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In an op-ed last week in the Wall Street Journal, Secretary Geithner argued that we have forgotten the reasons that the Dodd-Frank Act was necessary, and that’s why the act has become so controversial. The article was written as though the crisis had just occurred, based on assumptions that were made at the time. What the secretary seems to have missed is that we have learned a lot in the intervening years. The administration’s rush to judgment on the financial crisis is a case study in why it would have been worthwhile to wait for the facts.
Among other things, Secretary Geithner argued that neither the Fed nor anyone else had oversight responsibility for the investment banks that got into trouble, or the ability to impose risk controls on large nonbanks; that the derivatives market had grown to $600 trillion with little oversight; and that the government did not have the authority to wind down failing financial firms in an orderly way.
The essential elements of Dodd-Frank Act were designed by the administration and announced by the White House only six months after the president’s inauguration. What was the hurry? As the president’s chief of staff said at the time: “You never want a good crisis to go to waste.” That should tell us plenty.
“Why would anyone think the Fed will be able to improve on its bank regulatory record when it is supervising nonbanks?” — Peter J. Wallison
What most people have come to recognize since the crisis is that the Fed and other bank regulators had strong oversight responsibilities for the banking system, but banks–Citi, Wachovia, Washington Mutual and IndyMac–got into just as much trouble as the supposedly “unsupervised” investment banks. So tell us again, Mr. Secretary, why it makes sense to designate nonbank firms-insurers, securities firms, holding companies, finance companies, hedge funds and others-that will be regulated and supervised by the Fed? How can it be a good idea to declare, in effect, that these firms are too big to fail, and why would anyone think the Fed will be able to improve on its bank regulatory record when it is supervising nonbanks?
We have also been able to watch that $600 trillion dollar derivatives market since the financial crisis, and to see that AIG, which has been played and replayed as the poster child for regulation of derivatives, was the only firm that got into trouble because of its misuse of credit defaults swaps (CDS). If we’d waited a while to look at the facts, people might have noticed that no other firm–not even Lehman–was seriously damaged by its CDS activities. Given time, people might even have realized that the $600 trillion number is a gross exaggeration (in two senses) and less a description of real liabilities than a scare tactic. That’s why Lehman’s failure did not bring down the credit default swap market, which functioned effectively through the entire financial crisis.
As to the orderly winddown of failing financial firms: given more time, people would have noticed that the Lehman bankruptcy has gone relatively smoothly. They might also have seen that when Lehman failed many other large financial institutions were in trouble and were hoarding cash. They might have wondered, then, how it would have been different if the FDIC had taken over Lehman. Would the other institutions have looked healthier? Would there have been less reason for banks and others to hoard cash? And they might have asked why it was sensible to hand over the resolution authority to the FDIC, which has never resolved a nonbank financial institution, let alone one as large as Lehman Brothers.
Finally, a little bit more time and considered thought between the financial crisis and the administration’s legislation might have allowed people to recognize that the whole thing had begun with a mortgage meltdown, and that the government’s own housing policies–intended to make mortgage credit available to borrowers who could not previously qualify for loans–had fostered the creation of 28 million subprime and otherwise risky mortgages. They might have realized that it was the delinquencies and defaults among these mortgages–half of all mortgages in the United States–that drove the mortgage meltdown and the financial crisis. If people had known that, they might not have seen the point of giving yet more power to the government in the Dodd-Frank Act.
You said in your article that President Obama asked Congress to pass reforms quickly, “before the memory of the crisis faded.” As the expression goes, sin in haste; repent at leisure.
Peter J. Wallison is the Arthur F. Burns fellow in financial policy studies at AEI.
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