Is Dodd-Frank Missing Some Vital Regulatory Firewalls?

Investment bank Goldman Sachs became this week the last big institution to settle with the federal government for its role in the 2008 financial crisis. But in an election cycle that has seen big banks under more scrutiny than ever before, there are worries that regulations against institutions like Goldman Sachs aren’t going far enough. Lynn Stout of Cornell Law School joins John Yang.

JOHN YANG: Well, the banks say that they are, they are being reined in. The banks say that their profits are down, that Dodd-Frank has changed the way they do business. They’re holding more capital, they say. They’re being more closely regulated. There are things they can and they can’t do.

And, as I say, it’s cutting into their profits, they say. What do you say to that?

LYNN STOUT: Well, it’s true that bank profits are down, but I think we need to be realistic.

One of the primary reasons is that the banks basically lost the faith of their customers. They damaged their own reputations and destroyed much of their own customer base. Now, some regulation does play a role. And right now, regulators are watching the banks pretty closely, but the rules are still pretty flexible.

And we have to be concerned that in years that are coming in the future, the regulators are going to take their eye off the ball and we will be back to some of the same problems in terms of concentrations of risk and highly speculative activity that led to the 2008 collapse in the first place.

YANG: What do you think should be done?

STOUT: It’s actually very straightforward.

Up until around the year 2000, we had a bunch of banking regulations in place, including Glass-Steagall and rules against speculative derivatives trading that had proven time-tested at keeping banks from taking on excessive risks and had been very effective at keeping the financial sector stable and sound.

And most of those laws were eliminated in a — what’s turned out to be a very misbegotten profit of so-called deregulation. I think that if we put those rules back in place, experience and history suggest there’s no reason why we can’t have a safe, sound banking sector.

It’s just very hard without some of the original regulatory firewalls we used to have.

YANG: Glass-Steagall came out of the Depression and said you couldn’t — you couldn’t — had to separate commercial banking and investment banking.

The critics of that, of your assessment, say that a lot of what happened in the financial crisis had nothing to do with that. It had to do with a pure investment bank like Goldman Sachs. It had to do not with the mixing of the two. What’s your response?

STOUT: Oh, that’s true, to some extent, but Glass-Steagall wasn’t the only rule that was changed.

We also legalized over-the-counter derivatives for the first time, and we even gave a derivatives contracts priority in bankruptcy. There were lots and lots of financial rules that were changed in favor of the financial industry through a steady process of the application of campaign contributions and lobbying power.

And if we’re going to have a stable system, I think we need to find a way to get past this problem of lack of a political will to effectively regulate financial institutions.