The US arms its financial regulators

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By agreeing on a US financial regulation bill on Friday, the House-Senate conference teams armed President Barack Obama with good news for the G20 summit in Toronto. Now the full chambers of Congress must arm regulators with weapons to repair the dysfunctional US financial system by passing the bill without delay.

A number of compromises were struck to agree a text. The Volcker rule – which forbids deposit-taking banks to invest in hedge funds or engage in proprietary trading – and the Lincoln amendment – which forces banks to bundle their derivatives desks off into separate entities – were passed after relaxing both just enough to win over recalcitrant lawmakers.

Though among the most controversial elements in the law, these rules were distractions: they do little to rein in systemic risk. What matters is that they will not scupper the last stretch of the legislative process. Similarly, a surprise levy of up to $19bn on financial institutions to cover a last-minute estimate of costs to taxpayers is an acceptable way to rid the path to passage of remaining obstacles.

The bill is not perfect, but it vastly improves on the status quo. The US will finally regulate derivatives. It will have a system for winding down the largest financial institutions if they fail. And the responsibility for preventing both systemic risk and consumer abuse will be clearer and stronger.

Yet completing financial regulatory reform is less a final victory than an opening shot in a long struggle. Regulators will now have the authority to keep banks on a tight leash. But authority to act is not the same as action, and it will be up to regulators to wield their newly won powers. This they will only do effectively if other countries do the same, and if regulators everywhere have political backing to make enemies of the banks.

That looks increasingly unlikely. The consensus emerging from the Basel III negotiations shows that bankers have rediscovered some of their old clout. Their exaggerated claims about the cost to growth of tighter regulations are succeeding in weakening the reforms, despite rebuttals by Basel Committee and Bank for International Settlements economists. Unwisely, a proposed limit to maturity mismatches between banks’ assets and liabilities looks likely to be shelved. It is no surprise that banks oppose it: maturity mismatches are how they make money. But they are also the source of systemic risk.

If all goes well, the crisis will continue to wane. It is crucial that vigilance does not weaken with it.

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