Dodd’s bill won’t prevent another crisis

Breaking up is the hardest things to do …

Three years since the onset of the crisis, the United States Congress has finally got around to debating some serious proposals for reforming America’s banks and other financial institutions — and how they’re 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 and Democratic senator for Connecticut, published a second, 1,336-page version of his reform package — the Restoring American Financial Stability Act of 2010 — on 15 March. 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 will have to 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 to 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 hard 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.

A longer version of this blog post was published in Qfinance on 14 April 2010