Is Dodd-Frank missing some vital regulatory firewalls?

Investment bank Goldman Sachs became this week the last big institution to settle with the federal government for its role in the 2008 financial crisis. But in an election cycle that has seen big banks under more scrutiny than ever before, there are worries that regulations against institutions like Goldman Sachs aren’t going far enough. Lynn Stout of Cornell Law School joins John Yang.

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    Now to our occasional series of conversations about whether some banks and firms are too big to fail, and whether they pose a risk to the country's financial health.

    John Yang has our latest installment.


    Eight years after the housing bubble exploded, investment bank Goldman Sachs this week became the last big institution to settle with the government for its role in selling bundles of bad loans to investors, which led to the financial crisis.

    In this election year, there is a lot of talk about whether too many firms remain too big to fail and whether the Dodd-Frank law is working.

    Lynn Stout is a Cornell University law professor who now serves on the Treasury Department's Financial Research Advisory Committee. She has been very critical of Dodd-Frank, and she joins us now from Ithaca, New York.

    Professor Stout, thanks for being with us.

    Let's start off with that Goldman Sachs settlement this week. They have agreed to pay as much as $5 billion in this settlement with the government. What does this say about accountability now among the big financial institutions after the financial crisis?

  • LYNN STOUT, Cornell University:

    I'm afraid the settlement confirms something that we have suspected for quite a long time, which is that it looks like fraudulent practices were hard-baked into the banking sector during 2008.

    And, unfortunately, although $5 billion sounds like a lot of money, the settlement is actually relatively small. It's certainly small compared to the damage that was done by these fraudulent practices, and it's relatively small compared to some of the settlements by some of the other banks, by Citibank and by Bank of America.

    So, as large as the figure may seem, I'm afraid it creates the risk that this could be business as usual, that, at the end of the day, Goldman Sachs may have found these sorts of fraudulent practices to overall profitable, even in light of the fines.


    Business as usual, you say.

    Now, Dodd-Frank was supposed to address all this. It was the response to all of this, the financial crisis and what brought it on. You say Dodd-Frank isn't working. Why not? What about it isn't working?


    The basic problem with Dodd-Frank is that it created the appearance of Congress doing something, without that appearance being backed up by reality.

    What the Dodd-Frank Act did mostly was direct various regulators at the Federal Reserve, the FTC, the CFTC to draft regulations that were supposed to rein in the banks. But Dodd-Frank itself doesn't impose many hard and fast rules, and what's happened in all the years since is that the financial industry, through lobbying, campaign contributions, behind-the-scene actions, HAS been very effective at stymying regulators from doing anything that really crimps their style and reins them in.


    Well, the banks say that they are, they are being reined in. The banks say that their profits are down, that Dodd-Frank has changed the way they do business. They're holding more capital, they say. They're being more closely regulated. There are things they can and they can't do.

    And, as I say, it's cutting into their profits, they say. What do you say to that?


    Well, it's true that bank profits are down, but I think we need to be realistic.

    One of the primary reasons is that the banks basically lost the faith of their customers. They damaged their own reputations and destroyed much of their own customer base. Now, some regulation does play a role. And right now, regulators are watching the banks pretty closely, but the rules are still pretty flexible.

    And we have to be concerned that in years that are coming in the future, the regulators are going to take their eye off the ball and we will be back to some of the same problems in terms of concentrations of risk and highly speculative activity that led to the 2008 collapse in the first place.


    What do you think should be done?


    It's actually very straightforward.

    Up until around the year 2000, we had a bunch of banking regulations in place, including Glass-Steagall and rules against speculative derivatives trading that had proven time-tested at keeping banks from taking on excessive risks and had been very effective at keeping the financial sector stable and sound.

    And most of those laws were eliminated in a — what's turned out to be a very misbegotten profit of so-called deregulation. I think that if we put those rules back in place, experience and history suggest there's no reason why we can't have a safe, sound banking sector.

    It's just very hard without some of the original regulatory firewalls we used to have.


    Glass-Steagall came out of the Depression and said you couldn't — you couldn't — had to separate commercial banking and investment banking.

    The critics of that, of your assessment, say that a lot of what happened in the financial crisis had nothing to do with that. It had to do with a pure investment bank like Goldman Sachs. It had to do not with the mixing of the two. What's your response?


    Oh, that's true, to some extent, but Glass-Steagall wasn't the only rule that was changed.

    We also legalized over-the-counter derivatives for the first time, and we even gave a derivatives contracts priority in bankruptcy. There were lots and lots of financial rules that were changed in favor of the financial industry through a steady process of the application of campaign contributions and lobbying power.

    And if we're going to have a stable system, I think we need to find a way to get past this problem of lack of a political will to effectively regulate financial institutions.


    We had Barney Frank on in one of our conversations about this, the Barney Frank of Dodd-Frank.

    And he said that even if an institution were to get into trouble, that the way the law is now, there would be no government bailout, no propping up of an institution, it would have to fail, and that whatever government funds would be spent would be spent on letting it dissolve in an orderly fashion, so it wouldn't cause a big financial problem to the rest of the economy, and that any money the government spent would have to be recovered.

    Your response.


    I think that's, shall we say, an extremely optimistic view.

    And I think history has shown that the ties between the big financial institutions and Washington are so tight that the financial institutions are very good at engineering taxpayer-financed bailouts.


    Lynn Stout, thanks for joining us. Thank you very much.

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