Gary Cohn, the new National Economic Council Director, said yesterday the Administration will soon propose legislation to undo the Dodd Frank Act, according to the headline article in today’s Wall Street Journal. He stated this initiative has nothing to do with the largest and most powerful banks in the United States, naming Goldman Sachs, JPMorgan, Citigroup and Bank of America.
Mr. Cohn said the Dodd Frank Act had not solved problems it was supposed to address, and that today under Dodd Frank the United States has “the most highly regulated, overburdened banks in the world.” He said that the United States has “the best, most highly capitalized banks in the world, and we should use that to our competitive advantage,” while also observing that “I’m not sitting here saying we want to go back to the good old days.”
Mr. Cohn further stated there still isn’t a solid process to safely wind down the collapse of giant faltering financial companies or to ensure those firms have access to short-term liquidity. He said that the Administration would “redirect” the mission of the Consumer Financial Protection Bureau, created by Dodd Frank.
Let’s unpack this a little:
First, the big bank holding companies, including the banks named in the article, were big players in the explosion in private-label residential securitizations, including subprime residential loans. The meltdown in the residential-mortgage-backed-securities (RMBS) market brought the world’s financial markets to their knees in 2008, requiring the United States to infuse $400 billion into JPMorgan, Bank of America , Citigroup and many other banks, large and small.
Treasury’s bailout of AIG, related to its reckless issuance of credit default swap agreements it couldn’t possibly cover, greatly aided Goldman Sachs and other large financial companies in the United States. The Great Recession hit homeowners across the United States hard both in the value of their homes and in loss of employment.
Important parts of the Dodd Frank Act were aimed at an attempt to prevent such dangerous risk from building up in the country’s financial system. The Financial Stability Oversight Council (FSOC), made-up of heads of the financial regulatory agencies and headed by the Secretary of the Treasury, was established to assure there would be no gaps in the jurisdictions of these agencies in assessing such risks.
Second, there is no debate that capital levels in the nation’s banks are far higher than they were during the financial crisis, but those levels result directly from actions taken to implement the Dodd Frank Act. Memories can be short.
Third, to say there is no process in place to wind down distressed systemically important financial institutions (SIFIs) that assures access to short-term liquidity is curious. Besides FDIC’s resolving the affairs of over 500 banks that failed during the financial crisis—while maintaining the public’s confidence in the financial system—the FDIC since 2010 has been preparing to implement its mandate under the Orderly Liquidation Authority (OLA) of the Dodd Frank.
Under OLA, FDIC would act as receiver for SIFIs whose failure would threaten the U.S. economy, including ways to provide short-term liquidity. Under the OLA, such a SIFI would be resolved by FDIC instead of in bankruptcy. As you no doubt remember, the failure of Lehman Brothers in 2008 and its later resolution under the Bankruptcy Code resulted in significant destabilizing effects worldwide.
Under the OLA, FDIC would resolve SIFIs in a manner similar to the way it resolves failed banks, which strives to maximize the value of the failed institution’s assets while preserving confidence in the nation’s financial system. Many people were not even aware that their bank had been closed during the financial crisis, other than to notice that the name of the bank had changed. That’s a far cry from what happened during the Great Depression without FDIC deposit insurance.
OLA mandates that SIFI management be replaced and shareholders wiped out. Translation: management and shareholders would not be “bailed out” as they were in 2008. All creditors of the failed SIFI under Dodd Frank’s OLA provisions would be guaranteed to receive at least what they would have received had the SIFI been resolved in bankruptcy. Ultimately, the cost of such a resolution would be paid by other SIFIs and financial system participants. The Dodd Frank Act mandates that taxpayers not be left holding the bag because of a resolution under Dodd Frank.
Fourth, saying that the Administration will “redirect” the mission of the FCPB leaves much to the imagination, but sixteen states just filed briefs in PHH Corporation, et al. v. Consumer Financial Protection Bureau, pending on rehearing in the U.S. Court of Appeals for the District of Columbia Circuit. These state AGs assert the importance of the FCPB in protecting consumers of financial products in their state. One need look no further than FCPB’s role related to Wells Fargo’s phony credit card campaign to understand the important role the agency can play in protecting financial consumers.
Today’s WSJ article does not mention whether Mr. Cohn favors repeal of the Volcker Rule mandated by Dodd Frank. The Volcker Rule prohibits banks from using deposits insured by the FDIC, backed by the full faith and credit of the United States, i.e., the taxpayers, to fund speculative trading in equities for a bank’s own accounts. Treasury Secretary nominee Steve Mnuchin stated his support for the Volcker Rule in his confirmation testimony.
The Dodd Frank Act can be improved, like just about any legislation, and there is no real dispute that parts of the Act are overly complicated. For example, the plan of Chairman Jeb Hensarling (R-Texas), Chairman of the House Financial Services Committee, to relieve large banks from some of the regulatory burdens imposed by the Dodd Frank Act in return for a dramatic increase in equity capital held by the banks based upon a simplified leverage limit deserves serious consideration. And, the complexity of the Volcker Rule could be substantially eliminated by returning to black-letter rules such as the separation of commercial and investment banking in the Glass Steagall Act of 1933.
Not that we should re-enact Glass Steagall, although the idea has some merit; rather, the lesson of Glass Steagall is there is wisdom in simplicity, as there is in life. The Graham Leach Bliley Act of 1999, which removed some of the protections of the Glass Steagall Act, fostered the creation of huge bank holding companies with subsidiaries involved in banking, brokerage, underwriting, insurance and more. Within a decade, the crisis descended.