H. Rodgin Cohen, a top counselor to major financial firms, suggests that the government's response to the worst financial crisis since the Great Depression was compulsory but laden with flaws.
Described as the "trauma surgeon on Wall Street," Cohen, a partner and senior chairman at Sullivan & Cromwell LLP, said during the ILE Law and Entrepreneurship Lecture that there has been a "transformative pendulum swing" in the government's supervision of major financial institutions.
"The new supervisory regime for financial institutions is more prescriptive, more proscriptive, intrusive, and less flexible and predictable," said Cohen, whose clients have included Fannie Mae, Lehman Brothers, Wachovia, Barclays PLC, AIG, J.P. Morgan Chase & Co. and Goldman Sachs. "Capital standards are being sharply raised, specific liquidity requirements are being imposed, and examinations are more frequent and more extensive."
Reducing the risk of the U.S. banking system means less reward, Cohen cautioned. He predicts that new liquidity requirements will drive down net interest income and debt costs will increase.
Cohen said the Dodd-Frank Act assumes that "big is bad." Provisions like the Lincoln Amendment and the Volcker Rule were written in to prohibit banks from engaging in proprietary trading and derivative activities. Cohen, however, believes that there is not enough evidence to link these practices to the collapse of any bank. Further, he said, legislators did not think through the impact of their actions on bank profits and liquidity.
"More seriously, these activities are not going to be discontinued," Cohen said. "Maybe in banks, but they will migrate over to the unregulated sector, the so-called shadow banking system, where they will continue without oversight or transparency."
While the Dodd-Frank Act generally works well for U.S. banks, it fails to protect native banks that have operations overseas or foreign banks that conduct business in the U.S., Cohen noted. Consequently, Cohen said "ringfencing" has become increasingly popular. Ringfencing occurs when countries regulate foreign banks as if they were freestanding entities, resulting in higher capital and liquidity requirements and less-flexible customer support.
"Every time you take any institution and put it in silos there is greater risk," Cohen said.
"This practice constitutes a form of protectionism that is inimical to the free flow of funds and global banking and is likely to encourage other protectionist measures. If this process continues, we might look back 25 or 30 years from now and say this was really the Hawley-Smoot Tariff of the first part of this century."