After the Fall: How Has Wall Street’s Behavior Changed?

When Dodd-Frank regulations went into effect in the wake of the financial crisis, the intention was to create new oversight and reduce systemic risk. Part of our After the Fall series on what's happened since the meltdown, Jeffrey Brown and guests discuss how Wall Street has changed since the financial catastrophe.

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    Next: "After the Fall." We continue our look at what's changed since the financial meltdown of 2008, our focus tonight, Wall Street in the wake of laws passed to regulate it more tightly.

    The biggest change in the wake of the financial crisis, the so-called Dodd-Frank regulations, passed with mostly Democratic support and signed into law by President Obama two years ago. Intended to prevent future meltdowns, the law created new oversight agencies, including one to examine financial products for consumers and another to reduce systemic risk to the banking sector from institutions considered too big to fail.

    It also imposed new capital requirements on banks to limit their exposure to debt and avoid costly bailouts, brought risky shadow banking activities onto open exchanges under the watch of government regulators, and placed restrictions on banks making bets with their own money while engaged in consumer lending, known as the Volcker rule.

    But the new regulations have had critics from the start, including financial institutions that argue the restrictions are excessive and are having a negative impact on even solid banking practices, to the detriment of the overall economy.

    So what's changed and what hasn't?

    We hear from Lynn Stout, professor of corporate and business law at Cornell University, Mohamed El-Erian, CEO of PIMCO, a global investment management firm and the world's largest bond fund, and Peter Wallison, senior fellow for financial policy at the American Enterprise Institute. He served in the Treasury Department in the Reagan administration and as a member of the Financial Crisis Inquiry Commission.

    Lynn Stout, I'll start with you.

    So when you look at the practices of financial institutions today, do you see big changes, good or bad, from a few years ago?

  • LYNN STOUT, Professor, Cornell University:

    Oh, we only wish we saw big changes.

    It has — there have certainly been some changes, but the really fundamental problems have not been grappled with. There seems to be a denial on the part of the industry that there was ever anything wrong in the first place. And so what we're seeing is some marginal tweaks, a little retrenchment.

    But the structural problems that drove us into the 2008 crisis are still there.


    All right, we'll come back to some specifics.

    But, first, Peter Wallison, a denial? What do you see?

  • PETER WALLISON, American Enterprise Institute:

    I don't see denial.

    I think the industry is dispirited, maybe demoralized. They have been blamed for the financial crisis. I'm not one who believes that they caused the financial crisis. But they have been blamed. And they made some serious mistakes, certainly, and as a result of that, they're not the aggressive industry that they were in the past.

    And that is a shame because this was one of the areas where the United States was dominant in the world, that is, financial policy. And financial institutions coming from the United States were dominant. And I think that is beginning to recede.


    Well, Mohamed El-Erian, how would you describe the landscape today?


    I would say the landscape is changing, but it's changing too slowly, and the changes are incomplete.

    And there's good reasons for that, four in particular. One is, the regulatory framework is still a work in progress. Two, the institutions themselves are slowly adjusting, so old habits die hard. Third, because finance is so globally interconnected across borders, you need good international coordination. We don't have that.

    And, finally and most importantly, the outlook remains unusually uncertain, to use Chairman Bernanke. So think about it in the following way, Jeff. You've had a major accident on the freeway. You recognize that you have got to redesign the freeway, but the plans aren't complete, the cars haven't been modified, and it's really foggy. The result is suboptimal outcome. And that's where we are today.


    Well, Lynn Stout, you started by giving us a depressing picture of things that haven't changed.

    Give me an example. I mean, in terms of the regulatory system not kicking in or banks ignoring it, what are you seeing?


    What we're dealing with here is the fact that the banking industry and the financial industry changed fairly dramatically over the past 20 or 30 years, and not in a healthy direction.

    Twenty or 30 years ago, banks and investment banks were primarily involved in the capital-raising business. They helped connect up savers with entrepreneurs who were building new projects, building new companies. That was a very socially valuable activity.

    But over the past '80s, '90s, and into 2000s, what happened is that the financial sector increasingly moved away from its basic and important capital-raising function, and became a trading center, where people were just passing securities back and forth, trading bits of existing businesses or even trading derivatives on businesses.

    And that's not a business model that can sustain itself. It was great for a short-term party, where a lot of people got rich for a while. But at the end of the day, when you're just trading things back and forth, and you make your money by trading in an advantage relative to the other person, that's a zero-sum game. That's not a way to — towards sustainable growth.

    And, eventually, Wall Street cannibalized its own customer base. There really aren't people out there with the money to spend and the interest in trading that there used to be. And I think the Wall Street firms are having a real problem adjusting to the idea that trading isn't their lifeblood and can't be in the long run. They have to go back to their old capital-raising function. And they're having a problem doing that.


    All right.

    Peter Wallison, you were listening and shaking your head. You don't see that broader picture of a large-scale change in the business model?


    Well, there has been a large-scale change, but that's because the world has changed because of technology and for other reasons.

    The world has gone from a world in which loans were made by banks or capital was raised by banks through selling shares for companies, to a world in which most companies are now accessing the capital markets to finance themselves. And once they have started to do that, it's necessary for those who invest in those companies and the companies themselves to change their portfolios, to modernize their portfolios, to change the investments that they're holding in order to meet changes in demands and conditions.

    So we're in a different financial world than we were. And people who expect us to go back to lending and helping companies sell shares are thinking of a world that no longer exists and could never exist.


    And in that world, you're one of those who's argued that these new regulations are hurting the system.


    Yes, these new regulations are made by people who believe that we should go back to the old system.


    All right, Mohamed El-Erian, to you. First, do you see this broader new world we're talking about, and where do the new regulations fit into that, helping or hurting?


    So, both views can and should be reconciled.

    There were a number of very important innovations that facilitated the financing of productive investments. And that created a great age, not great in the terms of wonderful, but great in the sense it went too far.

    It was an age of leverage. It was an age of debt and credit entitlement. And it went too far. I'll give you a simple example. We now talk about the financial industry, but that's not what it used to be called. It used to be called the financial services industry, because it was always thought of as serving the real economy.

    And what happened in this great age is not only that financial services grow, but they try to outgrow the real economy. And that's where the problem occurred. So I think we have to resize and rescale it, but not swing the pendulum too far. And that is the fundamental challenge facing our leaders in Washington, D.C., today.


    And where do you see it? Where is the balance right now?


    I think, right now, the pendulum is swinging towards more regulation. I think that's correct.

    I get a sense it's going to go too far. These things tend to go too far. So, again, go back to the crash on the freeway. The initial reaction is to lower the speed limit. And the risk is, you lower it too much. But at that stage, what society wants is soundness, not efficiency. And I think we have to respect that that's the reality of the world today. People want safety and stability, rather than efficiency.


    Well, Lynn Stout, so how do you maintain — what do you suggest in this balance of regulation that allows for a certain amount of risk-taking and investment activity, but keeps it from going too far?


    I think we definitely need more regulation.

    I wouldn't say we have too much regulation, but I would say we have the wrong kind of regulation. We have a — we have created a very unhealthy regulatory system because what Dodd-Frank did was not pass basic rules, like setting speed limits. What it mostly did was give government agencies, Treasury, the Commodity Futures Trading Commission, the Securities and Exchange Commission, the authority to set different speed limits for different people.

    Instead of being asked to enforce relatively simple laws, the ability to write the laws was delegated to these agencies. And that's a problem, because it subjected them to enormous lobbying pressures from Wall Street firms to try and create particular loopholes that will favor particular industries or even individual companies.

    And those loopholes are actually now being created left and right, but it's all going on at a level where the public's not aware of it. It's not happening in the form of law that gets reported in the newspapers. It's in the details of all these regulations that make most people's eyes glaze over.


    Well, what about that, Peter Wallison? You're here in Washington. And you worked in the Treasury and worked with people in the financial sector.




    I mean, this nexus of politics and finance — and Lynn Stout is suggesting that that doesn't allow for the kind of regulation, the right kind of regulation.


    Well, when we talk about regulation, we really have to talk about the amount of regulation and the kinds of things that regulation is requiring.

    If we look at one particular regulation which has gotten a lot of attention recently, that is the so-called Volcker rule, the Volcker rule does interfere completely with the idea that a capital market system can be run by a series of financial institutions.

    It's telling banks and other large financial institutions that they have to get out of the capital markets. They're no longer permitted to engage in proprietary trading in those markets. Now, that will interfere substantially with the way these markets are — had been run in the past and should run in the future, because we're talking about. . .


    But isn't it the idea that it should interfere those past. . .


    Yes, of course, that's the idea. That's why I said these rules were made by people who don't understand the capital markets. And they have made inconsistent rules that will make it difficult for the capital markets to function the way they should.


    Mohamed El-Erian, last word for you in our last minute. Where do you come down on this question?


    I think there are inconsistencies, in the sense that different agencies are doing different things, and they're not coordinated. And the inconsistencies get even bigger when you go globally.

    I think the most important thing, Jeff, is let's get a set of rules in place so that the system can operate. What's happening right now is that people are going back to the sideline and waiting and waiting. And at the end of the day, that is going to starve the system of credit.

    So there is a middle path that has to be struck, but let's not make the best the enemy of the good.


    All right, Mohamed El-Erian, Lynn Stout, and Peter Wallison, thank you, all three, very much.

    And there's more in our "After the Fall" series. You can see last night's discussion of the housing crisis on our website. Also there, you will find a link to "Frontline"'s documentary "Money, Power, and Wall Street."