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June 9, 2013
David Warsh, Proprietor


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A (Rickety) Apparatus for Nipping Panics in the Bud

An expert story-teller knows how to employ a McGuffin to advance his tale – A McGuffin being something the protagonist and, often, his foe, are willing to do almost anything to possess or protect, like the lost ark in the Steven Spielberg film of the same name, or the meaning of Rosebud in Citizen Kane.  The specifics of a McGuffin are seldom explained, as Wikipedia says; it’s enough to believe that it matters.

Robert Kaiser, of The Washington Post, is nothing if not an expert story-teller.  He also happens to be an eespecially enterprising reporter: his last book, So Damn Much Money: The Triumph of  Lobbying and the Corrosion of American Government  unraveled the history of the congressional earmark/campaign contribution industry. (A good account of it is here.)

But you have to look very carefully at the cover of his new book,   Act of Congress: How America’s Essential Institution Works, and How It Doesn’t, to discover what the book is actually about. In only one of the six blurbs on the back of the jacket is the subject actually mentioned. The author David Maraniss writes:

Kaiser writes with the clarity of a world-class journalist, the depth of a scholar, and the evocative style of a novelist.  His latest book about Barney Frank, Chris Dodd, and financial reform, is a master class in understanding modern Congress.

The inside flap copy is a little more forthcoming:

Act of Congress tells the story of the Dodd-Frank Act, named for the two men who made it possible: Barney Frank, brilliant and sometimes abrasive, who mastered the details of financial reform, and Senator Chris Dodd, who worked patiently for months to fulfill his vision of a Senate that could still work on a bipartisan basis.

And if you read to page 384, you’ll find Kaiser’s own assessment of the situation:

A final curiosity about Dodd-Frank: This big, substantial, and consequential new law never really penetrated the public consciousness. As we’ve seen, it wasn’t even well-understood by most of the members of the House and Senate who voted for or against it. All of its complex positions were never carefully dissected in House or Senate hearings, or by the popular news media.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, in other words, has become, in Kaiser’s hands, a McGuffin – a device for keeping you interested in a story about the ins and outs of life on Capitol Hill, the veteran reporter’s chance to follow an important piece of legislation from first conception to final passage through both houses of Congress.  And if that’s what you’re interested in, it is a truly wonderful book.

As it happens, Kaiser and Frank  have known each other since they were kids, Kaiser an 18-year-old Yale sophomore, Frank a 21-year-old Harvard senior, both attending the National Student Congress in Madison, Wisconsin, in 1961.  They stayed in touch, and when, in the immediate aftermath of the crisis, Kaiser proposed that he become historian of the congressional response to the crisis, Frank responded in kind.  When he offered Kaiser the chance to follow at close quarters the legislation that he, as chairman of the House Financial Services committee, would be overseeing, with superior access to him and his staff, the newsman signed on. So did Frank’s Senate counterpart, Connecticut Democrat Christopher Dodd.

The result is an affectionate, detailed, sophisticated account of what it takes to be an efficacious legislator in these contentious times – very different in the House from the Senate. Frank lives up to his reputation as having been the brainiest, wittiest, and most eloquent member of the house. Dodd, the son of a former senator, is shown to be resourceful and hardworking – once he gets his presidential bid out of his system. The two shake off their losses, exult in their victories in their inside games, played out according to the peculiar rituals of Capitol Hill. Often it amounts to Frank thinking out loud. Act of Congress is a thriller for political junkies. The only thing like it I’ve ever read is Robert Caro’s intimate biography of Lyndon Johnson.

The trouble is, of course, that the Dodd-Frank Act itself is widely regarded as a disappointment, a 2,000 page omnibus whose bells and whistles – a Consumer Financial Protection Bureau, an Office of Financial Research – camouflage its lack of clear organizing principle. That’s why the topic doesn’t appear on the cover of the book. The statute makes no change in the mash-up of famous old names engineered by the Federal Reserve Board in the days of the crisis. Institutions that were already judged to be “too big to fail” only got bigger.  It allays no fears about the process known as securitization.  And, ever since J.P. Morgan’s embarrassment over the spectacular loss-making trades of its London rogue “whale,” the new dispensation has shown no evidence of having slaked Wall Street’s appetite for risk.  As is not the case with the Obama administration’s Affordable Healthcare Act, it is hard to point to any inarguable benefit the Dodd Frank Act has brought, including the lightning rod that is the CFPB.

Worse, on the evidence of the book, there is reason to think that Frank himself, the policy wonk, didn’t really understand the fundamentals of what he was trying to do. I don’t mean the political details; Frank was clearly on top of who wanted what and why. “I am amazed at how well Frank knows these subjects,” H. Rodgin Cohen, a top Wall Street lawyer, tells Kaiser.  But on the broad economic issues involved, he comes across at times in the book as, well, over-confident.

Here, for instance, is Kaiser on how Frank understood his task.

He fully intended to put his mark on what he saw as the third great “regulatory wave” to save capitalism from its own worst excesses.  The first, he thought, came early in the twentieth century, when Theodore Roosevelt (prudent from 1901 to 1909) and Woodrow Wilson (1913-1921) busted the giant trusts that formed in the late 1800s and imposed some basic rules on American corporations that regulated child labor, hours, working conditions, and workers’ rights.

The second was Franklin Roosevelt’s New Deal, which created regulatory structures for the banking and securities industries that had survived for eight decades. Bank examinations by federal regulators, insurance on bank deposits, and the Securities and Exchange Commission to police stock markets, the three fundamental reforms of the New Deal, gave investors and consumers confidence in the system, creating an orderly environment for American business and finance that allowed them to prosper, Frank thought.

Now the third wave could address a new problem made obvious by the crash of 2008, the need for more effective regulation of financial risk… He saw the need for a new systemic risk regulator, a government part empowered to limit or ban risky behavior by major players in the now enormous financial sector

As Frank thought about it, the risk regulator’s principal concern would be “leverage.”

There is nothing here about the relevant history:  about how the Federal Reserve System was established in 1913 to take over the role that J. P. Morgan had played in staunching the Panic of 1907.  About how the Fed was thought to have performed poorly after the Crash in 1929.  Nor about how, after a slow start in 2006, the same agency was thought to have saved the day in 2008.

At another point, Frank dismisses the creation of the Financial Crisis Inquiry Commission as “a silly idea whose time has come” because, he tells Kaiser, the causes of the crash “were already well understood.”

For an explanation of the crisis, he advised friends, colleagues, constituents, and reporters to read Financial Shock, a short book by Mark Zandi chief economists of Moody’s Analytics, who Frank liked to describe as “an adviser to John McCain,” which he was in the 2008 presidential campaign.  Zandi’s book argued that indiscriminate home loans by overaggressive mortgage brokers, sloppy securitization of mortgages by banks and investment houses, and woefully inadequate government regulation were the principal causes of the financial crisis. Frank agreed.

Nothing here about the banking panic about which Fed chairman Ben Bernanke gave testimony, lectured, and wrote a book to explain.  (Within a year, Zandi issued an “updated edition” that incorporated Bernanke’s version of events and turned his own analysis upside down.)

And so, because “we don’t have the staff,” Frank turns over to the Obama administration the task of writing a bill. The working group includes Diana Farrell, a former McKinsey consultant serving as deputy to Lawrence Summers at the National Economic Council; Cass Sunstein, the White House regulation czar; Neal Wolin, deputy to Timothy Geithner at the Treasury; Patrick Parkinson, an economist from the Fed; and Michael Barr, assistant Treasury secretary for Financial Institutions. In White House meetings their bosses debate. In June 2009 the administration issues a white paper describing its bill – the president has decided there will be no attempt to restructure the financial industry. Frank and Dodd concur, and the story of what happens to the draft as the legislators assemble majorities capable of enacting it into law makes fascinating reading.

But by the time the book comes to its end, at least two things are clear.  There is still deep disquiet about the process of securitization – that is, the practice of packaging debt obligations into complicated securities whose income streams can be traded in ever more complicated ways; and about the prospect of letting stand without further modification the array of firms hastily arranged in the crisis that, more than ever, are deemed “too big to fail.”

About the latter, Frank’s friend and one-time fellow committee member Michael Capuano, another Massachusetts Democrat (Frank retired from Congress this year, having chosen not to run again) last wee filed a three-page amendment to the Dodd-Frank Act, a “Subsidy Reserve Bill,” that would require large institutions to account for the subsidy they receive in the form of lower borrowing costs, given the widespread conviction that the Federal government will make good on their obligations rather than permit them to fail.  The brainchild of Boston University professor Cornelius Hurley, who served for many years as assistant general counsel of the Fed, the measure would require the six or seven largest institutions to establish balance sheet reserves equal to their gains from the implicit guarantee, thereby creating a powerful dynamic: either grow super big and super safe and not very profitable; or choose to downsize themselves however they please in order to shed reserves and to seek higher rates of return on their capital.  Capuano says he couldn’t find a Republican co-sponsor: “They all want to repeal Dodd Frank.  We can amend it, build on it, but we’re not going to repeal it. It’s law.” Hurley says, “It’s a long road ahead but it’s a start.”

Back then to the nature of a McGuffin. Alfred Hitchcock, who popularized the term (and who in his films used the device again and again), speculated that the word’s origins were to be found in a story told by a friend about two men taking the overnight train to Edinburgh.

One man says “What’s that package up there in the baggage rack?” and the other answers, “Oh, that’s a McGuffin.” The first one asks “What’s a McGuffin?” “Well,”, the other man says, “It’s an apparatus for trapping lions in the Scottish Highlands.” The first man says, “But there are no lions in the Scottish Highlands,” and the other one answers, “Well, then that’s no McGuffin!” So you see, a McGuffin is nothing at all.

Is the statute for which Barney Frank and Chris Dodd worked so hard really nothing more in the end than a McGuffin in the hands of an especially adroit journalist?  The answer, I think, is clearly no, and for the reason that Kaiser gives at the very end of the book.

[T]he bill itself remained an enigma. More than two years after the law was enacted, few citizens understood, for example, that the new Financial Stability Oversight Council, chaired by the secretary of the Treasury and consisting of the heads of eight regulatory agencies and one public member, was given unprecedented powers to instruct regulators to limit specific risky behaviors by financial firms…even to close down a financial firm if it decides, by a two thirds vote that includes the treasury secretary’s…. Someday the use of this extraordinary power could have enormous consequences, but it never got much attention….

This is, if I understand it correctly the kind of broad authority the lack of which hampered the government’s efforts to effect the sale of Lehman Brothers to another firm, as it had Bear Stearns to J.P. Morgan six months before. It was after Lehman declared bankruptcy that the Panic of 2008 ensued.

Perhaps the single weightiest political judgment Frank made, well described in the book, was that that the panel be created, rather than that similar power be lodged with the Fed.  We’ll see how the ten-member committee performs the first time it is called upon to save the world in a financial crisis.  I have my doubts, but it is certainly better than no authority at all.  And as for citizen awareness, just wait for the crisis to arrive.

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2 Comments

  1. marcel wrote:

    I hope you will not take this amiss, but your typos suggest some very interesting questions that I guess would take you rather far afield.

    For instance, if TR was prudent from 1901-1907, I am curious to know what specifically he did in the last 14 months of his presidency that you think so imprudent (I can guess that before he became president it was probably the same stuff that led Hanna to refer to him as “that damn cowboy”).

    Similarly, I’d love details about the fiend telling the story of the McGuffin on the overnight train. Was it a vampire? A werewolf? Or something more prosaic?

    Monday, June 10, 2013 at 1:40 am | Permalink

  2. admin wrote:

    Those missing fourteen months have been restored to the cowboy president’s term in office, and the missing R has reduced the fiend to friend. EP is grateful for two good catches. dw

    Monday, June 10, 2013 at 12:09 pm | Permalink

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