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Hal Scott on Dodd-Frank

by Robert Teitelman | Published January 26, 2011 at 2:23 PM

With the State of Union cuddlefest now over, the battles begin anew in Congress. On Wednesday morning, I caught up with Hal Scott, the longtime Harvard Law School professor and director of the Committee on Capital Markets Regulation, who was on his way to Capitol Hill to testify before Spencer Bachus' House Financial Services Committee. Scott now occupies a particularly interesting, if potentially contentious, battleground: He's in the center. The Committee on Capital Markets Regulation was launched by then-Treasury Secretary Henry Paulson in 2006, well before the financial crisis hit. Its original mission was competitiveness -- how to reform the rules to insure that American financial pre-eminence was not lost; back then, in those rosy antediluvian days, fears were mostly centered on London, which was famously picking up market share from New York in initial public offerings. As Scott himself is quick to point out, "competitiveness," in the sense of clearing away retrograde, anachronistic or redundant rules that are a needless burden on business, "is back," not least from the White House.
For Scott, the committee and, of course, Paulson, the early work on competitiveness was quickly pushed aside with the financial crisis. The committee, which consists of an array of major figures from regulation, financial services and academia (its co-chairmen remain Glenn Hubbard, economist and dean of the Columbia Business School, and former Goldman Sachs vice chairman, under Paulson, John Thornton), published a big report in May 2010, "The Global Financial Crisis: A Plan for Regulatory Reform," while Congress was still chewing over what became Dodd-Frank, and pumps out a stream of comment letters, testimony and proposals. Given its membership, the committee thus represents a kind of establishment perspective. On one hand, you're not about to get proposals from it to radically recast finance, through breaking up or nationalizing the banks. On the other hand, the committee was quick to respond to the depth and seriousness of the crisis. And it has long recognized that reform was necessary and that it needed to be engaged in the political process of reconstruction.

Scott himself was heading up to the Hill to offer a message that will not be necessarily welcome to partisans on either side of the aisle: He supports the general outline of Dodd-Frank and doesn't believe it should be dismantled, as voices from both left and right still insist. He believes the agencies need more budget, rather than less. He is mostly concerned, right now, with the sheer amount of rulesmaking that is going on within the agencies, and the speed with which those rules are being promulgated. "A large amount of rulesmaking is taking place right now," he says. "This is being done in a very compressed time period. I don't want to kill it [Dodd-Frank] -- but to take our time. That's my message."

Scott and the committee are particularly concerned about the rules being written to regulate derivatives, notably from the Commodities Futures Trading Commission, which, as he says, "has not traditionally done anything like this." He's not, he insists, "anti-derivatives regulation." He just wants these extremely complex rules to be written with some thoughtfulness and care.

That said, he's also realistic about the limits of Dodd-Frank. One argument for allowing the banks to remain too big to fail is that Dodd-Frank contains a resolution authority for winding them down without triggering wider systemic breakdowns. The process has never been tested, and Scott is quite forceful in his own belief that the resolution issue is essentially insolvable. No matter what the rules are, creditors will still race to the exits if they think they're about to take a hit. Indeed, he's willing to advance the notion that at times bailouts might be rational and inevitable -- and that it would be better to think hard about it ahead of time than simply declaring that they'll never be used again. "This is the No. 1 issue -- how to contain contagion," he says. The committee is currently working on a larger report on the contagion issue (as well as on bank capital).

Scott, like Paulson, may prove to get a few brickbats from both sides. He could well be accused of trying to delay rulesmaking, in order to allow more time for the industry to shape the final product to its liking. Despite the return of the issue, he'll be blamed for the committee's early competitiveness report that -- like just about everyone else -- failed to anticipate the larger systemic crisis. He'll be criticized for supporting intrusive regulation and a corporatist state. If he gets around to his views on bailouts, well, the response may be political incredulity.

Scott and the committee may be right or wrong on specific, very complex issues. They clearly do represent finance in its broadest aspects, and implicitly try to balance growth and competitiveness (including, Scott notes tartly, a financial sector that needs to be competitive too) with safety and soundness. As an establishment forum, they will, like regulators, eternally face the charge of capture. But for all of that, Scott and the committee do hew closer than many other private voices from the commentariat on these issues to the administration itself. Although it's sometimes hard to tell, they're not alone in the center. - Robert Teitelman

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Tags: Committee on Capital Markets Regulation | Dodd-Frank | Hal Scott | The Global Financial Crisis: A Plan for Regulatory Reform | Treasury Secretary Henry Paulson

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