Joseph Stiglitz gave a remarkable interview recently on the Australian Broadcasting Company. During the course of this interview Noble laureate Stiglitz echoed many of the points previously highlighted on this blog ranging from the weak state of the economy, to the failure of the Dodd-Frank Act to resolve the problems posed by the megabanks and the likelihood of expanded powers to bailout TBTF firms, to the possible impotence of both fiscal and monetary policy.
But the most disconcerting point he makes concerns the probability for another crisis after Dodd-Frank. Stiglitz was asked: can the whole thing happen again? His reply:
"It can and it almost surely will happen again, because we didn't deal with the problem of too-big-to-fail banks. It is one of the reasons why it will happen again. And we didn't really deal effectively with all the kinds of excessive risk-taking, all the problems of lack of transparency that were at the core of this crisis. And so, yes, we understand what the issues are, we understand the issues better than we did three years ago, but politics intruded, the power of the banks, was too great. They're making $20 billion off of derivatives. So rather than lending, they're engaged in all of these kinds of gambling and excessive risk-taking and generating large profits, but it's not helping the American economy and it's putting at risk American taxpayers."
Stiglitz highlights derivatives as yet another example where Dodd-Frank allows the economic and political power of the bankers to prevail over sound policy:
"the banks came in with their political power and gutted or at least eviscerated the provision. . . . [W]e said important for there to be transparency in financial markets, important for there to be transparency in derivatives. Remember, derivatives - the bailout of AIG was $180 billion. That's an amount of money that's hard to fathom. One company, and it was all caused by derivatives. So, everybody said we better regulate derivatives better, we oughta have more sunshine, we oughta have more transparency and they agreed on the principle, but 30 per cent of the market was exempt. Now, why? Why should you not have everything out in the sunshine? Not clear to me."
A review of Dodd-Frank regarding derivatives prohibitions illustrate Stiglitz's points. Under section 716 banks are generally prohibited from using derivatives. But, there is an exception for "bona fide hedging and traditional bank activities." This exception apparently would include 80 percent of the derivatives market. The section does not even take effect until July 21, 2012 and no prohibition regarding bank derivative activities takes effect until July 21, 2014, which regulators may extend until July 21, 2015. Thus, all of the derivative trading that fueled the crisis will continue for at least 4 or 5 years, and most derivatives trading will be permissible for banks thereafter.
Section 723 mandates that derivatives transactions be cleared; but regulators have one year for promulgating a process by which determinations are made for which derivatives must be cleared and which ones may remain over-the-counter. Moreover, they may exempt small banks, credit unions and farm credit institutions from the clearing and margining requirements. Finally, section 721 and 723 exempts end users if they are (a) not certain financial entities; (b) not "major swap participants;" (c) use swaps to hedge commercial risk, and (d) can demonstrate how they meet their financial obligations associated with entering non-cleared swaps. Highly customized derivatives also need not be cleared. So again, the exceptions threaten to swallow the rule and much depends upon regulatory rule making.
Anyone interested in the effect of D0dd-Frank must watch the entire extended interview (42 minutes) video, available here.
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