Dodd-Frank co-author lists benefits of law

Barney Frank tells St. A’s audience law needs tweaks, but it has worked

Former Massachusetts Congressman Barney Frank spoke at Saint Anselm College’s NH Institute of Politics Monday morning, reflecting on the events that led to the Dodd-Frank Wall Street Reform and Consumer Protection Act and offering a vigorous defense of the five-year-old financial regulatory law.

Frank first explained how the global banking industry evolved, creating the setting for the 2008 financial crisis.

He said that when Asian and oil-producing countries entered the banking system in the 1970s, it resulted in banks taking riskier loans to compete – what he called a philosophy of quantity over quality.

One of the ways they did it was by repackaging loans, including subprime mortgages, as securities, which he said is entirely a post-Internet phenomenon. By 2000, an overwhelming number of borrowers were already unable to pay back their loans.

“The notion that the poorest people should be able to buy homes is a good intention gone bad,” said Frank. “One of my missions for 30 years has been decent rental housing for low-income people.”

While Fannie Mae and Freddie Mac played a part, in purchasing mortgage-backed securities, they are not entirely responsible for the crash, said Frank, because they simply bought the risky mortgage loans and didn’t make them.

Other factors were credit default swaps, derivatives that exacerbated the crisis when debt wasn’t repaid.

“AIG had $170 billion in debt that it couldn’t pay and did not even know how much it owed,” said Frank.

One of the results of the collapse of the financial system in 2008 was the Troubled Asset Relief Program, or TARP, which provided a $700 billion bailout package.

“As far as a response to the crisis, I think it was a very good one,” said Frank, who pointed out he would have added in more aid to help prevent foreclosures. “No program in American history could more clearly combine two elements: great success and absolute unpopularity.”

The bill Frank sponsored with former Connecticut Senator Christopher Dodd aimed to avoid another taxpayer-funded bailout and eliminate that high level of risk in the market, including the addition of the regulatory Consumer Financial Protection Bureau.

He argued that AIG’s ignorance of its debt would be “impossible today. Derivative trading now has to be done with margin capital, price transparency, etc.”

Help for small banks

The event’s moderator, Joe Keefe, CEO of Pax World Management, cited a Sept. 2 Wall Street Journal article reporting that Goldman Sachs, Morgan Stanley, JPMorgan Chase, Citigroup and Bank of America were not participating in market bets on the sharp ups and downs in the market thanks to the Volcker rule. Taking effect this past July, the Volcker rule limits the risks bank traders can take with their firm’s own capital.

But Frank pointed out that one problem with the Volcker rule is that small banks get “over-lawyered” to prove their compliance while even though it has no impact on them. One change he’d make is to specifically exclude banks under $10 billion in assets from the law.

Frank said the law also should have indexed the $50 billion asset limit on large banks, perhaps to as high as $100 billion. That’s when a bank is labeled as a systematically important financial institution, or SIFI.

If any other bank fails, it would be taken over by the federal government and dissolved. But if it’s labeled a SIFI, and has so much debt that failure to pay it off would have a spiraling negative effect, the government will pay some of the debt, which will be recovered under law from the institutions with over $50 billion in assets. That’s why banks do and don’t want the SIFI label, which comes with additional regulations.

Frank also noted one concern over how Dodd-Frank is implemented – the loophole to avoid risk-retention. Originally the bill was written so entities that bought loans and securities had to cover the first 5 percent if they defaulted. But Congress, urged by mortgage lenders, homebuilders and low-income mortgage advocates, allowed a loophole to avoid risk-retention.

“They put that in there so that they basically did away with risk-retention for most residential mortgage loans, and I worry about that. I’m hoping they will come back and put that back in permanently,” says Frank. “Bad loans being made because the market incentive not to make bad loans disappeared.”