The Senate approval of the Dodd-Frank Act on Thursday made world-wide headlines, and is being recognized as an achievement for President Obama, on par with health care reform. Why is new legislation, fundamentally domestic in its scope and intention, so important to the rest of the world?
For the past three years, the financial markets have been operating in a state of complete confusion. They were wondering what the new regulatory the frame of reference would be in the largest capital market in the world, the United States. The lack of direction compounded with the sequence of disasters from Lehman Brothers to Madoff, has left banks such as Goldman Sachs in the unenviable role of the "bad guy."
While Europe timidly tried to take some individual measures against hedge funds, short selling, taxation or compensation, it was not able to undertake a comprehensive overhaul. Many market participants were actually waiting for the US legislation to look at the architecture of finance in the XXIst Century. That is exactly what was delivered this week.
This is only a starting point, and the devil will be in the details of the new rules and regulations. On a global basis, there is no need for micro convergence of rules and regulations. The world cannot, however, live in a macro divergence. For better or the worse, the United States occupies a unique position as the market leader. Its influence will be critical.
There is another reason why the world was waiting for US regulation: it was in the United States that the most extreme abuses of finance were perpetrated. And the lobbying of banks has certainly not been a shining example of democracy either. While Wall Street is still feared and recognized, it is no longer respected for its leadership and the level of self-interest in the financial world is as plain as day.
The basic message that finance is a service industry has not yet reached the shores of the Hudson River. While finance is supposed to service the economy and its clients, the obvious betrayal of its vocation continues to resonate.
Two pivotal changes, however, prove that there is at least some hope on the horizon. First, credit card companies will be forced to simplify products' terms and conditions, giving consumers the ability to make more informed decisions. And secondly, the creation of the Bureau of Consumer Financial Protection will work to improve product disclosures and financial literacy so that consumers ultimately make smarter purchases.
The banks might begin, although reluctantly, to look at their clients' interest, creating a sea change. "Initium sapientiae timor" says the Bible. The beginning of wisdom is fear. However, financial institutions would be sadly mistaken if they believed that the government's extraordinary effort would yield increase respect from the rest of the world.
If we start to breathe easier, one can be sure of one thing: it is because the "law enforcers" are regulating consumer finance, not because we trust the leadership of financial institutions.
With this domestic regulation in place, we are efficiently positioned for what remains the biggest challenge: the world regulatory framework. With negotiations progressing for the new Basel III rules, banks will be required to allocate equity to risks in a coherent way, ultimately stabilizing the financial structure of the banking industry.