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Dodd-Frank's First Birthday: One Year Under Constant Assault

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To say that the year-old Dodd-Frank Wall Street Reform and Consumer Protection Act is under attack in Washington is like describing Little Big Horn as an engagement between the cavalry and the Indians. What we are watching looks more and more like a one-sided massacre, and the hordes of financial industry lobbyists and their Republican enablers are taking all the scalps.

I take no pleasure in saying I told you so. But what many of us saw as the fatal flaws in Dodd-Frank are now fully exposed. I repeatedly said in the Senate debates last year that the bill did not include the kind of tough laws that were passed in the 1930s by the last Congress that had to deal with a catastrophic financial meltdown. It was painfully obvious to me and many others that banks that are "too big to fail" are exactly that -- too big. But there was nothing in Dodd-Frank that faced this reality, nothing that put hard statutory limits on the size and complexity of our megabanks. Instead, the bill passed the buck to future regulators.

We are now witnessing the consequences of that decision.

Efforts by U.S. regulators to require megabanks to maintain more capital have been pitifully weak. Internationally, the Basel Committee on Banking Supervision has proposed (Basel III) that banks hold 7% of common capital as a percentage of their risk-weighted assets, with a possible 2-3% surcharge for the megabanks. But Basel III is not binding on individual nations and in any case its new capital requirements would not go fully into effect until 2019.

The banks that were deemed too big to fail in 2008 and had to be saved by the massive Troubled Asset Relief Program and unprecedented help from the Federal Reserve have never been forced to slim down. The blind hand of the market charges the big six banks lower interest rates than smaller banks. The message of the market is clear: the government is still on the hook and cannot allow these banks to fail.

The central solution proposed in Dodd-Frank to avoid future bailouts is resolution authority. But no one has yet come up with a workable resolution plan for massive financial institutions with outlets everywhere. Different countries are promulgating different resolution rules -- the U.S. with a "living will" for the banks and other countries with proposals for special bonds or contingent capital. Three years after it went down, Lehman Brothers is still in bankruptcy, primarily because of creditors in the U. K. and around the world. How long would it take, and what would be the effect on the markets, if an institution the size of $1.8 trillion Citibank (according to National Journal "in 171 countries, with 550 clearance and settlement systems") were to fail? This month, Standard and Poor's said they believe that "systemically important financial institutions" could still receive government support.

The best way to curb the risky activities of megabanks would have been to reinstate a new version of the Glass-Steagall Act. From its enactment in 1933 until it was repealed in 1999, Glass-Steagall required that commercial banks, insured by the FDIC, be separate from investment banks and the risky investments those banks make. Instead, Dodd-Frank includes a much weakened version of a proposal by former Federal Reserve Chairman Paul Volcker requiring banks to separate proprietary trading from commercial activities. Many of us thought at the time that it would be impossible to create a proprietary trading definition that does not allow creative Wall Streeters to proceed with business as usual. Sadly, it looks like we were right.

No one questions the major role derivatives played in the financial meltdown. The Commodity Futures Trading Commission was supposed to come up with regulations on derivatives by July 16. The Commission recently announced that there would be a delay of six months or so. Why? Certainly because the task is complicated, but also because the Commission is dealing with a new Republican House of Representatives that seems dead-set against any kind of regulation at all.

One of the most promising parts of Dodd-Frank was the Consumer Finance Protection Board. Led by Interim Director Elizabeth Warren, the CFPB has been successfully staffed and organized. Now President Obama has nominated Richard Cordray to be its first Director. Unfortunately, Senate Republicans say they will confirm no one until there are "major structural changes" (i.e. severe limits to its ability to protect consumers) in the agency. The CFPB can make no rules without a confirmed Director.

Wall Street is winning the public relations and lobbying fight, but markets are for real. When they fall like they did in 2008, they send an unmistakable message. No amount of Wall Street lobbying money can change that. If we do not heed that message and institute real change, the next meltdown will be even worse.