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Dodd-Frank's Terrible Excuse For Financial Reform Sadly Lives On

Jun. 06, 2018 7:10 AM ET17 Comments
Laurence Kotlikoff profile picture
Laurence Kotlikoff


  • Our financial system was built to fail. It failed colossally in 2008. Dodd-Frank constitutes window dressing, not real reform.
  • This is no surprise given the financial leverage Wall Street has over Congress and the executive.
  • The Republicans' recent "reform" of the "reform" left Dodd-Frank largely in place and our financial system at ongoing risk.
  • The key problems with banking - leverage and opacity - can easily be addressed by requiring all financial corporations, including those transacting derivatives, to operate as 100 percent equity-financed mutual funds.
  • This is limited purpose banking, which has been endorsed by a Who's Who of former top government officials and leading economists.

The Dodd-Frank banking "reform" was passed in 2010 in the wake of the 2008 financial crisis, which cost millions of workers their jobs and millions of retirees much of their living standards. Resolving the crisis required a massive bailout of Wall Street by Main Street. The bill's goal was to prevent a re-occurrence. It contained new regulations, gave the Federal Reserve greater bank-resolution power, limited proprietary trading, and created the Consumer Financial Protection Bureau.

The bill runs 848 pages long. Its ancillary provisions run thousands more. Hence, fully digesting this legislation is no picnic. But one can easily appreciate the major features of the bill, not from its contents, but from its omissions. The bill fails to meaningfully address either bank leverage or bank opacity - the root causes of financial crises, past, present, and, surely, future. Last week's Republican "reform" of the Dodd-Frank "reform" relieves small- and medium-sized banks from the additional regulatory strictures of Dodd-Frank. But it too does nothing to address leverage or opacity and, therefore, does nothing to prevent the next financial crisis.

Our financial system is best described as faith-based banking. We lend banks money on the promise of repayment. The banks then invest our money in risky and, far too often, supremely stupid ways or they devise ways to steal it. When their investments go south or their malfeasance runs rampant, they hide their losses. But eventually, rumors about bad banks doing bad things reach the street and panic ensues.

In the old days, before deposit insurance, the public ran on banks. These days banks run on banks by calling interbank loans and restricting further interbank lending. They panic because other banks panic and because they too are in the dark. This is the message of The Big Short ­­­- Wall Street didn't know

This article was written by

Laurence Kotlikoff profile picture
Laurence J. Kotlikoff is a William Fairfield Warren Professor at Boston University, a Professor of Economics at Boston University, a Fellow of the American Academy of Arts and Sciences, a Fellow of the Econometric Society, a Research Associate of the National Bureau of Economic Research, Head of International Department for Fiscal Sustainability Studies, the Gaidar Institute, President of Economic Security Planning, Inc., a company specializing in financial planning software, and the Director of the Fiscal Analysis Center. Professor Kotlikoff is a NY Times Best Selling author and an active columnist. His columns and blogs have appeared in The New York Times, The Wall Street Journal, The Financial Times, the Boston Globe, Bloomberg, Forbes, Vox, The Economist, Yahoo.com, Huffington Post and other major publications. In addition, he is a frequent guest on major television and radio stations. In 2014, he was named by The Economist as one of the world's 25 most influential economists. In 2015 he was name one of the 50 most influential people in Aging by Next Avenue. Professor Kotlikoff received his B.A. in Economics from the University of Pennsylvania in 1973 and his Ph.D. in Economics from Harvard University in 1977. From 1977 through 1983 he served on the faculties of economics of the University of California, Los Angeles and Yale University. In 1981-82 Professor Kotlikoff was a Senior Economist with the President's Council of Economic Advisers. Professor Kotlikoff is author or co-author of 19 books and hundreds of professional journal articles. His most recent book, Get What's Yours -- the Secrets of Maxing Out Your Social Security Benefits (co-authored with Philip Moeller and Paul Solman, Simon & Schuster) is a runaway New York Times Best Seller. His other recent books are The Clash of Generations (co-authored with Scott Burns, MIT Press), The Economic Consequences of the Vickers Commission (Civitas), Jimmy Stewart Is Dead (John Wiley & Sons), Spend ‘Til the End, (co-authored with Scott Burns, Simon & Schuster), The Healthcare Fix (MIT Press), The Coming Generational Storm (co-authored with Scott Burns, MIT Press), and Generational Policy (MIT Press). Through his company, Professor Kotlikoff has designed the nation's top-ranked personal financial planning software and Social Security lifetime benefit maximization software. Professor Kotlikoff has served as a consultant to the International Monetary Fund, the World Bank, the Harvard Institute for International Development, the Organization for Economic Cooperation and Development, the Swedish Ministry of Finance, the Norwegian Ministry of Finance, the Bank of Italy, the Bank of Japan, the Bank of England, the Government of Russia, the Government of Ukraine, the Government of Bolivia, the Government of Bulgaria, the Treasury of New Zealand, the Office of Management and Budget, the U.S. Department of Education, the U.S. Department of Labor, the Joint Committee on Taxation, The Commonwealth of Massachusetts, The American Council of Life Insurance, Merrill Lynch, Fidelity Investments, AT&T, AON Corp., and other major U.S. corporations. He has provided expert testimony on numerous occasions to committees of Congress including the Senate Finance Committee, the House Ways and Means Committee, and the Joint Economic Committee.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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Comments (17)

MyPrivilegeIsShowing profile picture
So Barney Frank is on the BOD is Signature Bank. Just another hypocrite. Doesn't matter if you are a democrat or a republican
Some Lazy Bum profile picture
I am curious if personal loans, not backed by property or equity, would be allowed under LPS. What about credit cards?
wouldn't return to Glass–Steagall do about the same thing as Limited Purpose Banking.
Long Time Running profile picture
The Canadian Banking System did not have these issues because when they lend money for mortgages there is skin in the game, you have to prove you can make the payments and have 10 to 20 % down. Lower end mortgages have mortgage insurance

In Canada you cannot write off your interest on your taxes so there is a disincentive to take on bigger mortgage.

The financial crisis was caused by banks lending money without control excabberated by deritive trading which even Jamie Dimon did not understand.

Without better control of lending for car loans, mortgages and Deritive trading the US is headed down the same path.
Salmo trutta profile picture
@ stockanalysis1 :

The boom / bust in real-estate was the asset most impacted.

The Fed's loose money polices would just have been substituted elsewhere, viz., in the pro-rata share of the price level (consumer’s apportioned and ever shifting basket of goods and services), valuations that also depend upon Gresham’s law: "a statement of the least cost “principle of substitution” as applied to money: that a commodity (or service) will be devoted to those uses which are the most profitable (or in the case of consumption, the marginal utility and the price elasticity of demand segment).
Charles Cranmer profile picture
A big reason why Canadian banks weathered the crisis so well is that Canada had essentially eliminated its shadow banking system (except for Mr. Desmarais) due to its own crisis in the early 90's when all of its Trust Banks failed or were shut down. The Canadians were more conservatively managed and regulated as a result

The same applies to Sweden and Norway.
205427 profile picture
Arent canadian mortgage loans full recourse, so less incentive to just turn in the keys
Salmo trutta profile picture
@ cantercap: “Misguided regulation caused the 2008 crisis in the first place”

It’s simple. The GFC was predicted in May 1980 based on bad Congressional legislation, bad economic theory. That was before the regulatory malfeasance which you entwine. And it’s just math. Money flows’ RoC dropped for 29 contiguous months. That turned otherwise safe-assets into impaired assets. Case closed.

It has historical precedence:

“A born iconoclast with no reverence for his benighted superiors, he scoffed at the cumbersome procedures, excessive prudence and ingrained snobbery of the bank under Stillman Rockefeller. By 1967, having rise to chief executive, he began to mastermind the bank’s explosive change from a stagnant deposit-and–loan institutions to a global purveyor of financial resources.

A sworn fore of bureaucrats, Mr. Wriston often joked: “Regulators sit by while snails go by like rockets.” He devoted much of his career to diving through loopholes in bank holding-company legislation or wriggling free of interest-rate restrictions. As Mr. Zweig shows, Mr. Wriston presided over an encyclopedic range of innovations-among them negotiable CDs, term loans, syndicated loans, floating-rate notes and currency swaps-that ended forever the moribund bonking of the 1950s and ushered in our razzle-dazzle age of finance. The old prudential banker’s ethic was eclipsed by the hedonistic freedom of the consumer culture.”

-- Michel de Nostredame
Charles Cranmer profile picture
I would never defend Walter Wriston, but I think you are wrong that the changes introduced in the '80's engendered a hedonistic culture that led inevitably to the 2008 crisis. The economy changed, technology changed and ultimately the banking industry had to change with it. Those changes (e.g. interstate banking) have been hugely beneficial to the economy.

The idea that the industry was somehow pristine prior to 1980 is just wrong. It's incredible to me how people forget the "LDC crisis" of the early 80's. EVERY major US bank was technically insolvent, some of them by a lot. Folks also forget the Texas crisis and the related S&L crisis. Every major bank in Texas failed (and Continental Illinois in the bargain) and hundreds of billions was spent bailing out the S&Ls.

It's a very interesting question why the LDC crisis didn't produce a banking crisis like 2008. A few reasons: no mark to market accounting, a world regulatory system committed to supporting the banks, a much smaller and more conservative shadow banking sector and an extremely strong world economy post-1982 (except, of course, for the unfortunate LDC's.)
Salmo trutta profile picture
The DIDMCA turned 38,000 financial intermediaries into 38,000 commercial banks. This undid non-bank lending, viz., the Savings and Loan crisis. It decoupled lending from its credit control device, hence the GFC. Case closed.
Charles Cranmer profile picture
Say what? I don't follow.
Charles Cranmer profile picture
I disagree with too much of this to comment on everything. Misguided regulation caused the 2008 crisis in the first place. God only knows what the unintended consequences would be from a plan such as this. See my website cantercap.wordpress.com.

Mutual funds are not impervious to losses. It is my recollection that the worst part of the crisis was sparked by a couple of mutual funds that "broke the buck" because they were holding Lehman paper.

No large commercial bank failed in the crisis. There is some doubt as to whether Lehman was insolvent (now an academic argument). The 2008 crisis was a monstrous liquidity revulsion (run) driven by European universal banks and US shadow banks. The strength of US commercial banks was the best kept secret of the crisis.
Laurence Kotlikoff profile picture
No equity-financed mutual fund went out of business. Only the leveraged (backed to the buck) money market mutual funds went out of business. But 29 large global leveraged commercial and investment banks effectively failed. Only one, Lehman, formally failed. Please read Jimmy Stewart Is Dead. best, Larry
Charles Cranmer profile picture
Lehman was an investment bank, not a commercial bank. It was not regulated by the OCC, Fed, and FDIC.
205427 profile picture
And mortgage banks like countrywide and Indymac were far less regulated than commercial banks
Salmo trutta profile picture
Cause and effect is misconstrued. It’s not necessarily lax regulation. The problem with the banks is the American Bankers Association period. It is manifested by the Federal Reserve not constricting money flows, volume X’s velocity. In other words mal-investment and excessive speculation is generated by easy money, which is not reflected by the rate-of-change in, or composition of, commercial bank credit. It is the product of new money substitutes, identical with the acceleration in non-back-stopped, money velocity. The Fed must tighten money policy when money velocity rises.

The banksters seek higher margins by through riskier investments because of a paucity of credit worthy borrowing. You increase bankable opportunities by driving the banks out of the savings business, i.e., by putting savings back to work, recirculating income not spent (propagating non-inflationary financial perpetual-motion).

The problem with people is the excessive use of bank credit to finance consumption, to maintain the same standard of living during a protracted period of a deceleration in income growth. The deceleration in income growth has manifested itself in higher murder rates and social unrest.

The RX to achieving higher income, the ingredient from which debt is paid, is an accounting problem, which is resolved by driving the commercial banks out of the savings business. That makes the banks more profitable, the non-banks more profitable, economic real growth higher, real rates of return higher, and spurs CAPEX.

Rainy days are coming.
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