Financial Reform Watch

Financial Reform Marches Down Field--Fed Protects Its Turf

In the spirit of football season—when trite gridiron analogies are abundant—the Federal Reserve exhibited an aggressive defensive stand this week, asserting its regulatory authority in the face of an administration proposal to curb its independence through the creation of a Consumer Financial Protection Agency (CFPA). This, coupled with the SEC actions yesterday—moving to ban flash orders that enable certain market participants to execute trades faster than everyone else and proposing new rules to crack down on credit rating agencies—suggests that regulators are beefing up their own authority to head off anticipated reform efforts on Capitol Hill. How well the agencies address the perceived regulatory gaps may have a significant impact on a legislative reform bill and could potentially slow down its momentum.

The Fed’s first defensive play came on Tuesday when it announced new regulatory policies that will extend its oversight to certain non-bank institutions, including many of the top originators of subprime loans. As part of the consumer compliance supervision program, the Fed will immediately begin overseeing the activity of non-bank subsidiaries of bank holding companies and foreign banking organizations, specifically by enforcing existing consumer protection laws and investigating all consumer complaints leveled against such entities.

The Fed’s second play – although reportedly still a few weeks from final completion – is the drafting of a proposal that will allow the Fed to reject bank compensation structures that the regulators believe could promote risky financial incentives and practices. According to the Wall Street Journal, the forthcoming proposal would allow the central bank to review and amend not only the compensation polices for executives, but also those for mid-level employees such as traders and loan officers, likely forcing banks to utilize “clawbacks” or mechanisms to reclaim the pay of employees who engage in risky behavior. The Fed is citing its existing regulatory authority over bank safety and soundness to impose its reach into the normal workings of corporate boards and bank executives. 

Although the first announcement had been long expected—Fed Governor Elizabeth Dukes had earlier testified to the House Financial Services Committee of plans for permanent oversight following a successful joint pilot project that reviewed consumer protection compliance of non-depository institutions engaged in subprime lending—the executive compensation proposal caught many in the financial industry off-guard, going far beyond the expected restrictions on only the highest bank earners.

Next week, the House of Representatives is slated to initiate the drafting process for financial reform legislation, beginning with several hearings related to a systemic risk regulator and the CFPA tentatively scheduled all the way through October. House Financial Services Chairman Barney Frank (D-MA) continues to insist that December is the new October, in reference to his original deadline for completing a reform package; and the deadline may be pushed back even further—potentially 2010—due to this week’s regulator activity.

The timing of the Fed’s moves have sent a clear message to lawmakers that it has no intention of quietly ceding its regulatory powers, especially those related to consumer protection. However, the central bank’s inability to prevent many of the missteps and misdeeds that led to the financial crisis has led to a crisis in confidence on Capitol Hill. Additionally, President Obama, Senate Banking Chairman Christopher Dodd (D-CT), House Financial Services Chairman Frank (D-MA), TARP Congressional Oversight Panel Chairman Elizabeth Warren, and FDIC Chairman Sheila Bair are all on record favoring the CFPA. Despite the strength of the offense, there is still disagreement coming from Republicans and some Democrats. Financial Reform Watch anticipates more "delay of game" setbacks in the coming months.

Below is the full list of HFSC hearings that were announced on Tuesday:


September 23, 9:30 a.m.     Testimony from Treasury Secretary Geithner

September 24, 10 a.m.        Expert’s Perspectives on Systemic Risk and Resolution Issues

September 25, 9 a.m.          Oversight and Audit Issues at the Federal Reserve System

September 30, 10 a.m.        Consumer Financial Protection Agency

September 30, 2 p.m.          Credit Rating Agencies (Capital Markets Subcommittee Hearing)


October 1, 10 a.m.                Financial regulators

October 2, 10 a.m.               Capital Market Issues

October 6, 10 a.m.               Capital Market Issues

October 7, 10 a.m.               Derivatives

October 8, 10 a.m.               Systemic/Prudential Banking Reform Issues

October 9, 10 a.m.              Systemic/Prudential Banking Reform Issues

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