March was a bad month for the Dodd-Frank Act. We now know that Dodd-Frank, passed in the wake of the 2007–2008 banking crisis, doesn’t prevent bank runs. Neither do post–2008 arrangements tell depositors whether large deposits are safe or should be withdrawn with a swipe on a smartphone. This time, uninsured deposits were bailed out. But in testimony to the Senate Finance Committee, Treasury Secretary Janet Yellen couldn’t say what would happen to uninsured deposits at other regional banks, telling Oklahoma Senator James Langford that whether they were bailed out would depend on what federal regulators decided. Instead of clarity and predictability, we have subjectivity and confusion. In short, Dodd-Frank and the post-2008 framework failed.
This would come as no surprise to Lord Mervyn King, who, as governor of the Bank of England, piloted that institution through the financial crisis. In a lecture at NYU Stern in 2016, King was critical of his American colleagues’ approach of throwing vast amounts of liquidity at the financial system but then not taking steps to address the root causes of bank runs. Instead, the approach still relies on an outdated nineteenth-century doctrine of central banks acting as lender of last resort (LOLR), which assumes that banks have a plentiful supply of high-quality collateral against which central banks can safely provide liquidity. As King saw first-hand, in the heat of a banking crisis, it’s impossible to estimate the value of bank collateral or to tell whether a bank is solvent.
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