Finish the Job of Financial Reform

When President Obama came into office four years ago, the financial crisis had just thrown the U.S. economy over a cliff. The financial stability plan that the President and Treasury Secretary Geithner launched worked: the financial panic ended and the economy began to grow again. With the announcement earlier this month of AIG’s repayment of taxpayer funds, TARP and other federal investments are 90 percent repaid, and net costs of the federal intervention in the financial sector overall are expected to approximate zero. That is a remarkable achievement.

At the same time, the Administration put forward a financial reform plan, eventually enacted as the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, to make the financial system more resilient, and to protect taxpayers and the broader economy in the future. The Act brings shadow banking into the daylight; regulates the largest firms regardless of their corporate form; establishes a resolution authority to wind down financial firms in a financial panic; sets new rules of the road for financial derivatives; puts in place the tools to reduce systemic risk across the market; sets out important investor protections; and establishes a new Consumer Financial Protection Bureau to look out for the interests of households.

Regulators have been working hard over the last two and a half years to implement these reforms. A new Consumer Financial Protection Bureau has been built from scratch. New rules governing derivatives transactions have largely been proposed. The resolution authority and many new approaches to supervision have been put in place. The U.S. financial system is more resilient than it was four years ago.

While much progress has been made, a combination of financial sector lobbying and aggressive lawsuits, congressional appropriations cuts and moves to delay or block nominees, and interagency wrangling, has slowed rule making.

Now is the time to finish the job of financial reform.

The Financial Stability Oversight Council needs to bite the bullet and designate systemically important firms for heightened supervision. The Fed needs to finalize its rules for tough new oversight, including limits on counterparty credit exposures and on the relative size of liabilities held by the largest firms; and it must also urgently speed up reforms to repo markets. The CFTC and the SEC need to finalize derivatives rules, and push for LIBOR reform. Regulators need to put in place a firm Volcker rule on proprietary trading. And markets need clarity and a coordinated approach to the risk retention rule for securitizations (“qualified residential mortgages”), ability-to-pay rule (“qualified mortgages”), and the practices of Fannie Mae and Freddie Mac for loans they will guarantee (let alone legislation to determine the ultimate fate of the government-sponsored enterprises).

At the SEC, a Commission deadlock has blocked the outgoing Chairman’s proposed reform of Money Market Funds, which faced a devastating run in the financial crisis, stemmed only by a massive taxpayer guarantee of the entire sector. If the SEC is unable to reach a consensus on how to proceed, the FSOC and the banking regulators will need to step in with an admittedly second-best set of steps to make MMFs less susceptible to runs, and the rest of the financial system less vulnerable to contagion from such runs.

Beyond MMFs and derivatives, the SEC faces critical regulatory policy challenges on investor protection, market structure, high frequency trading, exchange-traded funds, JOBS Act implementation, and a host of other issues. And its embattled enforcement division still has a long way to go, working with the Department of Justice, in rebuilding the public’s trust that our financial markets are being adequately policed for unlawful conduct.

Globally, new capital and liquidity rules have been proposed; the Europeans are making progress on derivatives reforms, supervision and new resolution authorities; and U.S. and global regulators have made progress on mechanisms to coordinate action on all these topics. Yet much still remains in flux, and there remains the danger that the next financial crisis, like the last, will occur when there are still no globally coordinated mechanisms for regulation or crisis management.

To be clear: the financial system is safer, consumers and investors better protected, and taxpayers more insulated, than they were four years ago—by a lot. But that is not enough. In the next four years, it will be critical to stay on the path of reform.