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Breaking up is the hardest thing to do

Finance Blogger: Ian Fraser Ian Fraser

Three years since the onset of the crisis, the US Congress has finally got around to debating some serious proposals for reforming America’s banks and other financial institutions—and specifically for overhauling how they are regulated.

But will the measures outlined in Senator Chris Dodd’s financial reform bill be sufficient to prevent another crisis? And can they be expected to make it through the political mill given the opposition of laissez-faire Republicans, many of whom are directly funded by large banks?

Dodd, chairman of the Senate Banking Committee, published a second, 1,336-page version of his reform package—the Restoring American Financial Stability Act of 2010 [PDF, 2.0 MB]—on March 15th. The Senate committee voted the bill through a few days later. As the focus of the debate now shifts onto the floor of the house, senators from both parties can now be expected to file a flurry of amendments and filibusters.

Predictably the bill has already been slated by some Republicans. House Republican leader John Boehner last month advised hundreds of bankers at a conference to resist Washington’s proposals. “Don’t let those little punk staffers take advantage of you and stand up for yourselves,” he said.

The bill has also come in for more considered criticism over its failure to properly address issues including “too big to fail” and derivatives trading. The anonymous, whistle-blowing “fourteenth banker” has claimed that the “too big to fail” banks must be broken up if a second crisis is to be avoided. Yet the bill contains no proposals for dismantling giants such as Citigroup—in sharp contrast with the US government’s 1911 break-up of Standard Oil, 1974 break-up of AT&T, and attempted break-up of Microsoft a decade ago.

Rather than specific measures to limit bank size, Dodd depends on a “resolution authority.” The hope is this will make size per se less appealing for bank boards, as institutions whose assets exceed $50 billion would be forced to pay money into a resolution fund to support failing firms.

If a failing bank became a threat to the wider system, the Federal Reserve, the Treasury, and the Federal Deposit Insurance Corporation would step in and impose an “orderly liquidation,” leaving shareholders and unsecured creditors bearing the brunt.

However, Simon Johnson, a professor at Massachusetts Institute of Technology and former IMF chief economist, agrees with “fourteenth banker” in believing this goes nowhere near far enough. In his book 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, co-authored by James Kwak, Johnson argued the only way to combat the entrenched power of “too big to fail” banks is a forcible break-up.

In a more recent blog post, Johnson complained that lobbyists have already persuaded politicians to emasculate many of Dodd’s proposals. He wrote: “There’s nothing meaningful in the proposed legislation … Dodd was pushed hard by various interests to weaken all potentially sensible proposals—including anything that would bring greater transparency and safety to the derivatives market.”

A further bone of contention is that the consumer protection agency proposed in Dodd’s bill is to be housed in the Federal Reserve. The Fed’s governors don’t want it there. They fear that the Fed would be held accountable for the proposed consumer protection agency’s errors, even though it lacks control over its budget, staffing, and rulemaking.

Another vocal critic of Dodd’s reforms is the Boston University professor Larry Kotlikoff. In a recent Huffington Post article he complained that the proposals skirt around the elephant in the room of the crisis—financial fraud.

“This problem can’t be addressed by hiring more Keystone Cops or adding super regulators. We already have over 115 regulatory bodies who can't shoot straight. We need a system that is fool-proof, check that, fraudster-proof. That’s Limited Purpose Banking. It recognizes that Jimmy Stewart—the trustworthy banker in It’s a Wonderful Life—is dead and that we can’t pretend that the folks at the top in Wall Street have our best interests at heart.”

According to a Reuters report the fate of Dodd’s bill currently “looks uncertain.” Democrats control only 59 of the 60 votes needed to overcome procedural hurdles likely to be thrown up by recalcitrant Republicans eager to block reform.

Further reading on US banking reform

Tags: banking , central banks , financial crisis , regulation , resolution regime , Senator Chris Dodd , Too big to fail , US
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