First the giant stimulus package, then the ambitious revamping of America’s health care delivery system. Now Congress, under the patient prodding of President Obama, is lurching toward passage of another stupendously complex bill, this time centered on financial regulatory reform. Whether you like them or not, you have to admit that big things are getting done in Washington on Obama’s watch.
If Congress passes the Dodd-Frank bill, it will be another major notch in the belt of a president who could use a political victory about now. But what’s a non-master of the universe like me to make of this 2,000-page behemoth?
It may do considerable good, but we ought to be clear about one thing: It won’t prevent the next financial crisis. As long as there are fortunes to be made in financial markets, there will be excessive risk-taking and speculation, new bubbles and panics, and powerful incentives for chicanery and fraud. No regulatory scheme can fully protect the public against ingenious new forms of human greed and folly.
That, however, is not an argument for doing nothing. The government had to react to Wall Street’s near meltdown in the winter of 2008-2009. Its interventions, beginning under President Bush and continuing into Obama’s administration, doubtless averted a full-bore financial collapse. But they also triggered a fierce and abiding public backlash against bailouts.
The Dodd-Frank bill doesn’t get everything right, but on balance it’s a reasonable response to the crisis. It imposes new disciplines on bank behavior, increases transparency for complex financial transactions and institutions, and offers consumers new protections against the clever breed of predators who have degrees from elite universities and sport $3,000 suits.
Some liberals are chagrined that the bill doesn’t break up the big banks. Conservatives echo the Wall Street Journal’s charges that the bill is a regulatory nightmare that will make it more expensive for banks to supply capital to businesses. It’s tempting to say that Sen. Chris Dodd (D-CT) and Rep. Frank (D-MA) must therefore have found some kind of centrist sweet spot, but there is something to the left-right critiques.
Most important, for example, the bill doesn’t slay the “too-big-to-fail” dragon. It leaves financial power more concentrated than ever in the hands of five mega-banks: Goldman Sachs, J.P. Morgan, Citigroup, Morgan Stanley and Bank of America. True, Dodd-Frank does impose the “Volcker Rule,” forbidding banks covered by federal deposit insurance from making bets (called “proprietary trading”) with their own money. It increases capital reserve requirements to keep banks from taking excessive risks. It also sets up a council of financial guardians to anticipate systemic risks, and gives federal authorities power to seize and oversee the “orderly liquidation” of financial firms whose collapse could bring other institutions down as well.
But it’s hard to avoid the impression that the big banks will henceforth operate with a tacit government guarantee against systemic failure. This not only intensifies moral hazard – making it hard for administration officials to claim the bill would bar bailouts in the future – it also risks creating a privileged class of quasi-public banking utilities that will be able to borrow money more cheaply. That will raise the bar for new entrants and dampen competition in the banking sector.
Elsewhere, the picture looks more positive. Dodd-Frank would move much of the trade in financial derivatives onto exchanges and clearinghouses, though banks could still trade in over-the-counter derivatives to hedge their own risks. This seems like a sensible compromise that brings derivatives trading out of the shadows while retaining the ability of firms to hedge against interest rate and currency risks. In another boost for transparency, the bill would require private equity firms and hedge funds to register with regulators.
Dodd-Frank also puts in place what Obama last week called “the strongest consumer financial protections in history.” It creates a new Consumer Financial Protection Bureau housed with the Fed to police mortgage lending, credit and debit cards and other consumer loans – though not by auto dealers, who somehow won an exemption from oversight. This agency presumably will prevent abuses like the “no doc” and “liar” loans that helped to trigger the subprime lending frenzy, which was the spark that started the financial crisis.
The bill doesn’t deal at all with Fannie Mae and Freddie Mac. This is a huge omission, considering that these giant mortgage finance firms still hold a pile of dubious assets and are essentially in federal receivership.
For all its imperfections, Dodd-Frank seeks to protect consumers without creating undue regulatory obstacles to innovation in the financial sector, which traditionally has been a source of comparative economic advantage for the U.S. Pragmatic progressives ought to support it, while retaining a sense of humility about the ability of new regulatory bodies to prevent future abuses.
Photo credit: Center for American Progress Action Fund