There's a sad truth about the fate of financial regulation: It's almost certain to be outmoded by the time it's introduced. This was as true of Glass-Steagall in 1933 as it is of Dodd-Frank today.
This month we begin the third year since the Dodd-Frank Wall Street reform act passed, with the struggle over its shape ongoing. It's a still-unmolded toddler, and already on the fast track to fossilization. Does the most ambitious finance legislation in decades carry the DNA to successfully cope with the next crisis? In a word, no.
The take-away from this challenge doesn't have to be cynicism, inaction, or laissez-faire tirades. To be ready for the next shock rather than the last one, though, we need to reset our thinking.
Dodd-Frank is based on the idea that financial markets are normally stable, with the exception of the occasional alarming "event." The New Deal's Glass-Steagall Act and the Clinton-era Gramm-Leach-Bliley "Modernization" shared those assumptions. All of these efforts were conceived as system-wide overhauls. In reality, though, they were designed only to remedy random, ad hoc crises; shocks like the 2008 meltdown, sometimes called "Minsky Moments."
Ironically, the late economist Hyman Minsky actually believed that these "moments" were anything but. At the Levy Institute, we share his view that instability is central to the genome of modern finance.
In other words, it's normal for the boat to keep rocking. The increasingly risky practices that fuel danger and instability are still being rewarded, and the absence of penalties for losses continues. The shocks will keep coming.
And each new threat to stability is destined to be different than the last. Dodd-Frank aims to identify the most vulnerable institutions and practices. That approach is too brittle to contain the disastrous effects of risks that are always morphing. Even constructive aspects of the Act could have perverse consequences, unless the rules are subject to sophisticated re-examination as the finance world develops.
Banks carry an urge -- maybe it's a genetic imperative? -- to evolve in a way that maximizes revenue. We're always witnessing how quickly markets create newer, riskier, and more profitable instruments. Credit default swaps aren't the only example, of course; look at the whole range of off-balance-sheet special purpose vehicles. It's the very nature of modern finance to transform its structure in response to the prevailing regulation, and to evade it successfully.
Under Dodd-Frank, banks will function more-or-less as they did in the past.
Their enormous size and multi-function operations -- the business model that underlies the latest crisis -- will be subject only to a series of cosmetic changes. The act's most significant measure, the Volcker Rule, continues to be diluted, and many of its other regulations are tied up in delays.
Instead of fundamental changes that would cushion our fragile system from shocks, Dodd-Frank's centerpiece is a limit on the use of public funds to rescue failing banks. By enabling rapid dissolutions, it aims to avoid a repeat of 2008, when the Lehman Brothers bankruptcy virtually froze capital markets. It's also an understandable response to TARP, which recapitalized insolvent financial institutions at a great cost, while allowing failing households to fall into foreclosure.
But limiting taxpayer exposure to the next bank breakdown is not the same as preventing a system-wide collapse. Tweaks to Dodd-Frank aren't a solution. Glass-Steagall contained features worth preserving, but reviving the law -- outdated then; infeasible now -- won't help. Neither will blaming Gramm-Leach-Bliley which, profound as it was, merely reflected the new status quo of its day. It institutionalized the changes that had already emerged in the markets.
We need banks that can earn competitive rates of return while they focus not on big risks, but on financing capital development. Reforms that promote enterprise and industry over speculation will have to be as innovative, flexible, opportunistic and plastic as the markets they aim to improve.
Regulators could begin by breaking banks down into smaller units. A bank holding company structure with numerous types of subsidiaries, each one subject to strict limitations on the type of permitted activities, would be a valuable deterrent to risky behavior. Restrictions on size and function would allow a reasonable shot at understanding esoteric subsidiaries, and a chance to react quickly to mutations.
As Dodd-Frank reaches its second anniversary, it faces both the limitations of its scope and the disheartening obstacles to its implementation. Will we really wait for the next, inevitable crisis before we start to develop adaptable reforms? In a word, probably.
Dimitri B. Papadimitriou is president of the Levy Economics Institute of Bard College, which recently published an e-book on effective regulation.
The original Glass Steagall Act written by a couple of good old boys Carter Glass of Virginia, and Henry B. Steagall of Alabama was less than 30 pages & worked pretty well for over 60 years.
With BANKS TO BIG TO FAIL earning the reputation of poorly ran Casinos and manipulating interest rates is it not time to recognized this experiment was a mistake and put the BANKS TO BIG TO FAIL back into the bottle?
Repeal both The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (IBBEA) swept away all state barriers to interstate banking.
And
The Gramm-Leach-Bliley Act (GLBA), also referred to as the Financial Services Modernization Act of 1999, repealed part of Glass-Steagall, tearing down the walls between banking, insurance and investments.
Read more: The History of Bank Deregulation | eHow.com http://www.ehow.com/about_5413083_history-bank-deregulation.html#ixzz21GzIsi1z
After this mess in Greece & Spain suggest to Europeans they create their own version of the Glass Steagall Act. You know this whole banking mess had to be some Limey's idea anyway.
It does nothing to address too big to fail and enshrines TBTF making most of the banks corruptions legalized. The banks are now bigger and more systemic than ever before - they will be bailed.
Why are the financial ter.ror ists allowed to keep building the financial equivalent of neutron bo.mb or a WMD??!! We have found the enemy and it is us
For sure, but they still will only be "developed" and not "implemented". You're talking about institutions impervious to "reform".
Then on to the next crisis, and the next....
You gotta love bankstanomics!
WHAT!??? Gramm-Leach-Bliley and Glass-Steagall were not at all the same kind of legislation. The main thing Gramm-Leach-Bliley did was REPEAL Glass-Steagall. What Mr. Papadimitriou does not bother to mention is that for over 60 years after the passage of Glass-Steagall, though there were half a dozen various market crashes there was no global banking collapse and the subsequent bailout. 8 years after the repeal of Glass-Steagall we began the descent into this financial hell. I am truly stunned that such double speak passes for analysis.
Who is Mr. Papadimitriou writing for? The Levy Institute has opposed the restoration of Glass-Steagall repeatedly over the past years. Now, when Congresswoman Marcy Kaptur(D-OH) has introduced a bill to restore Glass-Steagall, cosponsored by 75 other Congress persons, the Levy Institute joins in the chorus of pro-Wall Street sycophants.
We the People demand jail time for perps and complete & total claw-back of ill gotten gains anywhere on earth and financial penalties as well as restitution for any and all losses incurred by the innocent.
This would be a starting position.
I thought that Glass-Steagle, with the separation of savings and investment banking, would be good, along with taking savings banks out of Wall Street, and allowing investment banks to speculate, but without the protection of government bailouts.
With knowing that no help would be available if they were irresponsible, investment banks would have to police themselves, or live with the consequences of their greed.