Lessons from America: progressive banking reform
Getting banking regulation right should be a high priority for the Labour Party as it formulates its policies ahead of the 2014 European elections and the next general election. Labour should adopt policies that protect taxpayers and the wider economy from the risk of further bank failures, which hold bankers accountable for their actions when things go wrong, and that protect the rights of consumers and small investors. The United States has a highly-developed regulatory regime for banking and financial services, and offers both positive and negative measures that progressives in the UK should consider when formulating policy.
In 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). Dodd-Frank is the most significant development in US financial services regulation since Roosevelt’s “New Deal” reforms of the 1930’s, and includes a number of positive measures. Dodd-Frank contains a number of good ideas for protecting the wider economy, as well as the taxpayer, from the risk of failure of large banks. One positive development was the creation of a Financial Stability Oversight Council (FSOC) to identify risks to the US financial system arising from interconnected banks, and to eliminate any expectation that a financial firm is “too big to fail” (that is, likely to be bailed out by the taxpayer if it gets into difficulty). In the UK, the Prudential Regulatory Authority (PRA) will come into being late this year, and will perform similar functions to the FSOC. UK progressives should push for the PRA to end the notion that any UK bank can expect to be bailed out by UK taxpayers.
Dodd-Frank also includes enhanced procedures for banks and other financial services companies to be wound down in an orderly fashion when they become insolvent. This is a positive development, as banks should not expect to be bailed out by the taxpayer when they get into difficulty.
Dodd-Frank also includes the “Volcker Rule” which is designed to reduce the risk of banks being “too big to fail” by prohibiting banks from making certain kinds of speculative investments that do not benefit their customers. The Volcker Rule will reduce the risk of large banks failing because of “casino capitalism” bets gone wrong. Progressives in the UK should push for a similar rule to be adopted at the EU level.
Another positive aspect of Dodd-Frank is the creation of the federal Consumer Financial Protection Bureau (CFPB). The CFPB says that its central mission “is to make markets work for financial products and services for Americans—whether they are applying for a mortgage, choosing among credit cards, or using any number of other consumer financial products”. The agency is the brainchild of bankruptcy law expert Elizabeth Warren, who happily for progressives last year won the Massachusetts US Senate formerly held by the late Ted Kennedy. Warren is a strong advocate for consumers, and her philosophy is to make contracts such as credit card agreements or loan agreements much easier for laypeople to understand. Instead of pages of small print, consumer contracts should be a page long, written in plain English and easy to compare with competitor products. In the UK, the Financial Conduct Authority (FCA) will come into being late this year, and its mission will be similar to that of the CFPB. Progressives should keep a close eye on the FCA to ensure that it is effective at protecting consumers and that helpful regulation is not blocked by the banking industry’s army of lobbyists.
An area where the US has a mixed record is the prosecution of financial crime. Individuals in the financial services industry should expect to be prosecuted when they break the law, just like any other criminal. Historically, US authorities have been willing to prosecute crimes such as insider trading or securities fraud (for example, consider prosecutions against Enron executives and celebrities like Martha Stewart). However, recently US authorities have taken the worrying step of declining to prosecute bank executives at HSBC responsible for financial crimes on the grounds that sending HSBC executives to jail could threaten the future of the bank and the stability of the entire banking system. In the UK, progressives should push for much more prosecution of crimes such as market manipulation. A start is to continue to press for prosecution of those involved in the LIBOR manipulation scandal.
The United States also offers examples of poor or disappointing policymaking. Foremost amongst these is the Gramm-Leach-Bliley Act of 1999 (“Gramm-Leach”). Gramm-Leach repealed laws which had been in place since the 1930’s and which prohibited investment banks, commercial banks and insurance companies from combining into one entity. Gramm-Leach cleared the way for mega-mergers which have vastly increased the risk of “too big to fail” institutions damaging the wider economy. The UK should adopt precisely the opposite approach, and require legal separation of investment banks and commercial (or “high street”) banks.
And despite the many positive measures contained in Dodd-Frank, the fact remains that the Obama administration has failed to bring about an end to banks that are “too big to fail”. With the recent failure to prosecute HSBC for its financial crimes, the Obama administration has essentially admitted that some banks remain too big to fail and cannot be effectively regulated. An act of Congress would be required to tackle this problem head on, and with Republicans controlling the House of Representatives, the odds of this happening any time soon are slim.
The Labour Party can adopt many good ideas from the US, such as more protection from the systemic risk to the economy of the failure of large institutions, and enhanced protection of consumers. A future Labour government can and should take steps in this direction, as well as taking more radical steps like legally enforcing separation of investment banking from commercial banking. Many of these policies will be most effective if they are adopted by many countries besides the UK; British progressives should therefore look to work with our partners in the EU to make policy at the European level. Getting these policies right is essential to protect taxpayers, consumers and our economy.
This article is the third in a three part series on financial services regulation.