President Obama Declares Wall Street Reform a Success

After meeting with regulators from the Financial Stability Oversight Council (“FSOC”), President Barack Obama declared that the Dodd-Frank reforms work. President Obama claimed that Wall Street reform (i) boosted jobs and (ii) created a safer and stronger financial system in spite of arguments by “certain members of Congress who are consistently pressuring independent regulators to back off; who want to strip away the authorities that were granted under Dodd-Frank; who tried to weaken those regulations, tried to water them down; or tried to starve these regulators of the resources and the budgets that they need to hire enough personnel to track everything that’s taking place in the financial sector.”

President Obama highlighted the following areas in which there is “still work to do”:

  • closing potential gaps in regulating the “shadow banking system” – a “set of institutions” that are not regulated in the same way as traditional banks (e.g., hedge funds, asset managers, etc.);
  • completing executive compensation regulations in order to provide fewer incentives for individuals working in financial institutions to take “big, reckless risks that could end up harming our financial sector overall”; and
  • “tightening up” cybersecurity within the financial sector by identifying areas where it might be weak and vulnerable.

President Obama asked Americans to check to make sure that Wall Street is “doing the right thing” and prevent their representatives from diminishing the authority or cutting the budgets of regulatory agencies. “That should be the target of your concern and your wrath,” he said. He emphasized that “unless we have strong, independent agencies . . . that can provide the oversight that’s necessary, it is absolutely true that these financial institutions with enormous resources and mountains of lawyers and accountants and analysts will run circles around the government and will end up engaging once again in the kinds of disruptive behavior that caused so much damage to so many people in the first place.”

Lofchie Comment: In this political season, it is important to posit facts accurately and to stop demonizing those who hold legitimate though contrary views. The President’s complaint that hedge funds are not regulated like banks is a good place to start. Banks take retail deposits; they benefit from FDIC insurance; they are not permitted to invest in equities; they are subject to minimum capital requirements to prevent their depositors from losing money; they are permitted to borrow from the Fed. Hedge funds are exactly the opposite: they are proprietary investment vehicles that take speculative risks; their owners might make or lose some or all of their money. The notion that hedge funds should be regulated like banks simply denies the different purpose and importance of these two types of entities within the financial system. Is the President suggesting that hedge funds (or private investors generally) should be prohibited from taking risks? If they should be prohibited, then who should be permitted?

Regarding executive compensation, the President’s views lead to a conclusion that government regulators know best. Have regulators ever demonstrated that they “know” how to manage compensation appropriately? If, in fact, they do possess such knowledge, then perhaps they should demonstrate it by managing compensation levels for states and municipalities, which seem to be in significant financial distress across the country.

The President’s regulatory approach to cybersecurity seems based on the premise that the financial services industry is averse to tightening it up in any reasonable way. Few industries are threatened by cyber criminals as often as the financial services sector which is eager, in fact, to partner with government to improve cyber safety.

As to the President’s claim that all recent work in financial regulation has been good, it is not difficult to argue the opposite case: that much of the new regulation has been utterly wasteful and beside the point; that the effect has been to diminish liquidity and further concentrate economic activity. By way of example, see the articles in today’s Newsletter about central clearing.

There are serious consequences when politicians treat financial regulation as a mere political device and call to “target” the opposition. It’s time to start focusing on precisely those points where the Dodd-Frank Congress and the implementing regulators might have gotten it wrong.