Are We Still on the Hook for Wall Street’s Screw-ups?

Reinstating federal insurance for risky Wall Street swap deals bothers Cornelius Hurley (right), but Mark Williams shrugs it off. Williams photo by Vernon Doucette; Hurley photo courtesy of the BU Center for Finance, Law & Policy

Ever since the market crash of 2008, observers of Wall Street have blamed the crisis largely on risky and little-understood financial transactions. Congress responded with the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, aimed at reining in many of the practices of big finance.

But hold the applause. The industry still has plenty of backers in Congress, and their battles with reformers have been noisy of late. December’s budget agreement scotched Dodd-Frank’s requirement of Federal Deposit Insurance Corporation insurance for banks doing certain risky”swaps” deals. Progressives, angered by that part of the budget agreement, managed to derail the nomination of Antonio Weiss, President Obama’s choice for a Treasury undersecretary job, largely because of his investment banking career.

Meanwhile, a leader of the opposition in both cases, Senator Elizabeth Warren (D-Mass.), wants to resurrect parts of the Glass-Steagall Act, the Depression-era law preventing joint ownership of both commercial and investment banks.

Are the reformers on the right track? Two BU experts who also are former government regulators see some of these matters very differently. Cornelius Hurley, director of the Center for Finance, Law & Policy, is a self-described moderate Democrat who is wary of Wall Street. He was assistant general counsel for the Federal Reserve’s board of governors in Washington, D.C., responsible for the Fed’s international banking regulation. Hurley is a professor of the practice of banking law at the School of Law.

Mark Williams (GSM’93) was a Federal Reserve examiner and also worked as an energy trading company executive. An executive-in-residence and master lecturer at the School of Management, he says his thinking has evolved since he called for tightening federal financial regulation in his 2010 book, Uncontrolled Risk. He now says that “well-intended regulation has turned into regulatory burden.” Both he and Hurley offer their views on what to do about Wall Street.

BU Today: Is repealing the financial reform provision a bad idea?

Williams: Repealing the provision was not a bad idea. Since the 2010 financial reform, capital standards and the amount of capital held on bankbooks have skyrocketed. Banks today are much safer than a decade ago. Stronger, highly capitalized banks should have more leeway to trade risky derivatives. Moreover, all derivatives are not risky, but are used to hedge risk. To simply label trading of derivatives off-limits to all insured banks is counter to strong risk management practices.  

Hurley: About 95 percent of the market for swaps activities is done by five banks, including Citi, JPMorgan Chase, and Wells Fargo. Those five lobbied against that provision because swaps are subsidized: these are risky activities; if you have a safety net, like the taxpayers, under it, you can charge a higher cost for it, and you make more money. But we’ve seen this movie before, in 2008. Repeal is a bad idea, unless you happen to be JPMorgan Chase.

How serious a blow to financial reform was the repeal?

Williams: Repeal was not a significant blow. Meaningful reform has already happened: a new Consumer Financial Protection Bureau, regulators’ expanded role over derivatives, greater SEC scrutiny, and higher capital limits. The top six biggest US banks now hold more capital than ever before.

Hurley: This is not the end of financial reform. In fact, there is a hidden benefit here, in that the banks have overplayed their hand. From the beginning, all the reform efforts have not gone at the taxpayers’ subsidy. The Federal Deposit Insurance Corporation has to calculate how repeal affects the actuarial soundness of its fund.

Should Antonio Weiss have been confirmed?

Williams: This “bankers need not apply” mentality when evaluating potential candidates for critical governmental oversight positions is a very disturbing trend and needs closer scrutiny. In filling key government positions, shouldn’t the main criteria be integrity-, experience-, and competency-based? If we are blindly excluding those that understand Wall Street, how can we effectively oversee Wall Street? Warren was able to successfully derail an extremely qualified candidate. Was this done to further her personal political aspirations at the expense of a strong Treasury operation?

Hurley: He should have been rejected. The last White House and this White House were controlled by the Citibank and Goldman Sachs interests and not by Main Street interests. I’m sure he’s a wonderful fellow, but he was a major campaign bundler for Obama. He wouldn’t be offered this position if he were not. He was a critical player in these inversions, where US companies relocate overseas. We don’t need any more Wall Street wise guys in the Treasury Department.

Do you think more financial reforms will be repealed or gutted by the new Republican Congress in 2015?

Williams: Regardless of which party has control of Congress, the sheer size and scope of Dodd-Frank make it a big target. Dodd-Frank consists of over 2,300 pages and 398 rules to be promulgated by various regulatory agencies, leaving a lot of room for vulnerabilities, flaws, redundancies, and inability of regulators to effectively interpret or enforce the rules. In this environment, special interests will pick their target rules to dismantle.

Hurley: The core belief of the Tea Party is anti–big government, anti–big corporations. They have exercised the anti–big government belief exclusively. They have ignored their anti–big business side. Establishment Republicans will defend the big banks, but the more ultraconservative Tea Party Republicans may well wake up and say, we want to do away with these too-big-to-fail banks. We want to break them up.

Is reinstating Glass-Steagall a good idea? And do you think it will pass?

Williams: It is virtually impossible to put the toothpaste back into the tube. The original Glass-Steagall Act was first implemented in 1933 as a fix to weak banking practices that triggered the Great Depression. In the last 80 years, banking services and activities have changes dramatically. The derivative trading industry born in the 1980s is now multitrillion-dollar in size. Moreover, most of the largest commercial banks also have investment banking arms that help to diversify revenue. If such activities were banned, monoline financial firms could theoretically pose greater bankruptcy risk. Banking is also substantially more global today, and imposing a Glass-Steagall 2.0 on our biggest banks would put them at a marked competitive disadvantage, costing revenue and US jobs.

Hurley: It won’t pass, and it shouldn’t pass, because it’s arbitrary. It worked in a much simpler world. Now banks are so interconnected—their products, their services, their people. As opposed to Elizabeth Warren’s approach, my approach—it’s been introduced to Congress by Congressman Michael Capuano (Hon.’09) (D-Mass.)—says each of the too-big-to-fail banks has to create a line item on its balance sheet showing the taxpayers’ subsidy. You add each year’s subsidy to it. In short order, that subsidy reserve will be enormous. It will not be very long before shareholders and boards of directors say, wouldn’t we be better off if we monetize that reserve for shareholders by divesting some of our risky business units?