At the Levy Conference, Elizabeth Warren launched a new campaign for tough-minded, effective financial regulation. This ought to be a straightforward call for restoring banking to its traditional role of facilitating real economy activity. Instead, in this era of “cream for the banks, crumbs for everyone else,” common-sense reforms to make banks deal fairly with customers and remove their outsized subsidies will no doubt be depicted by pampered financiers as an unfair plot to target a successful industry. But as we’ve stressed, Big Finance gets more government support than any line of business, even military contractors. They are utilities and should be regulated as such. Thus even Warren’s bold call to action falls short of the degree to which the financial service industry need to be curbed.
Below is the video of her speech; I’ve also embedded the text at the end of the post.
This speech is a bigger deal than Senator Warren’s Antonio Weiss speech or her famous Citibank speech. This speech is a blueprint for Dodd-Frank 2.0. It lays out a detailed vision of the challenges for reform work going forward:
- break up the big banks;
- a 21st Century Glass-Steagal Act that promotes narrow banking;
- a targeted financial transactions tax to reduce unnecessary volatility from excessive arbitrage;
- elimination of the tax system’s preference for debt over equity financing, a limit on the Fed’s emergency lending authority;
- a simplification of the financial regulatory system (does this as presaging a reduction in the number of bank regulators? The SEC should certainly feel the heat from this speech…);
- reforms aimed at the various types of short-term debt that are the hallmark of the shadow banking sector (money market mutual funds, repo).
There are three remarkable things about this speech. First, what is truly groundbreaking is that Senator Warren recognizes that the problems in the financial regulatory space are not just technocratic ones but political, and that technocratic fixes will never work until and unless the political structure of financial regulation is reformed. Senator Warren’s speech says exactly what needs to be said: the power of large financial institutions not only threatens our economy, it threatens our democracy. Senator Warren has picked up the mantle of Teddy Roosevelt.
Second, as a political matter this speech announces a reform offensive. Since the high-water mark of Dodd-Frank’s passage in 2010 we have seen a steady push for deregulation. For Senator Warren to take the offensive here, particularly when her party is in the minority in both houses of Congress shows real moxie. That this speech is credible in such political circumstances is also a testiment to its substantive strength.
Third, this speech presents the only vision for financial reform in the policy space. (OK, I guess the “deregulate ’em all” approach is a vision of sorts, but come on…) There isn’t a competing right or left alternative out there. No one else has a cohesive reform platform. I think that makes Senator Warren’s speech all the more important because this is the speech that will shape the policy field going forward into 2016. This is the yardstick against which all presidential candidates, Democratic and Republican will be measured. It will be interesting to see which ones endorse what parts of Warren’s vision and how enthusiastically. Silence will be particularly telling, as it is a vote for the dysfunctional status quo that leaves the Too-Big-To-Fail banks intact and growing.
And from Simon Johnson:
Senator Warren puts forward two main sets of proposals. The first is to more strongly discourage the deception of customers…
The second proposal is to end the greatest cheat of all – the implicit subsidies received by the largest financial institutions, structured so as to encourage excessive and irresponsible risk-taking. These consequences of these subsidies have already caused massive macroeconomic damage – this is why our crisis in 2008-09 was so severe and the recovery so slow. Yet we have made painfully little progress towards really ending the problems associated with some very large financial firms – and their debts – being viewed by markets and policymakers as being too big to fail.
Warren also hits important targets forcefully in her speech. She attacks the Department of Justice for its failure to take cases against big financial institutions to trial or to pursue their executives and managers who engage in fraud. She singles out the SEC as an even worse actor. She criticizes both agencies for entering into “cost of doing business” settlements as opposed to calling for (at a minimum) full disgorgement of their ill-gotten gains (the problem here, of course, is that both agencies tend to pursue only isolated examples of bad conduct, such as the SEC’s settlement with Goldman on only “Abacus” CDO out of a program of 25).
I hope readers will support Warren’s efforts. Her campaign will put a spotlight on the fealty of both parties, but particularly Hillary Clinton, to major financial players, and will expose inconsistencies between their messaging and their actual loyalties. It also serves to undermine the banking industry’s pretense that the crisis is over and nothing more needs to be done, when the Fed remains backed in a negative real interest rate corner that is a large, ongoing subsidy to trading and speculation, the very sort of activities that have been identified as negative from the perspective of economic growth.
But while I endorse Warren’s initiative, I feel compelled to highlight why it falls short. The notion that removing subsidies will end the “too big to fail” problem is misguided. Notice how Warren and her backers maintain that they are trying to make markets work better. Yet one big problem with our current system is that so much financial services activity has been moved off bank balance sheets into financial markets. During the crisis, the authorities didn’t bail out firms because they were too big to fail; they bailed them out because they were critical players in markets deemed too big to fail. Virtually no one would have deemed Bear Stearns to be systemically important prior to its rescue. So why was it salvaged? It was a big player in credit default swaps, and also a prime broker, meaning a large lender to hedge funds. Similarly, why did Federal and state banking regulators paper over the mess of mortgage chain of title, refuse to fix servicing (none of those firms remotely approached TBTF size), punt on securitization reform, and enter into an appalling “get out of liability almost free” Federal/49 state mortgage settlement? Because the officialdom deemed the mortgage backed securities market to be too big to fail.
The underlying problem is that in the US and far too many economies around the world, growth in private debt, particularly household debt, served to shore up stagnant worker incomes. But high household debt levels are actually a dampener over the longer term to growth. Yet the officialdom sees consumer relevering as positive and resisted the sort of widespread debt reduction and restructuring that could have set the financial services industry and consumers on a sounder footing.
As long as we have a market-based credit system, those markets, and the critical actors in those markets, will continue to be too big too fail. Recall that the comparatively modestly sized Bank of New York Mellon is also a “too big to fail” player by virtue of its role in clearing and tri-party repo. And rather than fix mortgage securitization, that market has instead been put on government life support via the fact that over 90% of residential mortgage issuance is now guaranteed by the Federal government.
So don’t kid yourself that removal of subsidies will do the trick. The officialdom will ride into the rescue if markets or institutions deemed to be essential start looking wobbly. Removal and reduction of subsidies needs to be accompanied by prohibition, particularly of low societal value/high risk activities like many over-the-counter derivatives. Regulators need to reject complexity and opacity. If they don’t understand a product and its risks thoroughly, they should not allow it to be offered. And that prohibition has to extend to lending or even taking anything more than trivial counterparty risk to firms that create or trade those products.
But this is a case where having Warren put serious financial reform back on the agenda opens up the topic of what is wrong with our current financial system up again for badly needed scrutiny. And instilling more spine in regulators would be a big step forward. So I hope you’ll press your Senators and Representative to join Warren’s campaign. It’s time to start taking ground back from an oversized, papered, and too often predatory industry.