There really are two worlds (at least) in banking: small community banks and giant investment banks. Howard and I agreed that the Wall Street meltdown exposed areas in investment banking that had simply gone out of control.
The creation of all sorts of confusing, barely trackable, financial products — sold privately and entirely unregulated — allowed levels of risk-taking that far exceeded the capacity of the financial system to manage once the house-of-cards arrangements started to fail.
Whether it was credit default swaps, collateralized debt obligations, “synthetic” versions of those, or other hybrid collections of mortgages and loans and insurance policies, they were all increasingly used primarily as constructs with which to speculate unrestrainedly.
What caused that behavior? Was it lying mortgage applicants, the federal government, Fannie Mae, the ratings companies or the investment banks themselves? What actions would eliminate a repeat of the crisis?
Dodd-Frank is one response. It attempts with legislation to write enough wise rules to define the contours of acceptable risk. Because our financial system is so immense and complicated — and interconnected globally — and because the activities of investment banks, hedge funds and insurance companies are so multifaceted and dynamic, it is easy for any attempt at comprehensive regulation to become long and complicated itself. That is the case with the rules being promulgated under Dodd-Frank, and, of course, it makes every thinking person concerned. Will the legislation achieve its intended purposes?
Some observers who look at the power and intractability of the government-banking symbiosis (our “Goldman Sachs government,” some say), and the constant difficulty of regulatory enforcement, are starting to wonder if any set of rules can tame the enormous, global, financial beast. For example, will we newly regulate derivatives only to see the actors develop other counterproductive extremes?
In response to these concerns, more discussion is likely about the value of breaking down the size of the largest banks (globally), and thereby increasing the manageability and accountability of their bureaucracies, and also reducing the vulnerability of the economy when a bank miscalculates.