13 Bankers: The Wall Street Takeover and the Next Financial Meltdown (40 page)

The missed opportunity is that the financial reform bill does too little to weaken the dominant economic and political power of the largest banks. The SAFE Banking Amendment, proposed by Senators Sherrod Brown and Ted Kaufman, would have imposed strict size limits on banks similar to those we argued for in
chapter 7
. Despite having no support from the congressional leadership or the Obama administration, it improbably made it to a vote on the Senate floor, losing 61–33. “If enacted, Brown-Kaufman would have broken up the six biggest banks in America,” a senior Treasury official said to journalist John Heilemann. “If we’d been for it, it probably would have happened. But we weren’t, so it didn’t.”
²⁰

Instead of breaking up the largest banks, the administration and its congressional allies settled for a version of the “Volcker Rule,” named after former Federal Reserve chair and Obama administration adviser Paul Volcker, which aimed at preventing banks from engaging in proprietary trading or sponsoring hedge funds or private equity funds. However, the version that was finally written into the bill contains enough exceptions that even Volcker himself was reportedly disappointed with it.
²¹
A stronger version proposed by Senators Jeff Merkley and Carl Levin (and supported by Volcker)
²²
was kept off the floor in a last-minute procedural maneuver.
²³

Instead of preventing banks from being too big to fail, Dodd-Frank gave regulators new resolution authority to protect the financial system from a collapsing financial institution in a crisis, hoping that fear of being “resolved” would be enough to deter financial institutions from taking excessive risks in the first place. While this is better than nothing, it is highly improbable that authority granted to U.S. regulators over U.S. institutions will be sufficient if a major global bank with subsidiaries in many countries is about to fail. The bill also gives regulators new weapons they can use against big banks, if they so choose. These include the ability to set higher capital requirements for the largest, most important financial institutions, as well as the Kanjorski Amendment (discussed in
chapter 7
), allowing regulators to force banks to shrink if they pose a risk to the financial system. But whether those weapons will ever be used remains a big question mark.

Just as it had a year earlier when it summoned thirteen bankers to Washington, the Obama administration decided to stick with the banks and the bankers it knew. This decision was not born of corruption, influence peddling, or even any love for the banks. By the middle of 2010, both Barack Obama and Tim Geithner were fed up with an industry that repaid all their efforts to save the major banks—and the bankers’ jobs—with all-out attacks in the back rooms of Capitol Hill.
²⁴

But that decision was born of a belief that America needed the financial system it had, with an oligarchy of megabanks at its pinnacle. Ultimately, the administration agreed with Jamie Dimon that big banks were crucial to the health of the economy and decided it could not live without them. Instead of changing the financial system, the Dodd-Frank Act places its faith in the idea that regulators, armed with additional, sorely needed powers, could constrain its excesses and prevent it from once again torpedoing the global economy.

As we said above, the financial reform bill was a step forward. Doing nothing would have left us with the same financial system that gave us the recent crisis, now even more concentrated and even more emboldened by its ability to call on government support to survive. But Dodd-Frank is not enough. At its core it is a bet on smarter, better regulation—yet it does too little to change the balance of power between Wall Street bankers and Washington officials that was the dominant factor in recent U.S. financial history. The financial sector still has the power to unleash torrential floods of money into the political process. The debate over financial issues is still dominated by people who come from or are going to Wall Street. And the ideology of finance—the idea that behemoth banks peddling increasingly incomprehensible products are somehow good for ordinary people—though shaken, remains dominant in Washington.

On the one hand, it is hard to escape the feeling that we will return to business as usual. In July 2010, only a few days before President Obama signed the Dodd-Frank Act into law, the SEC dropped its charges against Goldman Sachs as part of a settlement agreement. Goldman acknowledged that its marketing materials “contained incomplete information” and that not disclosing Paulson’s role in designing the synthetic CDO was a “mistake,”
²⁵
yet insisted that it was not admitting the SEC’s allegations.
²⁶
Goldman also agreed to pay a fine of $550 million—the largest penalty ever paid by a Wall Street firm, yet only a fraction of the $3.5 billion in profits the bank had earned in just the first three months of 2010.

And while the job of financial reform remains unfinished, it is not clear who will finish it. Not only do bankers have the incentive to seek short-term profits and ignore long-term risks; politicians also have the incentive to pretend that all is well in the short term and hope the next financial crisis will happen on someone else’s watch. The Republican line is that Dodd-Frank is excessive government intrusion into the private sector; the mainstream Democratic line is that Dodd-Frank is the best possible solution. There is no powerful constituency for far-reaching structural reform of the financial system.

But on the other hand, the fight is far from over. The Dodd-Frank Act, though imperfect, marked the end of over three decades of deregulation and nonregulation of the financial sector. As with the Sherman Antitrust Act of 1890, legislation can play a significant role in changing the mainstream consensus. Wall Street’s apologists still sing the praises of free market fundamentalism and unfettered financial innovation, but their accustomed air of inevitability and triumphalism is gone. The American public has become deeply skeptical of financial machinations they cannot understand, and many of them have invested untold hours in learning how the financial system works and whom it benefits.

We are perhaps at a pivotal moment in the battle between Jefferson and Hamilton. Hamilton remains ascendant, but his perch appears shaky and his view of finance has been discredited. What happens next will depend, improbably enough, on people like you. We can sigh with relief that the financial crisis is over and go back to our uncomprehending admiration for the fabulously rich men and women of Wall Street. Or we can continue to demand a financial sector that serves the interests of ordinary people and the real economy. In our democratic system, the political establishment, though slowly and very imperfectly, reflects the will of the people. It is there that the rest of this story will play out.

—Simon Johnson and James Kwak, September 2010

*
The manuscript of the first edition of
13 Bankers
was submitted in December 2009 and finalized in January 2010, after a version of the financial reform bill passed the House of Representatives but before formal debate began in the Senate. The first edition was published in the United States in March 2010, in the midst of the Senate debate.

Notes

EPIGRAPH

1.
F. Scott Fitzgerald,
The Great Gatsby
(New York: Scribner, 2004), 179. This quotation was used by Bill Moyers to introduce his program on September 19, 2008, the week that Lehman Brothers filed for bankruptcy and AIG was bailed out by the Federal Reserve.
Bill Moyers Journal,
September 19, 2008, transcript available at
http://www.pbs.org/moyers/journal/09192008/transcript4.html
. It was recommended to us by Graham Smith.

INTRODUCTION

1.
Quoted in Eamon Javers, “Inside Obama’s Bank CEOs Meeting,”
Politico,
April 3, 2009, available at
http://www.politico.com/news/stories/0409/20871.html
. Also confirmed by ABC News. Rick Klein, “Obama to Bankers: I’m Standing ‘Between You and the Pitchforks,’ ” The Note Blog, available at
http://blogs.abcnews.com/thenote/2009/04/obama-to-banker.html
.

2.
Stock market data are based on the S&P 500 index. Job losses are from Bureau of Labor Statistics,
Current Employment Statistics,
available at
http://www.bls.gov/ces/
.

3.
World output was 2.7 percent lower in Q1 2009 than in Q1 2008; this was the lowest year-over-year figure during the recent global recession. International Monetary Fund,
World Economic Outlook, October 2009: Sustaining the Recovery
(Washington: International Monetary Fund, 2009), 2, available at
http://www.imf.org/external/pubs/ft/weo/2009/02/
.

4.
“List of Bank CEOs Meeting with Obama at the White House,” Real Time Economics Blog,
The Wall Street Journal,
March 27, 2009, available at
http://blogs.wsj.com/economics/2009/03/27/list-of-bank-ceos-meeting-with-obama-at-the-white-house/
.

5.
Obama, Gibbs, and Pandit were quoted in Eric Dash, “Bankers Pledge Cooperation with Obama,”
The New York Times,
March 27, 2009, available at
http://www.nytimes.com/2009/03/28/business/economy/28bank.html
. Stumpf was quoted in Jonathan Weisman, Damian Paletta, and Dan Fitzpatrick, “Bankers, Obama in Uneasy Truce,”
The Wall Street Journal,
March 28, 2009, available at
http://online.wsj.com/article/SB123816459546857301.html
.

6.
Javers, “Inside Obama’s Bank CEOs Meeting,”
supra
note 1.

7.
Elizabeth Williamson and Damian Paletta, “Obama Urges Bankers to Back Financial Overhaul,”
The Wall Street Journal,
September 15, 2009, available at
http://online.wsj.com/article/SB125292937349508441.html
.

8.
Alan Greenspan, “Current Monetary Policy” (lecture, Haskins Partners Dinner of the Stern School of Business, New York University, New York, May 8, 1997), available at
http://www.federalreserve.gov/BoardDocs/Speeches/1997/19970508.htm
.

9.
On Brooksley Born, see Rick Schmitt, “Prophet and Loss,”
Stanford Magazine,
March–April 2009, available at
http://www.stanfordalumni.org/news/magazine/2009/marapr/features/
born.html
; Manuel Roig-Franzia, “Credit Crisis Cassandra: Brooksley Born’s Unheeded Warning Is a Rueful Echo 10 Years On,”
The Washington Post,
May 26, 2009, available at
http://www.washingtonpost.com/wp-dyn/content/article/2009/05/25/AR2009052502108.html
; and “The Warning,”
Frontline
(PBS television broadcast October 20, 2009), available at
http://www.pbs.org/wgbh/pages/frontline/warning/
.

10.
Frank Partnoy,
F.I.A.S.C.O.: Blood in the Water on Wall Street
(New York: W. W. Norton, 2009), 59. For another account of the derivatives industry, see Satyajit Das,
Traders, Guns and Money: Knowns and Unknowns in the Dazzling World of Derivatives
(Harlow, England: Prentice Hall, 2006).

11.
Bank for International Settlements,
Semi-Annual OTC Derivatives Statistics,
available at
http://www.bis.org/statistics/derstats.htm
.

12.
Quoted in Frank Partnoy,
Infectious Greed: How Deceit and Risk Corrupted the Financial Markets
(New York: Henry Holt, 2004), 163.

13.
Alan Greenspan, “Government Regulation and Derivative Contracts” (lecture, Financial Markets Conference of the Federal Reserve Bank of Atlanta, Coral Gables, FL, February 21, 1997), available at
http://www.federalreserve.gov/BoardDocs/Speeches/1997/19970221.htm
.

14.
Quoted in Roig-Franzia, “Credit Crisis Cassandra,”
supra
note 9. Summers declined to comment for the Roig-Franzia article. See also interview with Michael Greenberger,
Frontline,
July 14, 2009, transcript available at
http://www.pbs.org/wgbh/pages/frontline/warning/interviews/
greenberger.html
. Born declined to provide details of her conversations with other government officials. Interview with Brooksley Born,
Frontline,
August 28, 2009, transcript available at
http://www.pbs.org/wgbh/pages/frontline/warning/interviews/born.html
.

15.
Commodity Futures Modernization Act of 2000,
106th Cong., 2nd sess., Senate Rep. 106-390, available at
http://thomas.loc.gov/cgi-bin/cpquery/?&sid=cp106s5nKF&refer=&r_n=sr390.106
&db_id=106&item=&sel=TOC_42836&
.