The Fed’s and Republicans’ War Against Dodd Frank and How That Preserves the Greenspan Put and Too Big to Fail

A new story by Gretchen Morgenson of the New York Times highlights how the Federal Reserve and the Republicans* are on a full bore campaign to render Dodd Frank a dead letter, with the latest chapter an effort to pass HR 37, a bill that would chip away at key parts of Dodd Frank.

Mind you, we weren’t wild about Dodd Frank precisely because the bill did far too little to stop the reckless practices that produced the crisis. But both the Fed and the newly ascendant Congressional Republicans are keen to restore as much as possible the status quo ante that proved so lucrative to the banks, both the pre-crisis period and the bailouts, which stands as the greatest transfer of wealth in history. So even mild reform must be swept away.

Not that the Fed or the Republicans, and the bankers they represent, are being so frontal as to try to repeal Dodd Frank, mind you. Their strategy is a combination of endless implementation delays, like Penelope dealing with her suitors, and modifying or eliminating technical-sounding provisions that are of keen importance to the banksters. The assumption is that the chump public won’t figure out that Congress and the central bank are handing major concessions to big financiers with no punishments or required behavior changes attached. Morgenson isn’t alone in calling out this strategy. David Dayen and your humble blogger have also warned about it.

For the Republicans, any and every measure to help the banks is standard operating procedure (and let’s not kid ourselves, the Democrats give the banks most of what they want but do try to throw a few bones to Main Street and “consumers” to improve the optics).

The Fed’s and in Particular Scott Alvarez’s Role in Stymieing Bank Reform

But we have a much uglier fact set with the Fed. The Board of Governor’s general counsel, Scott Alvarez, a Greenspan holdover, comes close to controlling policy on regulatory matters. Recall that the Fed is chock full of monetary economists, leaving Alvarez both by position and by the Board’s preoccupation with the general economy, with considerable sway. He’s made his opposition to Dodd Frank and to bank reform in general abundantly clear, and has refused to grant regulatory neglect as playing any role in the crisis. So what does he see as the cause? “Regular mortgage lending. And in a disturbing breach of the Fed’s supposedly apolitical role, Alvarez took up the opportunity presented by an appeal from Scott Brown’s reelection campaign to get anti-Dodd-Frank messaging into the debate. Since when does a Fed employee have the right to act as a private lobbyist against an existing law?

Given Alvarez’s past offer of aid and succor to Republicans and banks eager to keep Elizabeth Warren out of Congress, one has to wonder if there isn’t more sub rosa coordination going on. As Dave Dayen pointed out last month, some soi disant liberals like Paul Krugman were opposed to Warren’s fight to get a provision to eliminate a Dodd Frank provision, the so called swaps push out rule, that required banks to move certain derivatives out of depositaries, removed from a must-pass budget bill.

Mind you, this rule was simply about bank profits at the margin; they could still do the very same business, at slightly higher cost, in other affiliates. Aside from the not having taxpayers backstopping risky products, this measure could serve as a precursor to restoring Glass Steagall, or the watered-down version implemented in the UK, ring-fencing the depositary.

So why were some normal bank critics like Paul Krugman not on Warren’s side? Because another provision, the Volcker Rule, was claimed to do pretty much the same thing, so why bother making a stink that might lead to a shutdown over it?

Aside from the fact that that the two provisions had different effects, and were complementary rather than redundant, the Fed almost immediately on the heels of the Congressional defeat on the swaps push out delayed Volcker Rule implementation by an additional two years. And this was clearly Alvarez’s doing, since the finesse to do what comes uncomfortably close to violating the statue has to have issued from his office. From Dayen:

To accomplish the latest two-year delay, the Fed had to break the spirit of the rules. The Fed is empowered under Dodd-Frank to delay regulations like the Volcker rule for only one year at a time. So in its announcement, the Fed both acted on a one-year delay to 2016, and also “announced its intention to act next year” on “an additional one-year extension.” It did not require banks to apply for the extension based on objective information about particular hard-to-unwind investments.

Get that? The Fed announced now that it plans to punt on implementation next year. Cute.

How Gutting Dodd Frank Preserves the Greenspan Put and Undermines Monetary Policy

Dodd Frank fails to deal with the underlying too big to fail problems, such as needing to greatly shrink the over-the-counter derivatives market and move it out of systemically important firms. However, getting the riskiest activities out of firms that benefit from taxpayer support is at least a step in the right direction. And that is what is in the crosshairs of the Fed and Congressional Republicans.

Last week, as we discussed and Morgenson covered in her weekly column, House Republicans tried and failed to pass another set of Dodd Frank weakening rules along with a dog’s breakfast of other minor reforms so as to mask the true intent of the operation. It failed to get the required 2/3 vote for fast track approval but will be tabled under the normal process this week and is sure to pass.

We highlighted two noxious bits last week, a two year delay in a stipulation that would require the sale of most collateralized loan obligations held on bank balance sheets, and a waiver for acting as an advisor to small to medium-sized merger and acquisitions of the long-existing rule that firms that engage in securities transactions above a very trivial level be registered as broker dealers.

As we discussed, both these provisions are gimmies to the private equity industry, which in turn are huge revenue sources to the banks themselves. Since banks can still retain CLOs that are made of loans only, the objections are not about facilitating commerce or even merger financing. This is about banks having maximum latitude and therefore profit opportunity in managing CLOs, which are active vehicles, de facto internal hedge funds with a very specific risk asset mix. The partial waiver for mergers similarly greatly reduces the SEC’s purview and enforcement weapons against miscreant private equity firms, since the punishment for operating as an unlicensed broker dealer is deliberately draconian (dollar for dollar of transaction value) and most private equity firms have been flagrant, longstanding violators of this requirement.

Morgenson flags a third issue:

Finally, the bill’s changes in derivatives would reduce transparency and increase risks in this arena by allowing Wall Street firms with commercial businesses — like oil and gas or other commodities operations — to trade derivatives privately and not on clearinghouses.

Trading on clearinghouses generates accurate price data that help both banks and regulators value these instruments. Because these clearinghouses perform risk management, problematic positions are easier to spot.

Bad enough that banks are in the physical side of the commodities business. Now they would get to hide even more risk. This is flagrantly at odds with the supposed object of post crisis regulatory policy, that of forcing banks out of risky, illiquid products and increasing transparency.

Now let’s consider the bank excuses. On CLOs, we are told not to worry because the banks with the biggest holdings have gains in their CLOs, at least at the end of the third quarter. Let’s parse this:

1. CLOs are thinly traded and prices have been manipulated in the past (as in extensively during the crisis) so query how reliable the marks are. If true, this would be a terrific time to force banks to get out of them. But instead, the implicit argument is, “This stuff is doing well, so what is the problem?”

2. Those gains may no longer be there now given what has happened in energy markets in the last few months (a high proportion of junk loan and junk bond origination in the last year was energy-releated, and a large chunk of that almost certainly wound up in CLOs).

Now let’s consider the justification for the Volcker Rule extension that the Fed gave in December: that banks might face losses if they were forced to exit positions if they indeed had to get out of various holdings by July 2015 as originally required.

See the “heads I win, tails you lose” logic? According to the banks, no time is every a good time to exit a position they don’t want to exit. Heaven forbid that they recognize a loss, and don’t make them take a gain at a time not exactly of their choosing.

And let’s dismiss the “loss/distressed sale” palaver. The banks have had years to exit these exposures. It’s now been four years since the Volcker Rule was passed. Are we to believe they need another two years? If that is true, this is the strongest proof imaginable that these instruments have no place on the balance sheet of a government-backstopped entity. The presence of such illiquid assets on a bank balance sheet preserves the banks’ too big to fail status.

One of the reasons the authorities were so allergic to the idea of taking over an insolvent institution like Citgroup during the crisis was that the last large bank resolution, Continental Illinois in 1984, took a full seven years to unwind. That was because some of its businesses were so colossally underwater that it took that long to restore them to enough of a semblance of health for the FDIC to be able to offload them. With our new incarnation of too big to fail entities, the government does not want to be in the business of having to manage an internal hedge fund or private equity operation that takes years to wind down, particularly since that “talent” will insist on its usual outsized pay.**

Moreover, if the officialdom were ever to force banks to get out of these positions, the last few years were the time. Interest rates have been and still are super low and even with the perturbations in the junk bond markets, asset prices and risk tolerance are high.

In fact, one can regard the Alvarez/Republican efforts to undo reform, whether by accident or design, making it even more difficult for the Fed to exit its super low rates. Recall how the central bank lost its nerve in the taper tantrum of the summer of 2013. Even thought the central bank has gone to great lengths to say really, truly, it will raise interest rates sometime this year, the bond market is saying loudly and clearly that it does not believe them.

If the Fed were to tap on the brake, the assets that react the most are the riskiest ones, the very ones the banks are insisting that they keep. Banks are structurally long and it is well nigh impossible for them not to lose money on credit markets inventory in a tightening cycle; there isn’t enough capacity with credible counterparties for any major firm to go net short. So by allowing banks to hold positions that are illiquid and risky amplifies their exposure to credit cycles. That of course will reinforce the Fed being overly concerned about their performance, and thus being altogether too ready to break glass and revert to the Greenspan/Bernanke/Yellen put at the first sign of trouble.

So in other words, Scott Alvarez isn’t merely undermining Congressional authority by working to undermine Dodd Frank. He’s also undermining Janet Yellen’s authority by limiting her degrees of freedom in implementing monetary policy. Nicely played.

*We have no illusion about the Democrats, since they are responsible for Dodd Frank being such weak tea. However, the unabashedly pro-corporate, pro-bank Democrats in Congress have been largely turfed out.
** We are firmly of the view that you could find much cheaper people to do the job, but AIG shows the officialdom is likely to be cowed into keeping the people who created the mess around. Mind you, you probably do need a critical core team to provide a roadmap, but needing them all is unlikely in most cases in a wind-down scenario.

Print Friendly, PDF & Email


  1. Dan

    This is so infuriating. What people do get a piece, but to put at risk many times over for the rest of us.

  2. Schofield

    It sounds doubtful if Scott Alvarez was locked in a cage in the New York Fed’s gold depository for an undefined period it would change his fundamentally narcissistic disposition.

    1. Jim Haygood

      One would hate to find bite marks in those beautiful bars of bullion.

      Oh wait, he just broke his tooth on it … and it’s gray underneath! :-O

  3. Bob

    Why not drop “Dodd-Frank” and start using the part of the title that describes what the Act was intended to do: the Wall Street Reform and Consumer Protection Act? Saying that the Republicans are trying to gut the Wall Street Reform and Consumer Protection Act does a better job of getting that point across.

    1. Yves Smith Post author

      Two different issues.

      Dodd Frank did not end TBTF. Resolution authority does not work and can never work unless you make the firms much more balkanized on a national basis and get rid of pretty much all OTC derivatives. That is what we’ve discussed repeatedly (often in long blogosphere arguments against bank shills).

      Dodd Frank does attempt to make the banks less likely to fail by making them get out of some of the forms of casino banking backstopped by taxpayers. It does not end TBTF (although it pretends to with its Title II resolution) but does make it somewhat less likely to happen.

      So rolling back Dodd Frank makes the TBTF banks more likely to get themselves in trouble. That makes it harder for the Fed to exit ZIRP, since the risky products show the biggest price declines in a credit tightening cycle, and also increases the speed with which Yellen will resort to the now Yelllen put in times of trouble.

      1. E.L. Beck

        I think it would be easier to define the financial markets by bringing back Glass-Steagall.

        There I go shitting unicorns and rainbows again.

        For now, it would be better to have a tightly defined outline of what would transpire should a TBTF bank require another bailout, with specifics on how the bank would be split, auctioned off, and bidders over a certain asset level barred from the auction, so as not to create another TBTF bank.

        Wait. That will never happen, either.

  4. Chauncey Gardiner

    Re: …”Get that? The Fed announced now that it plans to punt on implementation next year. Cute.”

    Do we need to wait until any unelected official at a government agency retires before legislation can be implemented? I don’t think so. I call for Alvarez’ resignation for blocking implementation of provisions of Dodd Frank at the Federal Reserve.

    Thank you for this post. For those of us distant from the “Versailles on the Potomac”-Wall Street axis who must rely on our representatives and the Federal Reserve to do the right thing, the actions summarized in this article are disheartening developments that virtually guarantee repetition of the control fraud crime wave that lead to the enormous bank losses and collapse of the financial system in 2008. Interesting that those who pose as “Free Markets” ideologues have again engineered a set of structures that will require both direct and indirect public bailouts in that eventuality. The Citizens United decision must be reversed.

  5. BillyBob

    Dodd-Frank was signed in July 2010 by a Democratic President with a Democratic House and Senate. The fact that it is still being negotiated and renegotiated four and a half years later tells you everything you need to know about the possibility of fixing our completely broken system without violence.

  6. MichaelC

    Re one has to wonder if there isn’t more sub rosa coordination going on

    The 1 year extension with the promise of an additional one year extension is particularly puzzling and seemingly unnecessary since the banks were provided with a loophole to continue their PE businesses as long as they were housed in merchant banking units.

    According to this piece

    Before the economic downturn of 2008, the largest U.S. banks bet billions of their own money through funds they managed – something that resulted in huge losses over 2008-2010. In view of the regulatory clampdown, most of the banks slashed their presence in the private equity business considerably since 2011. Many of them also resorted to alternatives such as the use of merchant banking and business development companies rather than structuring investment vehicles as private equity or debt funds and hedge funds to avoid the Volcker Rule completely (see Here’s Why Wells Fargo’s PE Unit Will Flourish Despite The Volcker Rule and Goldman’s Volcker Rule Policy: Creative And Profitable Compliance).

    The article explores Morgan Stanley’s current strategy of expanding their PE business (in conformity with Volcker 3%ownership restrictions) which is apparently at odds with its peers. The motivation is that the management and performance fees, even under Volcker restrictions, are simply too rich to walk away from.

    This suggests that the Volcker restriction was poorly designed (a point many non-banker commenters raised during the rule making) if its aim was to force the banks to exit the hedge fund/PE business.

    Morgan Stanleys expansion suggests that this part of the rule will be neutered through lax enforcement or eventually gutted through legislation.
    If, as the article points out, the other banks have transferred their PE activities to Merchant Banking vehicles, then there is even less justification for the FED to grant the additional 2 year extension for the legacy funds.

    Bottom line: PE has successfully avoided all the restrictions Volcker was intended to impose.The FED by excercising its rule making authority completely voided a key section of Dodd Frank law.
    Many of us expected the FED to drag its feet to appease the bankers, but this move makes it glaringly clear the FED has no intention of implementing the law as it was written.

    Let the fat fees and fat tails continue.

  7. Washunate

    Yves, I appreciate asterisk number one existing. However, I would still dissent from this notion that the Democrats are the lesser of two evils. First, the Democrats both nominated and confirmed the Fed chair. To mention the Fed but not the Democrats is to miss what is going on. It is to blame a subordinate for what the boss is doing.

    Second, the main issue in financial matters isn’t Congress. It’s the President. When basic laws are being broken without investigation, never mind prosecution, it’s irrelevant what is going on in Congress. That’s why impeachment – that thing taken off the table by none other than a Democrat from San Francisco – is a critical part of Constititional checks and balances. It’s the only way that the legislative branch can force the Executive Branch to uphold the laws of the land. Unless you are faulting the Congressional Democrats for not impeaching Democratic President Obama, I would say it’s inaccurare to paint this as a “Democrats in Congress” matter.

    Third, this dismisses the broader narrative of the past couple decades, which is that Americans are increasingly aware and frustrated about what is going on. This reached a boiling point in 2006 when Democrats were shockingly elected to a majority in both the House and Senate. And then of course they won the Presidency by a landslide in 2008. Their assignment was to change things, and they actively decided not to. They aren’t less culpable than the GOP. If anything, they are the heart of the problem.

    1. Yves Smith Post author

      This site has never been into lesser-evilisms, as our 2012 and 2014 election commentary made clear.

      However, given that we have a two party system, the small group of bank reformers are housed in the Democratic party and opposed to its leadership. Ironically, they may get occasional support from Richard Shelby, the head of the Senate Banking Committee, who is skeptical about a lot of modern finance (he’s pro smaller banks and not rabidly opposed to regulation).

      Our general take on the Democrats comes from Lambert:

      The Republican say they will knife you in the face. The Democrats tell you they are much nicer since they only want one kidney.

      What they don’t tell you is they will come for your second kidney next year.

      1. Washunate

        To be honest, I don’t really get Lambert’s analogy. He’s drawing a distinction between the two parties when they are actually doing the same thing. They are working together. Indeed, it is precisely the GOP threatening to stab you in the face that makes the Dem’s promise of only taking a kidney sound remotely palatable at all. That is one of the fundamental developments in American politics. Slowly and steadily we stopped having a two party system. Gridlock and partisanship isn’t our problem; complete lack of opposition rules the day. Of course there are pockets of resistance, but that’s irrelevant to majority-rules decision making.

        In fact, it is used to great effect now. There will always be a few Democrats who oppose a war or support financial regulation or whatever, but never enough at one time to prevent the current business of Washington from happening. Same with the GOP. There isn’t even enough opposition to the groupthink at this point to allow alternative ideas “a seat at the table”, never mind a chance of being implemented. Look at how even established figures like Robert Reich and Joseph Stiglitz have been sidelined.

        And all of this ignores the other major shift in American politics, which is that the office of POTUS is in practice today far more important than Congress. Congress is an excuse to sweep the problems of the Obama Administration under the rug.

        I’m not claiming to have an answer. But I am interested in pushing reality-minded people a little further down the trail – as politely and respectfully as possible of course – to explore the implications of what has changed in America. The most important step in problem solving is understanding the problem.

        It certainly may be true that there are notably more bank reformers in camp d than camp r. But that doesn’t mean there aren’t Democrats involved in bailing out the banks and protecting the criminals, which is what leaving them out of headlines like this implies.

        The Democrats, I would argue, are part of the ‘war’. After all, they are why there is a war at all. Dodd-Frank itself was a watered down compromise to prevent the bankruptcies, prosecutions, and nationalizations that should have happened instead.

  8. MichaelC

    In addition to the Merchant banking exception, banks can still do PE through Business Development Companies. which are publically traded closed end funds.

    Goldman set one up in 2013, Liberty Harbor Capital
    Spoiler alert. GS set it up to get around the Volcker Rule.
    Here’s a little more background

    When analysing the potential risks in PEspace its probably important to keep an eye on the HY lending that has been provided by these entities in the recent past.

  9. Greenbacker

    I could care less about the corporate entity known as “banks”, but the gold chewing bankers themselves. A corporation falls, a banker with vast sums of savings and assets lives off deflation and then builds a new ponzi-scheme. Get rid them period.

    I would repeal Dodd/Frank just to point out when the next boom/bust cycle crashes……..just to point. As long as usury consists in finance, you will have these panics and crisis no matter what type of financial system it is.

  10. Linus Huber

    Crony capitalism at its best. Excellent article showing how all actors support each other in one of the greatest thefts in history.

Comments are closed.