Bill Isaac
Chairman
LECG Global Financial Services

Senate Banking Committee Chairman Christopher Dodd (D-Conn.) finally unveiled his financial reform legislation. It was not worth the wait.

It is indisputable that our financial regulatory system failed us miserably in the two decades following the severe banking and savings and loan crises of the 1980s. Neither the bill passed last year by the House nor the Dodd proposal offers serious reform of this badly broken system.

The government agencies many identify as playing leading roles in creating the crisis of 2008 include the Treasury, the Securities and Exchange Commission and the Federal Reserve. Inexplicably, the House bill and the Dodd proposal enlarge the roles of the Treasury and Fed, pretty much ignore the SEC and do almost nothing to change the structure of regulation.

For example, the Treasury, with the Fed at its right hand, is given responsibility to run a new Systemic Risk Council charged with identifying and dealing with developing threats to the financial system.

That would be the same Treasury that, just a few years ago, justified the now discredited Basel II capital rules on the basis that the major U.S. banks were at a competitive disadvantage in the international financial markets because they had too much capital.

The same Treasury, during the 1980s, argued that the S&L industry did not have a solvency problem but instead had an earnings problem and advocated forcefully for allowing S&Ls to expand their activities and grow out of their problems – a policy that ultimately cost taxpayers $150 billion.

The same Treasury stood by while accounting rules on securitizations allowed trillions of dollars of loans to be removed from the balance sheets of financial firms, thereby escaping capital requirements and creating enormous risk in the financial system.

Getty Images Sen. Christopher J. Dodd (D-CT)

Senator Dodd had it right last November when he proposed a sweeping reform of the regulatory agencies. His proposal would have consolidated regulation of all banks and thrifts and their holding companies into a new independent agency he called the Financial Institutions Regulatory Administration (FIRA).

With two tweaks that proposal should serve as the centerpiece for financial reform. Dodd’s original proposal would have included the Federal Deposit Insurance Corporation under the FIRA, which would have eliminated a vital watch dog on the system. He also would have folded the regulation of state-chartered banks into the FIRA, which would have needlessly created strong opposition from states’ rights advocates.

The FIRA should have a five-member board with the Fed and the Treasury each having a seat and the other three members being independent presidential appointees. This structure would remove the FIRA as much as possible from politics and would enable the Treasury and Fed to have input into policy decisions and access to all information they desire.

This structure would unify bank and bank holding company supervision. A critical weakness in our current system is that large companies have their holding companies supervised by the Fed while their banks are supervised by the Comptroller of the Currency. Companies play one regulator against the other, and no one oversees the entire enterprise.

We desperately need a strong, independent Systemic Risk Council. It should not be dominated by the agencies it is supposed to oversee, as is proposed in both the House bill and the Dodd proposal.

The Council should be headed by a presidential appointee and should have its own staff of economists, bank regulators and analysts. It could have an advisory board consisting of representatives of the Treasury, Fed, FIRA, FDIC and SEC. Its job should be to keep everyone alert and honest.

Moreover, no legislation would be complete without reforming substantially the mission and organization of the SEC. The SEC played a major role in setting the stage for the crisis of 2008 by 1) demanding that the Financial Accounting Standards Board adopt the highly pro-cyclical and destructive mark to market accounting, 2) discouraging banks from creating large loan loss reserves during the boom years, 3) allowing investment banking companies to balloon their balance sheets, 4) repealing the short seller regulations put into place during the Great Depression, 5) failing to oversee the FASB and 6) failing to uncover massive frauds.

Senator Dodd is smart and experienced, and his proposal for reform last November demonstrates that he knows what is needed. The greatest contribution he can make to his country before he leaves the Senate is to put on the table the right reforms and force those who oppose serious reform to cast a public vote against it.

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Bill Isaac
Chairman
LECG Global Financial Services

Mr. Isaac, Chairman of the FDIC during the banking crisis of the 1980's is chairman of the LECG Global Financal Services, based in Washington DC and is a CNBC Contributor.