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Dodd-Frank Act will stand or fall on right people

Robert Shiller

At a Yale-hosted roundtable on the Dodd-Frank Wall Street Reform Act, professor of economics, Robert Shiller, said the success of the Act, and the agencies created to study aspects of the market, will depend on appointing the right people, who should be willing to take advice from his fellow economists.

“It is a good Act but only to the extent we make it a good Act,” he says. “There is enough in it, if they get the right people, people who have studied this kind of thing, then they can turn the Dodd-Frank Act into something that really does help prevent this type of crisis.”

He questioned the validity of appointing the Treasury Secretary, a position held in the past by many individuals who lacked finance and economics training, to head the Financial Services Oversight Council.

“I think it depends on who is in charge of the FSOC, how aggressive they are and how much they know what’s going on,” he says.

The Dodd-Frank Act creates the Financial Services Oversight Council, headed by the Treasury Secretary, which is tasked with making recommendations to government with the overall aim of preventing systemic failure.

“It is potentially a big and important change but I do have some questions. In 1987 Reagan put in place the President’s Working Group on Financial Markets to prevent systemic crisis, they didn’t do much, they didn’t prevent this crisis,” Shiller says.

The roundtable, hosted by director of the Yale Center for the Study of Globalisation and former President of Mexico, Ernesto Zedillo, and including Morgan Stanley economist, Stephen Roach and former Dean of the Stern School of Business at the NYU, Thomas Cooley, was held on September 15, two years to the day that Lehman Brothers filed for bankruptcy.

In his presentation, Shiller indulged in a “thought experiment”: if Dodd-Frank was in place 10 years ago, would Lehman have collapsed?

“Lehman was not a commercial bank, so it didn’t have bank regulation, this is critical to Dodd-Frank. The Financial Services Oversight Council, can on two-thirds vote designate such an institution to be regulated by the Fed – if it determines that there is material financial distress of that US non-bank financial institution that could possess a threat to the financial stability of the US. Would a Treasury Secretary make that call? I’ll remind you that Lehman’s debt was rated A+ by S&P until a few months before their bankruptcy.”

He says the past Treasury Secretaries, with the exception of Henry Paulson, had little knowledge of finance and economics; Paul O’Neill had a background in aluminium, and John Snow was in railroads.

“These guys are supposed to be stopping systemic risk.”

The Act also calls for the development of an Office of Financial Research under the FSOC.

“This can be a good thing if they fund it at a high level, but they are yet to decide the budget. It would be hard to turn down that job, it would be an important job,’ he says, commenting on a question as to whether he would take the position if it was offered.

Shiller says the Act takes account of a lot of the issues that have come out of the crisis.

“But the outcome will depend on what those people do, we can’t tell yet.”

There is also still a lot to be determined in how the Act is implemented – there are 112 rules to be written, and 60 studies to be completed.

The Act, which is 2,300 pages long, also has extensive sections on leverage ratios, and credit rating agencies as well as executive compensation

“Executive compensation is a political hot potato, our system may reward inappropriate risk taking. My recommendation, which I wrote in a New York Times article, is that executives should have part of their salary held back, and get it five years later, but they won’t get it if they are bailed out by government.”

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