June 2009

How Senator Dodd Caused the Financial Crisis

By James Lavin

In Part 1, I criticized Sen. Dodd for writing the legislation – HAVA – that pushed unauditable, privately operated electronic voting machines into American elections and for fighting – for years – against paper audit trails, thus undermining Americans’ trust in the legitimacy and integrity of our elections and our ability to verify election “results.”

In Part 2, I show that Sen. Dodd was uniquely positioned to prevent the banking crisis but utterly failed Connecticut and America.

Sen. Dodd – Chairman of the Senate Banking Committee – has taken millions of dollars from financial institutions to not do his job:

Why does Dodd – a long-term incumbent in a small state – need all this money? And why are powerful financial firms so eager to give Dodd money?

They wanted a friend running the Senate Banking Committee, a friend who wouldn’t push new regulations or tough enforcement of existing regulations. And that’s exactly what they got for their money.

What did we citizens get for Dodd’s close friendship with the finance industry? Dodd’s failure to regulate banks led directly to:

During Dodd’s watch as Chairman of the Senate Banking Committee, the U.S. banking system collapsed as it had not since the Great Depression. This occurred because Congress tore down laws preventing banks and other financial insitutions from taking massive risks. And then Congress failed to watch – let alone regulate – what those financial institutions were doing.

No one was better positioned to prevent the madness than Dodd.

But Dodd was part of the problem, not the solution. One landmark law – The Financial Services Modernization Act of 1999 (informally called Gramm-Leach-Bliley) – repealed essential legislation – the Glass-Steagall Act of 1933 and the Bank Holding Company Act of 1956 – put in place after the Great Depression to prevent another banking crisis.

Dodd voted “yes” on repealing Glass-Steagall and gutting the Bank Holding Company Act. Shamefully, only eight Senators – including five of the best (Boxer, Dorgan, Feingold, Harkin and Wellstone) – voted “no.”

Sen. Dodd absolutely should have known he was pulling the pin on a hand grenade. Many others shouted loudly that deregulation would cause a financial crisis & taxpayer bailouts:

Most damagingly, Senate Banking Committee Chairman Dodd failed to regulate derivatives. Since at least the mid-1990s, experts had been calling for derivatives regulation. In 1994, the government’s own Government Accounting Office (GAO) issued a 200-page GAO report calling for regulation of the exploding derivatives market. The report warned that failure to regulate derivatives could result in “a financial bailout paid for by taxpayers.”

Passing such legislation was Senate Banking Committee chairman Dodd’s job. He failed.

Public Citizen explains Congress’ central role in bringing on the banking crisis:

The current financial crisis is the natural and logical result of a failed financial regulatory system that placed an irrational faith in the ability of markets to self-correct. As a result, regulators ignored repeated warnings about the over-the-counter derivatives markets, problems with securitization and lax mortgage underwriting standards, excessive leverage in financial institutions, and the general movement of financial activity into increasingly complex and opaque forms…

This has allowed institutions to structure complex transactions and take on risky exposures without fulfilling the regulatory requirements Congress deemed necessary to prevent a systemic financial crisis after the Great Depression. These unregulated and under-regulated activities and institutions, the “shadow financial system,” were permitted to become so intertwined with the real economy that the government has chosen to use taxpayers’ money to bail them out when they failed.

No one was better positioned to understand the dangers or empowered to prevent them than Senate Banking Chairman Dodd. And when problems first appeared, instead of addressing them, he moved to Iowa and launched a presidential campaign.

It doesn’t matter whether Dodd was simply ignorant of the massive risks banks were taking or seduced by power and money. He failed, and America and Connecticut will pay a dear price for decades to come. It’s time for Sen. Dodd to go.

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James Lavin is an economist and blogger in Stamford. This article was originally published as "Please retire Chris Dodd from the Senate (Part 2)" on his blog, James Lavin — Blogging the Bust.