The new issue of Rolling Stone features an in-depth interview with President Obama. An interview with a sitting president is always an intense experience for any news outlet, but in this case the Obama interview offered us an additional surprise. When asked a question about financial regulation, the president turned the tables on us and critiqued Rolling Stone's reporting on issues like the Dodd-Frank reform bill. We – well, I, specifically – criticized the Obama administration for not going far enough in reforming Wall Street, and he used the interview as an opportunity to respond on that score.
Earlier this week, I spoke to a number of people in and around Washington who were my sources during the time when I was writing the stories about Dodd-Frank that the president referred to in the interview. I forwarded the president's response to them and solicited comments on his take on Dodd-Frank, then used them to put together a sort of respectful answer to the president's critique; you can find that answer further down this page.
First, here's the question and answer that appeared in the Rolling Stone interview with President Obama:
Forget for a moment about obstruction by Wall Street lobbyists and Republicans in Congress. If you could single-handedly enact one piece of regulation on the financial industry, what would it be?
The story of Dodd-Frank is not yet complete, because the rules are still being developed. Dodd-Frank provided a platform to make sure that we end some of the most egregious practices and prevent another taxpayer-funded bailout. We've significantly increased capital requirements and essentially created a wind-down mechanism for institutions that make bad bets, so the whole system isn't held hostage to them going under. We have to make sure that the rules issued around the Volcker Rule are actually enforced. So there's a lot of good work that will be done around Dodd-Frank.
I've looked at some of Rolling Stone's articles that say, "This didn't go far enough, we didn't institute Glass-Steagall" and so forth, and I pushed my economic team very hard on some of those questions. But there is not evidence that having Glass-Steagall in place would somehow change the dynamic. Lehman Brothers wasn't a commercial bank, it was an investment bank. AIG wasn't an FDIC-insured bank, it was an insurance institution. So the problem in today's financial sector can't be solved simply by re-imposing models that were created in the 1930s.
I will tell you, the single biggest thing that I would like to see is changing incentives on Wall Street and how people get compensated. That ultimately requires not just congressional legislation but a change in corporate governance. You still have a situation where people making bets can get a huge upside, and their downsides are limited. So it tilts the whole system in favor of very risky behavior. I think a legitimate concern, even after Dodd-Frank, is, "Have we completely changed those incentives?"
When investment banks, for example, were partnerships, as opposed to corporations, all those partners understood that if there was some tail risk out there – some unanticipated event that might result in the whole firm blowing up – that they were going to lose all their money, they were going to lose all their assets. They weren't protected. These days, you've got guys who are making five years of risky bets, but it's making them $100 million every year. By the time the chicken comes home to roost, they're still way ahead of the game. So I think it's something that needs to be discussed. But that's not something that can entirely be legislated – that's something that also has to involve shareholders and boards of directors being better stewards of their institutions.
President Obama's point about the repeal of Glass-Steagall follows a mantra that Tim Geithner and other members of the president's administration have been preaching for years. This oddly straw-man-ish, syllogistic argument goes something like this:
The repeal of Glass-Steagall created mega-merged "supermarket" firms that blended insurance, commercial banking, and investment banking services – companies like Citigroup. Lehman Brothers, whose collapse was a major event in the 2008 crisis, was not one of those companies. Therefore, the repeal of Glass-Steagall did not cause the financial crisis.
Now, it is true that Lehman Brothers was just an investment bank, and not one of those supermarket firms. But Lehman Brothers didn't cause the financial crisis all by itself (more on that in a moment). Moreover, many of the giant mega-merged companies that were spawned by Glass-Steagall did in fact play huge roles in the financial crisis.
For instance, President Obama failed to mention that the company whose merger was only made legal post-factum by Bill Clinton's repeal of Glass-Steagall – Citigroup – ultimately became the single largest recipient of federal bailout funds, taking in nearly half a trillion dollars in cash and guarantees, according to the Congressional Oversight Panel. Citigroup would almost certainly have gone under in 2008 without that massive $476 billion federal lifeline, and had Citi gone under, the impact would likely have dwarfed that of the collapse of Lehman Brothers.
In fact, as one former regulator noted to me, the fact that the most destrctive collapse in 2008 was from Lehman and not from a commercial bank – well, that is really a historical accident. Had the government elected to bail out Merrill Lynch and Lehman and let Citigroup and Bank of America fail, we'd be having an entirely different conversation today. That could easily have happened: the only thing that's unique about Lehman Brothers is that then-CEO Dick Fuld and his minions were so loathed by Henry Paulson and the rest of the Wall Street crowd that his bank was kicked out of the lifeboat, when everyone else was ushered on board.
Other commercial banks that in the post-Glass-Steagall environment also blended in investment banking activities – companies like Wachovia and Washington Mutual – also got into serious trouble and required massive bailouts or federally-aided shotgun mergers to survive. Many of these banks got into trouble thanks at least in part to activities that would have been prohibited under Glass-Steagall, like for instance originating mortgage loans and packaging them into securities to be sold; before the repeal, banks were not allowed to originate loans and underwrite securities.
Opponents of Glass-Steagall will argue that companies like Citigroup and Wachovia would have been in trouble with or without Glass-Steagall, that those firms weren't sunk by their new financial-supermarket structures, but by dumb investments in things like mortgages that might have been made by the dumb executives who ran those companies anyway – i.e. those executives would have been just as dumb if they were merely running commercial banks in the 2000s, instead of running cross-species financial behemoths that also offered i-banking and insurance services.
That might be true. But this would be an interesting argument for anyone in the Obama administration to make, given that president Obama brought in many people from the leadership of Citigroup to shape his economic policy, from chief of staff Jack Lew to transition team chief Michael Froman to a host of people connected in some form or another to former Citi executive and Glass-Steagall architect Bob Rubin (even Geithner served under Rubin in the Clinton administration).
The presence of so many Citigroup executives in the Obama administration makes it not terribly surprising that the president would be sensitive on the subject of Glass-Steagall. The fact that two of Obama's closest economic advisors, Geithner and Gene Sperling (who was NEC chief under Clinton), were original architects of the Glass-Steagall repeal is also an obvious factor here.
But it's still odd that he would focus so intently on that one point, given that the president himself proposed and supported a sort of new version of Glass-Steagall, called the Volcker Rule. Almost all the pro-reform voices I know on Wall Street and in Washington liked the original version of the Volcker rule, and many would have been content to forget about Glass-Steagall forever had the original version of the Volcker Rule that President Obama himself supported actually made it through to become law.
But it didn't. Instead, the Volcker rule was gutted from within by members of both parties during the Dodd-Frank negotiations, and as we reported on several occasions, it was Geithner and the Obama administration that were particularly aggressive in scaling it back behind closed doors. That was what we criticized the president for – not so much for failing to reinstate Glass-Steagall, but for allowing his own policy proposal to be punched so full of holes that it would never be an effective law.
Years after the passage of Dodd-Frank, even the critically-weakened version of the Volcker rule that did ultimately pass is still not officially federal law, its implementation recently delayed again until at least 2014.
Still, most of this is irrelevant. The issue with the president's reform efforts was never limited to a failure to reinstate Glass-Steagall, or even to pass a strong Volcker Rule. That was always just one part of a larger picture.
The biggest problem leading to the crash in 2008 was that a host of firms of many different types – insurance companies like AIG (which incidentally had an investment bank-like component, AIGFP, which helped cause its collapse), investment banks like Bear Stearns and Lehman Brothers and commercial banks like Wachovia and WaMu – all got into critical trouble, often when they leveraged themselves to the hilt to make ill-considered bets on things like subprime mortgages. And because all of these companies were so large and so interconnected with other, leading to what amounted to an explosively dangerous concentration of capital, massive state intervention was required to prevent a global depression.
The repeal of Glass-Steagall was just part of the decades-long deregulatory effort that led to this toxic situation. Another Clinton-era law, the Commodity Futures Modernization Act, contributed to it as well, by completely deregulating the market for derivatives (which were used to package all of those mortgages, were a major contributor to the collapse of AIG, and also played a huge role in the Jefferson County, Alabama disaster, among other things). Supreme Court decisions allowing interstate bank mergers where before they had been prohibited helped create the Wachovias and WaMus of the world. And a 2004 SEC decision to lift restrictions on leverage for the country's biggest investment banks allowed companies like Lehman to borrow forty dollars or more for every one they actually had.
Collectively, these and other policies created a market where banks were over-large, capital was lethally overconcentrated in the hands of a few huge firms, financial companies were all leveraged to the moon and the fates of federal insurance programs like the FDIC were suddenly tied to the gambling habits of some of the riskiest investment banks in the world. It wasn't just Glass-Steagall – it was Glass-Steagall plus all of this other stuff that made the world so dangerous.
So the first and most critical goal of any reform-minded administration should have been to alleviate these dangers by making things less concentrated, i.e. by making Too-Big-To-Fail companies small enough to fail. And Obama really didn't do that, on any front.
Reinstating Glass-Steagall or imposing a strong Volcker Rule would have been part of that, because it would have removed the threat that the federal government or the FDIC would ever again have to worry about what sorts of loony gambling schemes these new supermarket firms are getting themselves into. Obama also could also have helped reverse the damage of the Commodity Futures Modernization Act by forcing derivatives to be traded on simple, regulated exchanges. FDR did exactly the same thing with stocks and commodities after the Depression, but Obama passed on doing it with derivatives, again allowing his own party's derivatives reform proposals in Dodd-Frank to be severely gutted from within.
Finally, Obama had a chance to physically reduce the size of Too-Big-To-Fail companies by supporting the Brown-Kaufman amendment to Dodd-Frank, which would have forced big banks to cap deposits and liabilities to under 10% of GDP. He didn't support that amendment and it died.
The sum total of all of this is that Obama didn't really do anything to alleviate the dangers of Too-Big-To-Fail. If anything, we now live in a world that is more concentrated and dangerous than it was before 2008. TBTF companies like Chase and Wells Fargo and Bank of America are even bigger and less-able-to-fail-ier than they were when he took office. This is why Obama's answer to our interview question is so disappointing. If I'm understanding the president correctly, he basically says he doesn't think Glass-Steagall should be re-instated, and beyond that, he just thinks Wall Street needs to self-regulate better.
That's a pretty depressing take, at a time when even Sandy Weill – the bellicose Wall Street braggart who willed the now-infamous Citigroup merger into being and was a driving force behind the repeal of Glass-Steagall – thinks that Too-Big-To-Fail companies should be broken up. The only hope we really have to fix many of these problems is to do just that, and we will need the chief executive's help there. But President Obama apparently still isn't willing to take that step, which is really too bad.
Editor's Note: As several readers have helpfully pointed out, I confused "Glass-Steagall" with "repeal of Glass-Steagall" a few times in this piece. It's since been fixed. I tried to avoid muddying the waters by not using "Gramm-Leach-Bliley" to describe the law that finally repealed Glass-Steagall, but I ended up confusing myself -- apologies.
A few other quick notes. Some have tried to insist that Bill Clinton had nothing to do with Gramm-Leach-Bliley, that is was the brainchild of Phil Gramm and the Republicans. This just isn't the case. Gramm-Leach-Bliley was as completely bipartisan a bill as has ever been passed. It crucially had the support of Bob Rubin and others in the Clinton White House (Rubin of course later went to work for Citigroup and made over $100 million there). The Citi merger also would never have been possible without the aid of Alan Greenspan, who granted Citi a temporary waiver to do the merger before Gramm-Leach-Bliley was passed. Clinton, it should be noted, said Glass-Steagall was "no longer approproate" when he signed the repeal into law.