The first big test of how strictly regulators will interpret the Dodd-Frank Act comes next week when the Financial Stability Oversight Council explains how it wants the Volcker Rule to be enforced.
The regulatory reform law of July 2010 created the new umbrella organization and gave it six months to outline how proprietary trading should be reined in.
The Oversight Council, a motley collection of 15 federal and state officials representing everything from banking to securities to insurance, has held two meetings to date and issued its call for comments on the Volcker Rule in October. Not surprisingly it got an earful from industry participants who urged all sorts of exceptions and carve-outs.
The hawks and doves on the Oversight Council were still shaping the final report this week, but where they come out will begin to answer an important question Congress left hanging: how concentrated should the U.S. banking system be?
If the Oversight Council goes light on the Volcker Rule, there is little reason to expect it will take a tough stand on its other main job — deciding which nonbanks are systemically important.
Any firm so labeled will face the same oversight and rules as the largest banks, including the requirement to tell the government how it should unwind if and when trouble strikes.
Regulators are divided on this one as well, and again not surprisingly the comment letters received by the Oversight Council mainly argued against inclusion. The council is expected to refine its proposal later this month and issue it for another round of comments.
Federal Deposit Insurance Corp. Chairman Sheila Bair is the only member of the Oversight Council to repeatedly speak about using Dodd-Frank as a tool to encourage the largest financial companies to simplify their operations and shrink their size. She would not hesitate to use Dodd-Frank's living wills to require to company to spin off any subsidiary the agency viewed as a roadblock to an orderly liquidation.
But Bair won't be in office when those decisions are made. Her term ends this summer, and she has insisted she will leave when it does. Considering the Obama administration's weak track record on appointments, it's a good bet Vice Chairman Marty Gruenberg will be left to run the FDIC on an interim basis; and an acting chairman will not have the same independence or clout Bair has enjoyed.
So within months, it's likely the Federal Reserve Board will be the only banking agency with a presidentially appointed, Senate-confirmed leader in Ben Bernanke. The Office of the Comptroller of the Currency has an acting leader and the Office of Thrift Supervision is in the process of being folded into the OCC.
The Oversight Council is chaired by Treasury Secretary Tim Geithner, who is a former Fed official and has taken an outsize and active interest in financial regulation. That's understandable given the crisis, but it still bugs a lot of people who are used to Treasury leaving banking policy issues to the OCC.
The other key members of the council are the heads of the Securities and Exchange Commission and the Commodity Futures Trading Commission — both of whom are busy implementing their portions of Dodd-Frank and have not said much about these issues — and the director of the new Office of Financial Research, a potentially crucial job the administration has left vacant.
That means Bernanke and Geithner are likely to be the main decision makers when it comes to rules affecting the largest financial companies, including both the Volcker Rule and the designation of systemically important.
They were two-thirds of the trio (with then-Treasury Secretary Henry Paulson) who crafted the bailout programs of late 2008 and early 2009. That work established their records as incrementalists — do as much as needed to address the immediate problem and hope that more intervention is not necessary.
Many variables will come into play — including plenty we can't imagine today — but the rules implementing Dodd-Frank are likely to toe a tight line with the law.
That would fit the tenor of Washington after the midterm elections. The administration took to heart the Republican "shellacking," as President Obama put it, and is trying to defrost its relationship with corporate America. Never was that more clear than when Obama passed over an insider to name JPMorgan Chase executive Bill Daley as his chief of staff. To ensure the economy is revving by the 2012 elections, the administration needs the banking sector to be lending and businesses to be hiring.
"They are going to be conservative [in implementing Dodd-Frank] because they won't want to disturb the budding economic recovery," said Ron Glancz, a partner at Venable who is closely tracking Dodd-Frank's implementation. "They know they have a lot of power and they want to be able to pull the trigger when they have to, but they don't want to do anything that would shock the market."
