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Financial Reform Could Take Years to Reach Full Effect

When President Obama signed the financial regulation overhaul into law Wednesday, he said he believed it would “rein in the abuse and excess that nearly brought down our financial system” and bring transparency to a sector that became too dependent on risky bets, overleveraging and shadow banking practices.

While those claims will be debated for years to come (and were debated on our program Wednesday), one thing is very clear when you listen to the experts: It’s going to be quite some time before we can even begin just how effective it will be. That’s because it will take more than a year before the full power of the law kicks in. And much of the implementation and interpretation of the law will be tied to the attitudes and philosophies of federal regulators in charge.

Let’s start with the matter of the timelines:

Given the complexity of this bill, it would be hard to ramp up so much regulation quickly (not to mention hiring new talent; the SEC estimates it may need to hire 800 people just for its agency alone.) But the implementation of this law — and the efforts to curb risky behavior in the financial sector — may take longer than people expect. (The Washington Post lays it out with a graphic and Reuters spells out a more detailed timeline.

Take the so-called Volcker Rule, for example, named after former Federal Reserve Chairman Paul Volcker. Among other things, it’s best known for limiting some (but not all) of a bank’s proprietary trading on its own behalf that doesn’t benefit customers and would restrict the amount of investing banks could do with hedge funds and private equity.” The earliest that some provisions will take effect is 18 months from now. And the provisions limiting proprietary trading won’t take effect for two years.

But here’s the part that people really don’t realize:

Firms will have two years to fully comply after that. And in some cases they could still apply for three years of extensions beyond that. That’s right. We’re talking possibly five years if you work the system with precision and smarts. And analysts and attorneys say even more time could be allowed by regulators for illiquid assets such as real estate or private equity.

It was those kind of changes and others that made Volcker himself somewhat less enthused about the final compromise that was finally agreed upon.

The ban on proprietary trading is still there,” Volcker told the New Yorker’s John Cassidy in this week’s issue. “But I’m sorry we lost the tighter limitations on hedge funds and private equity…I’m a little pained that it doesn’t have the purity I was searching for.”

The effort to regulate derivatives is charted on a longer timeline as well. Derivatives are often thought of as bets or swaps that can hedge against risk but can also be risky and dangerously leveraged. (They’re best known for starring in that story you may remember all too well: The Fall of AIG…or How I Learned to Stop Worrying About Bets Gone Bad and Love Government Protection.)

Regulators will start defining who is restricted by these rules over the next six months. But the full brunt of the provisions won’t take effect for a year.

Still, some very important parts of the law will take effect more quickly:

A new council to watch for financial risks to the broader system will be formed quickly and must meet within three months. FDIC Chair Sheila Bair and Treasury Secretary Timothy Geithner will have authority immediately to seize firms that could pose dangers to the stability of the system (though it may take them some time to figure out how to define what exactly constitutes a threat). The new consumer protection agency that’s supposed to serve as a kind of cop and protect Americans from sketchy lending practices and create new rules for checking accounts, credit cards and mortgages would full operations in about a year.

There’s plenty more information about the questions surrounding the implementation of the law. American Banker has a good piece that lays out five key challenges.

Once you get beyond the issue of timelines, there’s the very important questions about the regulators themselves:

That council to watch the systemic risk from any firm considered “too big to fail?” It will include Secretary Geithner, who was criticized plenty for his role at the New York Fed. It would include leaders from the SEC and the Fed, institutions that have both been criticized in the past for being too lax in diagnosing or responding to potential risks.
As Douglas Elliott of the Brookings Institution wrote recently:

“There is broad agreement that one of the failings of the prior regulatory system was that no one was clearly responsible for monitoring the system as a whole, such as watching out for developing bubbles in the housing market or elsewhere.”
“Regulators here and around the world,” he writes, “will be critical to the success of financial reform.”

Already, the question of whom should head the new Consumer Protection Agency has already turned into a full-fledged battle with some critics and experts pushing for Elizabeth Warren, the Harvard bankruptcy law professor who has made a name for herself as the head of a congressional TARP oversight panel. In that capacity, she has grilled many people connected with the crisis — and she’s made a point of trying to take the Treasury Department past and present to task.

She would have “a definitive impact,” securities professor Lynn Stout told Judy Woodruff Wednesday. The banks are opposed, she said, “because they don’t want a watchdog, they want a lapdog. It remains to be seen whether the administration will have the courage” to appoint her.

But others have branded Warren as too difficult and too hostile to businesses and banks, someone who could overregulate and restrict credit and lending.

Because the stuff of financial regulation is so arcane, the media (with the exception of some in the financial press) are likely to lose interest in these kind of details in the months ahead. But if there’s one thing that the most recent bubble and crisis have shown us, these kinds of details over the implementation of the law — and who’s enforcing its toughest provisions — will be well worth monitoring in the months and years to come. We’ll try to find ways ourselves of staying on top of how it’s playing out and what you need to know.

Follow @murreyjacobson.

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