Friday, August 2, 2013

Dodd-Frank at Three: More Lawless Capitalism

President Barack Obama signed the Dodd-Frank Act on July 21, 2010. How has the Act fared after three Years?

Well, according to CNBC, only 39% of all the regulatory rule-making required under the Act has been completed (see video at right, at 0:44). The megabanks have lobbied the top regulators to the hilt, meeting with them over 1,000 times (1:58). Indeed, the Sunlight Foundation finds that: "As the Dodd-Frank law passes its third anniversary, lagging on deadlines, and increasingly defanged, the meetings log data offer a compelling reason why: the banks have overwhelmed the regulators." CFTC Commissioner Bart Chilton states: "Much of Dodd-Frank is dying on the vine. Lobbying, litigation and lawmakers who have tried to defund and defang Dodd-Frank have all brought rule-writing to a crawl." Chilton continues: "Regulators themselves have become overly concerned about finalizing rules. Over-analysis, paralysis, fears of litigation risks, and the lack of people-power have all contributed to the slowdown." According to former Rep. Barney Frank, the GOP controlled House has stripped out the resources needed at key regulatory agencies to effectuate the purpose of the Act (4:27). I predicted that a lobbying blitz would defang Dodd-Frank in August 2010. Thus, none of this effort or its success should surprise anyone who has followed the use of power to corrupt law and regulation in the past few decades, as demonstrated in Lawless Capitalism.


More surprising, Rep. Frank issued a challenge regarding Too-Big-to-Fail (TBTF) (8:13). He claims Dodd-Frank makes every bailout of 2008 "impossible." That is simply nonsense, as I posted on the day after the Dodd-Frank Act was signed. Specifically, the Dodd-Frank Act amends section 13(3) of the Federal Reserve Act in a way that paves the way for the Fed to bailout large banks so long as it does so pursuant to a program or facility that features "broad-based eligibility." Indeed, the Act directs the Fed and the Treasury to create emergency lending programs and facilities "as soon as practicable." The only limitations the Act imposes on this emergency lending power is that borrowers cannot already be in bankruptcy or receivership and the loan cannot be made with the "purpose of" assisting a "single and specific company."

New section 13(3) of the Federal Reserve Act empowers the Fed to provide for loan programs with "broad-based eligibility" for "the purpose of providing liquidity to the financial system." It is hard to see how the new section would stop bailouts like the AIG Bailout or the Bear Stearns Bailout--both of which explicitly occurred under section 13(3).

That is why both Treasury Secretary Lew and Fed Chair Bernanke now admit that TBTF has not been solved yet.


The megabank lobby also has scored impressive wins in derailing derivatives regulation. In May, the SEC under the leadership of Mary Jo White voted to exempt foreign subsidiaries and foreign megabanks from complying with Dodd-Frank. Meanwhile, the CFTC recently voted to delay the overseas impact of its derivatives regulations and a bill in Congress would mandate that the CFTC follow the lead of the SEC, and defer to nations with weaker oversight. Most of the great derivatives mischief in recent years occurred at foreign subsidiaries--the AIG fiasco, the Chase London Whale losses, Citigroup's off-balance sheet SIVs and Long Term Capital Management's implosion.

On May 16, the CFTC curtailed the obligation for derivatives clearing houses to facilitate competitive markets by cutting the number of required bids for a given trade from 5 to 2. The swing vote on this action was supplied by Commissioner Mark Wetjen who some think may soon head the CFTC.

This comes on the heels of another notable win for the megabanks. Specifically, the SEC and CFTC voted last year to reduce the threshold for derivative dealer regulation from $100 million in derivatives contracts per year to $8 billion. Further there are significant exemptions from that $8 billion limit. "Under the rule, companies can exclude the swaps they use to hedge their business against risk like, say, interest rate fluctuations. And the rule would apply only to a company’s swaps transactions, so firms would not need to count their other varieties of derivatives, like forwards and options." This means fewer (as few as 15%) trading firms will be designated as swap dealers and thus subject to the most stringent capital and collateral requirements.


 The Volcker Rule was intended to put the "kibosh on most proprietary trading, which is when an institution that has access to Federal Reserve funds and insured deposits (i.e. all big banks) invests with its own funds for profit. It also limits the ability of banks to use their own funds in risky activities like derivatives trading." Originally scheduled to take effect in July of 2012, the rule has been delayed until July of 2014. In the meantime, expect massive lobbying because banks "hate" this rule. As former Chief Economist at the IMF, Simon Johnson, puts it the rule will "no doubt continue to draw a lot of pushback and gaming by the industry.”

Dodd-Frank is not without its positive effects. I have blogged previously about its potential to mitigate CEO primacy and its impact on curtailing predatory lending.   

But, fundamentally, after three years, it does not prevent banks from gambling on speculative trades with the backing of the US government. That almost certainly means too much risk in the system and more crises down the road, as I predicted in Dodd-Frank as Maginot Line.

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