Opinion: Tracing a line from Dodd-Frank to Goldman Sachs
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The cliche ‘the devil is in the details’ would certainly apply to both of the big developments Thursday in the financial world: the final passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act and Goldman Sachs agreeing to pay $550 million to settle the fraud lawsuit brought by the Securities and Exchange Commission. In both cases there are significant issues still to be resolved; the Dodd-Frank bill left regulators to settle scores of questions about what financial companies would be required to do, and the criminal probe into Goldman Sachs’ behavior continues.
Both the bill and the settlement lose appeal the closer you examine them -- the former intrudes in too many areas yet takes too cautious an approach to the major weaknesses in the current system, and the latter seems more like a wrist slap than a gut punch. But I think they both head in the right direction and make the financial system better than it would be otherwise. Dodd-Frank’s efforts to regulate derivatives, stop banks from making risky investments with insured deposits, shed light on systemic threats and improve the government’s authority to dissolve failing institutions are all good things. Having Goldman Sachs admit that it didn’t disclose enough to investors is a good thing too.
More important, though, is the subtle pressure that both the bill and the settlement will bring on the financial industry to care more about the fate of the deals they engineer. Allow me a quick diversion here. Critics of Dodd-Frank say it ignores Fannie Mae and Freddie Mac, the housing-finance behemoths that helped feed the subprime-loan mania. Fannie and Freddie were a factor and they need to be restructured radically, but keep in mind that they got into the subprime game late, after they’d lost a significant share of their market to Wall Street firms. More important, reforming Fannie and Freddie wouldn’t be the GOP’s cause du jour if lenders during the housing bubble had cared whether their customers could repay the mortgages they were being sold.
Dodd-Frank prohibits some of the most predatory home-loan practices. More broadly, it requires that financial institutions insure that borrowers have a reasonable chance of repaying the loans they take out. In addition, it requires the companies that package loans into securities and sell them to investors to keep a small but meaningful stake in those securities. That ‘skin in the game’ mandate should deter companies from trying to pass ill-conceived loans and investments off to buyers with less information about their contents.
The housing bubble was just the most recent crisis. The next bubble will almost certainly involve some other kind of asset. What drives a mania is the belief among investors that the market is rising so inexorably that it doesn’t matter what they buy -- there will always be someone else willing to pay more for it eventually. And the enablers of the mania are the lenders who provide the cash investors need to make their imprudent purchases -- loans that lenders are happy to make because they, too, aren’t concerned about getting stuck with an asset of declining value.
There may be no way to prevent this kind of boom-and-bust mentality, but barring lenders from making loans that can’t reasonably be repaid and requiring companies to keep a stake in the loans they securitize should help. So should telling Wall Street firms that they can’t create products that are designed to fail for some customers in order to benefit others. As small as the Goldman Sachs penalty may be in relation to the company’s profits, it’s still a significant amount of money -- enough to tell other Wall Street firms that bundling a bunch of toxic securities into a new product is risky for them as well as their customers.
-- Jon Healey
