It is now time to get serious about major banking reform

Three years after the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, it’s time to be honest about financial-sector reform: It hasn’t gone well.
Specifically, three issues have become abundantly clear. First, there was insufficient commitment in the original reform effort to end the core problem of “too big to fail” financial institutions. Second, senior leadership at the Treasury Department and other officials became comfortable with the glacial pace of implementation. Third, weak intent and official foot-dragging created fertile ground for lobbying, which further allowed the megabanks to slow the detailed rule-writing. At present, reform is on a trajectory to do too little, too late with regard to addressing the next crisis.
Recently, Treasury Secretary Jack Lew promised to cut through this Gordian knot. It’s an uphill battle, but if Lew applies himself, he could make a real difference in changing the way the financial system operates.
Under Dodd-Frank, the Treasury secretary has a central role in financial regulation. While previous secretaries led a working group on capital markets and had the potential to exercise moral leadership on financial issues, most just let these issues slide. But Dodd-Frank created a Financial Stability Oversight Council and made the Treasury secretary its chairman.
The previous Treasury secretary, Timothy Geithner, used these new powers sparingly – rapid reform wasn’t his priority. But when it came to money-market reform, Geithner’s Treasury demonstrated that it could use the FSOC to overcome a roadblock at the Securities and Exchange Commission. In principle, the same approach could be used to speed up reform implementation more generally.
And that is what Lew wants to do. “Let there be no doubt: Finishing the job of financial reform is critically important to me and this administration,” he said in his speech to the financial community in New York.
He even gave a specific timetable. “We will measure our progress in weeks and months, not in years,” he said.
He listed measures to be taken, with particular emphasis on the so-called Volcker rule. And he made clear that, despite the best efforts of European trading partners to persuade the U.S. to water down the rules on bank equity and regulation more broadly, “we will not let the pursuit of international consistency force us to lower our standards.” The biggest weakness in the current reform process is that it does very little to address the issue of banks that are too big to fail. But at least Lew now acknowledges that “large financial companies pose significantly greater and distinct risks to the financial system.”
There is almost no chance that any of the reforms under way will end the problem of too big to fail. Some companies are so big and so central to the functioning of the financial system that they would be saved if failure was imminent – which is what Richard Fisher, president of the Federal Reserve Bank of Dallas, suggests is the real definition of a systemically important financial institution, or SIFI. As a result, these companies benefit from large implicit government guarantees.
Lew would have some strong bipartisan support on Capitol Hill. Democratic Senators Elizabeth Warren of Massachusetts and Maria Cantwell of Washington, Republican Senator John McCain of Arizona, and Angus King, a Maine independent, recently proposed the 21st Century Glass-Steagall Act, which would break up banks along functional lines.
The big banks will rise up in anger, mobilizing their friends – Democrats and Republicans – in Congress.
And, within officialdom, the Federal Reserve doesn’t yet show the same sense of urgency.
Fed Chairman Ben S. Bernanke said to Warren last week that, in comparison to Lew, he would like “another year from now” before considering new reform measures – which could mean until summer 2014 or the end of 2014, depending on how you interpret his words.
Treasury wants immediate action. Important people at the Federal Deposit Insurance Corp. and other officials seem inclined to move further and faster. For example, FDIC Vice Chairman Tom Hoenig has thrown his support behind the 21st Century Glass-Steagall Act. But though the Fed has taken some action recently, including support for more equity at very large banks, it doesn’t seem to share Lew’s sense of urgency.
As we approach the fifth anniversary of the failure of Lehman Brothers Holdings Inc., what exactly are we waiting for? •


Simon Johnson, a professor at the MIT Sloan School of Management as well as a senior fellow at the Peterson Institute for International Economics, is a Bloomberg View columnist.

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