07/23/2010 01:37 pm ET Updated May 25, 2011

Financial Reform: Nobody Is Happy

President Obama signed the finance reform bill into law today. While the legislative debate is over, the policy debate about how to deal with the financial system continues, as reaction to the bill comes in. At first blush, nobody seems very happy.

  • The Very Liberal are unhappy. They believe the bill got so watered down that it makes no fundamental changes in the financial system, leaving the institutions, risks, and people in charge largely intact, and making another large crisis inevitable.
  • The Moderately Liberal are unhappy. They agree with their more partisan friends that the bill is not a definitive solution, but, they argue, it makes important and needed improvements which future legislation can build upon. Contemplating the mid-term elections, they are sobered by both the political cost to get this bill and the magnitude of the task remaining.
  • The Center is uneasy. They find the arguments of the Left that the bill does not change underlying conditions as persuasive as the arguments of the Right about the dangers of subsituting the discipline of bureaucracy for the discipline of the market. The bill was about all they could take.
  • The Moderately Conservative are unhappy. They worry, with reason, about the complexity and opacity of the bill. Most unintended consequences are negative, and a 2,000-page bill that needs 100 expert panels to fully study is bound to have unintended consequences. This group is further frustrated by having its voice in the debate muted by the fierce GOP intramurals.
  • The Very Conservative are livid. The bill, like other Obama packages, represents a U-turn from the world view they successfully promulgated for the last 40 years. In this case, the value offended is their belief that regulation is to be relaxed, reduced and ultimately eliminated.

The operational definition of a compromise from high school civics is that everyone is equally unhappy. By that metric, the finance reform bill is an excellent compromise.

Former Treasury Secretary and Goldman Sachs chairman Hank Paulson and former SEC chairman Harvey Pitt publicly estimated that another major financial crisis could occur within six to ten years. That view provides one way to measure what the finance reform bill may have actually accomplished.

With no action, another crisis of at least the magnitude of 2008 could occur relatively soon: perhaps within one to three years. Readers of this blog may recall my pet theory as to why this is so, based on the confluence of opacity, arbitrage, and leverage. I find this concern echoed one way or another across the political spectrum.

So, if one believe's Paulson and Pitts, the financial reform bill perhaps pushes out the next crisis past the end of Obama's Presidency, even assuming he is re-elected in 2012. I think there will be a grudging, but growing, consensus to that effect.

That consensus will join similar conclusions about TARP and ARRA. TARP did not resolve the crisis of 2008, but it is generally agreed that without TARP, the crisis would have become far, far worse. ARRA did not end the ensuing recession/depression, but again it is generally agreed that without ARRA, it would have been worse. I think it will become agreed that the finance reform bill did not put the financial system on sound footing, but without it, the fragile recovery would be shattered by the next instance of extreme volitility.

Some fear that the "not on my watch / kick the can down the road to the next administration" aspect of the current bill will be all there is. Liberals, and even moderate conservatives, believe that would not be a satisfactory outcome.

So what's next?

During the hot, steamy summer of 2010, probably nothing. To proponents of further reform, the bill bought time. Enough time, perhaps, to get past the most poisonous political atmosphere this blogger can recall. The most ardent call for some additional incremental measures to be taken up in the lame-duck session between the November 2010 elections and the new Congress in January 2011. I do not expect much: the 111th Congress probably won't do any more on this topic.

It is thus up to the 112th and 113th Congresses. And so the policy debate continues.

Personally, I would like to see the discussion move towards what the few over-arching principles of a 21st century regulatory environment should be. Regulatory principles are like the rules of a sport. They should be observable, and thus not too complex. The regulators cannot be as powerful as the players or as cunning as the coaches, but they need to be able to call ball or strike, fair or foul, safe or out.

The principles underlying the regulations promulgated during the New Deal were simple enough: transparency through public disclosure and avoiding conflicting function in the same organization. They worked well to avoid a major cataclysm for perhaps two generations.

Nobody believes that we can find a set of principles that will permanently avoid financial melt-downs. Changing technology and continued innovation in products and services will eventually come up with something that the smartest people today cannot anticipate. Nobody in 1937 could have envisioned computer-driven program trading, which in 1987 led to the first market melt-down since Glass-Steagall. Fifty years is a pretty good run: I think we'd be happy with a scheme that holds for a generation.

We have the gift of time. Do we have the wisdom and the will to use it?