News Journal: How safe is the country’s financial system?

Wednesday is the fifth anniversary of the Senate passage of the Dodd-Frank Wall Street Reform Act. I won’t be celebrating.

It is not that Dodd-Frank hasn’t had some positive effects. It has. But I was in the Senate when Dodd-Frank was debated. Believe me, the one (probably only) thing all one hundred senators agreed on was that the new law somehow had to make certain that American taxpayers never again had to bail out a bank as they did in the financial meltdown of 2008.

If you think that kind of unanimity would guarantee a strong law, you underestimate both the power of the financial lobby and the human tendency to take the easy way out. Dodd-Frank has simply failed to do what was supposed to be its major priority. If (and I think history teaches us I should say when, not if) there is another financial crisis, and Congress does nothing to change the status quo, the government will have to bail out the major banks.

Why am I so sure that will happen?

First, because the Federal Reserve was forced to pump hundreds of billions of dollars into the major banks it believed were “too big to fail,” banks so critically important that their failure would mean a catastrophic collapse of the financial system. But if they were TBTF then, what about now, when they are even larger?

Ironically, one of the main reasons they are bigger now is because the government encouraged a bunch of forced mergers in 2008. JPMorgan Chase acquired Bear Stearns and Washington Mutual. Bank of American acquired Merrill Lynch and Countrywide Financial. Wells Fargo took over Wachovia.

So, more than ever, they are TBTF. That should be obvious to just about everyone. But when you look at how sophisticated independent market participants view banks today, there is supporting evidence. A recent study by New York Federal Reserve researchers Gara Afonso and Joan Santos issue found that, “The evidence suggests that rating agencies and market participants may have some doubts about the ability, so far, of the Dodd-Frank Act to deal with ‘too big to fail.’”

Second, not only are they still too big, but Dodd-Frank failed to address how the big banks got in so much trouble before 2008 that a bailout became necessary. That can be summed up in one word – derivatives, aptly described by Warren Buffet as “financial weapons of mass destruction.” Trading in esoteric and risky derivatives makes huge profits for the banks, until it doesn’t. That’s when the taxpayer steps in.

The major banks today all claim that their trading in derivatives today is under control, that they are at far less at risk than they were in 2008. That’s public relations nonsense and creative accounting at its worst. Tom Hoenig, vice chair of the FDIC points out that JPMorgan Chase, Citigroup, Bank of America, Goldman Sachs, and Morgan Stanley together report their derivatives exposure at “only” $300 billion. Under international rules, different from the accounting methods banks prefer, he says that exposure would be more like $4 trillion. Our eight largest banks claimed average capital of around 13 percent at the end of 2014. If international standards were applied, Hoenig says, that would change to something less than 5 percent.

If you read this column regularly, or even meet me on the street, you know I have long been a broken record on the issue of TBTF. But the fact is, the financial lobby and an acquiescent Congress have been chipping away at what few safeguards Dodd-Frank tried to put into place. One egregious example: In December, an amendment written word-for-word (really!) by Citigroup lobbyists was included in the end of the year must-pass government-funding bill. It reversed a Dodd-Frank provision that would soon have required banks to put risky derivatives into affiliates that were not insured by the FDIC.

That means that, as of now, we are right back where we were in 2008. Risky derivative trading is still FDIC-insured. FDIC’s funding comes from your taxes. The bottom line: The banks win big or you pick up the losses.

When I was in the Senate I co-sponsored a bill that would have reinstated the Glass-Steagall law that separated commercial and investment banks until it was repealed in 1999. The good news is that, three days ago, Senators McCain and Warren re-introduced a very similar bill. Passing it in the present Congress is still a long shot. But if it becomes law, taxpayers will no longer be on the hook for banking’s riskiest investments and you won’t be hearing this old broken record again.

Ted Kaufman is a former U.S. Senator from Delaware.

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