What's remarkable, when you listen to that recording, is not that the banks got everything they wanted—of course they did. It's that the new policy passed virtually without question. There was a single written dissent from an unknown risk management expert in Indiana, a couple of routine queries from one commissioner, and reassurances from staffers that the new rule posed no problems because the banks would police themselves. After less than an hour of desultory discussion, the new rule was in place.
The finance industry successfully convinced everyone that deregulating finance was not only safe, but self-evidently good for the entire economy, Wall Street and Main Street alike.
In other words, very little lobbying was even required. After three decades of deregulatory fervor, it had simply become unnecessary. The SEC, like so many other government watchdogs, was by 2004 a thoroughgoing victim of regulatory capture, its appointees mostly Wall Street insiders with more sympathy for banks than for the public they were supposed to protect.
But the problem was bigger than just that. Unlike most industries, which everyone recognizes are merely lobbying in their own self-interest, the finance industry successfully convinced everyone that deregulating finance was not only safe, but self-evidently good for the entire economy, Wall Street and Main Street alike. It's what Simon Johnson, an MIT economics professor and former chief economist for the IMF, calls "intellectual capture." Considering what's happened over the past couple of years, we might better call it Stockholm syndrome.
Like all the other products of the industry's three-decade lobbying spree, the change to the net capital rule ended up in disaster when the overleveraged financial system nearly collapsed on itself. By October 2008, even former Fed chairman Alan Greenspan, one of the country's biggest cheerleaders for self-regulation, was admitting the obvious: There was a "flaw" in the free-market worldview. "Those of us who have looked to the self-interest of lending institutions to protect shareholder's equity, myself especially, are in a state of shocked disbelief," he said in testimony before the House oversight committee.
If the case against self-regulation was strong then, it's stronger now. Far from being chastened by last year's meltdown, banks are back to their old tricks. The sliced-and-diced mortgage securities that caused so much trouble during the credit bubble are being re-sliced and -diced via something called a RE-REMIC (resecuritization of real estate mortgage investment conduit)—and business is booming. At Goldman Sachs, leverage in the first half of 2009 was at its highest level in its history. Even more astonishingly, the Wall Street Journal estimates that overall pay on Wall Street will rise to record levels in 2009, higher than at the height of the bubble. It's as if the global collapse that nearly destroyed them has been completely forgotten.
So what happens next? Congress and the Obama administration have plans to re-regulate the financial industry, but you can't undo 30 years of intellectual capture in a few months—especially when the reform effort is mostly in the hands of former finance executives. That's evident in the fact that the simplest, most striking proposals for reining in bank behavior aren't even getting a serious hearing. Former Fed chairman Paul Volcker, for example, suggests that commercial banks should simply be banned from securities trading altogether. They should go back to making loans and underwriting bonds, but leave the risky, leverage-heavy trading to hedge funds, where it's fire-walled away from the plumbing of the overall banking system. Another former Fed chairman, Alan Greenspan, thinks we should break up big banks the same way we broke up Standard Oil 100 years ago. "If they're too big to fail, they're too big," he said in October. Other economists have proposed a small tax on all financial transactions (perhaps a quarter of a percent or so), something that could reduce short-term speculation and help reduce the long-term deficit all at once.
But those reforms were never even considered. The problem isn't that Obama administration officials don't know where the real fault lines lie. Treasury Secretary Tim Geithner released a set of guidelines earlier this year that focused squarely on leverage, capital requirements, and regulation of the shadow financial system, not just on commercial banks. And a month later Obama economic adviser Larry Summers noted that our current deregulated system has produced economic crises like clockwork every three years. "Surely we cannot be satisfied with a system that misfires so seriously so frequently," he said.
You can't undo 30 years of intellectual capture in a few months—especially when the government's reform effort is mostly in the hands of former finance executives.
But Obama's actual regulatory proposal didn't reflect any of this sense of urgency. "We don't want to tilt at windmills," he explained last June—and there was little doubt which windmill he was talking about. Just a couple of months earlier the financial industry had won a stunning victory over a seemingly shoo-in administration proposal to modify bankruptcy laws for strapped homeowners—and they had not only won, they had managed to get billions in extra bailout money at the same time. That remarkable demonstration of raw power caught the Obama administration's attention, so rather than risk another defeat it began compromising even before its proposal was introduced. Top bank executives and financial lobbyists were part of the planning from the start, and as a result mutual funds and hedge funds got away with only modest new limits, credit ratings agencies were left largely untouched, the most dangerous varieties of derivatives were left alone, almost nothing was done to reduce the size of the biggest banks, and additional powers were given to the Fed, which has shown repeatedly that it's too close to Wall Street to ever regulate it effectively.
What's worse, it's not clear that even what's left will ever see the light of day. One of the best parts of Obama's proposal—and the scariest to bankers—was a new Consumer Financial Protection Agency that would regulate financial products the same way the Consumer Product Safety Commission regulates toasters. Even Alan Greenspan, perhaps humbled by the Fed's failures under his watch, supported the idea. The Fed, he admitted, simply wasn't likely to ever crack down on lending abuses.
Needless to say, the financial industry likes it that way, which is why the CFPA is the part of Obama's plan they've been working the hardest to eviscerate. And where intellectual capture isn't enough to do the job, there's always money. After a brief dip in political outlays at the end of 2008, the financial industry spent $402 million in the first 10 months of 2009 on both lobbying and campaign contributions, enough to put them on track to break 2008's record. Members of the House Committee on Financial Services alone received more than $8 million in industry contributions.
Whether the CFPA eventually survives is still up in the air, but the finance lobby scored a big victory almost immediately when Obama's proposal went to Capitol Hill and was quickly stripped of its requirement that banks offer consumers "plain vanilla" products—things like standard 30-year fixed mortgages and low-interest, low-fee credit cards—in addition to their more convoluted options. A couple of weeks later banks with less than $10 billion in assets—a category that includes 98 percent of all US banks—were exempted from the CFPA's scrutiny entirely. And proposals to regulate derivatives by forcing them to be traded on supervised exchanges, as stocks and commodity futures already are, were watered down as well.
How could all this happen so soon after the financial industry's reckless behavior nearly caused a global meltdown? Ironically, it's probably because the bailout was so successful. Without a sense of crisis to drive things, the political will to take on the industry has largely dissipated. Even after nearly destroying the world economy, the finance lobby is, still, simply too big to fight.