DOMESTIC
VANDERBILT POLITICAL REVIEW
Rhetoric vs. Regulation
The fractured relationship between Washington and Wall Street
T
he 2008 financial crisis stands as
one of the defining moments of the
last decade. With financial institutions shuttering their doors and unemployment skyrocketing, everyone from bankers
to builders was affected. Politicians, confronting a gaping ideological split between
Main Street and Wall Street, were forced
to make a difficult and public choice between voters and donors. As housing prices
plummeted, the political melodrama forced
banking regulation to take center stage.
However, political grandstanding does not
lead to effective legislation. While new
regulation was needed, aspects of DoddFrank and its international brethren were
often crafted to appeal to the public. This
can be seen across a variety of topics, such
as the policy for bank holding corporations’
recovery and resolution plans. Though only
time will tell whether these policies are innocuous or harmful, it is important to consider the dangers of having sound financial
regulation trumped by political rhetoric.
Before delving into the intersection between policy and finance, it is worth noting
the prevalence of political showboating.
As Mixon, Gibson, and Upadhayaya wrote
in a 2003 paper, the founding of C-SPAN
can be linked to increased filibustering and
other dramatic techniques. Additionally,
political scientists such as Keith Poole and
Howard Rosenthal have tracked the development of a more polarized Congress. Party lines are not an inherently evil divider,
but they are coupled with a few more menacing trends. Poole also notes that modern
politicians are not changing the way they
vote on issues over time. The worrying
ramification is that even in light of new
evidence, politicians may not change the
way they vote on particular topic. Throw
in the rise of the career politician, and the
6
by ALISON SHANAHAN ‘15
recipe for potential disaster is clear. With
politicians playing to their party’s constituents and focusing on re-election rather than
appropriate legislation, the probability of
making a serious legislative mistake rises.
Fortunately, politicians are not on their
own in drafting financial regulation. In
wake of the crisis, the Bank for International Settlements (BIS) gave global financial regulation a much needed overhaul.
The capital requirement was raised, the leverage ratio was introduced, and a host of
new methodologies and reporting methods
were approved for use by financial institutions. Other groups, such as the International Swaps and Derivatives Association
(ISDA), set guidelines for certain financial products. However, countries differ
in their implementation of these guidelines, especially with regard to the Basel
accords. Although countries are required
to meet the minimum standards, they are
free to add measures as they see fit. Perfect
global implementation of a single set of
rules will never happen even through international regulatory units, and the role of
electoral politics in regulation reemerges.
American politicians have tampered
with the banking system for decades,
and the financial crisis demanded political and economic intervention. Thus
Dodd-Frank was born, debated over, and
ultimately passed. Monumental in scope,
Dodd-Frank sourced the particulars of its
implementation out to an alphabet soup
of regulatory agencies. One of these provisions was for a recovery and resolution
plan (‘living will’) for banks and financial
institutions with total consolidated assets
of fifty billion or more to be implemented
by the Federal Reserve and the Federal
Deposit Insurance Corporation (FDIC).
Living wills are an easy pitch to con-
stituents. On the surface, they sound simple enough. Requiring institutions to have
plan for possible recovery and resolution
sounds responsible, and they have a few
merits in this regard. Consulting firms
appeal to financial institutions for adding value to the process. By gathering the
necessary information in a conscientious
manner, planning ahead when considering new ventures and taking other precautionary steps, the planning of a living will
could smooth proceedings during a crisis.
At the same time, everyone acknowledges that these plans are costly
in terms of time and strains on reporting resources and many would argue
that they have critical failings. Criticism
hails from all sides, but there are two
major flaws grounded in Dodd-Frank’s
politics: the uncertain role of the Federal
Reserve as the lender of last resort, and
the lack of international cooperation by
regulatory institutions and governments.
The obligation of the Federal Reserve
to serve as lender of last resort is oft contested, but has historical precedent. In
simple terms, in cases where a default by
a bank or other eligible institution may
have serious economic ramifications, the
Federal Reserve is able to provide a direct
loan. Some, such as Hal Scott, the Director of the Committee on Capital Markets
Regulation, use past Federal Reserve involvement in providing liquidity as evidence that ‘too big to fail’ is little more
than a catch phrase. Scott believes that
the Federal Reserve would step in as a
lender of last resort in case of a new crisis, as it has historically. However, with
Dodd-Frank’s passing, the role of lender
of last resort was restricted as banking supervisory power was increased.
Members of the Federal Reserve, such