Wall Street Lobbying

How hard will these banks fight to stay alive? I've heard $100 million was spent lobbying on Dodd-Frank. They're not going to go down easy.

If someone tried to eliminate you or me, we'd fight pretty hard for our own existence. Again, this isn't that we are bad people. It's the process.

And if you're a megabank, and you operate in say 20 states, you have 40 senators, right? Or if you operate in all 50 states, you have 100 senators. That's the way the process works. These people that run for office -- and I've been there, by the way; I went through a midlife crisis and I ran for public office, and so I understand how it works -- you have to raise money to run for public office. And it expands their power by being as large as they are.

Now having said that, during Dodd-Frank something very interesting occurred. Part of the legislation originally was to take away from the Fed … supervisory and examination powers over the community banks. The original proposal under Dodd-Frank was to have us only supervise the very largest banks, those with $50 billion and larger.

The community banks wanted to have the option to be members of the Federal Reserve System and supervised and regulated by us, as well as by the other regulatory agencies, freedom of choice, and they went to work. It was actually a Republican senator from Texas, Sen. Kay Bailey Hutchinson, who became their champion. She got 93 votes in the United States Senate. And Sen. [Chris] Dodd [D-Conn.], who had made the original proposal, only got six. It shows you the power of community bankers.

Community bankers know, because they bank their congressmen and senators, who they're sleeping with, who's got an alcohol problem, who's got a drug problem, who's good, who's bad, etc. And it was very interesting to see these community bankers sort of rise up and insist that they had a right to be supervised by the Fed, or by another agency, but they didn't want that option to be constrained.

And so I wouldn't underestimate the power of independent bankers. But it is true that these very large institutions are spending a great deal of money, as by the way you and I would as human beings, just to preserve our own existence.

I think your opinion is if we had another crisis and a large crisis, we would end up with the government ending up having to bail out the banks again, despite Dodd-Frank. I think it is an important point to understand what your thoughts are.

Well, under Dodd-Frank, the ultimate decision-making authority as to whether or not to close down an institution or not will be the secretary of the Treasury. That's a political appointment. They work for a president. Whether that president is Democrat or Republican, I don't think matters. …

And what's wrong with that?

Well, you tell me. Do you want politicians to have that ultimate decision-making power? Or do you want the marketplace to have that ultimate decision-making power?

What did we have the last go around? Politicians I guess.

We certainly didn't allow the private market to work its way. Again, I want to emphasize that in the heat of a battle, I think we did the right thing. The point is to not let it happen again.

… The thing that I think you guys brought up, which I think is important, is that if another crisis occurs, it means these banks are going to be in trouble all at once. And that they're all internationally based companies.

Sure, yeah, no, it's not just "too big to fail," it's too many to fail. What you end up with is the roots are interconnected. And you also find, and we've seen this through practice, ... if one risk strategy works, let's say the securitization of mortgages, and you find out it's immensely profitable, it didn't take a genius to figure out that your competitor is going to do the same thing to become immensely profitable.

And so again, with all due respect to Congressman [Barney] Frank [D-Mass.], who is a very able, smart fellow. He has written or has overseen the writing of 2000 pages of legislation, with 541 sections or whatever it is, it kind of reminds me of the French Prime Minister [Georges] Clemenceau's comment after Woodrow Wilson's Fourteen Points. Clemenceau said, "God did it in 10."

And so we've made this thing immensely complex. Sometime simplicity is the greatest virtue, and I think the simplest thing to do here is to just to make sure that we don't have institutions that are "too big to fail." I'm not alone on this front. Paul Volcker will argue the same thing. The head of the Bank of England, Mervyn King, would argue the same thing. ...

So the white paper comes out, and this launches the Dodd-Frank process. The banks gear up and are busy lobbying at this point. Do they find friends on the Hill? Do they affect that legislation?

They've got a lot of friends on the Hill. They did impact that legislation, absolutely.

This is one of the most powerful lobbies that Washington has ever seen.

It is, and they got too big as part of the market; they got too big as part of the political process.

Gretchen Morgenson's book Reckless Endangerment chronicles what Fannie did, how Fannie got its tentacles everywhere through not just lobbying and campaign contributions and hiring staff and all of that, but also through funded research with academics, with contributions to some community groups.

I think a lot of the big banks took a page from that same playbook. So it wasn't just the PAC contributions which are significant, but it's hiring former members of Congress and staff. It's funding research that supports your position. It kind of comes from you at all directions.

So even in their weakened position with this horrible financial crisis, they still had a lot of influence. And I think also this ideological dogma of self-correcting markets had taken hold and it was very, very difficult to dislodge, even with all these problems that were clearly related to just basic fundamental regulatory shortfalls. ...

If we'd just had higher capital standards for banks and they had mortgage lending standards that applied to everybody, so much of this could have been avoided. ...

Give us a sense of the power of the banking lobby and what it puts you as regulators up against. How does it work? How do they operate?

Well, it is tremendous. First of all, there are these ongoing relationships. Regulators aren't supposed to lobby, and we shouldn't lobby. We provide tactical assistance. We respond when asked our views.

And Congress generally very freely asks for our views, so it gives the opportunity to have a robust dialogue. But there are actual legal restrictions against lobbying by regulatory agencies, so it needs to be weighed into the balance.

Then [there is] also regulatory agency. The only thing we have are the force of our policy arguments. We don't have campaign contributions. We don't have big paying jobs to hire staff and former members of Congress. We don't have any of that.

So if we can't make our policy case -- and that was one of the reasons why I interacted so frequently with the media -- we needed public help on this, because we didn't have money, and we shouldn't, to counter all this lobbying. ... And these lobbying people don't have to disclose their relationships with the banks. …

... The notion out there on the street ... is that the banks have us over a barrel. That the bank lobbyists buy favor in Washington and that regulators like yourself really are at a tremendous disadvantage in terms of making any progress. ...

They have more influence than they should.

The optics are bad, as you would say.

Well, you can't not talk to them. ... And the fact that you meet with them or talk with them doesn't mean that there's something bad going on. You need to get input from a variety of sources to make rules.

But you do need to make sure that it's balanced input, that you're hearing from everybody, not just big banks, and that your decision is based on what's good public policy, not what some big bank lobbyist wants.

So do the big banks have too much influence? Yes. Is it as bad as people think with the regulators? No, I don't think it is. ...

Let's talk about Dodd-Frank a little bit. Critics will say that the administration shouldn't have gone with healthcare reform, for instance. When they had the leverage, they should immediately have gone to reregulating Wall Street, to changing the system so that this could never happen again. What's your take on that?

My initial take on that is that we actually accomplished some measure of both. We managed to legislate national healthcare reform. It's not everything everyone wants it to be, I absolutely grant that. There's no public option that many people really cared a lot about for good reason. And financial reform doesn't go as far as lots of people would like it to.

But we've got big noses under both of those tents in ways that no one has heretofore, and how we build on them is really the issue.

… It seemed like for healthcare, for instance, that was handed over to the Congress. Was that the case with Dodd-Frank as well?

I think Dodd-Frank was much more interactive. There was lots of input from Treasury, and then [Sen. Chris] Dodd [D-Conn.] and [Rep.] Barney Frank [D-Mass.] and their committees ironed out lots of the details that ended up in the bill, many of which are still being worked out.

So for example, everyone agreed that we needed to have capital requirements. This was something that was very big for Secretary Geithner, that banks need to have a certain amount of capital on hand, in the vaults, against their liabilities. And yet, the amount of those capital reserves is still being argued about.

When you look at Dodd-Frank, what are the weaknesses, what are the strengths?

… I think the problem with Dodd-Frank is that we traded off getting this critically important legislation over the legislative finish line with not dotting all the Is and crossing all the Ts in terms of the devil-in-the-details part. And now many of those details, which are of great consequence to how well Dodd-Frank works are subject to all the pressures from the lobbies and the politicking that could undermine them.

A lot of people suggest that almost the banks knew that they didn't have to have a big lobbying effort during the actual passing of the bill because they knew they'd have several more bites of the apples.

I think that's right. The fact is that we're having arguments now about key components of Dodd-Frank, and those arguments are not taking place under the scrutiny of the press in the light of day, and the bank lobbyists are in there with big, fat thumbs on the scale. And that has the potential to very much weaken the legislation.

So what can the Obama administration do about that, especially with an election coming up?

The problem with the executive branch is always going to be that you kind of get things over the finish line and then you turn to the next thing.

So I think that this is largely a matter of Congress. To have Barney Frank in the mix is actually very important in getting a good, solid financial reform bill with real teeth. As he retires, that's a real concern. Now, if Elizabeth Warren can come in and play a role, that's going to help. … If both Houses go Republican, one could justifiably worry a lot about the consequences for Dodd-Frank and its ultimate implementation. …

Why is it not traded on an exchange?

I think the reason it's not traded on an exchange is that people want to keep it in the dark. They don't want to be subject to an exchange.

Part of the reason is that these are customized contracts. They may have individual features. They might be four and a half years, as opposed to five years. They might have specific wording as to what a default is. And they aren't necessarily easily made into some sort of a plain vanilla transaction that you could put on to an exchange.

But I think one of the big reasons why people wanted to have these swaps off an exchange was so that they could be done privately, so that they wouldn't be disclosed, and most importantly, so that the swaps wouldn't appear as assets and liabilities on the balance sheet.

So back in the 1980s, there was a kind of showdown, where the regulators of accounting said: "We're looking at these swaps, and each leg looks like it's an asset or a liability. It looks like something that should be on the balance sheet." Just like a bank that loans money has an asset, and a bank that has deposits has a liability -- these are things that show up on the balance sheet. …

Wall Street mobilized in response to that, and they formed ISDA. At the time, this was called the International Swap Dealers Association. And the swap dealers got together and they said: "We cannot record these swaps on our balance sheet. It would introduce too much volatility. People would look at them, and they would be scared to death of the amount of risk that we're taking and the volatility of our income."

And they successfully lobbied the accounting regulators to push all of that off the balance sheet. That's where the idea of an off-balance-sheet transaction came from, from moving these swaps off balance sheets so they're not recorded as assets and liabilities.

And you might say, well, that's crazy. These are obviously assets and liabilities, just like a bank loan is an asset or a bank deposit is liability. But the word from the regulators was OK, we'll give in. We won't count them as assets and liabilities.

So originally, ISDA was called the International Swap Dealers Association, and it evolved over time and is now known as the International Swaps and Derivatives Association. So they kept the same acronym, but they have evolved in their name over time.

I should say it's a very effective marketing organization. Anyone who's interested in lobbying should really look to ISDA as one of the ultimate lobbyists of American history, unbelievably successful.

… But it seems unbelievable that a regulator would accept this, because ultimately, a balance sheet is important to understand if a bank is in trouble. And if you don't know how much risk it's taking or what its liabilities and assets are, you have no idea what the health of a bank is.

I think part of the problem was the banks didn't want anyone to know how healthy they were, how unhealthy they were, how much risk they were taking on. The banks had an incentive, starting really in the 1980s, but certainly building through the 1990s, to move into this new, complicated financial business. And that involved taking on a lot of risk. And they didn't want to have to tell the world how much risk they taking on. They didn't want to have to quantify it on their balance sheet.

They wanted to be able to push it off and hide it in these off-balance-sheet transactions. And that was why they lobbied so hard to make sure that swaps and derivatives would be treated differently from other kinds of financial products.