Global Crisis/Innovation Blog

Reforming America’s Banks: Dodd-Frank Act Got It Wrong –Why are We Not Surprised?

By Shlomo Maital

    Andrew Ross Sorkin’s regular Global NYT column (May 11/2011, p. 20) summarizes the Michael R. Milken Annual Conference held recently in Los Angeles, on financial reform and the Dodd-Frank Act.  You will recall, this Act, signed into law by President Obama last July 21, regulates “sweeping” financial reform, to prevent another meltdown like that of 2007-9, and in particular, preventing banks “too big to fail” from failing and needing bailouts.

    Sorkin says the video clip from the conference is “riveting”; find it at the Milken Foundation website.

    Critics at the Milkin Conference were fierce.  Thomas J. Wilson, chair of Allstate (a huge insurance company) and deputy chair of the Chicago Federal Reserve Bank, said the new law “creates more uncertainty than certainty”.  But the most damning critic is Kenneth C. Griffin, founder of a $15 b. hedge fund Citadel, who says the new legislation “will deeply entrench crony capitalism into the very fabric of the capitalist system”.  Readers will recall, it was crony capitalism that got us into this huge mess in the first place. 

    The problem, Griffin explains, is that when the government liquidates a bank (as it did with Lehman Bros.), it decides which creditors it will make “whole” (compensate) and which it will punish severely.  Griffin says, this means “companies connected to Washington that curry political favor will be favored at the expense of companies that do not have their business model “revolve around appeasing politicians and making campaign contributions”. Recall that Obama will spend $2 b. on his 2012 campaign, and so will his Republican counterpart.  One way or another, they have to raise that money – and much of it will come from the financial services industry. 

      Remember that $50 m. check we wrote for you?  Bank X will say, gently, to the ruling politicians, when it lands in trouble. 

     Wilson adds a doom loop scenario, noting that as soon as you declare a major financial institution insolvent, people are going to run from it (withdraw their money), and this will “actually accelerate people’s demise rather than stop it.”  Of course this happened with Lehman Brothers. 

    The fighting head of FDIC (Federal Deposit Insurance Corp.) Sheila Bair has announced she is leaving.   With her departure, and with Dodd-Frank, don’t look for serious fixes in the flaws that led to the 2007-8 meltdown.  And for bankers who gripe at government “over-regulation” – ask them if they would swallow an unregulated pill or fly in an unregulated airplane.   Why is regulation great for everything except where it really matters – banks and money?