January/ February 2012 Financial Regulation

Back to the good ol’ days of 2008.

By Michael Konczal

A third aspect of Dodd-Frank that the GOP has in its crosshairs is the law’s effort to deal with the “too big to fail” problem. In the wake of the financial crisis, many economists argued that the best and perhaps only way to avoid the need for massive bailouts in the future would be to cut the nation’s biggest financial institutions down to size, such that the failure of any one would not drag down the entire financial system. That’s not the course the Obama administration and congressional Democrats took. Instead, with Dodd-Frank, they placed a special set of regulations on the largest and most complicated financial firms, known as “systemically important financial institutions” firms—companies like Goldman Sachs and Citigroup. Under the law, these behemoths are required to hold more capital in reserve than they did before the crisis, and must prepare “living wills” so the government can take control of them if they do fail, cushioning the impact on the rest of the economy. When Barney Frank bragged that there “will be death panels enacted by this Congress, but they will be for nonbank financial institutions,” he was referring to this living-will provision and the government’s new authority to take over these institutions in the event of their failure. Several of the firms would also likely fall under the Volcker Rule, which bans firms with FDIC protection from outright gambling with a taxpayer backstop and secretly betting against the interests of their own clients. Needless to say, the banks would be glad not to have to deal with any of these new rules.

Beyond these three main areas of regulation, virtually all the other reforms in Dodd-Frank would be at risk from Republican efforts to stop regulators from writing the necessary rules and implementing them in the marketplace. Funding for the agencies will be important here; House Republicans have already attempted to radically cut the budget of the U.S. Commodity Futures Trading Commission. Nor will GOP attacks on financial regulation be limited to Dodd- Frank. Most of the major presidential candidates have stated that they intend to repeal Sarbanes-Oxley, the financial reporting mandate put into place after the corporate scandals at Enron and WorldCom.

If laws like Sarbanes-Oxley and Dodd-Frank are repealed or eviscerated in the ways Republicans have explicitly called for—or have at least hinted at—it is not hard to imagine the possible consequences. The largest firms would be dangerously risky, continuing to exert way too much influence over the markets and to keep finding new, innovative ways to gamble with other people’s money. Reforms that would limit abusive practices across the market won’t be put into place. The financial markets will be set up to generate maximum panic and confusion in a crisis. When the next set of problems starts to occur in the financial market, we’ll be in no better shape to deal with the crisis than we were before. Financial firms are constantly creating new, complex products and services that could pose risks to the entire financial system but are little understood by regulators. Unless agencies are given the funding and mandate to keep up with Wall Street’s innovations, it will be difficult if not impossible to stop the next crisis at an early stage.

It may be hard to fathom why Republicans would want to do away with commonsense regulations meant to stop the kinds of financial practices that wrecked the American economy—especially when, in the eyes of many, those regulations didn’t go far enough. But if the story you tell, against all available evidence, is that the government is the primary culprit, and the financial markets work fine without any serious oversight, then the only logical conclusion is to govern like you are there to serve the banks.

[Return to What if Obama Loses: Imagining the consequences of a GOP victory]

Michael Konczal is a fellow with the Roosevelt Institute.


  • Kill Bill on January 24, 2012 10:26 PM:

    “and my view is that Washington and the regulators are there to serve the banks.” -MK

    Congress gave up its constitutional authority to coin paper currency.

    Serving the banks [bailouts] doesnt work. Even Klaus Schwab, host and creator of the WEF in Davos, says that the 'old capitalism' doesnt work today.

    I agree with that. The problem seems to be that credit has become a false fulcrum. Fractionlized banking is okay when iimited to eight times the deposit [loan]. 40 or 120 x is quite problematic.

  • ifthethunderdontgetya����� on January 25, 2012 12:06 PM:

    This view is consistent with thirty years of Republican-backed financial deregulation as well as with the conservative explanation of what went wrong in the financial crisis.

    The corporatist Democrats have gone along with the same b.s.

    Dodd-Frank is nothing but weak tea for a case of malaria.

    This President has had 3 years to bring bankers to justice for the crimes they committed, and he's done nothing but protect them and fill their pockets.

    When and if that changes, I'll believe what Obama said in the S.O.T.U.