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Home > Blogs > Ian Fraser and Anthony Harrington > Review of 2010: Shaking up regulation

Review of 2010: Shaking up regulation

Finance Blogger: Ian Fraser and Anthony Harrington Ian Fraser and Anthony Harrington

In January, it seemed that few lessons had been learned from the most destructive financial crisis since the 1930s. Writing in Freefall: America, Free Markets, and the Sinking of the World Economy, his book on the global financial crisis, Professor Joseph Stiglitz lambasted the administration of President Barack Obama for what he saw as its lame response to the crisis.

The Nobel-prize-winning former World Bank chief economist said that, rather than take the opportunity to push for radical reform of Wall Street, Obama’s administration had favored papering over the cracks of a fundamentally flawed financial system (see blog post: Stiglitz lambasts Obama).

Obama’s biggest mistake, said Stiglitz, was to ask the very people responsible for causing the mess – i.e. bankers still clinging onto discredited neo-classical thinking – to “take charge of the repair job”.

Early in 2010 there was also a heated debate about the introduction of a Tobin tax on financial transactions globally (see blog post:Tobin becomes fashionable) with the UK prime minister Gordon Brown and French president Nicholas Sarkozy leading the charge from Europe.

However, they seemed to meet immovable objects in the shape of the IMF’s Dominique Strauss Kahn and US Treasury secretary Tim Geithner, neither of whom believed in such a transactions tax. Plans for a so-called “Robin Hood” tax have since been quietly shelved.

However it didn’t take long for Obama to pull a rabbit out of his hat when he came up with the so-called Volcker rule. Under the rule – first proposed in late January 2010 by Paul Volcker, the 82-year-old former chairman of the Federal Reserve, who Obama had appointed as chairman of the President’s Economic Recovery Advisory Board the previous year – deposit-taking institutions would be banned from proprietary trading, private equity or hedge funds.

The rule had enthusiastic backers including the leading investment manager Jeremy Grantham who said that prop trading was “at the heart of our financial problems” (see blog post: Volcker's right).

After a tortuous passage through Congress the act was enshrined into law as part of the wide-ranging Dodd-Frank Wall Street Reform and Consumer Protection Act on July 15. The New York Times said this Act closed the book on a 50-year spell in which politicians had, wrongly, believed that financial deregulation was best.

Dodd-Frank gave birth to a new Financial Stability Oversight Council, a “resolution authority” for failing banks and financial institutions, and a new Consumer Financial Protection Bureau within the Federal Reserve. It also imposed tougher capital, leverage and liquidity requirements on banks, as well as new requirements for derivatives, hedge funds, private equity funds, credit rating agencies, debit card interchange fees and corporate governance.

However critics said the act had missed the mark. Some complained it would do nothing to prevent further crises since it missed the boat on three counts:


  1. It failed to tackle the “too big to fail” issue by imposing size restrictions on banks,
  2. It failed to reform America’s secondary mortgage players Freddie Mac and Fannie Mae
  3. It failed to reinstate Glass-Steagall’s separation of “utility” and “casino” banking.

One of the harshest critics was John B Taylor, professor of economics at Stanford University (see blog post: Dodd-Frank won't prevent future crises), who said the Act’s biggest single lapse was that it muddied the waters where the regulation of over-the-counter derivatives was concerned. It did this by handing the regulation of derivatives to both the SEC and the Commodities Futures Trading Corporation – without clarifying who was to do what.

However, at least America was putting something on the statute book, albeit nearly two years after the global financial crisis erupted.

Other advanced economies took longer to overhaul their regulatory systems. In the UK, the Financial Services Authority, which is widely regarded as having made a dog’s breakfast of regulating finance in 1997-2008, largely owing to misplaced faith in “light touch” regulation, is due to be disbanded.

In July the coalition government said the FSA would be split into a Prudential Regulatory Authority (overseen by the Bank of England) and a Consumer Protection and Markets Authority.

As we noted in an earlier blog, there are a great many diehards in the City of London who are unhappy about these proposed changes. They are loath to see the end of soft touch regulator which they believe served their sector well.

Similar changes are afoot in Brussels with the European Commission’s internal market commissioner Michel Barnier and colleagues putting together a more centralised framework for overseeing financial markets and financial regulation (blog: Barely a whimper in the City).

The new regulatory structure will comprise the Frankfurt-based European Systemic Risk Board – which will itself be strongly linked to the European Central Bank – at the top. The ESRB will, in turn, oversee the European Banking Authority (to be based in London); the European Insurance & Occupational Pensions Authority (based in Frankfurt) and the European Securities Markets Authority (based in Paris).

The ERSB, chaired by ECB president Jean Claude-Trichet, has recently appointed the Bank of England governor Mervyn King as its vice-chair and is due to hold its first meeting on January 20, 2011.

The prospect of these new bodies overseeing financial regulation in Europe has also got some in the City of London into a bit of lather, as they suspect that they will end some cherished freedoms, overturn what was previously a somewhat clubby approach to regulation, and undermine London’s competitiveness as a global financial centre.

The thorny issue of bankers’ bonuses (blog: Barclays bonuses) is another matter that is being addressed at a European Union level. In December the Committee of European Banking Supervisors (CEBS) produced mandatory guidelines saying that no more than 20% of bankers’ bonuses ought to be paid in cash, although CEBS said the requirement could be "neutralized" for less risky firms and staff.

CEBS alarmed banks in October when it published draft guidelines that went beyond what had been agreed by world leaders at the G20 summit in South Korea. Bankers and lawyers argue that even the more flexible, revised guidelines which are due to take effect in January are the toughest pay curbs in the world.

Our overall take on these regulatory changes so far? Could do better.

Tags: central banks , EU , European Central Bank , G20 , regulation , UK , US
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