It was impossible this week not to feel the same dread and helplessness that plagued the fall of 2008 as bank stocks slid into terrifying territory and spreads on credit-default swaps jumped.
In part that's because three years after the financial meltdown, very few of the rules governing finance have changed despite last summer's enactment of the Dodd-Frank Act.
"Dodd-Frank seems to be having a tough time getting out of first gear," said Richard Hunt, president of the Consumer Bankers Association.
If there is a silver lining in this week's volatility it may be a renewed sense of urgency among policymakers.
"Regulators are human beings," said Rich Spillenkothen, former head of supervision at the Federal Reserve Board. "When the aroma of crisis is in the air, it can't help but affect your approach."
So it seems like a good time to ask what single rule, still to come from the regulators, will have the most impact on Dodd-Frank's effectiveness.
Sources had lots of candidates, including how tough the Commodity Futures Trading Commission goes on derivatives, how the Consumer Financial Protection Bureau defines an "abusive" product and how tightly the Fed interprets the Volcker Rule's limits on proprietary trading.
But the overwhelming pick was a rule the Fed is writing to implement Section 165 of Dodd-Frank.
"There are plenty [of rules] that might go on the list," former Comptroller of the Currency John Dugan said in an interview this week, "but in terms of the one that we really haven't seen that is going to have the broadest impact, it's 165."
The law requires the Fed to write rules that hold systemically important companies — both banks and nonbanks — to standards that are "more stringent" than those applied to other financial firms. These "enhanced prudential" standards will cover everything from risk-based capital rules and a leverage ratio to liquidity requirements and concentration limits. They will dictate risk management practices, resolution plans and credit exposure reports.
That's just for starters. The law also gives the Fed the option of imposing standards on any of these topics: contingent capital; enhanced public disclosures; short-term debt limits; and any other factors the central bank "determines are appropriate."
The statutory deadline for these rules is Jan. 1, 2012, so the Fed has less than five months to propose, collect comments and adopt a final rule. Fed officials have said little about the proposal other than noting it will be released before summer's end.
The rule is rumored to run 1,500 pages, and most sources expect the central bank to fully flex its authority.
"It's 1,500 more tiny cuts when we are already bleeding," is how an executive at one megabank described the coming plan.
Greg Wilson, a policymaker during the first Bush administration who did a stint at McKinsey & Co. before becoming an independent consultant and author, said the Fed likely will want to prove to Congress that it is taking the mandate seriously.
"I am concerned they will take a maximalist approach so they can say to the policymakers, 'Hey, we were tough. We did what you told us to do. Here are the heightened new standards, here is the risk matrix for how they increase in stringency based on risk profiles,' " Wilson said.
But once the government, as Dodd-Frank also mandates, flags the nonbanks it considers systemically significant, then the 165 rules will hold all financial players to the same standards.
"Before, if you looked at all the big players, half of them were inside the tent and half of them were out," Dugan said. "The most important point is the government now has the ability to take anybody inside the tent. … Not only is it powerful to do it, but it is powerful to be able to threaten to do it, because it keeps people from being wild at the fringes."
Many of the firms that were outside the tent before 2008 — Goldman Sachs and Morgan Stanley, to name the biggest — are now inside because they became bank holding companies during the 2008 crisis. But Dodd-Frank gives regulators the power to designate other big players, like hedge funds, insurers and asset managers, as important to the system's safety, and then those companies would be subject to all the 165 rules.
The law does give the Fed some leeway in interpreting Section 165. Take the concentration limits, which restrict a systemically important company's credit exposure to any unaffiliated company from exceeding 25% of capital. The Fed may delay the effective date of this provision until July 21, 2015. It may lower, or tighten, the 25% threshold, but it also gets to define what constitutes a credit exposure.
Regulators have gotten a head start on one aspect of 165, and that's the resolution plans or "living wills" that the Fed jointly proposed in April with the Federal Deposit Insurance Corp.
The law says living wills must detail the company's ownership structure, assets, liabilities and contractual obligations; explain how its insured depositories are protected from risks taken by nonbank subsidiaries; and identify major counterparties and determine where their collateral is pledged.
If the Fed or the FDIC aren't satisfied with a company's resolution plan, they can do everything from requiring more capital to banning certain activities. After two years, if a company still hasn't met the regulators' expectations, it could be forced into bankruptcy.
Former FDIC Chairman Sheila Bair tried to finish this rule before her term expired last month, but the agencies could not come to a final agreement. That has some critics concerned.
"Let's see what [the final rule] looks like, because that's the single biggest point of skepticism of why most people say Dodd-Frank did not stop 'too big too fail,' " said Neil Barofsky, the former special inspector general for Tarp and now a senior fellow at New York University's law school. "And if it looks remarkably sophisticated and something that is actionable, then I would feel a lot better about Dodd-Frank."
Former FDIC Chairman Bill Isaac agrees that fine-tuning oversight of big companies and preventing them "from getting to the edge of failure" is key to achieving Dodd-Frank's goals.
"The focus needs to be on strengthening firms, not on preparing for their demise," he said by email. "Recovery is far more important than resolution. We will never allow the largest firms to fail in the sense that losses will be imposed on creditors. We need to focus our energy on vastly improving large-firm supervision."
One tool for doing that is stress-testing, and Section 165 covers that as well. The law requires the Fed to do annual stress tests on these larger firms under at least three scenarios — baseline, adverse and severely adverse — and the banks themselves must conduct internal stress tests twice a year.
Companies must publish a summary of the stress-test results, and the 165 proposal is expected to detail "the form and content" of these reports.
The Fed also can use 165 to require disclosures that "support market evaluation of the risk profile, capital adequacy and risk management capabilities" of the largest firms.
Once these rules are in place, investors will have a much firmer grip on the risks these giants are taking and their ability to absorb losses. Information that should be reassuring the next time the market starts to panic.
Barb Rehm is American Banker's editor at large. She welcomes feedback to her column at
