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Dodd bill aims to simplify the patchwork of bank regulation

Sen. Christopher Dodd introduced a bill in the Senate Banking Committee Tuesday aimed at tightening bank regulation. Critics of the current system say regulators are too cozy with bankers now.

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• Set up a single federal bank regulator. Today’s system of multiple regulators allows banks to “shop” for regulators who may be most friendly. The House and Obama plans don’t seek such a change. Either way, finance experts say the problem of “regulatory capture” – in which regulators often see things from the perspective of the companies they oversee – may persist.

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• Create a new Consumer Financial Protection Agency to regulate products such as mortgages. This goal is shared by President Obama and House Financial Services chairman Barney Frank.

• Set up an independent agency to guard against systemwide risks, in addition to the regulators tasked with narrower oversight of specific types of institutions. The House plan, by contrast, would have the Federal Reserve take the lead in watching for systemic risk.

The 1,100-page draft bill contains many more elements as well.

“I’m impressed by the [Dodd] plan to have Federal Reserve Bank presidents appointed by Congress,” says Dean Baker, an economist at the Center for Economic and Policy Research in Washington. “This idea that the banks pick their regulators is crazy.”

Bankers help pick their own regulators

Currently, local business leaders including bankers play a key role in choosing who heads the 12 regional Fed banks. In turn, the Fed is a key regulator of large banks, and played a pivotal role in bailouts last year.

Mr. Baker says the Dodd plan moves in a positive direction on many fronts, but he questions whether it goes far enough.

One big example: complex trading in derivatives.

He says none of the plans Congress is considering will strongly regulate that arena, which could leave the financial system exposed to crisis in the future. Last fall, insurer AIG’s derivatives exposure sent fear rippling through financial markets, as investors wondered who would be caught short if AIG couldn’t pay off on the contracts it had entered. Taxpayers ended up footing the bill to cover the derivative deals, and rein in a potential panic.

More broadly, Baker says Congress hasn’t addressed the question of how to give regulators the right incentives. When times are good, bank supervisors face a political backlash if they try to crack down on credit-market excess. Baker adds that the regulators – including the Fed chairman – don’t tend to lose their jobs if they fail in their risk-management duties.

“What’s the structure of incentives ... when the next bubble builds?” Baker asks. “No one is even talking about that.”

See also:

Bankers face activists’ anger in the streets of Chicago

Foreclosures rise. Big banks show profits. How can that be?

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