The 2010 Dodd-Frank banking law, has made future financial crises more likely, not less

See ‘The Fed and Lehman Brothers’ Review: When the Bailouts Stopped: The collapse of Lehman Brothers shocked global markets. It could have been prevented, but politics won out over prudence. George Melloan reviews “The Fed and Lehman Brothers” by Laurence M. Ball. Excerpts:

"The law put a political officer, the Treasury secretary, in charge of banking oversight."

"populist measures more often lead to a reduction of banking soundness than to an improvement. Mr. Ball thinks that putting banking in the hands of Treasury makes it more likely that a future secretary will make the same mistake that he believes Mr. Paulson made with Lehman in 2008.

The author says that, had Lehman not been excluded from the kind of government support that went to other troubled financial institutions, it could have been saved. At the very least, it could have been wound down in a more orderly way than was the case when, after a Sunday- afternoon crisis meeting on Sept. 14, 2008, the New York Fed announced the firm’s bankruptcy in the wee hours of Monday morning, handing global markets a big shock. Fed Chairman Ben Bernanke said afterward that he didn’t have the legal authority to rescue Lehman because it lacked the collateral required under Section 13(3) of the Federal Reserve Act.

“This claim is wrong,” is the blunt reply from Mr. Ball. “The evidence shows clearly that issues of collateral and legality were not important factors in the decisions of Fed officials. In addition, Lehman actually did have ample collateral for a loan that would have averted its sudden bankruptcy.”

To be sure, it was hard to evaluate the holdings of any bank in 2008. A federalized Financial Standards Accounting Board had decreed that all assets be marked to their current market value. That requirement created a problem for banks when the air went out of the housing bubble in 2006-07 and left a huge amount of risky subprime mortgages under water. Banks, especially Lehman, were loaded with securities partly backed by such mortgages. When their paper became suspect (or toxic), the market froze up and values slumped. Lehman reported a $2.8 billion loss in its second fiscal quarter, mainly from marking its real-estate holdings down to the new collapsed market values. That change led to some firms refusing to roll over short-term overnight loans—so-called repo loans—to Lehman. Further trouble came when JPMorgan Chase, the clearing bank for Lehman repos, demanded billions of dollars more in collateral.

Lehman devised a plan to transfer its real-estate holdings to an investment trust, which would not be required to mark to market. But it needed time to make the transfer. After negotiations on a Korea Development Bank investment fell through on Sept. 9, Lehman faced a liquidity crisis. British regulators also scotched a Barclay’s rescue. In the emergency powwow on Sept. 14, 2008, with Fed officials, Lehman was refused support and ordered to declare itself bankrupt.

Though the Treasury secretary had no legal authority over Fed lending, in Mr. Ball’s view, Mr. Paulson’s forceful personality, as contrasted with the scholarly Mr. Bernanke, came into play."