We will have to come back to the part about AxSA. For now, however, let’s keep this objective…
The overarching goal of the financial-reform legislation, which is being crafted into existence more so by Senator Christopher Dodd than by the legislative experts at the White House, is to effectively reduce systemic risks in the financial system. According to POTUS and his ilk, this should stave off future financial perils and the subsequent need for bailouts…Oh, if only it was that simple.
The Democrats vehemently believe they are justified in their pursuits, and to their credit, they could be marginally on point here. The real-economy downturn began, after all, as a result of upheaval in the financial world and the disruption to credit markets, and most of America’s taxpayers, whether liberals or conservatives, seem to blame Wall Street’s “reckless bankers” for the current state of the world.
Consequently, it would be tough to slow this train on the track to reform, but that doesn’t mean the effort is entirely prudent or just. After all, I did say that the Democrats were only marginally on point. Maybe that is why, when POTUS traveled to Manhattan to launch his second salvo, he did not have the audacity to go to Wall Street, where he knew he would have undoubtedly earned a cold shoulder. (Note: the first, actual salvo came in the form of a lawsuit from a weak SEC against the Goldman Sachs Group, Inc.)
In this two-part treatise of the financial-reform legislation, I hope to offer you, the readers of this blog, a primer that delves into the good, the bad, and the ugly components of the bill working its way through Congress. I think that it is important to understand this effort, because, if passed into law, as it stands, it will impact everyone from young entrepreneurs seeking new investors for their companies to young couples planning to buy their first homes. In the remainder of this missive, Part One, I will discuss what is good in the Dodd bill and why these pieces of the legislation need to survive. Later, in Part Two, I will focus on the measures that make this reform so troubling. It is from the latter that I contend the bill must be scrapped.
So, let’s get stated. Oh, and pay attention here, POTUS & Co. There are a few facts here that makes this a teachable moment for you guys.
Without some type of regulatory reform for the financial sector, the truth is, our financial system could be headed for Round 2 in this death bout. Sure, the likelihood of a second liquidity crisis in the financial sector is not readily obvious to most, but the possibility does exist, what with EU nations teetering on default, or what with delinquency rates of commercial real-estate mortgages heading higher and higher (2.77% at the end of 2007, 5.53% at the end of 2008, and 8.81% at the end of 2009). This makes Dodd’s point even more important. While the same conditions that plunged the financial markets into chaos do still exist, we also must recognize that now Washington, D.C., is a bigger stakeholder in this game, essentially propping up a house of cards. Hence, if there is another crisis, it stands to lose, as well.
Does any of this mean the system is broken? Hardly. For these reasons, though, do there need to be more safeguards or better ways to monitor financial markets’ biggest players? Absolutely.
The financial-reform legislation does include some elements that are good and that merit the attention of both Wall Street and skeptical Republicans. Here are just a few:
· Commercial banks would be required to hold more of their cash on hand. Until recently, it would seem that bank executives thought the best way to maximize returns was to leverage every dollar it had – and then some. By loaning out so much from its coffers, banks could draw greater returns from the interest payments. This is to say nothing about a bank’s proprietary trading. What’s more, more loans meant a greater diversity of returns and more returns to offset the bad loans.
Understanding this, the financial-reform bill does aim to raise capital requirements for commercial banks. This measure would not only require them to keep more cash on hand, but it would also mean that their lending standard would need to improve. And as we have witnessed by the example of Canadian banks, whose government already enforces stricter leverage caps, such a move could help to keep our banks from slipping into insolvency in the face of another shock to financial markets.
· The financial-reform legislation also calls for greater margin requirements in the commodities and derivatives markets – and this, I insist, is absolutely essential.
For now, we will only focus on commodities…It is true that, for example, a trader of, say, sugar could buy a contract today for 50k pounds of the sweet stuff, set for delivery in December, and holding a price of, say, $2 per pound. The trader is only obligated to put down a small percentage of the contract’s value, and let’s say that his total margin requirement is 15%. That means that our trader is putting down $15,000 for a contract valued at $100,000. Now, let’s assume that, before December, the price of sugar goes way north, and he’s able to sell the contract for $140,000. Then our trader has mad off with a handsome ROI of 26.6%.
· The proposed financial-reform legislation also gives the Securities & Exchange Commission funding that does not have to go through annual budget approval by Congress. This might not seem like a lot, but it is more than we know. The SEC is a frail agency, but its responsibilities continue to mount. Following Sarbanes-Oxley, the SEC has been buried in documents from public companies, all of whom are forced to disclose increasing amounts of information under the force of law; the SEC has been totally unable to keep up. What’s more, this regulatory body cannot compete with the private sector for talent. Until its budget is strengthened and its infrastructure for monitoring and policing some of America’s biggest enterprises is improved, we will continue to be disappointed by the SEC’s ability to do its job. This bill seems to suggest that there is an understanding of that fact, and it takse the first step to rectify the problem.
· Under guidelines in this bill, more brokers and financial planners will come under regulatory scrutiny, and the concept of fiduciary duty will be broadened to better protect investors. This should be self-explanatory, but most people qua investors never seem to remember that their brokers and advisors are among the best-paid salespeople in the country. All too often, these individuals must sell their firm’s latest products, or speak in union with the firm’s interests, in order to keep their jobs. Unfortunately, that can be outside of the interests of the investors. Such was the case for the father of a dear friend who, in the wake of the 2008 stock market slide, was told by his financial advisor (a relative, no less) that, in spite of his retirement plans, it was a perfect time to pour more money into the market and not to close his battered accounts. He was not the only investor getting the same advice from brokers and planners at the time, but as an investor, he should have been able to trust that any advice from his financial advisor, particularly during times of uncertainty, was being given to him with his best interests in mind. That this type of trust has to be legislated in order for it is exist is truly disappointing, but it is also part of the simple reality of our times.