very effective provision in that it makes sure
that one who are taking the risks have a vested interest in the investment,
thereby reducing conflicts of interest.
Note
that even without the clarity of a final rule, and despite the exceptions for
certain activity, the scope of Section 621 is wider than prior law and
prohibits a great deal more than was illegal before. In addition, other
sections of the Dodd Frank Act are better suited to remedy the illegal activity
at issue in Abacus. As noted above, the abuses in Abacus were already illegal
under federal law. The broad scope of Section 621 sweeps in market activity
that is good, which could distort the market, while the detrimental activity it
prohibits was already illegal.
b.
Title XIV Mortgage Reforms: A proxy measure of Impregnability?
Title
XIV- Mortgage Reform and Anti-Predatory Lending Act
Title IV imposes requirements on mortgage
lenders and prohibits specific financial incentives that would cause a mortgage
lender to steer a consumer to a mortgage of higher cost. Subtitle A specifies certain
origination standards and also bans residential loans unless the consumer’s
ability to repay the loan determined is reasonable. Both, depository
institutions and mortgage lenders come under these regulations. Title XIV
effectively creates mortgage originator duty of care and underwriting
requirements that depend on the customer’s ability to repay a loan at the time
of origination. It also protects consumers by prohibiting steering incentives
for mortgage originators, yield spread premiums and prepayment penalties. The
mortgage needs the provisions issued under the Truth in Lending Act (TLA) by
the Bureau of Consumer Financial Protection (Dodd Frank Act 2010, Section
1401). Creditors are now requires to determine whether customers have
reasonable ability to repay loans before making mortgages. Such determinations
must be made on credit history, income, employment and other financial
resources. Finally, the Mortgage Act also allocates emergency mortgage relief and
other complementary stabilisation programmes (Anand 2011, p.118). From a legal
aspect, the most important thing that the reader must be aware of is that
unlike pre-2008, the mortgage originator has a duty of care with regards to
underwriting requirements for a consumer’s ability to pay and document
requirements. During the sub-prime mortgage crisis, banks leveraged this
position by issuing loans at arms-length. Fannie Mae and Freddie Mac had a
monopoly over the mortgage market during the crisis and their neglection of
lending best-practices towards clients fuelled the sub-prime mortgage crisis.
One of the shortcomings of the Dodd-Frank Act is that it does not address
mortgage reforms in the context of malpractices conducted by Fannie Mae and
Freddie Mac (see Appendix II.c). In 2008, creditworthiness of the mortgage
buyers did not legally oblige the seller to advise buyers in good faith because
(the deal was reliant on increasing house prices and) there was no duty of care
because it was known that the loans were ‘sub-prime’ and were deliberately
issued to those without the ability to pay for it.
c.
The Good, Not So Good and Vaguely
Obscure
DFA-Good
The DFA two aspects that are almost undisputedly beneficial
for the American economy. They are (i) emphasizing the Role of Capital and (ii)
reducing the Centrality of Large Credit Rating Agencies. Firstly, Dodd-Frank
underlines the role of capital in the future prudential regulation of financial
institutions. It is essential that prudential regulators remain diligent and
vigilant in the enforcement of higher capital levels. Secondly, it is possible
that designating a financial institution as a SIFI (Systematically Important
Financial Institution) might cause financial markets to believe that an
institution might be too big to fail and that its creditors would need to be
bailed out if it is in financial distress. This would give the institution an
unwarranted advantage, however the DFA prevents this by making prudential
regulation more onerous if an institution seems a bit too eager to attain a
SIFI designation. Secondly, financial institutions were heavily reliant on
rating agencies in making choices for choosing bonds for investment. This
overdependence aggravated the consequences of rating agency errors in being overconfident
about the creditworthiness of mortgage-backed securities with poor-quality
mortgages as collateral. In response to these issues, the Dodd-Frank Act
repealed all statutory language mandating the use of ratings in their
regulations and managed to reduce the centrality of ratings.
Another useful aspect of the DFA is the Orderly Liquidation
Authority (OLA) which entitles the FDIC to act as a receiver for insolvent
depository institutions. The bankruptcy of Lehman was highly disruptive to the
financial climate in America and triggered bank runs by short-term debt holders
of other investment banks. In theory, this means that the Dodd-Frank limits the
occurrence of such events by giving receivership powers to the FDIC for
insolvent firms. The FDIC has not yet finalised all its procedures for OLA as
it investigates the facilitation of ‘contingent capital’ (see Appendix IIIa.)
which is debt that can be converted
into equity in case of financial distress. Altogether, the actual
implementation and enforcement of the FDIC’s OLA authority will be crucial.
Finally, the DFA must be credited for its emphasis on stress testing to
simulate financial crisis conditions to ensure preparedness for the worst
possible outcome. An exhaustive analysis of stress testing is beyond the scope
of this paper. However, all the reader needs to know is that while facilitation
of stress tests is useful for ensuring people know what to do when disaster
strikes, it is not a substitute to core provisions such as Section 619 or
Glass-Steagall like legislations.
DFA- Not so good
Firstly, concerning the regulation of Interchange Fees on
Debit Cards, White et al. (2013, p. 180)
made a logical observation that debit card networks played no role in the
financial crisis and that regulation via interchange fee imposed on these
networks under the Durbin amendment of the Dodd-Frank Act was unnecessary and
counterproductive. The Durbin amendment required the Federal Reserve to limit
fees charged to retailers for debit card processing. The second aspect that is almost unanimously agreed
upon is the absence of tax on size (see White et al. 2013 and Acharya et al.
2010). Despite the proposal of a tax on the size of large financial
institutions by the Obama administration in 2009, the idea didn’t gain any
traction and was not included in the Dodd Frank Act. Secondly, even though some
policy-makers believe that Fannie and Freddie should operate at the centre of
mortgage markets, the DFA is silent with regards to any actions regarding the
government sponsored entity’s future. This has left the structure of
residential finance in America hanging in a limbo. Finally, the absence of tax
on size is an undisputed shortcoming of the DFA and shall be discussed further
in topic VI of this essay. Emergence of literature regarding taxing institutions
that cross a certain threshold (for size) is a recent phenomenon. While the
suggestion conveniently neglects the potential impact that institutions could
have on systemic risk despite them having to pay tax for it, there is a valid
point that imposing such a tax would lead to a more financially sound system
than if it were not in place.
Vaguely
Obscure
Section 351 clearly states its technical
and conforming amendments made shall take effect on the transfer date. It has
not been made clear as to what this transfer date really is. Section 217 of the
Dodd Frank act urges a study on the bankruptcy process for financial and
nonbank financial institutions without exactly stating what this section is
really achieving. The only relevant or somewhat effective part of this section
is the one which states that after one year of passing this act, the
Administrative Office of the United States court shall submit a summary of this
study upon enactment of the Dodd Frank act. Note that this is ambiguous. The
Volcker rule, despite being a part of the DFA, only came into effect in July
2015 (see The Economist (2015a)). Therefore, this act seems to be more of a way
to buy time until another financial instrument comes about and evades the
regulations whose enforcement and enactment moves at a glacial pace that
enables other to anticipate what it is going to be about and evade it.
If nothing else, the DFA adds many
words to the handling of cross-border dimensions of a large institutional
failure. Sadly, those many words
(See appendix IIa.) don’t lead to a practically workable solution. Two themes
emerge from the Dodd Frank Act in this respect. The first is a plea of
cooperation for American regulators and their foreign counterparts and the
second is a threat to exclude foreign brokers from US financial markets if
their home country does not appropriately regulate its financial institutions
(Skeel 2010, p.183). The requirement to prepare a living will (as part of DFA)
coupled with the two themes above are Dodd Frank’s contribution to the problems
of cross-border insolvency(Greene and Potiha,
2012). The first set of provisions add a general sense that cooperation
is very good in cross-border cases. The FDIC’s involvement into coordination
agreements will be much simpler as a consequence of this due to the permission
of sharing confidential information. The
second set of regulations i.e. the threats also have co-ordination as a core
theme, though their tone and approach is effectively different. Skeel (2010)
suspects that the principal objective of these provisions is not to protect the
US against financial stability (though this would probably serve as a secondary
aspiration), it is to mitigate the risk that compliance costs with the Dodd
Frank will drive derivative operations into other counties. Therefore, it would
not be wrong to see these provisions as back-handed strategies for achieving
international harmonization, which is considered to be one of the most
prominent solutions to deal with cross-border insolvency (see Nielson et al.
(1996) and Clift (2004)). Over the past two decades, the United Nations, IMF
and World Bank have all sponsored initiatives to develop best practices for
insolvency law. The initiatives assume that upon identification of core
principles, countries can improve their insolvency laws by better conformity to
soft-law guidelines. This is where the Dodd Frank’s threats are intended to
take effect so that the insolvency laws of different countries gradually
converge and make cross-border cases less messy in the future. In some sense,
the new threat provisions border on saying other countries should implement
regulations similar to Dodd-Frank or the U.S. would retaliate against big banks
that want to do business domestically. The U.S. could potentially be hauled
before the World Trade Organisation (Skeel 2010, p.184) concerning relevant
trading matters. Since America’s stance has been consistently discrete, it has
not attracted much attention so far. It is possible that this happens once the
harmonisation process digs its roots deeper.
iii. Regulatory
dynamics: A Socio-legal Panorama
Assessing
the Dodd-Frank Act using Law and Economics Theory of Regulation
This analysis is a legal
adaptation of the economic theory of regulation that requires a response with
respect to how well regulations address market failures responsible for the
financial collapse of 2008. In some sense, this is a blend of a stress test (for insolvent banks) and
legal reasoning. First, we must consider whether the DFA addresses negative
externalities. When an economic
transaction imposes costs on individuals who are not party to the transaction,
we call this an externality (or spillovers). The enormous build-up of systemic
risk in 2008 was funded with short-term debt and ran the risk of failing all at
once unless there was a correction in the housing market (Admati and Hellwig (2014) and Acharya et al. (2010)).
The Theory of regulation
suggests that governments should regulate where there is a market failure (see Roe (1991), Aglietta (2000)). The Dodd Frank legislation is an act whose
primary focus is on the market failure of the recent financial crisis-namely,
systemic risk. Since private markets cannot efficiently solve this problem,
there is a need for government intervention. Moreover, there are compelling
reasons to believe why existing regulations (by themselves) are not enough
because of their inadequacy to have a uniformly coercive impact. For instance, Hart and Zingales (2011) assert that capital
regulation alone cannot solve our problem. While this is theoretically
plausible, it is not practically feasible given the political unwillingness
towards simple but radical reforms. The reason is that the Dodd Frank Act, even
with the Basel capital regulation produces very linear capital rules. These
rules do not address cases in which financial institutions conduct trades involving
transactions accruing small gains with high probability and large losses with
low probability (i.e. tail risk). Existing capital regulation is very inefficient
because what we really should care about is those low probability states, which
tend to coincide with the systemic risk states. In addition, firms need to hold
a lot of capital in those states. This means that firms might have to hold too
much capital in states when they don’t need to. Under linear capital rules,
capital is going to be little or too much—too little because it does not cover
the losses in bad states and too much because it covers too much in good
states. The second reason why the focus cannot be primarily on capital
regulation is that it is difficult to measure leverage at the institutional
level because Wall Street is always ahead of the regulators. For instance, off-balance
sheet financing in the asset backed commercial paper market was unknown to
regulators while Wall Street was doing it. A study by New York Federal Reserve
Bank showed a lot of gaming around quarterly reports. Richardson (2014, p. 119)
makes a good point in saying that it is difficult to pin point leverage at the
institutional level , which is why even if capital requirements are defined,
banks are going to find ways to get around them. It is further pointed out that
the firms that effectively failed during the financial crisis were all well
capitalised on a regulatory level and even using current rules, some of them
would be well capitalised. Richardson (2014) uses these fact to infer that
while capital might be important, it might not be enough.
It is imperative to
consider whether the DFA addresses relevant market failures or not while
guarding well against the Act’s unintended consequences (as identified above). Acharya et al. (2010) believe that
while the language of the final Act is a highly diluted version than its
original proposal, the Volcker Rule limiting proprietary trading investments of
LCFIs (Large and Complex Financial Institutions) provides a more direct
restriction on complexity and should help simplify their resolution. The
Volcker rule also addresses the moral hazard arising from direct guarantees to
commercial banks that are designed to safeguard payment and settlement systems
to ensure robust lending to households and corporations. Despite its merits,
this response is inadequate because while it effectively lowers costs for
riskier functions such as making proprietary investments, it fails to terminate
thriving markets performing these functions. Considering the DFAs intention of
increasing transparency (see Appendix II e.), non-bank firms are now subject to
higher scrutiny by the Fed and the SEC. However, having been read in its
entirety (2319 pages), experts dismiss the
Dodd-Frank Wall Street Reform and Consumer Protection Act since it requires over 225 new financial
rules across 11 federal agencies and the attempts toward unified regulatory
consolidation are minimal. That said, Acharya et al. (2010, p.8) make a strong
point in arguing that given a choice between the Congress and the ‘admittedly imperfect regulatory bodies’ designing the procedures for implementing
financial reform, it would not be a difficult decision (i.e. choosing
regulatory bodies despite their imperfections is preferable). In pursuit of
streamlining the purpose of regulatory bodies, it is important to first
acknowledge why the DFA falls flat on four important grounds.
Firstly, the DFA does
not deal with mispricing of pervasive government guarantees throughout the
financial sector (Balasubramnian and Cyree,
2014). This will allow many financial firms to finance their activities
at below-market rates and take on excessive risk. Secondly, systematically
important firms are made to bear their own losses but not the costs they impose
on others in the system. Therefore, the market falters in addressing the
primary source of market failure in the financial sector, which is systemic
risk. Third, the DFA regulates financial firms by their form rather than their
function which will prevent the Act from dealing well with new organisational
reforms likely to emerge in the financial sector – to meet the changing need of
global capital markets, as well as to respond to the Act’s provisions. Finally,
the Act makes important omissions in ‘reforming
and regulating’ parts of the shadow banking system that are systemically
important (Acharya et al. 2010, p.8). It also fails to recognize that there are
systemically important markets that also need orderly resolution when they
experience financial distress.
To sum up briefly, these
flaws imply that government guarantees to the financial firms will be limited
to specific pockets. In time, allocation of capital may migrate to these
pockets and new pockets may develop in the future in the shadow banking arena
(for instance). This could sow the seeds of another significant crisis which is
why it is imperative that future regulation and implementation of this Act
should guard against this danger.
Section
619: Analytical Revisit and Brandesian concessions
It is quite remarkable
that even though the Obama administration modelled its response to the
financial crisis in 2008 on Roosevelt’s New Deal, no one in the administration
mustered the courage to handcuff or break up the largest banks (Skeel, 2010, p.
55). In President Roosevelt’s administration, a leading group of government
officials jostled with advocates of corporatism for supremacy in order to
ensure vibrant competition in every industry. In the 1930s, a Boston lawyer
named Louis Brandeis pressed for measures that would break up the so-called
Money-Trust-the large banks that dominated finance in the United States. The
signature New Deal financial reforms were Brandesian. Large wall street banks
such as J.P. Morgan were broken up under the Glass-Steagall Act by separating
commercial banking (deposits and loans) from investment banking. This resulted
in smaller banks becoming more competitive because deposits would now be just
as safe in small banks as in large ones. Unlike Roosevelt, Obama did not have
any Brandeisians in the house.
Despite the hostility
against Volcker Rule and Brandesians in general, the Obama administration did
make three concessions to Brandesians. The first and most important one is the
Volcker Rule. However, this is not a consequence of Timothy Geithner and his staff giving this
rule due appreciation but because they anticipated the political imperatives of
not passing the rule. This view can be confirmed (see Skeel 2010, p.87) by the
fact that when Volcker began advocating that Congress must ban proprietary trading
in commercial banks, ‘no one was listening’. The watering down of the Volcker
Rule means that the restriction will have less bite than originally intended.
The second concession to the Brandeisians is remains of the Lincoln amendment (Ludwig, 2012, p. 181). The amendment originally sought to address
the concern that banks subsidized in capital due to deposit insurance and the
right to borrow from the Fed must be prevented from gambling with government’s
money. As actually enacted, the limitation was deemed to be far less stringent
and did not actually forbid banks from dealing in derivatives. As the crisis
unfolded, MIT professor and former IMF economist Simon Johnson maintained his
stance on separating commercial and investment banks. He argued that aggressively
enforcing these limits would limit the increase in oligopolistic power of banks.
He stressed that it would “finish the job
that Roosevelt began a century ago” (Skeel 2010, p. 87). The final
concession to the Brandesians were nods to Professor Simon Johnson’s call for
direct limits on the size of banks such that no acquisition would be permitted
if the acquiring institutions has more than a 10 percent share of the overall
liabilities of the financial industry. However, this 10 percent concentration
has a large limit which is waived if systematically important institutions will
be acquiring a firm that is in default or danger of default or if the Federal
Deposit insurance is involved in the transaction. One particularly exciting
addition to the Brandeisian concessions could be the Dodd Frank legislations
giving regulators the authority to take extraordinary steps if there is a ‘grave threat’ to financial stability.
This could potentially create enough ground to manoeuvre arguments in favour of
ethical banking, but Skeel (2010) disagrees saying that such a provision is
more likely to function as a threat in the Fed’s partnership with Citigroup and
other systemically important enterprises. Skeel’s stance is logically sound but
ethically lukewarm because a system that puts its principles in top priority
should not be shaken by pressures from influential lobbyists and financiers. It
can be argued that it is better to have an authoritative regulatory body that
can make threats within its legal jurisdictions for the greater good of a
nation’s economy than one whose actions are influenced primarily by influential
corporatists.
Brandeisian concessions
have been defined by Skeel (2010, p.91) as concessions made to the Brandeisian
perspective in order to secure the passage of the Dodd-Frank Act. The
concessions were therefore politically motivated. That said, they are not
entirely irrelevant. For instance, the Volcker Rule does introduce complications
for the largest banks and sweeps broadly enough to interfere w..ith some
acquisitions that the largest financial institutions would otherwise engage in.
However, there is no reason for large financial institutions to start melting
away. In fact, since the details of the legislation will be determined by banking
regulators and financial institutions can be sure that their dominance will not
be challenged. Regulators were in charge of overlooking the implementation of
the Volcker Rule and many of its provisions were given time to come into effect
in the next two years. After being repeatedly delayed for the next five years,
the Volcker rule finally took effect on 25th July 2015 as the Economist
(2015c) reported that the much awaited rule to tame banks was finally in
place. This has now reduced the possibility of big bank losses in a crunch,
however, there has also been a decline in market liquidity. It can be argued
that this is a fair price to pay for the freedom of financial stability.
Another consequence of this act is that investors now require a higher return
to compensate for less liquid securities, raising the cost of capital, making
it harder to raise money. That said, it is anticipated that the most likely
outcome of the Volcker Rule taking effect is that trading will shift to
unregulated firms in the shadow banking sector. This means that instead of
being extinguished, financial risks might just become harder to spot.
While the recent success
of Volcker Rule seems to give renewed hope of financial security, regulators
must still be aware that distinguishing between market making and speculating
can prove to be quite daunting. Gabriel Rosenberg of Davis Polk & Wardwell
(law firm) said that “It’s impossible for
banks to know if they are completely in compliance with the rule, because there
are so many interpretive questions remaining” (The Economist, 2014b). Given the repeated market failures, it was
perhaps inevitable that the Volcker Rule reached this landmark of at least
taking some effect, however, it must be noted that the Volcker rule has until
21st July 2017 to stop trading in collateralised loan obligations
which is essentially asking them to move the risk of investment in loans off
their balance sheet (The Economist 2014). In other words, while part of the
rule has finally taken effect and banned proprietary trading, the other part
that requires banks to stop trading in collateralised loan obligations will
still take another two years to come to pass. Another concern is that
regulators will use their partnership with the largest financial institutions
as a channel for political rather than financial considerations. The Obama
administration’s management of the Chrylser bankruptcy foreshadowed this
possibility as the government struck a deal with Fiat containing unmistakable
evidence
of a corporatist dimension to the rescue (Skeel 2010, p.35). This shows that
the Dodd-Frank Act not only invites mixing of political objectives but also
encourages it.
There is some debate
about whether proprietary trading is a core activity of banks or now. Many
commentators say that it is not a core activity because a bank has other
functions too. However, this is not only an evasive answer, but also an
ignorant one overseeing that what constitutes a core activity in banks changes
over time. In fact, proprietary trading and market making may now be seen as
core activities of global universal banks. However, Richardson (2012) believes
that the important question is not whether or not it is a core activity but
whether or not it is so potentially destructive that we shoot first and ask
questions later. Richardson (2012) holds that proprietary trading is not that
potentially destructive and that prohibiting it will not prevent TBTF banks and
other banks from taking on excessive risks or from being bailed out when they
do. This view is controversial, given that the Volcker rule is the closest
analogy of the Glass-Steagall Act which is the best historical benchmark of
financial impregnability. Given the development of this thesis so far and
analytical review of what comprises proprietary trading, this study
acknowledges the potentially destructive nature of proprietary trading in sharp
contrast to Richardson’s views. Put another way, the dangers of proprietary
trading do give us enough reason to shoot first and ask later.
Defence
of Soft Law aspects of the DFA
This is one of the few
segments of this dissertation that backs the Dodd-Frank Act in terms of
provisions that come under soft law provisions. Despite their non-binding
nature, international financial rules under the Dodd-Frank Act are more
forceful than traditional law theories suggest (Brummer 2012, p. 127). A
state’s history of compliance can affect its global reputation and can have
substantial political and economic consequences. If there were no negative
consequences of non-compliance, regulators could either under-enforce them or
ignore them altogether. However, notwithstanding the informality of soft law,
non-compliance can have long-term repercussions. For instance, non-compliance
might result in an inability to form future alliances or having to deal with
tough institutional sanctions. Hence, legal outcomes can flow from acts that
are not customarily ‘binding’. It should also be noted that while soft laws
have the ability to transform into hard law, they must not be mistaken as a
‘stepping stone’ to hard law (Abbott and Snidal, 2000, p. 456).
Despite the efficacy of
soft law, positivists frequently lament the conceptual uncertainty associated
with the concept of soft law. Abbott and Snidal (2000) explain that the use of
the shorthand term ‘soft law’ distinguishes this broad category of deviations
from hard law on the one hand and purely political arrangements in which
legalisation is completely absent on the other. However, it must be noted that
the choice between hard law and soft law is not a binary one (Abbott and
Snidal, 2000, p. 422). That said, we must shift focus from a doctrinal fixation
on soft law’s non-binding status to a socio-legal perspective which focuses on
the extent to which obligations are clear and likely to constrain state
behaviour. Such a shift from the apparently non-coercive provisions of the
Dodd-Frank Act to its behavioural impact on newly instituted organisations and
regulatory architecture would facilitate a richer and more wholesome
understanding of its intent and practical outworking.
VI. Legal implications of Tax laws and Prospective Alternatives
A.
General
Discourse
The full externality
costs are not covered by parties in a transaction unless there are markets that
appropriately price the externality. Markets for externalities were missing
before the crisis and there were no legal provisions that facilitated the establishment
of such markets. Acharya et al. (2010, p.6) suggest that one can think of
carbon emissions, where there is an invisible hand operating through prices to
produce externalities at the efficient level. To address such a market failure,
economists prefer Pigouvian taxes which are thought to be the least invasive
remedies, given that they do not require heavy-handed government intervention
into specific interventions made by households and firms. Krainer (2012, p. 121), Masciandaro and Passarelli
(2012, p. 587) and Acharya et al. (2010, p.7) agree that Pigouvian taxes
would also raise revenue that the government can use to improve infrastructure
or reduce other taxes. However, taxes are not very ‘politically palatable’,
as the debates over the DFA made clear
Returning to matters,
regarding insolvency, regulators can now decide at the last minute that a firm
is at the risk of defaulting and would pose a risk to financial stability. This
makes the insolvency unpredictable and inefficient. Once resolution is under
way, regulators can decide which claims to pay for any which not to pay for.
This means that the rule of law takes a backseat as soon as regulators think
about intervening. For this reason, Edwards
(2011, p. 279) and Skeel consider the Dodd-Frank resolution to be a
‘mess’. Julia (2012, p. 1094) holds a
similar view and stresses that despite the fact that Dodd-Frank mandates
decrease financial participants’ exposure to the risk of counterparty default
and consequently decrease systemic risk, clearing members’ incentives during a
clearinghouse insolvency will cause enhanced systemic risk as a result of the
run on the clearinghouse.
The groundwork for alternative solutions can
be laid by starting at the grass-root level. In 2008, global financial markets
fell off a cliff. Stock markets in Europe fell by 55%. This drop was 42% in the
USA, 46% in the UK and around 50% in Latin America (Acharya et al., 2010). The widespread failure of financial
institutions impaired financial intermediation. A prototypical example of a
negative externality in the financial sector is the fact that some institutions
contribute more in a crisis to the capital shortfall than others (Acharya et
al. 2010, p.123). Negative externalities such as these are not priced by markets
and economists suggest taxing the externality as a suitable remedy (Krainer, 2012, Perotti and Suarez, 2011).
Since the 1920s, this is referred to as Pigouvian
taxes who argued that imposing these taxes will be optimal since doing so
didn’t require heavy-handed government intervention into the decision making of
market participants. Unfortunately, the Dodd-Frank Wall Street Reform and
Consumer Protection Act does not adopt this approach to financial reform.
Instead, the focus is centred on the ability of government to contain systemic
risk through the design of capital adequacy requirements. Naryana Kocjerlakota,
president of the Federal Reserve Bank of Minneapolis made a speech in Montraeal
(July 2010) saying that “knowing bailouts are investable, financial
institutions fail to internalize all the risks that their investment decisions
impose on society…Taxes are a good response because they create incentives for
firms to internalize the costs that would otherwise be external”.
Risk taking incentives are at the heart of a
lot of problems at large complex financial institutions
(Acharya et al. (2010, p. 123) and Admati and Hellwig (2014) ). Loopholes in
regulatory capital requirements were exploited to take undercapitalised assets
and leverage them by making one-way bets on credit portfolios tied to consumer
credit and real estate (commercial and consumer). This would be deemed safe for
the most part unless a severe economic collapse takes place. Deposit insurance
was put in place to increase consumer confidence. Nonetheless, this creates
perverse incentives because banks can now take on more risk, knowing that in
case of a failure, the government has to come to the rescue. The result is that
the economy suffers and the indebted country is caught amidst a massive
taxpayer funded bailout (Blount and Markel, 2012, p. 1023). The current
shortcoming of most financial regulations is that it seeks to limit
institutional risk in isolation. Unless external costs of systemic risk are
internalised by each financial institution, these institutions will have the
incentive to take risks that are not borne just by the institution but by
society as a whole. Put another way, firms may take steps to prevent their own
collapse, but not necessarily for the system. . This is why the risk of
financial institutions is a negative externality on the system.
Having discussed perverse incentives and
regulatory loopholes leading to negative externalities, we can discuss the
effectiveness of Dodd-Frank in dealing with these negative externalities. DFA’s
effectiveness and overall success is crucially dependent on the (i.)
identification, (ii.) development and (iii.) implementation of systemic risk.
Identification of systemic risk enables development of optimal strategies based
on those systemic risks. This, in turn, gives regulatory authorities the chance
to assess whether their policy is implementable or not (Tarullo (2013, p. 8)). An economic framework would be apt to
address such challenges. Consider a banking model in which each bank has
limited liability and maximises shareholder value. There is a safety net
provided by the regulator and the economy faces systemic risk. We assume that
systemic risk arises when equity in banks falls below a certain threshold and
that cost of systemic risk depend on how much ahead or behind banks are from
this threshold. Krainer (2012, p.12) and Acharya
et al. (2010, p. 124) assert that the optimal policy would be for
regulators to charge a premium (tax) to each bank. The systemic risk would thus
be an amount equal to the sum of two elements: (i) expected loss upon default
and (ii) Expected systemic costs in crisis multiplied by firm contributions to
these costs. The first element would require government guarantees to be priced
because firms must pay for the guarantees they receive. The second element
would require a firm’s contribution to potential losses above a certain
threshold to be multiplied by expected systemic costs when the financial sector
becomes undercapitalised. In a nutshell, the optimal policy to contain
excessive risks is to charge financial institutions for the implicit taxpayer
guarantee they enjoy. Charging a premium causes the financial institutions on
the margin to hold more initial capital up front and taking less risky positions,
which benefits the system as a whole and isolated a potential contagion effect.
B.
Industry
Based Interview Insights-Tax implications for Banks under Dodd-Frank
(i) Interview with Director of Banking and Capital
Markets-Big Four
A face-to-face interview with Mark about his perspectives on Dodd-Frank has confirmed that general
academic perspectives in this essay are largely in line with the accountancy
industry’s stance on how Dodd-Frank is likely to shape the future of
regulation. Professionals like Mark within the Big Four accountancy
firms are in a unique position to comment on this, given the absence of
conflicts of interest, regardless of their position on Dodd-Frank’s
effectiveness. While Mark is based in the
London, his focus on capital markets, both global and domestic, put him in a
good position to comment on comparative impacts of the Dodd-Frank Act. The discussion began with a clarification
that despite the absence of explicit tax sections within the DFA, its
provisions are likely to have significant tax implications. Section 619, 521,
1501 and Title VII (Subtitle A) are good examples of this. Our focus is limited
to Section 619 and Section 715 under Title VII of the DFA for the purpose of
this essay. The interview which lasted about 15 minutes enabled us to derive
the following key insights: (i) Section 619 limits use of private equity
funds and private equity funds by banks: The limitation placed on banks
is likely to have significant tax consequences, with firms needing to consult
tax advisors to ensure the required actions are taken and are as tax-efficient
as possible. (ii) Section 715 regarding the authority to prohibit participation
in swap activities ‘may prohibit an entity domiciled in the foreign country
from participating in security based swap activities’. Title VII requires
swap contracts to be centrally cleared for which the law is already in place.
At the same time, section 715 has further tax implications (for which the law
is not in place yet) related to restructuring of operations and separation of
swap activities. A Big Four online publication also addresses tax
implications with respect to section 165a which addresses Recovery and
Resolution planning, also known as “living wills”. The Act requires certain
financial institutions to develop living wills that outline how they will wind
down if their business fails. Upon drafting the will, companies are required to
review them periodically to address tax issues most relevant to their business.
Returning to our earlier discussion, the brief interview came to a close after
Mark’s final remarks about the general sense that the DFA instils in the
financial industry. He concluded by underlining that the sentiment among
bankers is that of distaste since they are losing money due to added compliance
costs. Auditors and other staff from the Big 4 Accountancy Firms worldwide are
largely unaffected. In fact, compliance officers within such professional
services’ firms might be better off, with increasing industry demands to be
fully compliant to the DFA and other internationally recognised legislations.
At a macro level, the Act raises the regulatory bar on a number of financial
products including mortgages, derivatives and swaps, which, for obvious reasons
has not gone too well with investment-intensive firms.
(ii)
Interview with Partner at St. James’s Place Wealth Management
This section covers a
telephone interview with Mike Heelan, partner at a London-based firm
specialising in providing high quality personal advice on many aspects of
wealth management, advising clients of widely differing financial resources.
Wealth management firms are regulated by the FCA (Financial Conduct Authority).
This interview was conducted to examine the extent to which the cross-border
regulatory impact of the DFA permeated from the United States to the UK. While
one would expect wealth management firms to be insulated from the impact of
regulations aimed at protecting taxpayer money, Mike revealed that the wave of
post 2008 financial services regulations caused deep changes in the wealth
management industry with higher regulatory costs squeezing managers’ profit
margins just as regulation forced business leaders to review the fundamental
ways in which they operated. However, Mike acknowledged that not all effects of
regulators are disruptive and new opportunities await those that adapt
adroitly. Returning to the DFA-specific impact, Mike anticipated that the
harmonisation of International Financial Law in the near future can potentially
lead to even higher regulatory costs for investment banks. Mike asserts that
the impact of harmonisation will be directly felt by big banks and indirectly,
by asset management firms like his own. The indirect link originates from the
influence of market conditions such as interest rates and market confidence.
For instance, if the economic climate is similar to a downward spiralling
recession, asset managers are likely to lose clients in the lower middle class
strata of society. Mike stressed that the current regulatory atmosphere has led
to the lower-middle class being squeezed out from getting advice from St.
James’ Wealth Management. This has led to a widening gap in public protection
that deprives lower-middle class groups alongside start-ups and medium sized
enterprises. They do not have the same access to strategic planning, risk
management and techniques to improve cost effectiveness. A working paper
written by Farrell (2012) for McKinsey Centre for Government confirms
this deduction and shares concerns about regulatory and law-enforcement
agencies facing intense scrutiny and pressure from the unintended consequences
of regulation leading to lost sector output and slower rates of innovation.
Mike also spoke about
the reach of the Dodd-Frank Act in relation to FATCA (Foreign Account Tax
Compliant Act). FATCA is a United States federal law requiring United States
persons to have yearly reported themselves and their non U.S. financial
accounts to the Financial Crimes Enforcement Network (FINCEN). This is intended
to make it more difficult for American citizens to have assets outside the
USA. FATCA is linked to the DFA since
both legislations contribute to the reduction of global systemic risk. FATCA
restrictions imply that wealth management firms like St. James’ Wealth
Management would have limited client interaction with offshore clients based in
the United States. One aspect of the DFA that Mike Heelan commends is the fact
that it provides a solution to the issue of double taxation [as under the
Double Taxation Convention (DTC)] whereby you may be taxed on your foreign
income by the UK and by the country your income is from. Mike explained that
the provisions in the Dodd-Frank Act would prevent such a double taxation by
providing that the policyholder’s home state would have the sole tax collection
and regulatory authority over such policies. While global symmetry in this law
is still lacking, the Dodd-Frank makes a commitment, in-principle, until it
becomes legally enforceable across borders.
VII. Limitations
This thesis attempts to give a bird’s eye view on
post-crisis regulatory architecture with selected analytical incisions into
relevant Titles of the Dodd Frank Act. An exhaustively comprehensive analysis
would be more suitable as a PHD topic given that the Act consists of sixteen
titles spanning across 848 pages that still consist of 243 rulemakings and 67
studies that are yet to be completed for full implementation. For this reason,
a specific but less comprehensive focus for this thesis has been appropriate.
This study acknowledges that the scope of its
legal arguments are limited to the level of completion of the Dodd-Frank Act,
which confines the analytical ambit of specific titles and subsections.
Nonetheless, this is justified on grounds that the DFA is still a work in
progress. Despite the Dodd-Frank bill having been passed in congress, many of
its provisions are not in place yet, with over half of its sections requiring
further study that is unlikely to be completed before the end of 2020. In
addition, while the DFA is referred to as ‘hard binding law’, many of
its provisions are not legally binding, but morally directive requiring further
research before complete implementation. The purpose of this paper was to
affirm recent socio-legal scholarship on the deceptive ambiguity of the
Dodd-Frank Act advancing prescient deductions with resolute clarity. Therefore,
the lack of legal scholarship on the imminent socio-legal impact of the DFA
does not undermine this study but bolsters its scope and directs the course of
future research.
VIII. Conclusion
The Dodd-Frank Act’s
ornate over 800 pages are a far cry from the Glass-Steagall Act’s 46 pages.
Ironically, the extra pages diminish rather than enhance the law’s
effectiveness. While
not everyone agrees on the future Dodd Frank Act provisions, most concede that
the end outcome depends on the implementation and administration. That said,
even the most favourably inclined observer would not say that the Dodd Frank
Act has done a particularly impressive job (see (Reza,
2011, p. 79), White et al. (2013), GAO (2013)). The Dodd-Frank Act institutes the most
significant changes to the federal oversight of mortgages in at least twenty
years. However, many of the details have been left to financial regulators. The
Consumer Financial Protection Bureau (CFPB) now plays a lead role. Although
mortgage rules are likely to increase the future cost of mortgage credit, their
effects on reducing foreclosures during the next housing bust are likely to
modest and could even increase foreclosures. Despite the significant changes in
the Dodd-Frank to the mortgage market, those features of the American mortgage
market that are most relevant to the financial crisis, such as lack of market
discipline, remain unaddressed and in many cases have been made worse.
Increased capital requirements undisputedly
lessen the chances of a global financial crisis. Deductions of this nature,
backed by the influence of advances of technology assume that the nature of all
financial crisis are superficially similar and fundamentally different.
However, this fallacy is baseless because the inherent nature of financial
catastrophes makes them superficially different (given the growth of
technology) but fundamentally similar, the common thread being a departure from
established benchmarks of financial impregnability. Threat to global economies
have already started coming from China’s recent market fragility and
stock-market imbalances (Economist, 2015). This is only to assert that it is
premature to say that the DFA and Basel are adequate to prevent another financial
crisis. Its ability to withstand a crisis could spark an interesting discussion
with compelling arguments, both for and against. However, its ability to
prevent a crisis altogether is highly questionable.
The course of history makes it evident that
Wall-Street outmanoeuvres regulators every time. For this reason, all the big
investment banks will eventually change (and many already have) their internal operative
structures to comply with Section 619 well before the implementation of Volcker
rule. A reasonable suspicion would be to think of the Wall Street’s next tactic
to spot regulatory arbitrage opportunities for beating the market or perhaps
the analogical equivalent of securitisation. A more likely possibility is an
eventual, but radical shift in academic perception (as in the 60s and 70s that
led to the repeal of the Glass-Steagall Act) that distorts the stability that
current regulations seek to achieve. The DFA, born of crisis
tries to fix parts of the financial architecture that failed in the crisis. Acharya et al. (2010) argue that the DFA brought
much needed improvements in financial regulation but fell short of what could
be achieved. Some denounce the DFA in saying that it does not go far enough to
curb risky behaviour of financial institutions. Others condemn it others for
going too far and hampering innovation and efficiency in markets. This study
provides a comprehensive description of the important parts of the Act and a
balanced assessment of its likely success as the new regulatory architecture of
the financial system. The DFA, together with the regulatory reforms introduced
by the SEC, the Federal Reserve and other regulators as well as financial
sector reforms being put in place in Europe is going to alter financial markets
in profound ways.
The
deep question at the heart of controversy over the Volcker Rule is whether we
want to destroy US global universal banking or not. The answer to the question
of ‘want’ might be ‘no’ but the answer to the question of ‘need’ is a
resounding ‘yes’. The glamour of banking can lull the common man into thinking
about how great universal banking is and that the world would fall apart
without it. The truth is far from this. In fact, the world would be a much
better place if boundaries were respected. A synonym for universal bank could
be ‘complex bank’ or ‘Rob the Taxer’ Bank because the concept of a universal
bank is to blur the lines between investment and commercial banks to a point of
non-existence. The absence of such crucial boundaries means that the neighbouring
banker can walk into a tax-paying depositor’s backyard and pick the fruits of
his/her labour. It is time to realise that bankers are reliant on the argument
that regulation is anti-competitive and that it hurts. Responsible parents
correct their children if they do something unacceptable. This incorporates a
respect for boundaries, despite the initial discomfort and eventually leads a
child to become a successful adult in the future. The same principle applies to
bankers and market participants, who have not only crossed the boundary but are
now trying to erase it and justify their actions by using the ‘morality of greed’ argument. Initial
resistance to effective regulations is natural and expected. In the long run,
however, it will reap a better future for America and the global economy.
Regulation must not be seen as anti-competitive or inefficient. Trees are
pruned to remove damaged and diseased branches to prevent decay-inducing
organisms from entering the tree. Consequently, the tree bears more fruit than
it would have if not pruned. Regulatory intervention is no different in that it
intends to curb practices within the financial industry that are parasitic in
nature and rob tax-payers through legal loopholes. Pruning unregulated markets
will lead to safety and soundness that will enhance growth, not hamper it.
IX. Acknowledgements: This paper has benefited from
direct inputs by Dr. Kamala Dawar and her lectures on ‘Principles of
International Financial Law’. They helped in developing an understanding of the
overall content, existing scope and breadth of International Financial Law.
This helped in conceptually placing the article at hand within the frame of
broader views by academics and practitioners in this area. The author has also
gained useful insights from Dr. Maria Mercedes Frabboni about the economic
analysis of the law which offered various methodologies to consider the impact
of legal systems and legal reforms. In addition, this dissertation has been
enriched by insights from industry professionals from the fields of banking and
Finance. Firstly, Michael Heelan, Senior partner at a London wealth management
firm. Secondly, Mark, Director of Banking and capital markets at one
of London’s big four accountancy firms. Further details of interviewees are
held for confidentiality purposes.
X. Appendix
I.
Generic
A. Background-Financial Services
Regulation: The US Government Accountability office (GAO) gives annual
reports about the Dodd-Frank Act since its inception in 2010. The December 2012
report on Agencies’ Efforts to Analyse
and Coordinate their Rules explains that complexity of the US financial
regulatory structure in context. The structure consists of multiple federal and
state regulators as well as self-regulatory organisations (SRO) that operate
along functional lines. Put another way, financial products or services are
generally regulated according to their function, no matter who offers the
product or participates in the activity (GAO 2010, p.6). The functional
regulator approach is intended to provide consistency in regulation, focus
regulatory restrictions on the relevant functional areas, and “avoid the potential need for regulatory to
develop expertise in all aspects of financial regulation”. The specific
regulatory configuration in the banking industry depends on the type of charter
that the relevant banking industry chooses. The different charter types for
depository institutions include commercial banks, credit unions and thrifts.
These can be obtained at state or federal level.
B. Dodd-Frank Act
Regulations: According to the DFA, federal
financial regulatory agencies are directed or have authority to issue hundreds
of regulations to implement the Act’s provisions. For example, the Dodd-Frank
Act makes permanent a temporary increase in FDIC deposit insurance coverage
amount ($10000 to 250,000). FDIC revised the implementation of its regulations
in response to this legislation. However, it was then realised that the
provisions in the act appear to be discretionary in nature, stating that
specified agencies may issue implementable rules that are necessary but have
some level of discretion over the substance of the regulations. As a result,
agencies may decide to promulgate rules for some or all of the provisions and
might have broad discretion to decide what the rules exactly contain and what
exemptions apply.
Exemptions to the DFA
provisions are encompassed in definitions of terms that are broadly established
in stature and require clarification through regulation. Entities that meet the
regulatory definitions are subject to the provisions and those that did not
meet the provisions are not. For instance GAO (2010, p.9) suggest that the CFTC
and SEC promulgated a regulation that defined the terms “swap dealer”,
“security based swap dealer” and “eligible contract participant”. Entities that
do not meet the definitions of these terms may not be subject to the Dodd-Frank
Act provisions concerning swaps and security-based swaps, including capital,
business conduct and other requirements.
C. Regulatory Analysis Provide
Limited Information about Costs and Benefits of Chosen or Alternative
approaches
Federal agencies have conducted regulatory
analysis required by various federal statutes for all 54 Dodd-Frank Act
regulations. As part of their analysis, agencies generally considered but did
not typically quantify costs and benefits of these regulations. As independent
regulatory agencies, federal financial regulators are not subject to executive
orders that require comprehensive benefit-cost analysis (Posner and Weyl, 2013) in accordance with guidance issued by OMB
(Office of Management and Budget). While most financial regulators pledged to
follow OMB’s guidance in principle, GAO (2010) found that they did not
consistently follow key elements of the guidance in their regulatory
analyses.
D. Dodd-Frank Act and Regulators
Recognize the Importance of Interagency Coordination
Both, the DFA and
federal financial regulators recognize the importance of interagency
coordination during the rulemaking process. Generally speaking, coordination
during rulemaking process occurs when two or more regulators jointly engage in
activities to reduce duplication and overlap in regulations (GAO 2010, p.23).
Efficient coordination can help regulators minimize or eliminate staff and
industry burden, administrative costs, unintended consequences and conflicting
regulations. The Act imposes specific interagency coordination and consultation
requirements and responsibilities on regulators. For instance, the Collins
amendment or Section 171 requires that appropriate
federal banking agencies establish a risk-based capital floor on a consolidated
basis (GAO 2010, p.23). Moreover, section 619, referred to as the
Volcker Rule does not require the federal banking agencies to issue a joint
rule together with CFTC and SEC. Instead, section 619 requires federal banking
agencies (FDIC, the Federal Reserve and the OCC) to issue a joint rule together
with CFTC and the SEC such that they coordinate with each other and prudential
regulators before starting rulemaking or issuing an order on swaps or swap
related subjects for the purpose of regulatory consistency and comparability
across rules or orders. The Act also makes specifications for CFPB (Consumer
Financial Protection Bureau). Title X has 8 subtitles relating to the Bureau of
Consumer Financial Protection requiring CFPB to consult with appropriate
prudential regulators or other federal agencies, both before proposing a rule
and during the comment process, regarding consistency with systematic objectives
administered by such agencies. Federal financial regulators have acknowledged
the importance of coordination during the rulemaking process. FSOC’s (Financial
Stability Oversight Council) chairperson emphasised the importance of
coordinating both domestically and internationally to prevent risks from
migrating to regulatory gaps—as they did before the 2008 financial crisis — and
to reduce U.S. vulnerability to another financial crisis. It was also noted
that coordination in the rulemaking process represented a major challenge
because the Dodd-Frank Act left in place a financial system with multiple,
independent agencies with overlapping jurisdictions and different
responsibilities.
E. Impacts of Dodd-Frank
Act-Uncertain
Despite efforts by
federal agencies to implement the Act through rulemakings, much work remains.
This led the GAO (2010, p.32) to announce that the full impact of the DFA
remains uncertain as of now. One estimate suggests that regulators have
finalized less than half of the total rules that may be needed to implement the
Act. In addition, sufficient time has not elapsed to measure the impact of
those rules. The financial industry is yet to fully comply with Dodd-Frank
provisions. Therefore, any over-specific response concerning the impact of the
Dodd-Frank Act is likely to be premature at this point. The evolving nature of
implementation makes isolating the effects of the Dodd-Frank Act on the US
financial marketplace difficult. Recognizing these limitations, we can analyse
some of the DFA’s initial impacts as institutions react to issued and expected
rules. First, the DFA has provisions that serve to enhance the resilience of
certain bank and nonbank financial institutions and reduce the likelihood of
financial distress in any one of these companies to affect the financial system
and economy. More specifically, the DFA requires the Federal Reserve to impose
enhanced prudential standards and oversight on bank holding companies with $50
billion or more in total consolidated assets and nonbank financial companies
designated by FSOC (See GAO 2010, p.33). The GAO has developed indicators to
monitor changes in certain SIFI characteristics. While these might be
indicative of the act’s impact. It does not imply causality. The second
approach is a difference in difference analysis that can be used to infer the
act’s impact on the provision of credit and soundness of bank SIFIs. The third
approach involves an analysis of the impact of several major rules that were
issued pursuant to the DFA and have been final for around a year or more.
II.
Relevant Figures
A. Increasing Length of Regulatory Legislations
since 1913
Source: Kane (2012, p. 27)
B. Missing deadlines: Number of
rule-making requirements for Dodd-Frank
Source: David Polk (Cited in Economist (2012))
C. Growing Guarantees: Fannie Mae and
Freddie Mac own three-quarters of new single-family mortgages in the U.S.,
double their share of 5 years before
Source: Federal Housing Agency (cited in Kane 2012, p.27)
D. 
Dodd-Frank:
A bit too complex perhaps
Source: JPMorgan Chase (cited in Economist (2012))
E. Shades of Opacity (Scale of 1-10):
The most and least transparent firms, 2013
Source: Transparency International (cited in Economist (2014a)).
III.
Specific Titles and Subsections:
A. Title I-Financial Stability,
Subtitle A-Financial Stability Oversight Council:
Section
115 I. Contingent Capital-
“(1)
STUDY REQUIRED- The Council shall conduct a study of the feasibility, benefits,
costs and structure of a contingent capital requirement for nonbank financial
companies supervised by the Board of Governors and bank holding companies:
(iii)
An
evaluation of the degree to which such requirement would enhance the safety and
soundness of companies subject to the requirement, promote the financial
stability of the United States, and reduce risks to United States taxpayers;
(ii)
An evaluation of the characteristics and amounts of contingent capital that
should be required;
(iii)
An analysis of potential prudential standards that should be used to determine
whether the contingent capital of a company would be converted to equity in
times of financial stress.”
Consider
the section above and note the ambiguity in the text. While Chris Dodd and
Barney Frank have tried to cover multiple areas in financial services to give
the impression that a lot has been done to prevent another global financial
catastrophe, the truth is that it is not enough, which means that it will
happen again. To reiterate what a German philosopher Hegel once said;
“We
learn from history that man can never learn anything from history.”
The
reason this is relevant is because we know that the Glass Steagall Act was a
landmark piece of legislation that safeguarded not only the USA but global
economies for 40 years and this safeguard got removed only when the law was
repealed. A decade later, the crisis happened. Three years later, the DFA was
passed, but largely lacked the coerciveness and clarity that the GSA had. A job
half done in the financial world is a job not done at all and that is the case
with the DFA. The DFA is deceptively comforting. Consider Section 115 I.
Subsection 1 suggests that a study is required for the feasibility, benefits,
costs and structure of contingent capital requirements. Note that the
quantitative ambiguity is not a result of a shortage of intellectual capital
but a lack of political will. The fact that this section urges a study about
what the contingent capital requirements means that it lacks the coerciveness
that an act, by definition must have. In other words, the authors had an
opportunity to make hard binding law, but subsections (i), (ii) and (iii) above
seem to be more like soft law in that they are more suggestive than they are
legally binding. It would be better to have no law at all than have laws that
are ambiguous to the point of everything depending on how we interpret it.
IV.
DFA
Highlights and Relevant Links
A.
Dodd
Frank Act: Six Highlights for General Reference
The Dodd-Frank Act is
very comprehensive buts its functions can broadly be categorised into six
categories, of which , the latter two shall be covered most extensively in this
paper. The six functions are: (i).Identification and regulation of systemic
risk: DFA has established a Systemic Risk Council authorised to classify
financial firms as systemically important, regulate them, disintegrate them and
also release relevant information for downsizing future crisis. (ii) Proposing
an end to TBTF: The DFA encourages orderly liquidation procedures for unwinding
of SIFIs, ruling out taxpayer funding of wind-downs and instead requires that
management of failing institutions is dismissed, with wind-down costs being
borne by shareholders and creditors. (iii) Expanding the responsibility and
authority of Fed: The DFA grants the Fed authority over all systemic
institutions and responsibility for preserving financial stability. (iv)
Restring discretionary regulatory interventions: Prevents or limits emergency
federal assistance (v) Reinstating a limited form of Glass Steagall (the
Volcker Rule): Limiting bank holding companies in proprietary trading
activities, such as hedge funds and private equity, and prohibits them from
bailing out these investments. (vi.) Regulation and transparency of
derivatives: The DFA provides for central clearing of derivatives to enhance
transparency of all derivatives, except those used for commercial hedging. In addition to the above, the DFA introduces
a range of reforms for mortgage lending, conflict resolution in rating agencies
and for risk control on market funds. Presumably, the most popular reform
(although secondary to the financial crisis) has been the creation of a Bureau
of Consumer Financial Protection that will write rules governing financial
services offered by banks. This
dissertation addresses (v). Volcker Rule and (vi) Regulation and transparency
most extensively with analytical digressions into related matters concerning
cross border insolvency and mortgage reforms.
B.
Whistleblower
protection and disclosure: DFA and Sarbanes Oxley
The Dodd Frank Act works its amendments in a manner that enters the
Sarbanes Oxley Act (SOX) and added new private rights of actions for
whistleblowers by establishing a whistleblower incentive programme. In doing
so, the DFA prohibits employers from taking punitive actions against employees
who: provide information to the SEC, assist the SEC in taking certain actions
and ‘making disclosures protected under SOX’, Securities Exchange Act or
a regulation subjected to the SEC. The FA provides a private right of action
for commodity whistleblowers and whistleblower protection for financial
services employees. The paid incentive reached up to at least $1 million.
However, there might be some issues with the rule so far since the Act could
result in employees holding back relevant information until the matter
snowballs to become big enough to be worthy of compensation. Anand observes
(2011, p.141) that the most progressive organisations have adopted the concept
of employee reporting and incorporating hotlines into their enterprise-wide
risk plans. The Dodd-Frank endorses such behaviour and seeks to reinforce core
values of public companies and must inform employees and partners of these
companies of the importance of telling the company when its code of conduct is
violated. This is why section 922 on whistleblower protection does not inhibit
the use of hotlines.
List of Abbreviations
Abbreviations
|
Full
Form
|
DFA
|
Dodd
Frank Act
|
GSA
|
Glass
Steagall Act
|
GAO
|
Government
Accountability Office
|
SEC
|
Securities
and Exchange Commission
|
FDIC
|
Federal
Deposit Insurance Committee
|
SOX
|
Sarbanes
Oxley Act
|
TBTF
|
Too
Big to Fail
|
CFPB
|
Consumer
Financial Protection Bureau
|
EMP
|
Efficient
Markets Paradigm
|
CFTC
|
Commodity
Futures Trading Commission
|
OCC
|
Office
of the Comptroller of Currency
|
OTC
|
Over
The Counter
|
UNCITRAL
|
United
Nations Commission on International Trade Law
|
EIR
|
EU
Insolvency Regulation
|
QFC
|
Qualified
Financial Contracts
|
CDO
|
Collateralised
Debt Obligation
|
TLA
|
Truth
in Lending Act
|
IMF
|
International
Monetary Fund
|
FATCA
|
Foreign
Account Tax Compliance Act
|
FINCEN
|
Financial
Crimes Enforcement Network
|
DTC
|
Double
Taxation Convention
|
OFR
|
Office
of Financial Research
|
DISCLAIMER:
The views
expressed in this essay are those of the author, informed by established academics
and financial industry experts and directed by the author’s supervisor.
Insights formed as a result of primary research are mostly within, but not
limited to (1) a direct reading and analysis of the Dodd-Frank Wall Street
Reform and Consumer Protection Act & (2) interviews of 2 employees from a
professional services account firm and a wealth management
firm respectively (St. James’ Place Wealth Management). Both interviews were
semi-formal in nature with the first being face-to-face and the second being a
telephone interview. The consent of both participants was obtained before using
the information obtained for the purpose of this study. Note, however, that the
views of the interviewees are entirely their own and not necessarily indicative
of the stance of their affiliated firm (as a corporate entity) about the
Dodd-Frank Act.
Direct
references to specific titles, sections or sub-sections within the dissertation
are sourced from a purchased (in-print) copy of the Dodd-Frank Wall Street Reform and Consumer Protection Act H.R 4173. The printed copy is not an initial
bill, but the final Act, as passed by both Houses of Congress and signed by
President Obama. Also note that the stance on the Dodd Frank Act adopted in this
essay does not necessarily reflect the position of the US Congress or the Federal Reserve System.
Any errors or omissions are the responsibility
of the author.
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A
populist movement came Senator Blanche Lincoln had to deal with a tough
challenge from her left in the Democratic Party. She pioneered an amendment
through her agricultural committee to forbid commercial and investment banks
from dealing in derivatives. The Lincoln Amendment was eventually changed to a
set of complicated rules that allowed banks to trade derivatives so long as
derivatives operations were conducted in entities separate from traditional
banking operations.
