Three years ago, the world was falling apart. Lehman Brothers was bankrupt, Merrill Lynch was bought for peanuts and the government’s response was a three-page proposal for bailing out the banks. It would take another year and a half — and a lot more paper — for the government to take on the root causes of the financial crisis with the Dodd-Frank Wall Street Consumer Reform and Protection Act (aka, simply, “Dodd-Frank”). That bill had thousands of pages and hundreds of rules, but what did it amount to? We asked risk expert Satyajit Das, author of “Extreme Money: Masters of the Universe and the Cult of Risk.”
Satyajit Das: We’re having a lawyer-, consultant- and regulator-led recovery. Because there’s more people working on Dodd-Frank than are working on any piece of real economy stuff.
The Dodd-Frank process is fascinating to watch as an exercise of how not to regulate anything. Because, essentially, what happened was when Dodd-Frank went in, the legislation is deeply flawed, because it actually doesn’t say anything. It puts very broad brush framework things in place, and the banks very carefully made sure that the legislation was drafted in that way. Because now it’s moved to what’s called the rulemaking phase. And in the rulemaking phase, what happens is detailed rules are drawn up. But it’s done in smoke filled rooms, full of banking lobbyists and regulators. And the process itself goes something like this:
Basically, the regulators say, “Well, what really happens here?” And the banks say, “Let me show you!” And the banks *educate * the regulator. Then, mysteriously, the rules that come out are, firstly, weak. If they’re not weak they’re so convoluted and full of loopholes.
Let me give you one example of that. The Volcker Rule. Now this was meant to fix the problem of banks essentially taking risks speculating with depositors’ money. The problem with that is as an idea it has huge merit, but in practice what’s going to happen is it’s going to be diluted. And one of the pieces of dilution is what’s known as the “market making exception.”
So, David, if you were to sell me — and I was a bank — a security, my argument would be: I bought that security, but I intend to sell it to somebody else. So the question is: Is this speculating when I buy your security and hold it? The answer is of course not, because I intend to sell it. Now the question is how long am I going to hold it? Is it for for ten minutes? Is it for ten hours? Is it for ten months?
These types of rules are very subtle and they’re being drafted with great care. A derivatives lawyer said this to me beautifully. He said, “Look, there are so many exceptions here I’d be *embarrassed * if I couldn’t excuse all your proprietary trading or speculative activity under these rules.
That whole process is ongoing. So I think what we’ll see here is a very elaborate set of rules which will make a lot of attorneys and lawyers very rich. We will have tons of regulators trying to enforce rules which are impossible to actually enforce. But in terms of actual progress in terms of regulation we’re not going to get further and we’re not going to actually prevent the next crisis; we’re just going to have a different crisis next time. That’s all that’s going to happen.
There’s a fundamental lesson here which is an important one. Wolfgang SchÃ¤uble, the German finance minister, summed this up very neatly. He said: “If you want to drain a swamp, you don’t ask the frogs for an objective assessment of the situation.” Unfortunately, it’s the frogs who are making the rules.