Do Not Go Gently Into That Financial Regulatory Rollback

(Washington Post) – Here’s a headline from last week’s Washington Post: “Congress to roll back post-crisis financial rules as banks post record profits.”

On Wednesday, a New York Times article began: “Big banks are getting a big reprieve from a post-crisis rule aimed at curbing risky behavior on Wall Street.”

If those don’t make you nervous, you’re either too young (or too stricken with amnesia) to remember the financial crisis of a decade ago or you have a vested interest in such financial deregulation.

I assert this not because the financial rules are costless to the sector. They’re burdensome, and some of them, including the Volcker Rule referred to in the articles above, are ambiguous. I assert this for the following reasons:

• The historical record shows that underregulated banks will eventually and systematically underprice risk, leading to asset bubbles.
• When those bubbles implode, the costs will be born not by the banks, who will get bailed out, but by the rest of us.
• Despite the compliance burden, lending and liquidity in the sector have been robust, leading to record profits (amped up by the tax cuts), even amid historically low interest rates.
• This recent deregulatory push isn’t just the work of our checked-out president and a Republican congressional majority that is devoted to providing valued goodies to their donor base. It’s the return of bipartisan, lobby-driven amnesia that regularly afflicts us at this point in the economic expansion.

To better understand how we got to this moment, start back in September 2008, when the investment bank Lehman Brothers went bankrupt, taken down by a combination of its high leverage ratio (for every dollar of borrowing, it had about three cents of equity), its exposure to the bursting housing bubble, and the lax regulation that allowed, or more precisely, encouraged such levels of leverage and exposure. The ensuing credit crisis helped to fuel the worst recession since the Great Depression, with millions of mortgage defaults leading to foreclosures, trillions in lost housing wealth and rolling job losses that sent the unemployment rate up to 10 percent in late 2009.

Motivated by public anger at the finance sector that helped cause the meltdown but was largely insulated from its worst impacts, the Dodd-Frank financial reform bill was passed to prevent the next meltdown. One of the new rules was intended to prevent banks with federally insured deposits (and thus backed by taxpayers) from playing the “heads-we-win-tails-you-lose” game that ensues when private banks with public backstops gamble in risky markets.

This part of Dodd-Frank — the Volcker Rule — is now at risk of being rolled back. The core of the proposal is to let banks, as opposed to regulators, decide whether the trades in which they engage are the risky type that blew up in the crisis or safer bets that don’t expose their insured deposits.

Why go there? True, the Volcker Rule became a lot more complicated and burdensome as it was legislated, though this was in no small part due to the bank lobby’s fighting for exemptions. And some small banks faced Dodd-Frank compliance costs that were too high, given the minor risks such banks pose to the financial system.

But these are details. Profit-wise, the financial sector was crushing it even before the Republican tax cut delivered huge benefits to the sector (and didn’t touch the carried-interest loophole that allows fund managers to pay a special, low rate on their earnings).

Meanwhile, members of both parties put aside their dysfunctional ways to cooperate on pulling dozens of sizable banks either partially or wholly out from under Dodd-Frank’s oversight. Key regulators have proposed raising leverage limits, making bank stress tests (simulations of solvency in a crisis) less stressful and aggressively dialing back consumer protections.

What’s occurring here is a function of the powerful momentum generated by the long path of financialization of the U.S. economy, beginning in the 1980s, when protections in place since the Great Depression began to come down, and continuing through the era of Alan Greenspan, the powerful chair of the Fed from 1987 to 2006 and an Ayn Rand acolyte who believed banks would self-regulate, rendering government efforts redundant and inefficient. Even today, after Greenspan himself admitted that he found “a flaw” in his model (ya think?!), the same bias toward deregulating finance looms as large as ever.

In fact, as long as the United States has existed, this tension has defined our political economy, whether it was the bankers foreclosing on the farmers in the 1890s, the capitalists and the industrialists fending off the socialists and the unions in the 1930s or, most recently, the 99 percenters.

Who’s fighting back today? Unions are struggling to survive. Our political system is more money-driven than ever, and no lobby has deeper pockets or political connections than the finance lobby. Stalwarts such as Sen. Elizabeth Warren (D-Mass.) understand everything I’ve written here, and she inveighed strongly against the rollbacks noted above. Some great, progressive think tanks punch above their weight in this space. But these forces demonstrably lack the resources and clout to stop the tide.

Although I don’t see any large credit bubbles in the system today, and many of the Dodd-Frank rules remain in place, I guarantee you that, absent strong guardrails, the finance sector will eventually drive off the cliff. The driver will once again parachute out, but the rest of us passengers will not have that luxury.

The only way to avoid this fate is for enough of us to become the countervailing force that does not succumb to the regulatory amnesia. Our goals should be twofold: Avoid regulatory rollbacks and introduce a small tax on financial transactions, to both dampen excessive, noisy trading and raise revenues for progressive uses.

By remembering the not-so-distant past, just maybe we will not be condemned to repeat it.

Jared Bernstein, a former chief economist to Vice President Joe Biden, is a senior fellow at the Center on Budget and Policy Priorities.