Dodd-Frank's Successful Predecessor: Echoes

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More than a year and a half after the Dodd-Frank financial reform was enacted into law, many of its provisions are under attack.

Banks have fiercely opposed everything from its proposed limits on proprietary trading to its new rules on derivatives to its regulation of the muni-bond market. Republicans in Congress have opposed much of what the Consumer Financial Protection Bureau was established to do. Republican presidential candidates have called for the act's repeal. And regulators have missed three-fourths of the law's rulemaking deadlines.

"Less than half of Dodd-Frank will ever see the light of day," former SEC Chairman Arthur Levitt told Bloomberg Radio on Jan. 31.

As Congress's attempt to impose transparency on the financial industry comes under increasing strain, understanding the past provides some insight. There are myriad examples, but one stands out more than the others.

In the wake of the 1929 stock-market crash and in the midst of the Great Depression, the Senate Committee on Banking and Currency launched an investigation into the financial industry's practices. It was later known as the Pecora Commission, after Ferdinand Pecora, the committee's chief counsel.

In 1933, Albert Wiggin, the president of the Chase National Bank, testified before the committee about his activities following the crash.

As prices on the New York Stock Exchange plunged during one of the great bear markets, Wiggin sold short his personal shares of the company's stock. The sales were difficult to detect because the stock had been "voluntarily" delisted from the exchange after the crash and traded over the counter in a very opaque market.

Wiggin had been one of the highest-paid executives in the country. He retired from the bank on a $100,000 per year pension for life, and a $275,000 retirement bonus. So these revelations cast a long, dark shadow over him and Chase National. They demonstrated that those entrusted with what was considered a fiduciary responsibility were more interested in looting a system that had already made them rich than they were in righting the ship that was capsizing.

Although Wiggin was fairly forthcoming, others, such as J.P. Morgan Jr., revealed almost nothing about their banks’ role in the crash -- and maintained that events were beyond their control. To the public, both Wiggin's revelations and Morgan's stonewalling led to the same conclusion: The financial industry needed far greater transparency.

When bankers say they are just as clueless as the rest of the population, a dilemma arises. Testifying before the Financial Crisis Inquiry Commission in 2010, Jamie Dimon of JP MorganChase & Co. stated that a financial crisis "is something that happens every five to seven years" and had come to be expected, implying that bankers knew little more than anyone else about the economy. Lloyd Blankfein of Goldman Sachs Group Inc. told the committee that his bank was "hedging" the securities it had been selling to its clients in what many argued was an obvious short sale of mortgage-related bonds.

When bank presidents display what appears to be only a slight advantage in knowledge over, say, Occupy Wall Street protesters, they are inadvertently begging for more regulation.

In 1933, Pecora summed up the activities of Wiggin and others by stating that they had demonstrated an extraordinary example of "low standards in high places." What Pecora showed was that the traditional opaqueness of the financial industry caused distortions in the marketplace that threatened the entire economic system. And the result of his inquiries was strict regulation of banking and the securities markets. The increased transparency that followed the 1933 and 1934 banking and securities laws served the markets well -- until they were rolled back in 1999 under the Gramm-Leach-Bliley Act.

As Congress once again debates how to make Wall Street more accountable, and as many in the financial industry fight to water down Dodd-Frank, it's worth remembering the Pecora Commission. And relearning some of its lessons.

(Charles Geisst is the author of "Wall Street: A History," which is appearing in a revised edition in September. The opinions expressed are his own.)

To read more from Echoes, Bloomberg View's economic history blog, click here.


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