We have weathered the worst of the financial crisis of 2008-9. Time for renewed optimism? Unfortunately not. The next financial crisis is already programmed. It’s somewhat like an earthquake in Southern California. We cannot predict exactly when it will happen, but we know that it will. Yet unlike earthquakes, financial crises are man-made. They need not happen. They happen because we allow them to happen. We could take many measures to reduce their frequency and depths, but we fail to do so.

What about Dodd-Frank? Won’t it help? To its credit, it contains many good ideas. For example,

• Financial firms with access to the Fed should not be allowed to speculate. (The “Volcker Rule” prohibits proprietary trading.)
• Financial firms that are too big to fail should be broken up by the financial risk council.
• Financial firms should have higher capital requirements.
• Compensation of executives in financial firms should be subject to claw back.
• Whistle blowers can collect bounties for turning in executives if the executives’ compensation was based on inaccurate accounting.

Some good ideas, like an industry rescue fund, died along the way. Other good ideas have been put forth in academic discussions and been by-and-large ignored. For example, there is the suggestion that financial firms should be primarily equity-funded instead of debt-funded, that deposit insurance premia should be risk based, and that firms should disclose much more information about their bets publicly on a daily basis (which all large financial firms already have readily available), so that traders can become aware of systemic correlations in bets.

However, there are two critical problems with all these reforms and ideas. First, meaningful reforms will never happen. This even applies to the provisions already in Dodd-Frank. They will be castrated long before they are implemented. Wall Street simply has too much influence in Washington to allow any meaningful reform. More likely, Dodd-Frank will end up just as another Full Employment Act of Financial Lobbyists (a phrase coined by Barth, Caprio, Levine) and a source of rich campaign donations for influential politicians. As a whole, Washington is corrupt. This is not necessarily because individual politicians are corrupt, but because politicians that are well-funded by lobbyists tend to win elections.

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