The missed opportunity on financial reform

Sam Zamarripa Contributor
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Senators ought to know they shouldn’t make promises they can’t keep.

Yet, that hasn’t stopped financial reform’s chief architect, Sen. Christopher Dodd, D-Conn., from declaring his legislation is needed “to make sure what happened (with the financial meltdown in 2008) can never happen again.”

Never happen again? The one thing this legislation almost guarantees is that a future financial crisis will lead to another massive taxpayer bailout. Why? Because up to this moment, it has failed to deal with the crux of the problem – having institutions that are too big for government to allow them to fail.

Federal Reserve presidents clearly get that point. They may not offer the same prescription, but almost everyone of them who has spoken up about the financial reform package passed by the House and being promulgated in the Senate has warned the actions don’t do enough to prevent the kind of risky behavior that has cost millions of Americans their jobs and trimmed trillions of dollars from household wealth.

For example, Federal Reserve Bank of Minneapolis President Narayana Kocherlakota noted that the bills “significantly understate the extreme economic forces that lead to bailouts during financial crises. Indeed, the opening language of the Senate bill actually declares that it will end taxpayer bailouts. … I do not believe that better resolution mechanisms will end bailouts.” Kocherlakota has suggested the best that might be done is to levy a tax on banks with an uncapped fund for the level of risk to discourage bad. Dodd’s bill initially would have levied a tax without regard to risk and capped it, a sure inducement to take more risk, and subsequently put unwinding big financial firms in the hands of the FDIC, with the Treasury to raise money after the fact to cover their cost.

James Bullard, President of the St Louis Federal Reserve Bank, questioned whether such an authority would pass the Citigroup test. Would it let Citigroup fail? He doubted it. And he noted that a proposal to require banks to plan how they would be wound up “is not credible. I think they will draw up something, and put it on the shelf, and five years later there’s a crisis, and it will be ignored.”

Jeffrey Lacker, President of the Federal Reserve Bank of Richmond, worried about that likelihood while also noting that Freddie Mac and Fannie Mae “that securitize and guarantee the bulk of U.S. mortgage debt grew their businesses under an ambiguous regime that led most market participants to view them as implicitly guaranteed. Housing finance cannot achieve a sustainable configuration without a final determination of the status of these companies and of whether and how we deliver government subsidies to mortgage finance.” The bill has left Fannie and Freddie unreformed and intact.

As Dennis P. Lockhart, president and CEO of the Federal Reserve Bank of Atlanta, put it: “Uncomfortable as it may be, a responsible working assumption is that another crisis will occur at some point in the future. This assumption is not intended to be a forecast; rather, it’s an anchoring statement to bring a cautionary perspective to the task of regulatory reform.”

There are some bits and pieces in the legislation that are worthwhile, such as separating derivatives from support from insured deposits as has become the case in the biggest financial firms.

But as Richard W. Fisher, president of the Federal Reserve Bank of Dallas, pointed out, “The social costs associated with these big financial institutions are much greater than any benefits they may provide. We need to find some international convention to limit their size. …It takes an enormous amount of political courage to say we are going to limit size and limit leverage. But to me it makes the ultimate sense. The misuse of leverage is always the root cause of every financial crisis. Why should you have a small group of institutions get an advantage simply because they have grown too large? It’s un-American; it’s not what makes this country great.”

Until there is legislation that limits the size of these financial institutions, the promises of reformers that their efforts will ensure against a recurrence of such devastating crises will remain empty.

Indeed, rather than a mission accomplished, the current reform effort leaves real protection for our finances and jobs a task yet to be done.

Sam Zamarripa, a former Georgia State Senator and chairman and co-founder of Stop Too Big to Fail, serves as president and founder of private equity firm Zamarripa Capital and as founding director of United Americas Bank of Atlanta.