President Barack Obama met with his financial regulatory chieftains on Monday, and I got the distinct impression that something was on his mind. See if you can figure it out.
“The laws we have passed have worked,” Obama said, referring to the Dodd-Frank Wall Street reform legislation. “I want to emphasize this because it is popular in the media, in political discourse—both on the left and the right—to suggest that the crisis happened and nothing changed.” About three minutes later, he reiterated, “So I want to dispel the notion that exists both on the left and on the right that somehow, after the crisis, nothing happened.” And later, Obama hit that point again: “So when you read articles, whether on the left or the right, that suggest somehow nothing happened and everybody just went back to the same go-go years that they were engaging in before, those are factually incorrect.”
Looks like somebody didn’t like the ending to The Big Short!
Obama’s frustration probably springs from the fact that the Democratic presidential primary has become a referendum on Wall Street’s influence on politics and the economy—and with 100 percent of precincts reporting, “negative influence” won in a landslide. Senator Bernie Sanders based his entire campaign on antipathy to the banks, and Hillary Clinton has scrambled to argue that her plan to crack down on the financial sector is stronger and more comprehensive. Both believe that more needs to be done to make the system safer and fairer, which is enough to drive to distraction a president who describes Dodd-Frank as the most sweeping financial reform in 80 years.
Obama’s anger should be reserved for Sanders and Clinton, not nameless article-writers and discourse-mongers on the “left.” Nevertheless, as one of those perfidious article-writers, I could perhaps explain to the president why people credibly believe “nothing happened” to disrupt Wall Street, and why stressing that actually bodes well for the future of financial reform.
Take the examples Obama gave to prove the utility of Dodd-Frank. “We have seen banks that now have much greater capital,” Obama said, referring to the $700 billion available to absorb losses in the event of a crisis. It’s worth noting that none of that is due to Dodd-Frank, which includes no statutory levels of capital, only a minimum floor that the Obama administration worked very hard to eliminate, as explained at length in Sheila Bair’s book Bull By the Horns. International banking regulators designed the capital mandates, and the Federal Reserve decided to push them up further at their discretion. Dodd-Frank added no new discretionary authorities on capital; in fact, regulators were talking about increasing them well before Dodd-Frank passed.
But more importantly, how do we know for sure that the additional capital in the banking system will be sufficient in a crisis? We haven’t had a crisis yet to check this proposition, and all the stress tests in the world wouldn’t have envisioned 2008.
Obama’s defense of Dodd-Frank is similar to how defenders of welfare reform reacted in the early years of its implementation, concurrent with the best economic expansion in three decades. They said that the late 1990s “proved” that welfare reform works, when the true test would only come when the poor really needed assistance. During the Great Recession, we finally learned that welfare reform was a miserable failure for growing numbers of poor Americans.
Dodd-Frank suffers from the same problem. Since most of the law was designed to secure the system during a crisis rather than prevent that crisis from occurring, we cannot hypothesize about its effectiveness until that crisis hits. And since the basic structure for banks to take huge risks and connect them across the financial system remains in place, a crisis appears inevitable. The industry has naturally exercised caution after an epochal event like 2008. But Wells Fargo recently ramped up its trading of credit default swaps, a financial instrument that magnified the housing bubble collapse. Even though executive bonuses fell, the average salary for securities traders hit a new record in 2015, and executive compensation rules to discourage risk-taking remain unwritten nearly five years after the due date, something even Obama referred to yesterday.
Yet nearly all Obama’s examples of successes in Dodd-Frank refer to crisis response. He touted the new process for unwinding banks in an orderly fashion if they fail, without taxpayer support—but we haven’t had to use that yet. He talked about adding derivatives clearinghouses, “so that we know if and when somebody is doing something that they shouldn’t be doing,” without explaining if that’s happening now. (Incidentally, derivatives traders have skillfully avoided clearinghouses by pushing billions in trades overseas, and the U.S. only struck a deal with Europe to create common global rules three weeks ago, so I don’t share the president’s confidence.)
Outside of the Consumer Financial Protection Bureau, which actively polices markets, Dodd-Frank mainly concerned itself with mopping up in the aftermath. Until we reach that point, those worried that the law won’t work have an obligation to speak up about it, in pointed terms. In fact, such disagreement happens to be the proven method for forcing regulators to go further.
Take the previous discussion on capital. Why has this been such a successful element of the post-financial crisis regulatory framework? Because there’s been an bipartisan group of dissenters who made clear that capital requirements needed to be much higher. You have academics on the left like Anat Admati and on the right like Arnold Kling, condemning initial capital standards as inadequate and demanding more. They made this particular piece of regulation vital, and got results.
In other words, suggesting that nothing happened after the crisis was part of the process to strengthening the reform. For all of Obama’s anger at this suggestion, at one point he understood this. Obama has often repeated in his campaigns the story of Franklin Roosevelt telling civil rights organizer A. Phillip Randolph, “I agree with everything you have said. Now, make me do it.” On capital requirements, individuals on the outside made the regulators do it. Obama’s playing his role, and the activists, theirs.
Finally, the real reason people are disinclined to believe that Obama made financial regulation stronger is that they never saw a banker in handcuffs headed to jail. I know law enforcement and regulation aren’t precisely equivalent, but letting fraud go unpunished created a rot at the heart of our democracy, and made any claim about deterrents to another meltdown suspicious. Obama said on Monday, “When there’s a perception that nothing happened, that that feeds cynicism that actually weakens our ability then to make further progress.” He fails to realize that his administration’s failure to prosecute Wall Street’s worst offenders contributed greatly to that cynicism.