Is there a conservative alternative to financial reform?

December 14, 2013

The Manhattan Institute’s Nicole Gelinas recently wrote an essay critiquing the Dodd-Frank financial reform law and titled “Too Convoluted to Succeed.” It’s worth reading to get a sense of what the conservative critiques of the law actually are — and of whether wonks on the right have any viable alternatives.

A Morgan Stanley building in New York's Times Square. (Mark Lennihan/AP )
A Morgan Stanley building in New York's Times Square. (Mark Lennihan/AP )

Gelinas makes a lot of criticisms of Dodd-Frank, but one of her biggest complaints is about the law's "resolution authority" — the legal powers that have been given to the Federal Deposit Insurance Corp. (FDIC) to take over and wind down a megabank in a crisis. Gelinas argues that this doesn’t end the problem of “too big to fail” banks. Instead, it makes the problem permanent.

Why is that? Because, Gelinas says, the FDIC will be managing the receivership. That means that “regulators could use Treasury funds” in these resolutions, thereby “injecting money from the Orderly Liquidation Fund into [the banks] and keeping them going.” Got that? In other words, the resolution authority allows the government to provide emergency liquidity to large banks during a crisis.

This is an odd criticism. In 2009, in the aftermath of the crisis, Gelinas wrote a book called "After The Fall" that included a chapter on how to fix the financial sector. (The book got a big endorsement from Ross Douthat at the time.) Here’s how Gelinas recommended fixing the too-big-to-fail problem back then:

The FDIC was an effective solution to systemic risk, but it couldn’t stem a modern financial panic because so much of the financial world had moved beyond banking…. [Congress] must do what they should have done two decades ago: create an FDIC-style conservatorship for too-big-to-fail financial institutions…the government could provide financing to assure the institution's continued operation temporarily to maintain stability.

That is exactly what Dodd-Frank set out to do. It isn’t clear from Gelinas’s latest article what has changed in her thinking. Is the core idea right, but the implementation poorly done? Or is the whole idea wrong, and either nothing is needed or something radically different is needed? Gelinas notes that any losses usually get funded after the fact through additional fees on banks, implying that they should be pre-funded. But Republican opposition killed off a proposal for pre-funding in the Senate in 2010 (it had passed the House).

There are still many open questions about how resolution authority can work. Some, however, like Sheila Bair, think the process is going very well. But instead of seeing this as a problem to work through, arguing that it enshrined too-big-to-fail without trying to figure out how to fix those remaining issues doesn’t point to a path forward. And it won’t function as an alternative path for reform.

So what would a conservative alternative to Dodd-Frank look like? Gelinas concludes her piece by arguing that the “nation did not need a sweeping new financial regime” like Dodd-Frank, but instead “incremental change to fix the specific things that went wrong before 2008.”

Here’s what that entails: (1) regulating the over-the-counter derivatives market to ensure debt and reporting requirements, which would require repealing a major derivatives deregulation bill from 2000; (2) imposing higher leverage requirements overall, as well as liquidity requirements against short-term borrowing; (3) overhauling the parts about derivatives in the 2005 bankruptcy act to make runs at large financial firms less likely.

The first two items here are two of the biggest parts of Dodd-Frank (Title VII and I respectively). It would be odd to repeal Dodd-Frank just to pass most of it again. It's also clear that the GOP wouldn’t support that. Republicans in the House have declared war on derivatives regulations, consistently voting to delay any implementation of derivatives rules, trying to cut the Commodity Futures Trading Commission's budget and undermine it politically, as well as rolling back major parts of derivatives specifically, as well as Dodd-Frank overall. If you thought regulating the over-the-counter derivatives market was a priority, it would be strange to not support Dodd-Frank and instead push conservatives in this cause.

A massive increase in capital requirements could function as another avenue for reform. But as for the second item, Brown-Vitter, which Gelinas puts forward as a possibility for reform, would eliminate liquidity requirements for large firms. Meanwhile, regulators are using Dodd-Frank to put in liquidity requirements that are tougher than Basel.

If the third suggestion is meant to be paired with repealing Dodd-Frank, it would explicitly bring us back to the status quo 2008, with the hope that minor changes to capital structures in bankruptcy can manage another Lehman Brothers. Regardless of what you think of Dodd-Frank, this should strike you as predicated on the hope that nothing bad will happen, and that we don’t need to plan for the worst. It would be a major step back.

Notice how this mimics the dilemma of conservative health-care wonks. They attack things they previously supported, while proposing reforms that the movement has made clear it has no interest in supporting. How can that possibly be a way forward?

Mike Konczal is a fellow at the Roosevelt Institute, where he focuses on financial regulation, inequality and unemployment. He writes a weekly column for Wonkblog. Follow him on Twitter here.

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