By Simon Johnson
There are two fundamentally different views regarding modern Wall Street. The first is that the financial sector has been terribly and unjustly put upon in recent years – regulated into the ground and treated with repeated disrespect, including by the White House.
There was, for example, an impressive amount of whining this week when no one from a big bank was invited to a high-profile meeting with the president on fiscal issues. As the people holding strongly to this view run large financial institutions and have effective public relations teams, this has become an important part of the conventional or establishment wisdom, repeated without question in some parts of the media.
The second view is that the powerful people who run global megabanks have lost all sense of perspective – including failing to realize that they have more access to people at the top of our political power structures than any other sector has ever had. Anyone who doubts this view – or wonders exactly how the revolving door among politics, lobbying and banking works – should read Jeff Connaughton’s account, “The Payoff: Why Wall Street Always Wins” (which I have written about in more detail before). Mr. Connaughton is most gripping when he describes the failure of law enforcement around securities issues, including issues with both the Department of Justice and the Securities and Exchange Commission.
Which of these views is correct? We will soon know, because there is a simple and direct test that is fast approaching: Whom will President Obama nominate as the new chair of the S.E.C.? (Mary Schapiro, the current chairwoman, is widely reported to be stepping down soon.)
There are only two possible outcomes. The president could pick someone who is very close to the securities industry, for example a senior financial services executive or one of their favorite lawyers or someone who already works in their “self-regulatory” apparatus. Any former politician who has taken large donations from Wall Street or an academic who sits on the board of a large financial company would also fit into this category. There is no shortage of candidates from this side of the contest.
Alternatively, the president could choose someone who is not only willing to enforce the law and regulation but who would actively seek to change the conventional wisdom around finance. For example, all too often we hear – including from some top officials – that if we relax the capital requirements, the economy will grow faster in a sustainable manner.
This is a very dangerous idea that completely ignores the fact that Europe went much farther than we did in reducing bank capital in the run-up to 2008 (i.e., allowing banks to finance themselves with more debt and less equity) and that this directly contributed to the complete disaster they now face. Thank goodness that Sheila Bair, then head of the Federal Deposit Insurance Corporation and a few others successfully resisted attempts to lower bank capital in a parallel manner in the United States. (If you want more detail on these points, look at Ms. Bair’s book, Bull by the Horns, or the forthcoming book by Anat Admati and Martin Hellwig, “The Bankers’ New Clothes: What’s Wrong With Banking and What to Do About It.”)
Without doubt, part of the problem that led to the crisis of 2008 was weak regulation. But can any regulation be effective at any moment the conventional wisdom is that we have some form of “new economy” in which asset prices can only go up – and therefore financial institutions should be allowed to borrow a great deal more relative to their shareholder equity?
To make Wall Street safer – and more helpful to the rest of the economy – implementing new rules is not enough. We need completely new thinking about securities markets, including all dimensions of how investors are treated and where financial-system risks lurk. We must be able to trust the financial system again – and we are currently a long way from this point.
There are three potential S.E.C. chairmen who could have this kind of impact. If you have other names, see if they match these three in terms of integrity, willingness to go against the consensus and ability to get things done.
First, former Senator Ted Kaufman of Delaware has been a consistent advocate for financial-sector reform and was one of the clearest voices during the 2010 legislative process that led to Dodd-Frank. His advice was ignored then; in fact he was opposed directly by Treasury and the White House (see Mr. Connaughton’s book for details). It is not too late for the president to change his mind. (See this longer piece I did a few days ago on Senator Kaufman for this Boston Globe feature.)
Second, Neil Barofsky is the former special inspector general in charge of oversight for the Troubled Asset Relief Program. A career prosecutor, Mr. Barofsky tangled with the Treasury officials in charge of handing out support for big banks while also failing to hold the same banks accountable, for example in how they treated homeowners. He confronted these powerful interests and their political allies repeatedly and on all the relevant details – both behind closed doors and in his compelling account, published this summer: “Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street.”
His book describes in detail a frustration with the timidity and lack of sophistication in law enforcement’s approach to complex frauds. He could instantly remedy that if appointed — Mr. Barofsky is more than capable of standing up to Wall Street in an appropriate manner. He has enjoyed strong bipartisan support in the past and could be confirmed by the Senate (just as he was previously confirmed to his TARP position).
Third, Dennis Kelleher is a former senior Senate leadership aide with a great deal of political experience, including during the financial crisis and in the negotiations that led to Dodd-Frank, and now runs the pro-reform group Better Markets. Previously, Mr. Kelleher was a partner at the international law firm of Skadden, Arps, Slate, Meagher & Flom, where he specialized in the S.E.C., securities, financial markets and corporate conduct in the US and Europe. No one has been a more effective advocate of implementing substantive reforms. Mr. Kelleher and his team are in the trenches every day, arguing on behalf of taxpayers and ordinary citizens at every opportunity before the entire range of regulators, in court cases and with Congress and the administration. They are also amazingly effective – particularly considering the huge resources of the firms that they go up against (for some examples, see this New York Times profile of Mr. Kelleher). His private and public sector experience and expertise are very highly regarded throughout the financial regulatory agencies and in the legislative and executive branches more broadly. He also has strong relationships on both sides of the aisle and could likely be confirmed.
At the start of this second presidential term, many people are optimistic that President Obama will finally push hard for meaningful change around Wall Street – including at the S.E.C.
Goldman Sachs, JPMorgan Chase and Citigroup were all big donors to the Obama campaign in 2008 (see this recent column by William D. Cohan), but they did not make the top 10 list this year. Now would be a perfect time for the president to clean up Wall Street with a strong S.E.C. that is focused on enforcing the law and overturning dangerous parts of the conventional wisdom.
An edited version of this post appeared on the NYT.com’s Economix blog on Thursday; it is used here with permission. If you would like to reproduce the entire post, please contact the New York Times.