American Financial Regulation Has Worldwide Reach

July 15, 2010, is a date that will go down in the annals of U.S. financial regulation history. No piece of legislation this fundamental and vast has been passed by Congress and signed by the president since the Securities Act of 1933 and the Securities Exchange Act of 1934. Just like three quarters of a century ago, this law, too, is not perfect. To obtain the required minimum of 60 percent of Senate votes, some concessions had to be made.

This new regulation, even if it has over 2,000 pages, is a framework. Putting the principles it enumerates into place and creating the institutions necessary will be the object of numerous rules of implementation, and the financial lobbyists will be neither short on work nor on income. None of this is very pretty. But this is how the American democracy works, and money can buy a lot of things.

The real error would be in downplaying that this will impact regulatory authorities worldwide just as much as it will impact the United States; this legislation will affect the third Basel Accord (Basel III) which comes into effect at the end of the year and will be applied to all banking worldwide. Moreover, it is inspired by principles defined by the G-20. Given the importance of American capital markets and financial institutions, what happens to them will be important. Let us not forget that most of the large global financial institutions operate on Wall Street and are subject to its activities. Beyond the concrete aspects of this regulation, which I have enumerated in a previous post, I would like to give you an idea of what has just been voted on.

The main victim of the financial crisis has been the consumer: Forced to abandon his home, unable to pay for his children’s education or medical bills, literally raped by the banks who issued the credit cards, the American consumer has suffered like no other. With an unemployment rate still at 9.5 percent, there are now no less than 50 million Americans living below the poverty line. The creation of an agency charged to protect the consumer has been rejected in every conceivable way with great unanimity and in gross manipulation of the facts by the banking sector. The banking sector is entirely to blame. That is who acted irresponsibly, even if the consumer lacked prudence.

Financial instruments of sometimes dubious transparency have impeded progress and created a bubble: Derivatives, securities, short sales and financial structures that evade all regulation were created through financial regulation. They must be transparent, and the banks that use them must be made to take on part of the risk so they can’t get away with swindling the investors. It is an important step in the plan, where each attempt to put them under control has been seriously torn apart under the George W. Bush administration, which had simply let go of the reigns by letting all financial regulation go down the drain.

Systemic risks will also be put under control. As part of an institution which is going to have the power to intervene, the banks will be forced to externalize certain risks in a way that no longer takes the consumer or the taxpayer hostage of their own speculation. It is unarguably the most arduous task of a process to regulate the complexity of financial institutions whose assets on the balance sheet are over $1 quadrillion or whose assets under management are sometimes higher than these figures. It concerns the implementation of analytical instruments and the power to intervene up to the point of forcing a bank to part from the activities that risk its stability.

Although I support this titanic task — President Obama and the Democrats and a few Republicans have braved the lobbyists who are receiving over a million euros a day to defend the interests of the bankers — I remain nevertheless disappointed. Paul Volcker, former president of the Federal Reserve, who worked for this regulation to be solid, had to accept some compromises when faced with the assault of the bankers’ interests. Certain essential protections had been abandoned in the name of Realpolitik. Congressmen and women of both parties who are responsible for having forged these texts carry a historic responsibility. The regulation is not airtight, and its application will be difficult. This disillusionment is not a reason not to recognize the historic and remarkable nature of this achievement. A regulation is not an end, but a starting point. Let us hope that those who will be applying the regulation will find the courage and the integrity necessary to steer us clear of an economic and social tragedy similar to that of the past two years.

Finance serves the economy and is not an end in itself.