The Obama administration and Senate leadership tell us that the "Dodd bill" pending in the Senate would create "the most sweeping financial reform since the Great Depression." If that claim were accurate, I would be one of the bill's strongest supporters.
In truth, the bill does almost nothing to change a dysfunctional regulatory system that drove three very serious banking crises in the past 40 years: the real estate collapse of 1972-1974, the banking and S&L crises of 1980-1991 and the financial panic of 2007-2009.
Our financial regulatory system requires major overhaul. The Federal Reserve regulates bank holding companies, and the Comptroller of the Currency regulates their national bank subsidiaries. Large companies play one regulator against the other when seeking to engage in new activities or ease prudential standards. The Federal Deposit Insurance Corp. is supposed to be a watchdog, but its oversight is vigorously resisted by banks and the other regulators.
Senate Banking Committee Chairman Christopher Dodd, D-Conn., proposed sweeping reform of the regulatory system last November. That bill would have combined the regulatory functions of the Fed, the Comptroller and the Office of Thrift Supervision over banks, thrifts and their holding companies in a new Financial Institutions Regulatory Authority.
I endorsed Dodd's FIRA proposal because it would have created a strong, independent agency not dominated by the Treasury's political agenda, unified bank and bank holding company supervision and allowed the Fed to participate in bank regulation through its membership on the FIRA board while reducing the conflict between the Fed's monetary policy mission and its regulatory role.
The original Dodd proposal would have folded the FDIC into FIRA, which I opposed because it would have eliminated an important watchdog. I felt the FDIC should remain outside FIRA, where it could oversee all banks and thrifts and their holding companies, including state-chartered banks.
Dodd's original proposal, if accompanied by an independent FDIC and a new, independent Systemic Risk Council, would significantly upgrade our financial regulatory system. This structure would be our best hope to end the policy of "too big to fail," as it would reduce the likelihood that our major institutions would get into the kind of trouble that could force taxpayers to come to the rescue again.
Sen. Dodd announced in January that he would not seek re-election. I hoped his plan to retire might cause him to stand firm for the right kind of reforms, but it appears to have had the opposite effect because it trimmed the time frame for getting something done.
Dodd was quite critical of the House financial reform bill and declared he was unwilling to rush through the wrong reforms. After his decision to retire, however, he cobbled together a bill that looks like the House bill's evil twin and pushed it through his committee without hearings or debate. Did Congress learn nothing from rushing to judgment on the ill-conceived Troubled Asset Relief Program?
There is little in the Dodd bill that would have prevented the financial crisis of 2007-2009, or the next crisis, for that matter. The Dodd bill does almost nothing to fix a badly broken regulatory system.
That regulatory system brought us the badly flawed Basel II capital models on the theory that major U.S. banks were not competitive in international markets because they were required to maintain more capital than their foreign peers. That same regulatory system determined that savings and loans should be allowed to "grow out of their problems" in the 1980s, a decision that cost taxpayers $150 billion.
The Dodd bill does not address the glaring weaknesses in the Securities and Exchange Commission that played a central role in creating the financial panic of 2007-2009. Nor does it address the SEC's failure to properly oversee the Financial Accounting Standards Board. The latter's rulings allowed trillions of dollars of securitized loans to be removed from bank balance sheets and capital requirements, and its mark-to-market accounting rules senselessly wiped out massive amounts of bank capital and panicked the financial markets.
Dodd's bill is being touted as a move to end too big to fail but will do no such thing. As long as most of our banking system is controlled by five megabanks that are overseen by a plethora of regulators subject to intense political pressures, the next crisis will always be just around the corner, and too big to fail will remain a fact of life.
We need to slow down this train and take the time to understand the real causes of the last three banking crises. If we do not, the next train wreck will be just a matter of time.