Obama versus Romney on financial reform

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Americans have paid a heavy price for the financial crisis: massive losses to Americans’ retirement portfolios, a collapse in residential real estate values and an unemployment rate that peaked at 10.2 percent.

Candidates on the issues

Preventing a similar crisis in the future, and the unpopular bank bailouts that accompanied it, while not handicapping the role banks play in the economy have become important issues in the presidential campaign.

The two candidates, President Barack Obama and former Massachusetts Gov. Mitt Romney, have some major differences when it comes to how they would accomplish that. Obama’s biggest move was signing into law the Dodd-Frank Wall Street Reform and Consumer Protection Act, a wide-ranging overhaul of the nation’s regulatory framework.

Obama’s main task in a second term will be applying the financial reform law on issues ranging from the safety and soundness of money market funds to the Volcker rule, says Thomas Cooley, a professor of economics at New York University’s Stern School of Business. A September report by New York-based law firm Davis Polk & Wardwell LLP found that less than a third of the total rules called for under Dodd-Frank had been finalized.

“We are still a long way from dealing with the real bite,” Cooley says.

For his part, Romney has pledged to repeal Dodd-Frank and replace it with a “streamlined framework” of financial regulation that would be simpler and less burdensome for banks.

Still, when it comes to these differences, looks can be deceiving. While the campaigns play up the candidates’ differences, there are significant areas of overlap, says Leeto Tlou, a managing director in the FTI Consulting Forensic and Litigation Consulting practice based in Washington, D.C.

For instance, both camps have expressed support for banks keeping more liquid assets on hand to ride out economic downturns, he says.

“I think that a lot of people agree that capital provides a buffer against adverse events, and so when you increase those capital requirements, there is less of a chance for a bank to operate and take on more risk than it can shoulder,” Tlou says.

Here’s where the candidates stand on some of the hot-button issues surrounding financial reform.

Financial reform and the presidential race

Ending ‘too big to fail’

During the financial crisis, the federal government provided millions of dollars in liquidity to some of the nation’s largest banks rather than allowing them to fail, taking down the U.S. financial system.

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The Dodd-Frank Act requires the Federal Deposit Insurance Corp. to take over and shut down troubled institutions that were considered “too big to fail” in the past.

Under the law, Obama appointees in the FDIC have collected “living wills” prepared by institutions deemed “systemically important.”

The wills are designed to help regulators unwind the complex web of connections between a troubled institution and the rest of the financial system.

Mitt Romney has said he believes designating some institutions as “systemically important” implies the government will bail them out should they run into trouble.

Instead, he would seek to limit the risk of failures by increasing capital requirements and limiting banks’ borrowing.

Regulatory burden on banks

Financial institutions have seen their regulatory burden rise substantially in Obama’s first term, with new reporting requirements, restrictions on how they treat consumers and lending restrictions.

Barack Obama Mitt Romney
Beyond his administration’s continued implementation of the Dodd-Frank Act, which is slated to put in place hundreds of new regulations on banking, Obama has criticized Romney’s calls to roll back banking regulations on the campaign trail. Romney has criticized Dodd-Frank for the regulatory burdens it places on banks, especially community banks, saying that such regulations are making it harder for banks to lend, muting the economic recovery.

Romney would repeal Dodd-Frank and create a new “streamlined” regulatory framework to replace it. He also would create a “regulatory cap” that would put a dollar limit on the amount of impact regulations can have.

Under the policy, regulators would have to eliminate an existing regulation of equal value to the one being proposed.

Transparency in the derivatives market

Leading up to the financial crisis, banks signed trillions of dollars in confidential derivative contracts, creating a web of connections that threatened the financial system.

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Derivatives, such as the credit-default swaps, helped torpedo the economy in 2008 and early 2009 by creating risky links between banks.

In a second term, Obama appointees would continue building the new regulatory structure called for under Dodd-Frank, making the Commodity Futures Trading Commission and the Securities and Exchange Commission responsible for regulating and recording derivative transactions.

Romney has said that lack of regulation in the derivatives market was a major cause of the financial crisis, and he supports making the derivatives markets more transparent and more closely watched by regulators.

His economic plan calls for “greater transparency for interbank relationships.”

Risk retention

Before the financial crisis, many banks created and sold asset-backed securities, purposely insulating themselves from the consequences if they failed. Risk retention rules force banks to hold on to part of the investment so they have “skin in the game.”

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Dodd-Frank requires banks to retain a percentage of the mortgages and other types of loans they bundle and sell to investors in the secondary market.

In a second term, Obama appointees in the SEC and the FDIC would continue crafting guidelines that require banks to hold on to up to 5 percent of many asset-backed securities.

Although he supports full repeal of Dodd-Frank, he would favor making risk retention on mortgages part of replacement regulatory regime. “If a bank originates a loan or a mortgage, (then) it should be on the hook for some portion of the loss if that loan or mortgage fails,” he told Time magazine in August.

Sarbanes-Oxley Act

Sarbanes-Oxley was passed after the collapse of Enron in 2001 to ensure greater transparency in corporate accounting practices.

Barack Obama Mitt Romney
Obama signed the Jumpstart Our Business Startups Act, which eased Sarbanes-Oxley’s accounting requirements for small startups’ initial public offerings, as recommended by the President’s Council on Jobs and Competiveness.

Beyond that, Obama has expressed support for “tweaking” the legislation to make it less burdensome on businesses.

Romney has called for a full repeal of Sarbanes-Oxley, calling it a “legislative monster” that was “created to kill jobs.”

Capital requirements and leverage limits on banks

Many banks failed because they didn’t have the liquid reserves necessary to ride out the financial crisis and cover the bad bets they had made.

Barack Obama Mitt Romney
In a second Obama administration, Federal Reserve Chairman Ben Bernanke, who Obama reappointed, would continue implementing stringent capital requirements for banks with more than $50 billion in assets, as called for in Dodd-Frank.

Those requirements eventually will force banks to hold more cash on hand to ride out economic downturns. Dodd-Frank also requires the Fed to come up with leverage limits, or limits on the amount that banks can borrow relative to the amount of fixed assets they hold.

Romney seems to generally support federally mandated capital requirements and leverage limits for banks.

“We have to look at what the causes were of the last crisis and take action to prevent those causes from reappearing. What kinds of things come to mind include capital requirements, levels of leverage which are appropriate and inappropriate,” he told Time magazine in August.

His economic plan also references “enhanced capital requirements” as a concept from Dodd-Frank that deserves to be retained.

Volcker rule

During the financial crisis, many banks and bank-holding companies that held trillions in consumer deposits suffered devastating losses from their investments and had to be bailed out.

Barack Obama Mitt Romney
Dodd-Frank included the so-called Volcker rule, which largely prohibits banks and companies that own banks from risking their own money, trading in world markets, known as “proprietary trading.”

After the “London Whale” incident, in which JPMorgan Chase & Co.’s derivatives traders lost almost $6 billion in the first half of the year, an Obama administration spokeswoman affirmed the president’s support for the rule.

The rule is slated to be finished by year’s end. In a second term, Obama appointees in the Office of the Comptroller of the Currency, the FDIC, the SEC and the Fed would begin enforcing it.

While the Volcker rule isn’t specifically mentioned in Romney’s economic plan, Romney has called for the repeal of Dodd-Frank, which includes the Volcker rule.

In an interview with Bloomberg News, Romney policy director Lanhee Chen said, “You have to look at the Volcker rule as being an example of one of the problematic elements of Dodd-Frank and one of the problematic elements that, quite frankly, Gov. Romney would seek to replace.”

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