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Despite being a requirement of the 2010 Dodd-Frank Wall Street Reform law, the final rule designed to prevent large financial firms from becoming too big won’t precent another crisis, says Gerald Epstein, professor of economics and a founding Co-Director of the Political Economy Research Institute

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SHARMINI PERIES, TRNN PRODUCER: Welcome to The Real News Network. I’m Sharmini Peries, coming to you from Baltimore. And also welcome to this edition of the Gerry Epstein report.

The Federal Reserve unveiled a final rule designed to prevent large financial firms from becoming too big, so big that their failure could shake the core of the U.S. financial markets as it did in 2008. The rule is a requirement of the 2010 Dodd-Frank Wall Street Reform law prohibiting banks and certain large financial institutions from acquiring another company if that merger would cause their liabilities to exceed 10 percent of the total consolidated liabilities for all financial firms. However, the rule has an exception that would permit firms to continue securitization activities even if they have reached the limit set forth by the rule.

Here to discuss all of this is our regular contributor Gerry Epstein. Gerry Epstein is the cofounder of PERI, Political Economy Research Institute, at UMass Amherst. He’s the author of many books, too many to actually mention here. But do look at his full bio just below the player.

As always, thanks for joining us, Gerry.


PERIES: Gerry, is this final rule a good rule? Will it get at the problem of preventing another financial collapse like we did have in 2008?

EPSTEIN: No, because the problem is it just prevents these big banks from becoming even bigger through mergers. But many of them are already too big, they’re already too complex, they’re already too hard to manage because they’re so big and complex. This rule doesn’t do anything to reduce the size of the already too big to fail banks.

But on the other hand, at least it signals to the public that the size of these banks is a problem, and so in that sense it’s a positive step. But it really won’t do anything to the current situation, where these banks are already too big.

PERIES: And what does the exception actually mean, they continuation of securitization activities?

EPSTEIN: Well, this securitization activity exception was actually a separate rule that was just finalized. And the problem with this is the Dodd-Frank rule said, look, one of the reasons why these banks got into so much trouble and that these banks took on so much risk is because they were able to package all these complex securities–they would take mortgages from all of the country, put them in these complex securities, sell them off to the rest of the world, to pension funds in Detroit and pension funds in banks in Europe, and they weren’t left holding any of the risk, so the story goes, so then they didn’t have to worry about these securities blowing up. Well, the securities did blow up, and they brought the world financial system to its knees.

The idea was these banks should be forced to hold on to some of these securities. The idea is that this would align their risk concerns with their own bank, and so they wouldn’t take on so much risk. So this rule on risk retention is a great example of how the whole Dodd-Frank system has worked. First of all, it’s completely misguided, ’cause in fact the reason the banks themselves got into so much trouble is ’cause they did retain a lot of these securities. They wanted to retain them because they had high rates of return. So they kept them on their books, or off their books and then brought them back on the books when they got into trouble. So just forcing these banks to hold on to these securities isn’t going to be sufficient.

The main problem was that the bankers didn’t care if these things blew up, because they knew that the government was going to bail them out. And unless that changes, nothing’s going to change. The only reason why these bankers didn’t really care about holding on to this risk is because the rainmakers in these firms made their bonuses before the whole thing blew up, and then they were sitting pretty with their bonuses, and the shareholders and the taxpayers ended up holding the bag.

So this whole idea about retaining the risk is kind of a red herring, and as–unfortunately, so much of the Dodd-Frank has been that way.

PERIES: And what is the magic 10 percent? Why 10 percent and not 20, 30, 40 percent?

EPSTEIN: I think probably the 10 percent came from the idea that that would catch some banks, really, really large banks, and let other banks fly under the radar screen. So it was probably a political deal about which banks it would capture in which banks it wouldn’t.

The idea about this merger thing, there is one other positive thing about it, which is the strategy of Tim Geithner and Paulson dealing with the last financial crisis was to try to get all of these banks to merge and become even larger. Well, this rule, I think, will make that afternoon next time there’s a crisis more difficult, so they’ll have to do something else. Maybe what they’ll do have to do this time is what they should have done last time, namely, put these banks into resolution, force them to restructure, fire the management, and not force the taxpayers to take the whole bill.

PERIES: And does the Fed have that kind of authority?

EPSTEIN: Well, the Fed does have that kind of authority now under the Dodd-Frank. The problem is: who’s going to blink first? The Fed, if it thinks that by doing that it can crash the whole system because these banks are still too big to fail. Or will the banks blink and will the Fed actually break them up?

I’m afraid that as long as these banks are allowed to remain so large and so complex, in the end the Fed will blink again, just like it did last time.

So this rule, by not breaking of the banks put simply by saying maybe they can’t get a lot bigger through these mergers, does almost nothing to deal with the fundamental problem of incentives being wrong, regulation being too lax, and the banks being too big.

PERIES: Right. And, Gerry, is other examples around the world that one could draw from if you were looking for a better way of securing public financing?

EPSTEIN: Well, that’s a good question. Unfortunately, in many parts of the world, certainly in Europe, the banking lobby is almost as strong as it is here in the United States. In developing countries–and I’m thinking particularly of India, for example–there was much stricter regulation on the financial system prior to the crisis. For example, the Central Bank required that the banks go to them before they sold very risky securities like collateralized debt obligations. They had to go to the Central Bank and get permission. And basically the Central Bank refused to give them permission. And they did this multiple times. And that’s one of the reasons why the Indian financial system did not crash in the financial crisis.

So we do have examples, particularly in developing countries, where regulations have been stricter, and that helps to explain why they were not taken up so much or hurt so much by the financial crisis. We have a few other examples in the Nordic countries, in Finland and Denmark and Sweden. They learned from their mistakes. They had a big financial crisis in the late 1990s. They implemented some pretty strict financial regulation. And they also escaped the worst of this most recent financial crisis. Unfortunately, we haven’t learned that lesson, and now, at the midterm elections, with Republicans taking control of the Senate, I think what we have to look forward to is further gutting of the already weak Dodd-Frank rules, and I think we just have to wait around for the next crisis to hit.

PERIES: I thank you as always for all that good news, Gerry.

EPSTEIN: Good news, right?

PERIES: And thank you for joining us on The Real News Network.


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Gerald Epstein is co-director of the Political Economy Research Institute and Professor of Economics at UMass Amherst.