There is the crisis, then the reform. There is the bubble, and the anti-bubble. In the way that history flows into the past, every cause is an effect, and the reform triggered by the crisis sets up conditions for the next crisis and the next reform. It was ever thus. Of course, it could be a "good," or at least a nonlethal, crisis; it could be a crisis that happily occurs many decades in the future; or it could be a crisis separated from us by bountiful times. All of which suggests that while reforms can never guarantee that crises will not recur -- that bubbles will not burst, banks will not fail and risk capsize reward -- they can make the situation in the near term, whatever that means, better and not worse.
What should we think about our most recent financial reform package, which has staggered from Congress under the unwieldy name of the Dodd-Frank Wall Street Reform and Consumer Protection Act? At well over 2,000 pages, Dodd-Frank covers a lot of ground. And yet, despite a massive amount of commentary, particularly in the blogosphere, the bill remains fuzzy. Some of its most important features, like resolution authority for large institutions, have never been tested in the real world of politics and power. Its much fought-over consumer products agency, housed and funded but not controlled by the Federal Reserve, is being invented as we speak by Elizabeth Warren, a Harvard Law School professor who may never get to actually run the operation she dreamed up. And much of the rest of the bill's substantive reforms, from bank capital to derivatives regulation, has been kicked back to regulators, who must now frantically write new rules for the game. Dodd-Frank leaves two big questions hanging: too-big-to-fail and regulatory capture. Indeed, the solution to TBTF may well depend upon the effectiveness of resolution authority, which in the end will come down to the will and fortitude of regulators and policymakers.
This is neither a pretty or particularly clear picture. Which is why a compact book, really an extended essay, recently published by University of Pennsylvania law professor and bankruptcy specialist David Skeel, the author of the seminal Debt's Dominion, is essential reading. Skeel's The New Financial Deal: Understanding the Dodd-Frank Act and its (Unintended) Consequences steps back and takes an intelligent look at Dodd-Frank in its entirety, pointing out its strengths and weaknesses and offering suggestions for improvements. Perhaps more importantly, Skeel, who constructs a deceptively complex argument that informed laymen can easily get through, provides a way of thinking about the legislation that gives it a coherence that I, frankly, thought it lacked. This is an important contribution, not only to weighing the reforms themselves, but in making some sense of the larger crisis.
Skeel argues that Dodd-Frank is based upon a policy approach he calls "corporatism." This approach, he writes, has been apparent since the crisis broke and the bailouts began. The government made no attempt to reduce the size of the big banks, to undermine the clear subsidy the markets provide institutions they believe will be bailed out in the event of trouble. In fact, banks like J.P.Morgan Chase & Co., Bank of America Corp. and Wells Fargo & Co. grew ever larger as they took on failing institutions. Skeel identifies this approach most clearly with Tim Geithner, formerly of the New York Federal Reserve, and now, of course, Treasury secretary, although he argues that it's a uniform tendency among top Obama policymakers. Unlike many pundits, Skeel does not say that Geithner was somehow created by malign Wall Street Svengalis like Robert Rubin. Rather, he says, Geithner, even more than Paulson, who he characterizes as man of action ricocheting from one problem to the next, had been trained in the rescues of the '90s, from Mexico to the Asia crisis to Long-Term Capital Management, to build partnerships between government and large financial institutions that will require ad hoc interventions when things go bad. This corporatist partnership goes both ways. On one hand, financial institutions receive the market subsidy for being TBTF and retain their size and reach. On the other hand, the government gets large, global institutions and is able to use these institutions for their own political ends (Skeel goes into detail about what that means with the GM and Chrysler bankruptcies), from social policies to foreign policy.
This corporatist approach, Skeel argues, has been built around "a narrative," which explains and justifies it: what he calls "the Lehman Myth." This interpretation of events locates the heart of the crisis in the decision to allow Lehman Brothers to fail. Paulson often insists that the government let Lehman collapse into bankruptcy because it had no resolution authority, which would have provided a more orderly disposition of assets than Chapter 11. In a larger way, focusing on Lehman justifies bailouts generally and disregards the usual bankruptcy system. Skeel rejects these notions entirely. He believes that the key moment in the affair occurred with Bear Stearns Cos., when bailouts began and expectations arose, certainly with Lehman's Dick Fuld, that other firms would be saved as well. Moreover, Skeel adamantly denies that the Lehman bankruptcy was disorderly, particularly considering how unprepared the firm was: Derivatives positions were effectively closed out, and much of the firm was sold off within a short period of time. He also downplays the damage Lehman did to the global financial system, pointing to other crises at the same time -- although parsing out causality in that panic strikes me as very difficult. Still, all this ushers in one of Skeel's key points: bankruptcy, particularly in the U.S., has a long and distinguished history of reorganization and rehabilitation. It's based on the rule of law and the active participation of creditors, not ad hoc bureaucratic decisions. The fact that bankruptcy was regularly characterized as disorderly and dangerously slow, was simply a cover for an increasingly corporatist approach.
Skeel contrasts this approach with what he calls Brandeisians, advocated by the likes Simon Johnson and Joe Stiglitz, who want to either break up the banks, thus resolving TBTF, or nationalizing them. The Brandeisians (named for that old Progressive trustbuster, Louis Brandeis) argue that no such "partnership" really exists. Banks that are allowed to remain overly large not only pose a grave risk to the system, and produce that market subsidy, but also will use their huge resources to co-opt the state -- what Johnson famously referred to as a bank oligarchy. Skeel is more nuanced than either Johnson or Stiglitz on these matters, though even he admits that the corporatist approach produces a big-bank sector (which may include nonbank systemic risks) not unlike government sponsored enterprises like Fannie Mae and Freddie Mac. (For one thing, Skeel is willing to admit that there are good arguments for big banks: It's not a black and white affair.) In fact, corporatism can also be viewed as a halfway house to nationalization.
Much has been made of how the Fed will gain from Dodd-Frank. Skeel, however, sees the corporatist impulse significantly expanding the power of Treasury -- again a reason for noting the influence of Geithner. "Because the Treasury secretary is directly responsible to the President, he is the least independent, and the most political, of the financial regulators," Skeel writes. "Yet the Treasury secretary is given leadership responsibility on the new Financial Stability Oversight Council and in other areas. Dodd-Frank also locates an enormous new research facility -- the Office of Financial Research -- in the Treasury Department. Control over knowledge is power, of course, which suggests that the ostensibly neutral research facility could become yet another channel of Treasury influence."
In the real world of Congress, and in the unfolding realities of Dodd-Frank, such broad dichotomies rarely hold up, as even Skeel admits. He describes the bill as a product of these two approaches. The bill primarily is corporatist in nature, but with key provisions, driven by the politics of the moment, that are Brandeisian: the consumer agency (apparently pushed by Summers -- Geithner was never a fan -- after meeting with Warren) and the Volcker Rule on proprietary trading (tossed in after the Scott Brown election). Skeel locates the real heart of the bill in the resolution authority provisions, which he finds deeply corporatist and flawed -- though fixable. Skeel sees several problems with resolution authority. First, it takes a model controlled by the FDIC and used with reasonable success with small and medium-sized banks and applies it to the largest, most complex institutions. Second, it will have to be triggered by a relatively complex set of three authorizations -- three "keys" -- belonging to regulators and the White House, which the markets at least do not believe will occur. Third, it has a strong bias, once triggered, to liquidation, which he argues runs against deep American tendencies in insolvencies toward rehabilitation.
Why can't bankruptcy procedures be used? After all, bankruptcies have grown more efficient and faster over the last decade or so -- as witnessed by the speed with which Lehman, Chrysler and GM were resolved (of particular note: It's far easier today to sell assets out of Chapter 11 than in the past). The big obstacle to using bankruptcy, beyond the conventional wisdom that they're not appropriate in finance, is the fact that previously unregulated derivatives have long had an exemption from the stay that bankruptcy applies to other contracts. In other words, if a bank or financial firm declared bankruptcy, counterparties could seize collateral or break contracts. Change that rule, Skeel says, and create a stay on derivatives of three to five days, and you will provide financial firms the chance to avail themselves the option of insolvency, thus allowing creditors a say in the process and avoiding the rigid Dodd-Frank bias to involuntary liquidation.
That said Skeel is not optimistic that the political will exists to make even that simple change. Nonetheless, this is both an informative and provocative book that, whether you agree with it in its specifics, still poses the kind of clarifying questions that have been missing from the debate over financial reform. It's not so much a matter of big banks versus small banks, utility banks versus universal banks, investment versus speculation. It really is a question of how we accommodate a modern, global, complex and innovative financial sector into a democratic political system. The corporatist model that Skeel describes has its benefits; after all, the Europeans have been using that model for many decades. And, if you decide that a mature, developed economy requires large, sophisticated banks, it may be the only way to accommodate the danger they pose. (There are a lot of countercurrents here: The Europeans have been drifting away from bank-centric economies over the past decade.) But as Skeel argues, the New Deal took a clearly Brandeisian approach to the banks, despite the creation of a large regulatory state. Measures like Glass-Steagall were designed to reduce the power and potential toxicity of the big banks. Indeed, the passing of those New Deal bank restraints inevitably created the conditions for a greater corporatist partnership -- a partnership, Skeel adds, that under normal conditions will tend to tilt toward the private sector.
For Skeel, bankruptcy would remove some of the onerous aspects of the corporatist partnership. But the larger questions remain. Do we need big banks? What compromises must we make to insure both equity and safety?
Robert Teitelman is editor in chief of The Deal.