NEW YORK ( TheStreet) -- Sen. Chris Dodd would like to streamline banking regulation. Good luck. Under a 1,136-page proposal outlined on Tuesday, the Connecticut Democrat would strip the Federal Reserve of its supervisory power over banks. The Fed's ability to issue emergency loans, as it did for the rescue of American International Group ( AIG) would also be erased. The Fed would instead focus on its primary job all along: Adjusting interest rates to promote sensible economic growth.
Banks would be overseen by a newly created Financial Institutions Regulatory Administration, or FIRA. The Federal Deposit Insurance Corp. would be charged with handling -- and, if need be, dismantling -- firms deemed "too big to fail." A Consumer Financial Protection Agency would do what its name implies, and an Agency for Financial Stability would be broadly responsible for monitoring systemic risk. The Fed chairman would hold a seat on its board, along with eight other appointees. The idea of restructuring the regulatory powers that be in such a manner has been floated by policy wonks since the start of the financial crisis. However, the Fed's future power -- or lack thereof -- has been a hotly debated issue. One camp believes the central bank failed to adequately monitor risk. Therefore, those powers ought to be doled out across a committee of agencies in order to ensure adequate checks and balances. Others say the institution needs reform, but that having political appointees make decisions about financial stability would set up a situation far more toxic than TARP.
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"ABA supports comprehensive reform, but not this reform," says Edward Yingling, president and CEO of the American Bankers Association. According to Yingling -- whose group represents all of the major financial firms, including Bank of America ( BAC), JPMorgan Chase ( JPM), Wells Fargo ( WFC), Citigroup ( C), Goldman Sachs ( GS), and Morgan Stanley ( MS) -- the proposed reform would create additional conflicts between state and federal regulators, unnecessarily increase the cost of doing business and restrict available credit for consumers and businesses in need of loans. The ABA would prefer to add a systemic risk regulator, come up with a solution for "too big to fail" entities, and strengthen consumer protection measures within the existing framework. The bank lobby also points out, importantly, that while the Dodd plan would perhaps simplify federal banking oversight, it wouldn't address the issue of conflict between state and federal banking authorities. It may add confusion from a banker's point of view, but it also leaves opportunity for banks to go "regulator shopping" for the agency most friendly to their goals. "It doesn't eliminate regulatory arbitrage -- let's be realistic about that," says Kevin Petrasic, a lawyer for financial companies at the law firm Paul Hastings, and former special counsel at the Office of Thrift Supervision. The OTS, along with the Office of the Comptroller of the Currency, would be rolled into FIRA. The federal regulator would also usurp the supervisory powers of the Fed and the FDIC, though the FDIC would still operate as an insurance fund for state-chartered banks. In response to criticism of Dodd's proposal, consumer advocates have dug in their heels for a fight: "We intend to ... strengthen
lawmakers' bills and fend off pernicious special interest amendments to weaken or delay final passage," said Ed Mierzwinski, director of consumer programs at U.S. PIRG, the federation of state Public Interest Research Groups.
Given the rhetoric of Fed Chairman Ben Bernanke's recent congressional testimony, and the hue and cry from conservatives like Sen. Jim DeMint (R., S.C.) and Rep. Ron Paul (R., Texas) who have proposed launching an examination of the Fed's financial activities, advocates of the central bank's purported political independence will have a tough time. After all, Fed chairpersons are elected by the president, and if former Fed Chairman Alan Greenspan is any example, that independence and perceived infallibility can be dangerous. Paul calls the notion of political independence a "facade," noting that chairmen must set up alliances with presidents in order to re-appointed: "There is a lot political shenanigans going on with the Fed already." Petrasic agrees that the Fed is "politically sensitive" already, but says its thin layer of independent sheen was enough to prevent a major financial catastrophe during the crisis. "Imagine a year ago that the Fed chairman and Treasury secretary had to get a sign off from the House and Senate to implement all these crisis programs?" Petrasic asks rhetorically. "It never would have happened. Things would have been far worse." Before Dodd's bill can go anywhere, he will have to negotiate with House Financial Services Committee Chairman Barney Frank (D., Mass.) and the Obama administration, whose competing proposals would expand the Fed's power, rather than constrict it. The House and executive branch appear to be focused on what's politically feasible, to make some meaningful reforms as quickly as possible. Dodd, on the other hand, is working from the other end of the spectrum - what the senator considers the ideal reform - and hoping that the two will meet somewhere in the middle.
"This is a thorough and carefully constructed plan," Dodd said on Tuesday. "It will promote innovation and job creation while protecting consumers and our economy as a whole from another crisis like the one we are now in. I look forward to the continued input and cooperation of my colleagues from both sides of the aisle." As the political wrangling proceeds, Bernanke awaits confirmation for his second term. -- Written by Lauren Tara LaCapra in New York