There is a financial markets reform that would avert the next financial meltdown, support free-market capitalism, infuriate the mega-banks, (which are far from free-market institutions)and make Sen. Dodd a genuine hero. For decades hence historians would speak of "the Dodd reform" as a turning point in the history of American and perhaps global capitalism.
But he won't propose it. Neither will the GOP (which is about as genuinely capitalist and devoted to free markets as the mega-banks).
And that means--bizarre as it may seem--the bank-toadying, campaign-contribution-sucking, GOP leadership is right. As it stands, the Dodd bill, like the Frank bill, is worse than useless and deserves to die. Both bills run on flawed assumptions, the most important being that the regulators would have gotten it right if only there had been more of them, if they had known what was going on, if they had more power to stop it, if they hadn't been ideological free-market types, if they had been appointed by Democrats, or if they hadn't been divided by interagency turf battles.
The is roughly the opposite of the truth.
The regulators weren't outfoxed by the banks. The regulators knew exactly what the banks were doing and were wildly enthusiastic about it. They aggressively pushed the banks into replacing the musty old mortgage market run by your local banker with the go-go, securities market casino it became. Far from being divided and working at cross purposes, regulators here and globally were all-but unanimous in their enthusiasm for the new system as were the elite MBA programs that trained regulators and bankers alike.
It is hard to think of a period in U.S. history during which the banking system was more responsive to the government's desires than the past couple decades. And in no area were the banks more compliant with government policy than in the making and capitalizing of mortgages. Both U.S. and global regulators, from the Fed and the FDIC to the Basel group and the International Monetary Fund were if anything more enthusiastic about securitization and structured finance than the banks themselves. The Basel standards, for instance, score mortgage backed securities as significantly less risky than individual mortgages.
Moreover, even if the Democrat thesis about why the regulators failed were correct, both the Dodd and Frank bills would make it worse.
Both bills, not surprisingly, do the one thing the modern Congress loves to do above all others: abolish bold black letter law, passed in the full light of day with citizens watching, and replace it with "discretionary regulation." Offload responsibility from our elected representatives to "the club", the cozy coterie of regulators and regulated, who misinform citizens and markets alike, and decide among themselves that what's best for Citibank is best for the country.
The only thing that would change is that with the new "council of grand-high regulatory pooh-bahs" in charge there would be even less chance of dissent among the regulators and so less chance of citizens hearing even a distant rumor of what is going on--until once again it was too late.
The late crisis happened not because banks were reckless or regulators incompetent, though both were surely true. It happened because together banks and regulators forged a system that denied citizens and markets the information they needed to respond rationally to events.
Banking has always been too secretive in this country. Banks are quasi-public institutions, performing both private and public functions, including sustaining the credit system that sustains the dollar itself. In return, the big banks especially are granted extraordinary privileges, such as the right to borrow from the Fed virtually for free at times of crisis. Under the circumstances there is no excuse for bank balance sheets to be anything but utterly transparent to the citizens and investors.
Government policy has always been just the opposite. Precisely because of the banks' quasi-public, quasi-government status, disclosure in the financial sector is horrible, always has been, and has gotten worse in recent years.
The essence of the mortgage crisis was "structured mortgage finance" under which the true value of hundreds of billions of dollars of investments were unknown. It became impossible to trace a straight line from Sally's or Sam's mortgage to the ultimate investors in the multiple securities with multiple complex claims on the cash flow from Sam's or Sally's monthly payments.
The banking collapse that flowed from the mortgage crisis was a function not of actual solvency or insolvency of Bear, or Lehman, or Goldman, or Citi but of the fact that no one, not the regulators, not investors, not bank CEOs themselves could tell whether those institutions were broke or not.
To this day we do not know whether Bear Sterns was "really" broke or simply the victim of a run. We still don't know because Secretary Geithner won't tell us. To this day we do not know the names of the "toxic" securities on the books of Maiden Lane LLC, the taxpayer funded entity into which the governments dumped some $30 billion of Bear Stearn's "toxic" assets to facilitate JP Morgan's takeover of the failing firm. Secretary Geithner takes the position that publishing the details would only hurt the taxpayer-owners of Maiden Lane.
This sort of secrecy is not merely a reaction to the crisis. It is how the financial sector does business and always has with the government's full approval.
Imagine for a moment that in 2004 the government had required every major financial institution in the U.S., any one with the potential for imperiling credit markets, to publish their investment positions. All of them. In detail. Lists of every security or derivative held in their portfolios, along with all data about the underlying mortgage pools, defaults so far, etc.
With such a rule in place, the mortgage crisis likely would never have happened on the scale it did. Most of the worst mortgages, the loans that crashed the system, were written from 2005 through the early days of 2007. Opening the banks' books would have revealed just how near the edge they were playing. The resulting market pressure on bank securities would have forced them to cut back their mortgage books. This would have been a crisis of a sort; the housing bubble would have popped. But popping the bubble two years earlier would have avoided the worst of the damage.
Even if transparency failed to avoid the mortgage crisis, it almost certainly would have prevented the banking crisis and the crash of 2008. Because we would have known. We would have known how much -- or how little -- trouble Bear was in long before March 2008. We would have known, for better or worse, about Lehman, and Morgan, and Goldman, and Citi. Not instantly. It would take time to digest millions of lines of information kept secret for decades. But surely millions of investors poring over the information, including those heroic rag-pickers, of capitalism the vultures and short-sellers would have given us a quicker and better answer than the grand-high-poo-bahs.
The megabanks would hate it. Hate it far worse than they hate the Dodd or Frank bills (if they really do hate them at all.)
They would scream bloody murder about being forced to let competitors see what they owned. Nonsense. Investors who hold interesting or unusual positions in their portfolios may have something to lose by disclosure. But too-big-to-fail banks have no business taking "interesting" positions. Banks are not supposed to be extra clever, they are supposed to be extra careful.
Senator Dodd should stop playing tough guy with the banks and do something they would really hate -- make them tell the truth.