Financial risk is declining.

Author:Berry, John M.
 
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Dodd-Frank, while incomplete, is working. Now if only the European banks were fully recapitalized.

It's been nearly three and a half years since President Barack Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act that is supposed to protect the nation and the world from the financial excesses that caused the worse economic slump since the Great Depression. Unfortunately, many of the new rules and regulations the act mandates have yet to be finalized and some aren't even in the draft stage. Nonetheless, however, some key provisions that are in force have sharply reduced the danger of any new crisis.

Leading the list are rules put in place last summer that require banks to hold far more capital than the relatively scanty amounts that left them and the financial system itself vulnerable to the crisis. Now almost all large institutions have substantially more capital than the new minimums available to absorb losses and avoid the need for taxpayer-financed bailouts. Those rules are now backed up by much closer supervision of major institutions that includes serious annual stress tests and the power to restrict dividend and other capital distributions if the level of capital is inadequate.

More important, perhaps, is the state of the world economy. At an International Monetary Fund economic research conference in early November, Lawrence H. Summers of Harvard University observed that another financial crisis "will surely come sometime and some place." But the recent one was partly the result of worldwide "complacency and euphoria" which is hardly the case today, he said. "I think those kinds of crises are a long way off."

Even if attitudes were to become far more upbeat, the new rules governing financial firms and the added oversight have made another crisis highly unlikely despite the missing pieces of Dodd-Frank. Furthermore, together the rules and added oversight have made another financial crisis highly unlikely even without all the other pieces of Dodd-Frank having been put in place. And some of those missing parts should show up soon. For instance, Treasury Secretary Jacob Lew is pushing multiple financial regulators to wrap up by the end of the year their long-running debate over the so-called Volcker Rule to restrict proprietary trading. And a few weeks ago the Federal Reserve Board put out for comment a proposal to institute a new liquidity coverage ratio, or LCR, so firms would be less likely to run out of cash if short-term funding were to dry up for some reason. Supervisors at major banks are already monitoring liquidity at those institutions on a daily basis, according to Fed staff.

"Since financial crises usually begin with a liquidity squeeze that weakens the capital position of...

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