Former Secretary of State George Shultz famously quipped about Washington: “Nothing ever gets settled in this town. You have to keep fighting, every inch of the way.” This is proving just as true for banking reform as for other aspects of American government policy.
For example, Senators Carl Levin of Michigan and Jeff Merkley of Oregon, after considerable effort, were able to place strong language in the Dodd-Frank financial-sector legislation – enacting a version of the “Volcker Rule” that would require big banks to become significantly less risky. While this idea originated with Paul Volcker, the former Fed chairman and senior adviser to President Obama, and was announced with great fanfare by the president himself in January, it was clear – from the beginning and throughout the detailed negotiations this spring – that the Treasury Department was less than fully enthusiastic about this approach.
Treasury’s position – ranging from lukewarm support to outright opposition at times – created an uphill task for Senators Levin and Merkley. And now that they have reached the top of the Dodd-Frank hill, what do they see? Another even steeper climb awaits, because the Treasury Department is digging in publicly against the drafting of detailed regulatory rules that would actually make Volcker-Levin-Merkley effective.
In a strongly worded letter to regulators, released on Tuesday, the two senators laid out in some detail exactly what the law requires – and they are tough and quite specific on reducing conflicts of interest, limiting proprietary trading and ensuring that market-making doesn’t become a hidden way for banks to take huge risks. Just in case there is any doubt about the legislative intent, the senators forwarded their colloquy from the Congressional Record – an exchange on the Senate floor in which they, as drafters for this part of the legislation, made the intent as clear as possible. This is the entire Congressional discussion on the specifics for this part of the legislation, and the Senators have made it easy for any judge in the future to determine what they really wanted to achieve.
Treasury Secretary Timothy Geithner made his view on these issues quite clear in a major speech at New York University on Monday, and it would be an understatement to say he is not in complete agreement with Volcker-Merkley-Levin. Mr. Geithner’s theme sounded reasonable enough – “maintaining a balance” between curtailing financial excess and benefiting from financial innovation. But if you look carefully at the details, you understand why so many pro-reform people behind the scenes are becoming increasingly frustrated with Mr. Geithner’s philosophy.
Amazingly, Mr. Geithner made no reference to the Volcker Rule, either explicitly or even implicitly – despite the centrality of this idea to the recent debate. It appears to be nowhere at all in his list of priorities (or on the “to do” list of Michael Barr, the responsible Assistant Secretary, who gave a follow-up speech on Wednesday). He is apparently signaling to all the regulators involved that this is not a top priority for the administration and – presumably – they should toe this line if they would like to be reappointed. Treasury carries great weight on these issues, even with nominally independent regulators, and in the Treasury interpretation big banks would be allowed to rearrange their activities so they can still effectively take big risks – earning big returns in good times and creating major problems for the rest of us when the cycle next turns down.
Mr. Geithner is insisting, as he did throughout the Congressional negotiations, that all the weight should be placed on increasing capital and improving its quality. This is not objectionable as one element of a reform strategy, but it still looks very much like putting all our eggs in one dubious basket – one that has failed us repeatedly before.
The latest details on the international negotiations for higher capital requirements – to which Mr. Geithner continually defers – are not any more encouraging. All the indications from the so-called Basel 3 process are that banks are fighting back hard against having to hold substantially stronger buffers against future losses. The Treasury may not have conceded all the ground on this issue, but it is in retreat – with the Secretary insisting on Tuesday that raising capital requirements could damage growth, despite all the evidence to the contrary (reviewed here last week).
Given this context, we should worry and wonder about the “financial innovation” to which the secretary alludes. Again, this sounds good in principle, but in practice the benefits are elusive, if not illusory – other than for people in privileged positions within the financial sector. Mr. Geithner wants the financial sector to be able to take more risk – but to what end, from the point of view of society as a whole?
Mr. Shultz is also reported to have said: “I learned in business that you had to be very careful when you told somebody that’s working for you to do something, because the chances were very high he’d do it. In government, you don’t have to worry about that.” For all our sakes, let us hope Congress fights hard to prevent important parts of the Dodd-Frank bill from falling into the abyss of regulatory inaction and inattention – the place that just brought us the greatest recession since World War II.
This post appeared today on the NYT.com’s Economix; it is used here with permission. If you would like to reproduce the entire post, please contact the New York Times.