Island Investing: Status of Reform

From my column last Saturday in the Keys Weekly.

Q. What’s the latest on financial reform?

A. Last week the Senate passed major financial reform legislation that is in now being reconciled with a bill passed by the House last year. Once the differences are ironed out, it will be signed into law.

The legislation, not without controversy, contains a number of provisions intended to try to reign in banks, set up new regulatory agencies and avoid future taxpayer-funded bailouts. Among other things, the legislation would:

– Create a council of risk regulators tasked with preventing the failures of massive companies which could threaten the entire financial system;

– Establish a consumer protection division for financial products;

– Allow the government in extreme scenarios to seize and close down failing financial companies in order to protect taxpayers from future bailouts;

– Call for a one-time audit of the Federal Reserve;

– Force most derivatives to be traded on exchanges, where regulators will have more transparency and power to oversee them.

On Wall Street, most of the angst revolves around one particular aspect of the proposed reform. The Senate version of the bill directs regulators to restrict banks from proprietary trading – currently a huge source of profits for the banks. Whether or not the banks are forced to spin off, or completely separate from, their derivatives trading business remains to be seen. The Street and its lobbyists appear to be trying quite hard to derail this provision.

In general, the changes in the proposed legislation seem to imply that our financial system was sound, but the credit crisis and Great Recession were caused by a lack of regulation and oversight. As a result, the legislation will reduce the size of the industry’s profits, but will not address the size and/or political power of Wall Street. Read into that whatever you may.

One particular part of the reform that I was particularly glad to see dealt with the credit rating agencies. A system where the banks getting rated pay the firms doing the rating is hard to defend. The end of that practice alone is something to be noted.

Cale Smith

About Cale Smith

Portfolio Manager at Islamorada Investment Management.
This entry was posted in Island Investing and tagged . Bookmark the permalink.

2 Responses to Island Investing: Status of Reform

  1. Kirk Kinder says:

    Until we get a separation of depository and investment banks, this is all fluff. The prop trading might work, but it doesn’t go far enough.

    The Fed needs to be audited constantly. Every institution is audited. Taxpayers face the IRS. Nonprofits face the IRS and auditors. Corporations have two auditors. Even guv agencies have internal audits from GAO.

    How can we be a capitalist economy when such a large part of our economy is controlled by a cartel of bankers locked behind closed doors with no accountability. Sounds like a commissar from old USSR.

  2. David says:

    //rant on

    Smoke and mirrors. Bring back the Glass Steagall act as a starting point or it’ll be back to business as usual on Wall Street, assuming it isn’t already. Grrr…I don’t even know why I get hung up on this political stuff, since we all know D.C. and Wall Street are two faces of the same coin.

    //rant off

    …better if I just stick to making money….back to my 10-Q and K’s….