Washington Post veteran Robert Kaiser’s latest book, “Act of Congress: How America’s Essential Institution Works, and How It Doesn’t,” provides an insider’s view of the making of Congress’ response to the 2008 market crash, the Dodd-Frank Act.
He begins with a Sept. 18, 2008, meeting of congressional leaders, Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben S. Bernanke. Paulson asked Congress for $700 billion, arguing that another Great Depression was looming. Bernanke warned that Wall Street meltdowns are always followed by depressions in the rest of the economy. Main Street cannot be shielded from Wall Street, and Congress needed to act quickly, he warned.
Act it did, passing the Troubled Asset Relief Program in October of that year. The ink from President George W. Bush’s signature had barely dried when Treasury announced that it would not bother with the troubled assets part of TARP. Paulson chose instead to use the money to invest in troubled companies, an idea he specifically rejected when meeting with Congress.
TARP was meant to keep the ship afloat, with an overhaul coming later.
The longer-term legislation, the Dodd-Frank Act of 2010, began when President Barack Obama told House Financial Services Chairman Barney Frank that the administration would largely write the bill. The Massachusetts Democrat agreed. House Republicans played little role, as Frank and the House Democratic leadership were able to force the legislation through.
The Senate was a different story. Banking Chairman Christopher J. Dodd, D-Conn., worked hard to come to an agreement with Republicans. While the legislation passed the Senate mainly on party lines, Kaiser’s book makes clear that the biggest roadblock to securing GOP votes was the creation of the Consumer Financial Protection Bureau, a harbinger of the struggles over the CFPB and its leadership that endure today.
Meanwhile, the law’s “Volcker rule,” a ban on proprietary trading by banks, is confounding the regulators tasked with its implementation. Named after former Federal Reserve Chairman Paul Volcker, it seeks to prevent Federal Deposit Insurance Corporation-insured banks from taking risky bets. The line between banned proprietary trading and market-making, an essential function performed by banks to keeps markets liquid, however, is unclear.
The difficulties of restricting proprietary trading are made clear in the book’s account of the appearance of Goldman Sachs’ CEO before the Senate Homeland Security and Governmental Affairs Permanent Subcommittee on Investigations. “The evidence shows that Goldman repeatedly put its own interests and profits ahead of the interests of its clients and our communities,” according to the panel’s chairman, Michigan Democrat Carl Levin. At issue was whether Goldman sold products to clients and then bet the firm’s own money that these products would lose value, according to Kaiser. Goldman CEO Lloyd Blankfein responded that its proprietary trading account was irrelevant to market-making, and likely not of concern to its clients. One person’s proprietary trading, restricted by the Volcker rule, is another’s market-making.
Kaiser’s book does a good job of demonstrating the risks of regulatory arbitrage, where firms shop around for the weakest regulator. Insurance giant AIG, for instance, would not have been able to operate in Europe without a consolidated regulator, and it found an easy way around this. It purchased a savings and loan to come under the supervision of the weak Office of Thrift Supervision, thus allowing it to work with derivatives in London. Some of its derivatives, credit default swaps (which are essentially insurance on subprime mortgages) were a major cause of the market crunch. The OTS was abolished by Dodd-Frank.
Regulatory arbitrage continues to be an issue, and federal financial regulators are currently deciding whether to exempt foreign firms from U.S. regulation over certain derivatives, if they face adequate foreign supervision.
“Act of Congress” describes how AIG was a major headache for lawmakers. It received a bailout of more than $170 million, making it into what Kaiser called a ward of the state. The country then learned of AIG’s plans to pay its employees $165 million in bonuses. Kaiser noted that around the same time, the company reported a $100 billion loss for 2008, the largest ever by an American company.
Many in Congress were appalled by the Wall Street bonuses. The book tells how the administration argued that it was powerless to stop these bonuses, and how they were needed to keep quality staff. Where these quality employees would have gone if they had quit over not getting bonuses remains a mystery. Although not in the book, it is worth noting that the head of General Motors Co. was fired by the U.S. government after its bailout, while many Wall Street executives did just fine.
Whether banks could trade in derivatives was another hot topic during Senate consideration of the legislation. Blanche Lincoln, an Arkansas Democrat who chaired the Agriculture Committee and lost her seat in November 2010, urged pushing derivatives trading out of banks and into affiliates. The idea posed significant unintended consequences, according to bank regulators. A bank that sold its swaps operation might need to use swaps to hedge risky assets on its balance sheet. This hedging could, under the Lincoln proposal, deny the bank access to FDIC insurance. In the end, Congress approved a weaker proposal.
Whether Dodd-Frank has addressed “too big to fail” is an open question. While supporters and the administration say the law allows no more bank bailouts, the six largest bank holding companies account for close to 75 percent of all bank assets. Given this concentration, the Dodd-Frank Act may only be good until the next big crisis.
The book has the feel of the winners writing the history, as most of those cited by Kaiser are Democrats, and there are plenty of sour grapes to go along. A Dodd staffer recounts that Republican staffers say they will be available to talk, but then are not. Lincoln, no longer in office, comes under particular scorn for her derivatives proposal, both by the author and by staffers mentioned in the book. Her amendment was a “truly horrible experience,” according to a Democratic staffer cited in the book.
Many of those involved lacked experience. A Treasury official discussed having “intense, blank-sheet-of-paper sessions” with colleagues, only to discover that most of these brainstorming sessions led to ideas that others had already suggested. Derivatives have been a big issue in Washington for 20 years. The officials at Treasury, most of whom had little banking experience, were never likely to come up with new ideas by brainstorming.
Dodd-Frank’s most lasting legacy will be the Consumer Financial Protection Bureau. Obama added fuel to the fire by naming its director via a recess appointment, outraging many in Congress. Republicans won a pyrrhic victory in keeping Elizabeth Warren from becoming the agency’s director. She instead ran for Senate in Massachusetts and beat Republican Scott P. Brown in 2012, who might otherwise have retained his seat.
Peter Feltman is an analyst for the CQ Roll Call Washington Securities Briefing.