So it looks like financial reform is going to be Dodd-Dodd rather than Dodd-Corker. The consumer finance regulator is like the new public option, a real deal killer. Also not helping is the wider, harsher version of the Volcker Rule that a group of Dems have proposed. I call it the Goldman Sachs Rule since it is targeted at the supposed conflicts of interest GS has. Throwing GS into the mix further politicizes the process and makes compromise tougher. A real poison pill. But that might be the idea all along. Push a weak, Democrat-only bill vulnerable to a host of anti-bank amendments on the floor of the Senate. Then force Republicans to vote against them with the midterm elections looming. With the economy weak and healthcare unpopular, financial populist may be the only card Dems have to play.
Politics and policy from inside Washington
President Obama is continuing to push the Volcker Rule to ban prop trading by banks. My sources give me no indication this has a realistic chance of happening. Certainly none of the key members — Dodd, Shelby, Corker, Warner — have warmed to it. So why is Obama pushing it, then? Hey, it is about the only part of his agenda with any popular support. Certainly not healthcare or cap-and-trade or the stimulus. Anti-Wall Street populism works, so more anti-Wall Street populism we will get. This is also why the GOP wants to pass a financial reform bill. It deprives Dems of a political weapon that plays on the stereotype of Republicans as the Party of the Rich.
Rightly or wrongly, Wall Street is given blame for the Great Financial Meltdown — at least far more so than the Fed, US housing policy and government Too Big To Fail policy. So looking at how financial reform is coalescing in Congress, the big banks have to feel relieved. No one is being broken up, no return of Glass Steagall, the new consumer protection regulator is being continually whittled down, no super regulator. Things may have gone much differently had financial reform been more of a priority than healthcare. Wall Street’s execs may not deserve bonuses, but its lobbyists sure do.
A few points:
1) The much-hyped Volcker Rule proposal is failing fast in the U.S. Congress. But Paul Volcker himself probably isn’t that surprised. The former Federal Reserve chairman joked he was “just a photo op” even after President Barack Obama’s public embrace of his proposal to limit bank proprietary trading. More evidence that the moment for sweeping reform has probably passed.
2) The hope for any reform at all rests with the U.S. Senate’s new negotiating tag-team of Democrat Chris Dodd, chairman of the Banking committee, and Republican freshman Bob Corker. But Corker says the Volcker Rule isn’t going to be a “major topic” for discussion. And that is probably OK with much of the committee. As one banking industry lobbyist told me, “There is just not a lot of appetite among members of the minority or the majority to add [bank trading limits]. So I just don’t think you’re going to see it.”
3) Increasingly, the Volcker Rule looks more stunt than viable solution. Though Volcker had been pushing it for months, White House advocacy surprised both the Banking committee and banking industry. A poor way to introduce serious legislation in Washington. Lame-duck Dodd, who sees reform as his legacy, hears the clock ticking. A bill not passed by early summer is probably dead for the rest of this election year. His view: The Volcker Rule is a sudden and unwelcome complication.
4) Cynics saw it as a populist, knee-jerk response to the loss of a Massachusetts U.S. Senate seat held by Democrats for more than a half century. Even some Volcker Rule advocates admitted the plan didn’t directly address the regulatory failures that contributed to America’s financial meltdown. And although the proposal was introduced in January with great fanfare by Obama – Volcker standing prominently at his side – Senate Democrats say the creation of a new consumer finance regulator is actually the issue the White House is spending political capital on.
5) It is a reality that highlights the Obama administration’s scant interest in more extreme measures to limit the size of the banking sector or its activities. And if Volcker did harbor any small doubts about that, he shouldn’t any more.
With healthcare on ice, financial reform is the hottest game in town. Now Dodd is trying to bypass Shelby to somehow gin up a bipartisan bill with Corker – who takes the issue extremely seriously. A few thoughts:
1) A CFPA is still the stickler. GOP, including Corker probably, will only accept a non stand-alone regulator will narrow rule-writing and enforcement powers. But CFPA is dominant issue for Obama WH.
2) Corker is more easily undercut by McConnell than old bull Shelby. If McConnell doesn’t want a bill, there will not be a bill. At this point, the smart betting is that GOP views denying Dems a victory more important than anti-populist backlash for opposing reform. They will label it a bailout bill if there is even a hint at giving Treasury TARP 2.0 powers. But if it is watered-down enough, it can pass.
3) If a Dodd-Corker bill gets to the floor, both Left and Right will push a flurry of amendments that they would’t try with Dodd-Shelby. Should be a chaotic mess.
4) Looks like the Volcker rule isn’t going anywhere.
This is part three (part one and part two here and here) of my recent email chat with the Nicole Gelinas, author of the wonderful After the Fall: Saving Capitalism from Wall Street and Washington.
Why should capital standards be uniform across different asset types; why is this important?
Consistent capital standards are an acknowledgment of humility. For example, the next financial crisis could come from government debt. Yet governments around the world say for regulatory-capital purposes that sovereign debt is the safest investment imaginable. They said the same thing about highly rated mortgage-backed securities four years ago.
Regulators should allow financial firms and investors to do their own assessments of risk, rather than decree what debt is safe and what is not. Bottom-up risk assessment would protect the economy as a whole. If one financial firm makes a mistake in thinking that a class of securities is perfectly safe, the rest of the system will survive its failure. But if the government makes a similar mistake in one of its universal decrees of safety, the mistake multiplies itself over the entire financial industry.
Consistent capital requiremens would also make ratings agencies irrelevant – a much easier way of “reforming” them than what Washington is trying to do.
You brings up lots of reform ideas that don’t necessarily coalesce into a specific plan. But a common theme seems to be bright, clear rules instead of regulator judgment? Is that right?
Right. Of course, there’s always some human judgment involved. Back in the Eighties, hen-Fed chairman Paul Volcker, for example, used human judgment when he applied old-fashioned margin rules to limit speculative borrowing to the new-fashioned junk bond markets. Investors – and people in the Reagan administration – howled. But Volcker was humble enough to know that neither he, nor the financial industry, was able to predict the future and obviate the need for consistent rules.
The theme of my book is that free-market principles should govern the financial system. How do we make that happen? Big and/or complex financial firms must operate under a credible threat of failure. Lenders to such firms must know that that failure comes through a consistent, predictable, transparent system, in which losses come according to a creditor’s place in the capital structure – not through arbitrary, opaque government bailouts.
How do we make that happen? We must make the economy better able to withstand financial-industry losses. And we do that through everything that I talk about here and in the book. Moreover, we know that this works. It worked from the Thirties until the Eighties, until financial innovation began to evade the regulatory system and thus market discipline.
Do you buy the John Taylor idea that the credit crisis escalation in September 2008 was caused not by Lehman but rather lack of investor confidence in Paulson/Bernanke/TARP?
No, although I do not think that Lehman caused the crisis, either. If our “free market” financial system is dependent on “investor confidence” in the competency of government as it executes arbitrary bailouts, then we’ve got a real problem! I do agree, however, that arbitrary government actions starting in 2008 have prolonged the recovery and made it less robust. The answer to that problem, though, isn’t for the government to perfect its arbitrary actions. It’s to make such actions unnecessary by making the economy safer for financial-firm failures.
Would you have let Lehman fail
Yes. The financial system’s business model was itself a failure. That model was to borrow every last dollar based on Panglossian assumptions multiplied decades into the future. It was fatally brittle even to the slightest wavering in assumptions, and thus worked only in an environment of too big to fail.
When we took that veil of government protection away even for a moment, as we did with Lehman, what was underneath wasn’t pretty. It revealed that a financial system that’s immune from market discipline and exempt from prudent regulations is a system that can destroy the economy.
I hope that Washington learns this lesson, and takes it to heart. If not, the next time the financial system cashes in on its implicit government guarantees, it may overwhelm the government’s ability to bail it out. Markets will work, in such a case – but will exact a cruel economic and social price.
Mark Calabria of Cato, a supersmart observer of the financial sector in DC, gives me his two cents:
I find it hard to believe that the govt has any clue as to what correct size and level of trading is for banks. Sounds like nothing more than cheap politics.
Ex ante, no one told Bear was too big. So is the size limit going to be even smaller than Bear?
Obama misses one reason for banks becoming so large: their fund advantage due to “too big to fail” – if he were serious he’d come up with a plan to end too big to fail, rather than a plan for permanent bailouts.
And where’s the break-up plan for fannie and freddie? Just seems like just picking winners and losers based on politics.
I don’t see it going anywhere in the Senate [though I'm] not completely ruling it out. House could easily pass something so stupid – it is the House after all.
It does complicate financial reform – Obama might just be killing financial reform – hard enough time reaching agreement.
She emails me on the Obama plan to limit bank activities:
1) I think that they are now panicking and veering from solution to solution. They will roil the markets and just make themselves panic more. Politically, i’m not sure. It will be hard for republicans to be against this, just like it is hard for them to fight the bank tax. Although if markets fall by hundreds of points, it gives the GOP an opening to say that Obama doesn’t know what he’s doing.
2) As for the merits – the problem is, Bear and Lehman didn’t have insured deposits, didn’t have recourse to the Fed, etc., but still posed significant risk. Why? Because by securitizing, derivative-izing and short-term-izing all manner of long-term debt, non-commercial banks made the economy’s store of credit much more vulnerable to market exuberance on the upside and panic on the downside. Mortgage and other credit depended at the margins not on bank balance sheets but on speculative demand.
3) To deal with that, I think we need consistent (and likely higher) margin requirements, capital requirements, clearing rules, etc., no matter who is holding/trading the debt. That would protect the economy more by putting a buffer between the pure, raw market and these debt instruments, just as we did long ago with equity markets.
4) I fear that if we curtail the big banks without doing these other things, the risks will just move, and people will continue to move their savings accounts into money markets to fund these risks. In fact, that is why we got rid of glass-steagall on the first place – to let banks compete fairly with the non-banks that had stolen their business.
5) So, do the margin and capital stuff to recognize the world we live in today … Doing that will make the economy better able to withstand financial failure, anyway, and the market, knowing this, will bring the institutions down to manageable size.
Obama’s plan to limit risky activities at big banks is more about forcing Republicans to take tough votes than preventing another credit meltdown.The Volcker Plan was already rejected by the WH econ team (Summers, Geithner) and this is being pushed by the political team (Rahmbo, Axelrod) in the wake of the Massachusetts Meltdown. (In fact, this may help tamp down pressure from congressional Dems to dump the econ team.)
The WH can’t trumpet the economy, can’t trumpet healthcare, so Plan C is to go after Wall Street and make the GOP look like its best friend. Who cares that some of the worst problem children of the financial crisis were relatively small and undiversified? Wasn’t it regulator pushing for Wells Fargo to absorb Wachovia, and BofA to absorb Merrill? But I think the Dems will be surprised at how many GOPers might go along with this, starting with John McCain who has already advocated the return of Glass Steagall. But he will be far from the only one.
Scott Brown’s stunning capture of the Massachusetts Senate seat held for decades by Ted Kennedy was a political black swan, a near-unpredictable event.
The result ends the Democratic supermajority in the Senate and leaves key parts of the Obama agenda in deep trouble. But the biggest loser just might be Wall Street. Desperate Democrats may see anti-bank populism as a way of holding power as the November midterm elections approach.
The last days of the heated Senate race saw the first attempts at that political gambit. Democratic candidate Martha Coakley’s allies in Washington, both the White House and national Democratic officials, used President Barack Obama’s proposed bank tax as a cudgel to bash Brown via emailings and telephone calls.
But the game was probably over by then for Coakley. A combination of high unemployment, an unpopular healthcare reform bill and the candidate’s own lack of charisma and effective experience were more than enough to clinch an easy Brown victory.
A historic victory, really. It is hard to overstate just how “blue” a state Massachusetts is. Obama won it by 26 percentage points in 2008. Until now the state’s 10 U.S House members, two U.S. senators and all statewide officers were Democrats. The state hasn’t had a Republican U.S. senator since 1979. And, of course, the seat Brown captured had been held by the late Edward Kennedy since 1962.
Now Brown’s victory threatens the healthcare reform bill that Kennedy championed on his deathbed. Democrats could still ram it through before Brown makes it to Washington. But potential legal challenges make that unlikely.
As it is, Brown’s election is enough of a systemic shock to freeze the political process on Capitol Hill. Moderate Democrats in both chambers are nervous about their previous “yes” votes for healthcare. They may be unwilling to make any more. The prospects look even bleaker for cap-and-trade energy legislation, a bill with even less support than healthcare.
Financial reform legislation was already likely to get milder rather than stronger. But not so the rhetoric. Unable to trumpet the economy, hitting Wall Street is one of the few political bullets Democrats have left.
So expect the Obama administration to go all out for the bank tax with increasingly harsh words for big financial institutions. Democrats may also be more willing to consider controversial proposals banks hate, like letting judges rework mortgages. But given the Massachusetts precedent, it may not be enough to save the party from a wipeout in the fall.