Too Big to Jail?
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Capital City

Three years after the biggest bailout in US history, Wall Street lobbyists don't just have influence in Washington. They own it lock, stock, and barrel.

Their defense against the taxman is something called the carried interest rule, and it's elegant in both its simplicity and its shamelessness: It simply declares their compensation to be capital gains, not ordinary income. That means it gets taxed at 15 percent instead of 35 percent.

At first, it's hard to figure out how they get away with this. After all, capital gains are the profit you make on money of your own that you invest. But hedge fund managers invest other people's money and get paid a piece of the action. By any customary definition, this is ordinary income, the same as a sports agent taking his 10 percent or a CEO whose bonus depends on performance.

But enough money can buy you a defense of the indefensible. "If you get Chuck Schumer on your side, you are okay," one former SEC official told the New York Times, and that's exactly what the finance lobby has done. The New York Democrat is a member of both the Senate Committee on Finance and the Senate Committee on Banking, Housing, and Urban Affairs, and he's received so much money from Wall Street over the years—more than $14 million—that he actually shut down his personal fundraising efforts between 2005 and 2008. Since then he's raised a staggering $284 million for the Democratic Senatorial Campaign Committee, which he headed until recently, and much of it has come from Wall Street. In June 2007 alone, when lobbying for the carried interest rule reached a fever pitch, employees of private equity firms contributed nearly $800,000 to the DSCC.

It was money well spent: Schumer agreed to support a repeal of the rule only if taxes were also raised on things like venture-capital and real-estate partnerships, a stand that guaranteed resistance from enough interest groups to let the hedge funds' special treatment survive unscathed. A million-dollar investment had allowed the hedge fund industry to keep a billion-dollar loophole. Not a bad return.


A Flock of Scandals
Congress isn't the only place that draws the finance lobby's attention. When the Federal Reserve was created in 1913, it was designed to be an independent agency. But that only means that it's technically independent from Congress and the president. It's not independent from the finance lobby.

Just the opposite. The 12 regional Federal Reserve Banks—including the all-important branch in New York City—are governed by boards of directors dominated by bankers chosen by...the banks themselves.

Let's take a virtual stroll down K Street and see what everyone is spending on the world's second-oldest profession. The defense lobby? Big ag? Health care? Pikers all. The finance industry is No. 1, with a very, very big bullet.

That might explain why the Fed has dragged its feet addressing the scandal of overdraft fees on debit cards. And "scandal" isn't too strong a word. The overdraft industry, which started only 16 years ago, has grown to nearly $40 billion. It's one of the banking industry's biggest honeypots.

How? Well, many people don't realize that you can incur more than one overdraft fee in a single day, or that many banks deliberately reorder purchases to ensure that you pay the maximum number of fees. And while the Fed finally ruled that come July consumers must opt in to overdraft protection, it didn't address the central flaw: Overdraft fees are essentially a form of loan sharking. Consider that the average overdraft amount is $17 and is paid back in five days. With the typical overdraft fee now around $35, this works out to nearly $2 in fees for every $1 borrowed, an effective annual percentage rate of more than 10,000 percent. Not even the Mafia has a vig like that.

And the only reason it's legal is because in 2004 the Federal Reserve bowed to industry pressure and ruled that overdraft fees shouldn't be classified as loans. Sure, it conceded, banks promote overdraft protection "in a manner that leads consumers to believe that it is a line of credit." And the Fed politely encouraged them to shape up. But it didn't actually require anyone to stop these practices. It was yet another multibillion-dollar cash cow protected by the finance lobby at the expense of consumers.

As recently as 40 years ago this would have been inconceivable. In 1968 Congress passed the Truth in Lending Act, which, among other things, regulated the disclosure of interest rates on consumer loans and prevented credit card companies from charging customers more than $50 if someone stole their card and ran up a big bill. The financial industry didn't much like the new regulations, but the idea that banks should be required to watch out for both themselves and their customers was popular and widespread. The bill passed.

By the end of the 20th century, though, that sort of George Bailey attitude was gone. In fact, an effort to strengthen the Truth in Lending Act to regulate predatory lending failed four separate times between 2000 and 2003 thanks to tenacious resistance from the finance lobby. So what happened between then and now?

Money, of course. To get a better sense of just how much money, let's take a virtual stroll down K Street and see what everyone is spending on the world's second-oldest profession. It's all laid out for us by The defense lobby? Pikers. They contributed $24 million to individuals and PACs during the last election cycle. The farm lobby? $65 million. Health care? We're getting warmer. Health care was the No. 2 industry, at $167 million.

And the finance lobby? They're No. 1, with a very, very big bullet. They contributed an astonishing $475 million during the 2008 election cycle. That's up from $60 million almost two decades ago.

But this just pushes the question back a step: How can the finance lobby afford to spend so much more than anyone else? It feels silly to say that it's because they have all the money—these are banks we're talking about, after all—but that's basically it. They have all the money. Princeton economics professor Hyun Song Shin laid it out last June in a paper that tracked the flow of money through various parts of the economy. Between 1954 and 1980 every sector he studied grew at roughly the same pace, increasing about tenfold. (See "The Securities Boom.") But in 1980, after the great financial deregulation of the Reagan era began, his charts show a sudden discontinuity—while households, corporations, and commercial banks grew another tenfold between 1980 and 2008, the securities sector grew nearly a hundredfold.

This was the financialization of America, as Wall Street evolved from providing financial services to creating products—junk bonds, credit default swaps, subprime loan securitization, collateralized debt obligations—designed to allow Wall Street itself to prosper. By the height of the credit bubble between 2000 and 2007, the financial industry earned a staggering 40 percent of all corporate profits recorded in the United States, four times what they earned in 1980. Over the same period, average pay on Wall Street doubled, while bonuses at the top sextupled.

It was, depending on your perspective, either a vicious circle or a virtuous one. Deregulation produced vast profits, and those profits in turn provided the money to lobby for further deregulation. It was this ocean of money that allowed the financial industry to spend nearly $500 million on political contributions in just a single election cycle, and it was those contributions that helped keep so many flagrantly abusive—but profitable—practices alive and well. It was, for example, what allowed Big Finance to keep Congress from banning "universal default," the small-print declaration on millions of credit card applications that banks could retroactively raise interest rates on consumers at any time for any reason.

It was why the FBI's warnings of an "epidemic" of mortgage fraud as early as 2004 were completely ignored.

It's why no one ever did anything about the multibillion-dollar abuse of the "yield spread premium," a kickback paid to mortgage brokers for guiding their customers into higher-interest loans than they qualified for.

It was why the Fed ignored years of pleading from community groups to do something about abusive mortgage lending.

It's why the credit card industry could afford to spend 10 years and $100 million lobbying for a punitive bankruptcy bill that, among other things, made it harder to write off credit card debt.

It's why banks are paid fat subsidies to make government-backed student loans even though the Congressional Budget Office estimates taxpayers would save $80 billion over 10 years if the government made the loans outright.

The industry's real power lies in the fact that they've so thoroughly changed our collective attitude toward financial regulation that sometimes they barely need to lobby in the traditional sense at all.

It's why Hawaii Sen. Daniel Akaka's bill to require a warning to consumers about how long it takes to pay off a credit card balance if you make only the minimum payment was effortlessly swatted aside year after year.

It's how the late Delaware Sen. William Roth (also the creator of the Roth IRA, another bank windfall) could get away with slashing tax audits on the superrich by doing nothing more than holding transparently comical hearings in 1997 and 1998 that portrayed IRS agents as jackbooted thugs who kicked down doors and held guns to young girls' heads while forcing them to undress.

But there's more to the finance lobby than just money and political influence. Their real power lies in the fact that they've so thoroughly changed our collective attitude toward financial regulation that sometimes they barely need to lobby in the traditional sense at all. That became obvious one spring day more than five years ago—or rather, it would have, had anyone paid attention.


Stockholm Syndrome
In April 2004 the SEC held a hearing. It was sparsely attended and quickly forgotten, but in 2008 Stephen Labaton of the New York Times got hold of an audio recording of the session and wrote an account of what happened.

The issue at hand was something called the net capital rule. Originally put in place in 1975, it set limits on how much leverage investment banks were allowed to carry on their books—limits that all five of Wall Street's biggest investment banks wanted loosened. Goldman Sachs CEO Hank Paulson, later to become George W. Bush's treasury secretary, had begun pressing for higher limits in 2000. Now, the SEC was considering doing just that.

The SEC meeting took place almost six years after the collapse of LTCM had dramatically demonstrated the systemic danger of unrestricted leverage. It came four years after a Fed staffer wrote a journal article clearly pointing out that banks were hiding more and more leverage. It came two years after the FDIC had passed a rule allowing banks to use complex hedges to effectively increase their leverage even more. It came at a time when the housing bubble was already heating up, the credit derivative market was exploding, and the Fed's easy money policy was in its third consecutive year.

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