Following three days of resistance to the introduction of proposed financial reform legislation, Senate Republicans conceded to their Democratic counterparts last week. In acquiescing to debate on the Restoring American Financial Stability Act of 2010, members of the Senate have now opened the door for what may become the most far-reaching overhaul of domestic financial services regulation since the Glass-Steagall Banking Act of 1933 and its partial repeal under the Gramm-Leach-Bliley Financial Services Modernization Act of 1999.
In spite of efforts on both sides to reach bipartisan compromise on issues of legitimate disagreement, financial reform passed out of the Senate Banking Committee on party lines. And even then, amendments to the bill are now proving to be more extreme than its original framers may have hoped.
Among the more controversial proposals, Senators Sherrod Brown and Ted Kaufman introduced language last Thursday that would address “too big to fail” with discrete caps on the size of large financial institutions. Specifically, the Brown-Kaufman amendment would impose a hard limit on the size of bank holding companies, capping institutions at 10 percent of insured deposits. At the same time, non-deposit liabilities would be capped at 2 percent of G.D.P. at banks and 3 percent of G.D.P. at non-bank financial institutions. Separately, Senators Maria Cantwell and John McCain may push forward a bill-originally introduced in December-that would reintroduce the separation of commercial and investment banking, resuscitating a key underpinning of Glass-Steagall.
Just as new amendments are being introduced, opposition to key measures in the proposed legislation is rising outside of the Senate. The positions of the largest banks and many trade associations have remained fairly predictable, especially with regard to proposed restrictions on proprietary trading activities and the regulation of derivatives.
Popular sentiment has steered the administration to a hard line in the face of opposition from financial services firms. In his April 17 weekly address, the president did not characterize opposition to the reform proposal in terms of considered disagreement. Instead, he offered that “these reforms have not exactly been welcomed by the people who profit from the status quo-as well their allies in Washington.” Last week, during a visit to Illinois, the president framed the current reform proposal in urgent terms, adding that “… we need it today. We don’t need it next year. We don’t need to do another study and examine it. We need it now.”
HISTORY SUGGESTS THAT the further we move from the moment of crisis, the less likely it is that meaningful reform will take place. Still, we must guard against recklessness in our desire to act decisively. It is because the proposed financial reform is so far-reaching that it should be considered carefully. And yet it is apparent that many of the actors who are taking the most entrenched positions have yet to read the legislation’s more than 1,400 pages and 1,210 sections.
Underlining the debate’s high stakes and the credible concerns of various stakeholders, regulators and monetary policy makers have been unusually outspoken over the past week. The president of the St. Louis Fed, James Bullard, has been among the most vocal of monetary policy makers in cautioning against an erosion of the Federal Reserve System’s mandate and independence. In April 15 comments, he said that “the Fed should remain involved with community bank regulation so that it has a view of the entire financial landscape. … It is important that the Fed not become biased toward the very large, New York-based institutions. … The reform response should be to provide the Fed with an appropriately broad regulatory authority.”
Although Mr. Bullard’s comments focused on preserving or expanding the Fed’s role in regulating smaller banks, Fed Chairman Ben Bernanke has expressed a need for expanded powers over large institutions. In testimony titled “Lessons from the Failure of Lehman Brothers,” presented to the House Committee on Financial Services on April 20, Mr. Bernanke stated that “the Federal Reserve was not Lehman’s supervisor. Lehman was exempt from supervision by the Federal Reserve
because the company did not own a commercial bank. …”
As a prescription, he added that “we must eliminate the gaps in our financial regulatory framework that allow large, complex, interconnected firms like Lehman to operate without robust consolidated supervision,” while also describing the need for new mechanisms for resolving failing institutions.
Regulatory Arbitrage
In a letter sent on Friday to Senators Chris Dodd and Blanche Lincoln, Federal Deposit Insurance Corporation Chairwoman Sheila Bair offered her “wholehearted endorsement of the ultimate intent of the bill, to protect the deposit insurance fund from high-risk behavior.”
While supporting the need for reform in principle, Chairwoman Bair expresses serious concerns with regard to some of the legislation’s specific measures. As in the case of the Federal Reserve officials’ objections, Chairwoman Bair’s concerns cannot be easily dismissed as partisan, obstructionist or uninformed. Indeed, few people have as deep an understanding of the causal drivers of the financial crisis and the weaknesses in our current regulatory regime.
One of Chairwoman Bair’s particular concerns is that more stringent regulation of one subset of the market can simply lead to risk-taking in other, relatively unregulated areas. “I urge you to carefully consider the underlying premise of this provision-that the best way to protect the deposit insurance fund is to push high-risk activities into the so-called shadow sector,” she stated in Friday’s letter. “A central lesson of this crisis is that it is difficult to insulate insured banks from risk taking conducted by their nonbanking affiliated entities.”
Investors Apparently Unfazed
Differences among regulators, the administration, lawmakers, and the industry itself mean that the outcome of the debate-scheduled to last approximately two weeks-is far from certain. This presents a degree of uncertainty for the financial services landscape of the United States.
The New York City economy and office sector’s dependence on financial services suggests that investors should respond to the uncertainty presented by the reform debate with wider risk premiums. But recent investment trends suggest otherwise. According to Real Capital Analytics’ tracking of property and portfolio transactions of $5 million and greater, Manhattan led the nation in the first quarter, with $1.4 billion in commercial assets traded.
While New York City’s first-quarter activity was modest as compared to the market’s peak, it compares favorably with domestic and international peers. Only one other domestic market-Boston-exceeded $1 billion in sales in the first quarter. On the global stage, Real Capital reports that New York ranked seventh in the office sector, sixth in the hotel sector and second in the apartment sector. The list of most active markets is dominated in the first quarter by Pacific Rim markets, including Tokyo, Hong Kong and Taipei, and by Western European business centers.
Transactions and financing announcements from the past few weeks-including Carlos Slim’s acquisition of 417 Fifth Avenue, the sale of 600 Lexington Avenue and the refinancing of One Bryant Park-suggest that buyers, sellers and lenders will continue to engage even as the financial reform debate enters its most visible and potentially acrimonious stages.
Sam Chandan, Ph.D., is global chief economist and executive vice president of Real Capital Analytics and an adjunct professor of real estate at Wharton.
