The Dangers of Undoing Dodd-Frank – By Nicholas Lemann (newyorker.com) / May 7 2018
Will the Trump Administration dismantle our best protection against another financial crisis?
We are fast approaching the tenth anniversary of the worst financial crisis since the Great Depression. What passes for the official date is September 15th, the day that Lehman Brothers collapsed, but the crisis was under way months earlier, and the commemorative reëvaluations have already begun in the business press. The obvious question to ask is whether the financial markets, which have risen for most of the past decade but have been alarmingly shaky of late, could crash again. The answer largely depends on whether the Trump Administration undoes the best protection that we have against such an event: the Dodd-Frank law, which was passed in 2010, in response to the crash, after thirty years of financial deregulation.
In the early days of the New Deal, the federal government set up an elaborate array of controls over the financial system. For half a century before that, the system crashed regularly; for half a century afterward, it didn’t crash at all. Effective precautions created the illusion that they were not necessary, and, little by little, the government drastically scaled back what Democrats as well as Republicans had come to view as an outmoded set of constraints on banks’ size, scope, and assumption of risk. Conventional wisdom is a powerful force. Even on the verge of the 2008 crisis, almost no one believed that a collapse of the entire system was possible. Dodd-Frank, by placing unregulated new markets under government supervision and by requiring big banks to behave less riskily, reversed the swing of the pendulum.
By no means, though, has the potential for crisis passed. Moreover, if anything were to go wrong now, it would do so under an unstable and ill-informed head of state at a moment of political uncertainty, making the problem much more difficult to manage. The markets have calmed—except when Donald Trump unsettles them with a tweet—and the banks are healthy, but some negative trends that have been building for decades, and destabilizing politics, have worsened: income inequality, large regional variations in the distribution of economic well-being, and the political system’s adoption of an excessive faith in markets. After the crash, banks received swift, substantial help from the government, while people who had lost their jobs and their houses were largely left to fend for themselves. The result was that some places—roughly speaking, the financial capitals—recovered much faster than others, helping to create a populist resentment that Trump exploited to win the Presidency. The same phenomenon drove the success
of the Brexit referendum, in Britain, and Viktor Orbán’s three electoral victories, in Hungary.
In the United States, the immediate political response to the crash was predictable. Liberals blamed deregulation and lax supervision of the big banks. Conservatives blamed the growth of subprime mortgages. It’s a false apposition. Subprime mortgages, which were bundled and sold as glamorous new financial instruments, were poorly evaluated by private rating agencies, and fell outside the scope of the government’s securities regulators; they were bought and sold with borrowed money by banks that had become wildly incautious about speculating with their funds. Today, because of a wave of post-crash mergers, the biggest banks are even bigger than they were, and financial power is more concentrated than it has been in at least a century. So everything depends on how well the government regulates the handful of “too big to fail” institutions that sit atop the system.
During the 2016 Presidential campaign, Trump was more showily anti-Wall Street than Hillary Clinton was, but he has consistently attacked Dodd-Frank. Anything involving banks brings to the fore the conflicts in his Administration between the Wall Streeters and the anti-globalists. It’s hard to tell at any moment which camp is winning, because Trump is so blithely unconcerned with consistency. So far, his most worrisome financial-policy move has been to appoint Mick Mulvaney, the former Republican congressman from South Carolina, who is the head of the Office of Management and Budget, to be the acting chair of the Consumer Financial Protection Bureau. The Obama Administration set up the bureau, which was authorized under Dodd-Frank, to guard against banks’ offering too-good-to-be-true products to unsophisticated consumers. It was intended to be an independent agency, protected from direct political influence. The idea of someone who works directly for the Trump White House supervising the bureau traduces its e
ntire purpose. Sure enough, Mulvaney, who opposed it from the start, has begun to weaken safeguards against predatory financial activity. He has proposed, among other things, rolling back restrictions on short-term, high-interest bank lending.
There are lots of places to chip away at Dodd-Frank, until the changes add up to systemic risk. The insurance giant A.I.G., which the government rescued a day after it let Lehman Brothers fail, is no longer deemed a “systemically important financial institution,” subject to maximum government scrutiny. A bill now in Congress would lower the level of government supervision of two institutions, State Street and Bank of New York, that practice “custodial banking,” and would exempt a larger category of big but not enormous banks from regular stress tests.
The most significant threat to the safeguards of Dodd-Frank would be to sharply lower the amount of capital that the biggest banks are required to hold in reserve. Doing so would make them—and the financial system as a whole—far more vulnerable in a moment of panic, when everybody wants to withdraw assets in a hurry. Such a move wouldn’t require congressional approval, just the assent of several agencies. And it could happen soon, when Martin Gruenberg, the only remaining Democratic appointee to head a government financial agency—the Federal Deposit Insurance Corporation—steps down. Trump’s nominee to replace him, Jelena McWilliams, declined, in her confirmation hearings, to state a position on capital requirements.
Financial deregulation doesn’t take place in secret, exactly. It unfolds step by technical step, across half a dozen federal agencies, with the prospective details revealed in long lists of dense rules. The banking industry has the means and the motivation to stay on top of it all. The public, except in a crisis, does not. But, if we don’t want to be subject again to devastating events in the markets and their even more devastating political consequences, we will need to pay close attention. ♦
This article appears in the print edition of the May 7, 2018, issue, with the headline “Crash Course.”
https://www.newyorker.com/magazine/2018/05/07/the-dangers-of-undoing-dodd-frank
