Financial reform will fail if industry writes the rules. Robert Kuttner
Liberals cheered when Elizabeth Warren was appointed interim director of the new Consumer Financial Protection Bureau after a long internal fight. The bureau, which Warren first proposed in 2007, is one of the more expansive innovations of the financial-reform law known as the Dodd-Frank Act.
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The miracle of Dodd-Frank is that it got stronger as it moved through the process. The question now is whether that forward momentum will be reversed. Because the factions in the executive branch mirror those in Congress, it's worth looking back at the legislative story.
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Reformers ultimately prevailed on a few key issues, including tough regulation of financial derivatives, the Volcker Rule, and Warren's consumer protection agency, while the moderates and their Wall Street allies were able to block other proposals outright, such as breaking up the big banks. But time after time, to gain the support of key swing votes, the bill's managers had to punt details to the executive branch
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The premise behind the Volcker Rule, like Glass-Steagall before it, is that there is a fundamental difference between commercial banking and investment banking. Commercial banking requires detailed local knowledge and patience. Nobody gets filthy rich lending to ordinary businesses. Investment banking, by contrast, is a trading culture. You don't need to know much about the underlying business if you have a feel for doing deals and reading market trends and can make a quick fortune. In the old days, investment bankers took these risks with their own money. Since the repeal of Glass-Steagall, giant outfits like Citigroup and Bank of America do both kinds of activity, putting their customers at risk and the taxpayer on the hook.
The counterweights to the Treasury and the Fed include not just other regulatory agencies but the legislators who wrote Dodd-Frank. "If we consider our jobs done and walk away on this, it would be over," says Sen. Merkley, who co-authored the Merkley -- Levin amendment drastically limiting proprietary trading by federally insured banks. Without vigilant congressional oversight, Merkley adds, regulators tend to take the easiest course. "The regulators hear from lobbyists every day telling them how and why to weaken the Merkley-Levin protections and many other parts of the Dodd-Frank Act."
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Though Dodd-Frank gives government new powers to protect against flagrant abuses, the core business model that crashed the system is still basically intact. As economists Jane D'Arista and Gerald Epstein observe in a recent paper for the Roosevelt Institute, the biggest banks are still dangerously dependent on short-term borrowing and high leverage to finance the trading activities that account for nearly all of their net profits. This business model explains the fierce industry pushback against tough rules. "
Dodd-Frank is a lot better than many of us feared," Damon Silvers says. "The risk is that the most promising aspects of this bill will never be used."
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