Dodd: 'It's not size; we're preoccupied with size.'
Chris Dodd is chairman of the Senate Banking Committee and principal author of the financial regulation bill that the Senate will consider next week. We met at his Senate office Wednesday to speak about the makings of the financial crisis, his approach to financial regulation and whether we need to break up the banks. An edited transcript follows.
Ezra Klein: Tell me your narrative of how the financial crisis happened. What happened to us in 2008? What brought the financial sector down?
Chris Dodd: I'd been chairman of the Banking Committee for 38 months. I actually remember a day in the fall of 2007, before Paul Sarbanes retired, that we were in some chaotic mess in the committee and he put his right arm around my shoulder and swept his left hand in front of him and he said, "Just think, in a few months all of this is yours." I had no idea how prescient that was.
So I take over as chairman in January of 2007. The first week in February, we had our first hearing on the crisis of 2007, and it was on the mortgage crisis. We had witnesses who laid out exactly what was going to happen; in fact, they underestimated what would happen, and they were ridiculed for estimating what they did! And all that spring we went back and forth had meetings, we had a big gathering at the Banking Committee room with all the major players on mortgages. We had an awful time getting Hank Paulson to recognize anything. And Ben Bernanke, too. They'd come to meetings and they'd kind of have this blank stare, all during that spring, through that summer, into the fall.
In fact, Dick Shelby, that night of September 18th as he was sitting next to me in Nancy Pelosi's office, kept on whispering to me, "If they'd only listened to you." But on the mortgage thing, we just couldn't get any attention. That was the primary cause of what was otherwise a manageable set of issues. It would have been a difficult time, but it didn't have to explode into what it became in the fall of 2008. People don't know this, but we came within a hair of the United States government declaring that Monday a bank holiday for the first time since the Great Depression.
EK: Huh. I haven't heard that before.
CD: I went on a flight Sunday night to Brussels to meet with central bankers over there to talk about these issues, and I got on the plane at 6 or 7 at Dulles and didn't know until I landed in Brussels the following morning that in fact J.P. Morgan had stepped up. Then in the summer, you had the Fannie/Freddie stuff, Hank Paulson saying, "I'm not going to use the bazooka, but I've got it in my pocket here," so in '08, everyone became more engaged. But there should have been a deeper appreciation that this wasn't just a Bear Stearns issue. Then of course comes September 18th, the night where Hank Paulson and Bernanke says, "Unless you act within a matter of days, the entire financial system will melt down."
I got charged that night by Harry Reid that Barney [Frank] and I would pull together what turned out to be the Emergency Economic Stabilization bill. And, of course, you may recall that we got an e-mail, three pages from Hank Paulson. He wanted $700 billion, no court can intervene, no regulator can intervene, and of course over the weekend the country went nuts when they heard about this. By Sunday night, we had an 82-page bill drafted in the Banking Committee, and frankly there were concerns I had that the House was going to go along with Paulson, just give him the money, get the issue off the table. So we wrote a bill, and those next two weeks were a wild time, with John McCain suspending his campaign and everything else. But the bill passed 75 to 24; Ted Kennedy was the one missing vote that night.
EK: And to ask about the other dimension to that question: What actually happened to cause this? Not just how did the government respond, but literally what created the problem? What, when we talk about the financial regulation and Wall Street, are we attempting to fix?
CD: The first thing that happened was that you had a lot of unregulated entities…
EK: Shadow banks.
CD: Yeah. You need securitization, but the failure to have underwriting standards, the fact that they could go out and just lure people in, the no-doc loans, the fabrication of information. When you go to the Web sites of these brokers they said that the first thing you as a broker should do is convince the borrowers you're their financial adviser. I put that up in my first hearing. And of course they were anything but your financial adviser. , But then the bank was selling the loans off in eight to 10 weeks, so they were out of the game, and of course the rating agencies don't conduct due diligence. So it was just a series of dominoes that created this huge bubble and there was nothing underneath it. That's why so much of what this bill is designed to do is make sure that there's no one again in the financial services sector that can escape regulation.
EK: There are a lot of pieces to the bill, there's derivatives, there's resolution authority, and on and on and on. So is that the theory of the bill? Get the shadow banks into the regulatory structure? Is there a theory of the bill? Or is it just a lot of different things we should do?
CD: There are three main things. One is to fill in the regulatory gaps that clearly were the source of the problems that created this crisis. Secondly, to provide the kind of tools that didn't exist. In the world in which you and I live today, we have no radar system, really, that allows us to be able to look over the horizon, not just domestically but internationally to see what's happening. So what happened in England with Rock, what's the name of the bank…
EK: Northern Rock.
CD: Northern Rock, for instance. Or Greece. How do you get the ability to identify potentially systemic problems? So that's the second piece of this bill. The third piece is, in a way, is to say, "Look, be careful now." We're a global leader in financial services, so I want to make sure as we fill in the gaps, provide the tools and the radar for the future problems, you don't strangle the system. Some of these words have become pejoratives, and they're not, they're needed. Derivatives are needed for stability in the marketplace. So we want to make sure that in our ability to do this, we're not doing it in a way that causes us to lose our leadership in the world, one. So those are my three goals. It's not easy to manage all of them.
EK: You're saying we need to balance the need to help regulators more easily detect and respond to a crisis with the need to preserve Wall Street's basic functioning. But do you worry, and does anything in this bill address, the question of regulatory failure? You have Alan Greenspan coming before the FCIC saying, "We just didn't know. We didn't see it. We need this to be automatic because in the future we won't see it again." You have Robert Rubin, who comes in and he says, "I was on Citibank's board of director's but I just didn't know, I didn't realize this could happen." There was a fair amount of information out there already, there were people, as you say, before your committee who predicted it. But there were incentives, in the boom times, to ignore it. How do you handle that?
CD: Because they too narrowly defined the word "safety" and "soundness." Things are going up, money's being made, that's it! What could be not safe and sound about that? But "safety" and "soundness" ought not to be so narrowly defined as "people are making money." What are capital standards? Where are the leverage points in all this? How much liquidity is there? What's happening to consumers out there? The consumer protection idea is not just nice, to have something over here for consumers, it was the missing element in a lot of this in terms of what was actually going on in that marketplace.
In addition, I don't buy these, "Oh, we didn't see it," they didn't want to see it, things were going too well, they were too fat, too much money was being made, and smart people, when you look at 40, 50 to 1 leverage, who in their right mind would have thought that made any sense at all? And regulators were being told that every bank was going to go to London. The first thing I got when I came in, "Boy, it's a new chair of the committee, you better get with it, everybody's going to go to London." I haven't heard that comment lately. But that was the move in January of '07 even.
EK: But nothing in your bill says you can't have 40 to 1 or 50 to 1 leverage.
CD: It says regulators…
EK: It says regulators can decide that you can't.
CD: Barney put the number in there, in his bill.
EK: At 15 to 1, right?
CD: Yeah. And I don't disagree with it; obviously it makes sense to me, or 12 makes sense. I'm not opposed to it. But what's the competency of Congress? When we write this up, I'll guarantee you, before the ink is dry, some 22-year-old is going to come out and figure six different ways to get around what I've just written. Not that that can't happen with the regulators, but those are the people we ask to do this, these are supposed to be the talented, bright people who spend all day focusing on this and learning the subject. Maybe I'm wrong about it, but I honestly feel that I've got a better chance of getting better results in terms of what we're trying to achieve through that approach than the approach of, "Forget the regulators, we're just going to write it ourselves."
EK: It seems you're caught between a rock and a hard place here. On the one hand, you can't look at what happened and say, "The regulators will not fail us." The regulators will tell you themselves that they'll fail you. Then, on the other hand, Congress does not feel that it has the competency to write these rules, there's the fear that what you could write here will be gamed in five years. Which is why I think some of your colleagues, like Senator Kaufman and Brown, along with some in the expert community, have argued that as long as we're going at this "too big to fail" problem, it's just going to be unsolvable. They're too powerful, it's too complex, we don't have the expertise, and it's why we should do the simplest thing and just break up the large banks beyond some basic level of assets.
CD: I don't agree with Paul Krugman a whole hell of a lot of stuff, but I agree with him on this one. It's not size; we're preoccupied with size. And I'm not suggesting that any size is okay, but it's really risk, it's these other elements in here. A relatively innocuous product line in a relatively small company can pose huge, systemic risk. That said, in our bill, we provide the authority to break up companies. That is clearly in the bill, the authorization to do that under certain circumstances. But I'm not sure that we ought to become so preoccupied with it. And again, I've looked at the 13 Bankers book, and so forth, that approach, and I hear this, by the way, not just from them, but from CEOs of major corporations. This is not some left/right question. But I just don't think that it makes a lot of sense. I don't think it'll prevail.
What we've done here says that if you're going to become a certain size, that's fine. But you're going to have to meet different capital standards, you're going to have different criteria that are going to protect us against the possibility you can fail. And just in case you have any doubts about this, if you do fail, all your management's fired, all your shareholders lose, all your creditors lose, you can't go back into the business for years to come. So yeah, you can get bigger, but there are going to be a lot of things to insulate us and our economy from the kind of hazards you could pose by your size.
EK: A lot of what you say, when you say it's not size but interconnectedness, seems to be a critique located in the derivatives market. That's where the interconnectedness comes, that's where the complexity is. What are your bright lines on derivatives?
CD: Let the market work. I've had people tell me that had the market known about the financial products division of AIG, that that wouldn't have lasted 30 seconds. But they didn't. It was the shadow economy. So a lot of sunlight, a lot of transparency, ought to be the presumption as you're looking at this. I believe if people can see what's going on, then the markets will react to this stuff. Now I accept the notion that there are certain derivatives where there just isn't a volume in what you're dealing with here that it probably doesn't need to be on an exchange. But I like the idea of a presumption of an exchange, because the exchange is where I get the sunshine on this. And if markets are reacting as they ought to be, they'll have their own way of pricing these products or rejecting them because of their shortcomings or their weaknesses.
EK: The final question here, and I don't want this to sound like cheap populism because it isn't, but a lot of the current level profits in Wall Street come from this complexity, this over the counter, bilateral trading. There's just a lot more money in trading products that only you understand. We saw before the crisis that Wall Street profits were a bit below 40 percent of all domestic profits,and now they're back up there again. Should we worry about that systemically? Is a country where 40 percent of our profits are in the financial sector, is that a healthy economy and is it even possible to regulate a sector where there is such enormous reward for risk?
CD: I don't like the equation. I don't believe you ought to be giving up manufacturing and the kind of job creations that go on with producing things. Putting aside the debate on what should happen to the financial sector, I worry about a country that is innovative enough to produce plasma televisions, but not smart enough to figure out how to make them here. The other piece here is accountability afterwards. This becomes the responsibility of Congress, in every administration you've got to be overseeing what the regulators do. You've got to be bringing them up. The fact is, we put the Vice President of the Fed and tell him or her, "You're responsible for systemic risk. That's your job." So that person comes up for the vice chairmanship of the Federal Reserve Board, your job is, you're getting called up because you're the point person on the Fed board now for systemic risk. There's someone I can grab by the lapels in the future and say, "What are you doing? What's going on out there? What's happening out there?"
Now if Congress doesn't do it, and future chairs of the committee doesn't do it, I don't know how to regulate that. We had, basically, eight or 10 or 12 years here, members of Congress saying basically, "You guys are doing great." So the notion of getting back to an economy where, again, institutions are performing back to more of their core functions is something that I think is important. I don't restore Glass-Steagall in this bill. But we come pretty close to trying to at least push or cajole or lure institutions back to more core functions. Banks being banks. We've got to move this thing back, and I think we achieve a lot of that through this bill. That answers your question, we need to get back to the time before 40 percent of our economic success was just coming up with fancy instruments that allowed people to make a profit off of them without producing much.
Photo credit: Andrew Harrer/Bloomberg News.
April 22, 2010; 9:27 AM ET
Categories: Financial Regulation , Interviews
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