News & Politics

Why Every Aspect of Dems' Handling of Wall St. Overhaul Seems Headed for Disaster

It's not just Dodd's collapse on the Consumer Protection Agency -- it's the whole financial reform enchilada.

For Senate Banking Committee Chairman Christopher Dodd, D-Conn., retirement probably can't come soon enough. After the latest round of compromises, capitulations and castrations of the Senate financial reform bill, it's looking increasingly clear that Dodd is simply no longer willing to fight for real reform, assuming he ever was to begin with.

Dodd's latest effort at creating a new Consumer Financial Protection Agency would render the regulator utterly powerless, but it's not the only issue Democrats appear willing to sacrifice to Wall Street campaign contributions. Right now, just about every other major element of the so-called Wall Street overhaul seems headed for disaster.


The drama currently swirling around the creation of a new Consumer Financial Protection Agency has captured the most public attention. With passionate support from progressives and widespread approval among the general public, the establishment of some kind of new consumer agency has been certain since President Barack Obama proposed it in June 2009. But the bank lobby and Republicans are fiercely opposed to creating a new agency that goes to bat for consumers, not bankers. Since June, we've been waiting to see whether Democrats had the spine to make sure the final agency would actually do something, or quietly gut reform with a barrage of loopholes.


What we need is a prominent, independent agency with its own budget and the ability to both write and enforce strong rules. In essence, Congress needs to take every consumer protection power the Federal Reserve currently wields, and give it to a new agency that won't ignore abuses in the name of bank profits. Sadly, in a misguided effort at bipartisan hand-holding, Dodd appears to have abandoned this vision.


Dodd actually offered two separate proposals in the past few days. Last week he suggested housing the new consumer agency—dubbed the Bureau of Financial Protection in Dodd's language—within the Treasury Department, where it would have to consult with other bank regulators before issuing rules. Treasury? The place that shoved trillions of dollars into Wall Street's rapacious mouth after it nearly over-leveraged itself into oblivion? We already know where Treasury stands in conflicts between bank balance sheets and the public.


But on Monday, Dodd managed to make his proposal even more ludicrous. Instead of Treasury, Dodd now wants to house the new consumer regulator at the Fed. That's right, the same Fed that refused to regulate subprime mortgages, credit card abuses, reckless commercial real estate speculation and just about every kind of arcane, non-transparent and speculative banking activity, that has wreaked havoc on the American economy over the past decade. We'd almost be better off with some rotating committee that pays rent to convene at the various different banks' headquarters.

If we're going to go the route of finding a home inside a home, at least go for the Department of Justice so fraud indictments can be made easier. But Dodd obviously is no longer interested in justice, at least where Wall Street is concerned. He'd even bar the new consumer agency from enforcing the rules it writes, allowing the same regulators who dropped the ball for 30 years to keep dropping it. The strongest rule in the world doesn't mean a thing if nobody will enforce it.

If Dodd moves ahead with a CFPA that can't enforce rules, he's given up on consumer-oriented reforms at the committee level, without even forcing Republicans to vote for a real bill on the Senate floor. There is simply no excuse for that. But the bungling of Wall Street reform goes far beyond CFPA. After the most expensive bailout in history, protecting our economy from reckless banking—consumer-related or otherwise—shouldn't be a partisan issue. Anybody who doesn't want to see trillions of taxpayer dollars dumped into the banking system again should be on board.

The massive bailout supported a system that created $14 trillion in securities on the back of just $1.4 trillion worth of actual subprime loans. Banks borrowed by an average of 10 to 1 on the back of those $14 trillion of securities, brewing a toxic cocktail of credit derivatives in the process. The consumer fixes are important, but they only address those original $1.4 trillion in loans. What if Wall Street had binged on commodities or corporate bonds or the future of Greece instead of houses? Let's take a moment to review the issues that should be core reforms:


Who gets to have the most power over regulating the biggest banks?

At the moment, that remains the Fed. Dodd's bill would ostensibly create a council of supervisors to sit around pontificating about growing risks to the overall financial system, but the council is comprised of the same regulators that not only missed the housing bubble, they are blissfully unaware of the current risk posed by 2009's batch of federally subsidized record bank profits. The Fed would maintain its existing authority to police our banking behemoths, despite its total failure to regulate prior to this economic crisis.

Since the Fed retains the authority to bless mergers (think J.P. Morgan Chase-Bear Stearns-Washington Mutual, Bank of America-Merrill Lynch and Wells Fargo-Wachovia), and the Fed gets to create non-transparent loan facilities to help the big banks whenever it feels like it, the Fed would remain fully empowered to let banks take bigger risks and saddle taxpayers with the bill if they don't pan out.


The Fed should stick to setting interest rates. Regulating the biggest banks should be under the domain of the FDIC, which has a strong record of protecting depositors and taxpayers at smaller banks. The FDIC manages the fund that backs deposits, so it gets in serious trouble if a big bank fails and wipes out that fund. It has stronger institutional incentives to rein in wild banks. Needless to say, we also need a strong, independent CPFA, to make sure consumers are dealt with fairly, but more importantly expand upon those protections to curtail the very lucrative business of securitizing those consumer products from which banks extract mega-fees before the related toxicity becomes our bill.

Will the biggest banks engage in the riskiest trading and speculative securities gambling?

They already are. The record profits (and bonuses) made by the banking system in 2009 were made possible by two things: 1) the cheap funding provided by the federal government; and 2) trading division revenue. Banks lost money in their consumer-oriented businesses due to rising defaults, delinquencies and foreclosures (which in many cases haven't even been properly accounted for) and they certainly didn't attempt  to use their federal money for lending purposes, even to proven, prudent borrowers. Why bother? The trading profits they disclosed came not from their proprietary books (which would only be partially dealt with under the Volcker rule Obama has proposed), but in their "client-related" trading books. That trading increased systemic risk.


Meanwhile, inane accounting rules enacted in 2008 make it very easy for banks to assign almost any value of their own choosing to their least liquid (read: most toxic) trades, instead of requiring banks to account for these "assets" at the price the market would actually pay for them. This means that trading profits are the kinds of profits most likely to be improperly manipulated.


Any good reform bill should restrict the percentage of all trading revenue, not just proprietary trading revenue, within any bank that receives any kind of federal funding.


Will the derivatives and multi-layered securitization markets remain largely intact?


Despite ongoing debates about which derivatives will have to trade on regulated exchanges and which won't, so far, Congress has kept the most offensive securities in the realm of the unregulated.


There isn't anything in the bill that strictly limits the amount of fabricated debt that can be packaged into a security with solid collateral. Part of Wall Street's big derivatives con was to slice and dice actual mortgages on an actual home into complex securities. But then clever investment bankers realized they could slice and dice the securities themselves, not just mortgages, into second-order securities called "collateralized debt obligations" (CDOs). Many took the scam even further, slicing and dicing CDOs into "CDOs squared" to the point where traders weren't betting on housing anymore, but pure speculative confidence.

Dodd does nothing to limit this fantasy finance. Today, there is a growing market for "distressed assets" – re-packagings of all the toxic crap bankers lost money on in the fall of 2008 into complex "new" securities. Without real reform, these assets could blow up anew at any time.


Will banks be Glass-Steagallized, or remain unnecessarily big and complex?

A number of senators have spoken out in favor of a solid barrier between banks that deal with the public through taking deposits and making loans, and banks that package and trade securities. These include Senators Bernie Sanders, D-Vt., Maria Cantwell, D-Wash., John McCain, R-Ariz. and most recently adding his voice, Senator Ted Kaufman, D-Delaware.

Congress created Glass-Steagall to protect the entire general economy from banking recklessness in 1933, and Congress killed Glass-Steagall in 1999. Now it's time for Congress to resurrect it. This is not a matter of Depression-era nostalgia (I wasn't around at the time and I'm sure many of you weren't either). It's a matter of simple economic prudence and practicality.

Since the repeal, banks have consolidated, becoming bigger and inherently more systemically dangerous. Bank that had deposits and loans could use them to back more speculative businesses, while enjoying access to the Fed for cheap money if they found themselves in a bind, and the FDIC to back their more solid base of deposits.

Post-repeal, banks found themselves competing to borrow as much money as possible to back the riskiest and most speculative aspects of finance, since those activities scored the most profit in the short-term. The result of these bank wars was a massively risky system that collapsed in late 2008. After the rescue, the big banks are bigger, extracting more money from trading with access to deposits and the Fed, and able to raise money more cheaply based on the presumption of further government bailouts. Even the planned "resolution mechanism" to help unwind failing banking behemoths can't undo those unfair (and unsafe) competitive advantages.

This is unacceptable and economically moronic. Dissecting the landscape and dividing boring banks from wild securities firms will do more to protect the public's money and do more to rein in Wall Street stupidity, greed and entitlement than any other reform measure. 

Dodd is leaving the Senate after this year. He could get behind real reform and secure a meaningful place in the history books as an important statesman, or continue to wimp out for Wall Street, pull a Robert Rubin and secure a cushy job in banking come 2011. The next few months will indicate whether Dodd cares more about his legacy than his wallet.

Nomi Prins is a senior fellow at the public policy center Demos and author of It Takes a Pillage: Behind the Bailouts, Bonuses, and Backroom Deals from Washington to Wall Street.
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