Perhaps democracy works! Running for reelection to the Senate and scarred by accepting a discount mortgage from Countrywide, Christopher Dodd (D-CT) managed to hear the anger America now feels toward Wall Street. He has ushered through the banking committee, which he chairs, a proposal to reregulate Wall Street that puts both Barney Frank’s and the Obama administration’s efforts to shame. It has teeth, relevance, and some moxie. It is also clumsy, inadequate (if less so), and kicks the can down the road on the more difficult decisions.
What is most striking in the whole discussion is how little serious analysis is taking place on all sides of the regulatory-proposals arguments.
But Dodd deserves congratulations for facing reality when his counterparts at the other end of the Capitol and the other end of Pennsylvania Avenue continue to bury their heads in the sand. And that’s to be charitable. They may simply be more willing to comply with the demands of the financial lobbyists who have basically set up camp on the Hill. Dodd has a decidedly different political agenda.
The shallowness of the Obama white paper, issued last June, is now only too obvious. It could not hold together an intellectual consensus and certainly not a political one. Its only serious reform of financial institutions was to enable the Federal Reserve to raise capital requirements (and restrict leverage) both for banks and nonbank financial institutions deemed too big or too interconnected to fail. At least it included the nonbanks—mostly the investment banks that made up the banking system, now called the shadow banks.
• Jeff Madrick: Why Washington Won't Prevent Another Meltdown • Nomi Prins: How Big Banks Fleece You The Obama team apparently gave little thought to why the Fed would be up to the job after having failed so dismally to do it for 20 years. The Fed had plenty of tools to tighten the screws on the commercial banks. Had it been imaginative, it may have figured out it could even regulate the major investment banks as primary U.S. bond dealers, a bit of authority its chairman, Alan Greenspan, gladly gave away in the 1990s as being too interventionist. The Fed essentially didn’t do its job because it was dominated by the free-market fundamentalism of Greenspan, the disciple and romantic idolator of libertarian Ayn Rand.
Dodd knows better. He would basically strip the Fed and three other agencies of key supervisory powers over banks. His proposal also would create a consumer protection agency to oversee credit cards and mortgages, as would Obama. Again, the Fed would lose its consumer powers to the new agency.
As for the all important systemic risk regulator, as it has come to be called, Dodd would not rest the authority with the prestigious Fed, in contrast to Obama. Dodd’s proposal has a nine-member board with an independent chairman to determine who is too big to fail, set higher capital requirements, and have the authority to cut a bank’s size if necessary.
This is fairly radical stuff by Washington standards today. The Fed’s nose is more than a little out of joint. But it is not good enough. One supervisory regulator for supervisory tasks may indeed make sense. But why would a board do better than the Fed at managing systemic risks? Won’t they be subject to the complaints of the industry or overconfidence in the next boom? I think they may well, but at least they will not be the bankers’ agency, as the Fed now is, with all its hauteur.
The real news is that the Fed is at least getting a frightening comeuppance, and the public will probably like it. Dodd also will insist the local Federal Reserve banks be no longer entirely run by local bankers. Nevertheless, no one is talking about how the too-big-to-fail decision will be made in detail, probably for good reason, because if that debate were waged all would realize how unrealistic the proposals are. And no one is talking about how to make these regulators hang tough for decades to come.
That is partly why voices for breaking up large banks and other institutions are being increasingly heard. Paul Volcker has long been talking about how deposit-taking banks should not be allowed to deal in securities—that is, to underwrite and buy mortgage securities, derivatives, and so on. Another old hand, Henry Kaufman, once the most respected economists on Wall Street, is sounding a similar theme. If the banks are broken up, he says, they can’t irresponsibly take on absurd levels of risk, no matter how spineless the regulators.
And in Europe, they are actually doing what seems impossible here. First to break up is the giant Dutch bank ING. Under pressure from the European regulators, ING announced in October it will sell its insurance operation and some overseas retail banking. The concept is to reduce risk and return to core businesses, enabling the authorities to regulate these entities more efficiently. Bank of Scotland and Lloyds Bank are now to follow, and there probably will be more. The Europeans believe it simply makes sense that if banks are too big to fail, they should be cut down to size. Mervyn King, the head of the Bank of England, has talked favorably about such breakups in principle.
No one in the U.S. with serious political power, however, is talking a similar line. It seems one step too far, perhaps especially for elected officials who like the look of all those campaign donors from Wall Street. The Obama team will certainly not step out of line, or so it appears. But some legislators are at least writing amendments to give any new banking authority the clear power to whittle these banks to size.
In Britain and France, people in high places also are talking about a tax on financial transactions. The idea is an old one—or as the irritable Economist magazine calls it, “hoary.” Lord Turner, England’s highest financial regulator, endorsed the idea. Gordon Brown, the prime minister, mentioned it as a possibility. But the financial industry, which would bear the tax burden, of course, seems now prepared to shoot down the idea in England, and it has been moved to the back burner. Here, Treasury Secretary Timothy Geithner immediately said the administration did not support it.
In sum, there is a long way to go to create proposals that may well protect the nation from the next crisis, and, maybe even more to the point, make sure the financial industry does what it is supposed to do, which is to allocate capital to business where it will do the most good, not make the most money for a thousand well-placed traders. The Dodd plan is not significantly superior, at least at first read, to the regulation of complex financial derivatives than the Barney Frank plan in the House Banking Committee. It will force financial firms to give shareholders some say over pay, for what that is worth. The Securities & Exchange Commission will be more soundly financed by financial firms themselves.
A battle is shaping up over the Dodd plan, however, and this may bring more of the dubious reasoning of Washington to public attention. Perhaps more anger will be stoked, which will be a good thing. But there is now little chance a single bill will be passed soon. The Obama administration and Dodd are at odds. Will Dodd back down quickly or fight it out? The bill is to be marked down in December, according to the latest estimate.
What is most striking in the whole discussion is how little serious analysis is taking place on all sides of the regulatory-proposals arguments. For years, we have been told, for example, that big banks are more efficient than smaller ones and will keep the cost of loans down. I say prove it to me with some serious analysis. I am inclined to like a financial transactions tax, but I’d like to see analysis about how high a tax is necessary to reduce destabilizing speculation.
The American people probably assume an educated and well-staffed set of lawmakers have worked up support for their contentions. There is less there than they realize. If and when they find out, it will be just another reason to be angry.
Jeff Madrick is a contributor to The New York Review of Books and a former economics columnist for the New York Times. He is editor of Challenge magazine, visiting professor of humanities at Cooper Union, and senior fellow at the New School's Schwartz Center for Economic Policy Analysis. He is the author of Taking America, The End of Affluence (Random House) and The Case for Big Government.