Bove, a widely followed banking analyst on Wall Street, calls Dodd-Frank “the dumbest piece of legislation ever created by the U.S. Congress. They wanted the big banks to have less control, yet they built in rules that ensure the increased control of the financial sector by big banks.” The hundreds of new regulations drive up the cost structure of banking, as do new capital and liquidity requirements. The new law even reduced some of the modest profit centers for small and medium-sized banks, such as overdraft fees, Bove says. “And there is nothing in Dodd-Frank that will do anything to stop a meltdown from occurring.”
Indeed, top regulators, including Fed Chairman Bernanke—who has long fretted about the too-big-to-fail problem—worry whether they’ll have the tools they need if a large global bank has a liquidity or bad-debt crisis. “In my judgment, as best as I can recount history, not just the last three years but the history of mankind, I can’t think of a single case where we were able execute the orderly wind-down of a systemically important institution—especially one with an international footprint,” says Gerald Corrigan, the widely respected former head of the Federal Reserve Bank of New York. “There’s a reason why we’ve never been able to do it—and it’s because it’s so damn hard to do it. It’s really that simple. Therefore, if there are serious flaws in the design and execution of enhanced resolution authority, there is a risk that the system ends up less stable.”
In a February speech, Thomas Hoenig, the outspoken president of the Federal Reserve Bank of Kansas City, declared that Dodd-Frank creates as many incentives for big banks to take new risks as it removes old ones. “It is even worse than before the crisis,” he said in February. The continued “existence of too-big-to-fail institutions poses the greatest risk to the U.S. economy.” The largest financial firms “are now more powerful and more of a threat to our capitalistic system than prior to the crisis.” The only solution, Hoenig said, is to break up the biggest banks. That’s a nonstarter in today’s environment.
Dodd-Frank has its defenders, of course. FDIC head Sheila Bair—the regulator most responsible for implementing the resolution authority—says that the rule is still being developed, along with the 250-odd other Dodd-Frank regulations and studies in process. In an interview with National Journal last week, Bair sternly warned Wall Street against overconfidence and defended the government’s stance. “The first thing everybody needs to understand about [the rule] is that it puts the burden on the institution itself to show it can be resolved. It’s not our obligation to show whether Citi or any large institution can be resolved” or broken up in a crisis, said Bair, a tough critic of banks, who plans to leave her job by summer. “If they’re not able to rationalize their legal structure or the resolvability of financial operations,” she said, the FDIC and the Fed will have the power to order structural changes and the divesting of assets.
Serious questions remain, however, about whether the Fed, FDIC, or other regulators will ever have the know-how—or backbone—to demand that firms divest themselves of dubious or risky assets. “Bottom line: Nobody on Wall Street believes that these big institutions are no longer too big to fail,” says Dan Senor, a New York City hedge-fund manager who doubles as an informal Republican advisor in Washington. “No one believes they would not be bailed out and backstopped in some way by the government. That’s just the reality.” Senor, a graduate of Harvard Business School, adds: “No one on Wall Street believes you can look at the financial statements of these big companies and understand them. They’re incomprehensible. They were incomprehensible before the crisis, and they’re incomprehensible today. So how [are] the SEC or other regulators going to be able to do it?”
Bair says that the major international financial institutions would be well advised to remember that “the law is the law,” and that it would be dangerous indeed to assume that firms like Citi are too big to fail. “If I were an investor, I would not assume that whatsoever,” she says. “I think some of these large entities try to make it sound more complicated than it really is. I don’t know that’s the case.… Most of these international operations are concentrated in major jurisdictions where we have a good bilateral relationship.”
But other skeptics of Dodd-Frank worry that Washington has set up an enormously complex structure—multiplying the number of regulators, rather than streamlining them—that the banks will just arbitrage their way through, as they always have. Take proprietary derivatives trading. If the “Volcker rule” prevents banks from doing it, why not just fob that revenue stream off on an affiliated insurance company? The insurance industry, after all, still has no national regulator.