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Will Proposed Financial Regulatory Overhaul Actually Reform Wall Street?

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With the main healthcare reform bill signed into law, Democrats say congressional efforts to reform Wall Street and the nation’s financial regulatory system will soon top the Obama administration’s agenda. A measure put forward by Sen. Christopher Dodd is being described as the biggest overhaul of financial rules since the 1930s, but critics have faulted the proposal for giving additional power to the Federal Reserve while gutting the proposed Consumer Financial Protection Agency and housing it inside the Fed. [includes rush transcript]

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This is a rush transcript. Copy may not be in its final form.

JUAN GONZALEZ: With the main healthcare reform bill signed into law, Democrats say congressional efforts to reform Wall Street and the nation’s financial regulatory system will soon top the Obama administration’s agenda.

On Wednesday, the President held a strategy meeting at the White House with Senate Banking Committee chairman Christopher Dodd and House Financial Services Committee chair Barney Frank. The meeting came two days after the Senate Banking Committee advanced Dodd’s measure to overhaul financial regulation on a party-line vote. Dodd spoke to reporters after Wednesday’s meeting.

    SEN. CHRISTOPHER DODD: We intend to get a strong financial reform package. We’re going to end “too big to fail.” And never again are American taxpayers going to be asked to bail out a failing financial institution because they have an implicit guarantee from the federal government. We’re going to have a strong Consumer Protection Agency, so that people can count on someone watching out for their interests on mortgages and credit cards and other financial activities. We want to have that systemic risk council so we have a good radar system to pick up problems before they challenge and threaten the entire financial system in our country. We want strong statements and strong regulations on dealing with exotic instruments like over-the-counter derivatives and others that can put our system at risk.

    I think the American people expect us to address the largest and most significant financial crisis since the Great Depression, caused by a collapse in our financial system either because regulators didn’t do their job or there were no cops on the beat at all, and certainly in unregulated activities that contributed to this mess.

JUAN GONZALEZ: Meanwhile, Congressman Barney Frank said the issue of financial regulatory reform will be Congress’s number-one concern after a two-week Easter break.

The Dodd bill has been described as the biggest overhaul of financial rules since the 1930s. The measure includes new regulations of derivatives, new protections and incentives for Wall Street whistleblowers and the establishment of an oversight body for credit-rating agencies. But critics have faulted Dodd’s proposal for giving additional power to the Federal Reserve while gutting the proposed Consumer Financial Protection Agency and housing it inside the Fed. Economists are also divided over whether the bill does enough to address the “too big to fail” banking problem.

AMY GOODMAN: To talk more about reforming Wall Street, we’re joined by two guests. Rob Johnson is a former economist at the Senate Banking Committee and the Senate Budget Committee. He’s now the director of the Economic Policy Initiative at the Franklin and Eleanor Roosevelt Institute. Kai Wright is the editorial director at ColorLines Magazine and a fellow at the Nation Institute.

We welcome you both to Democracy Now! Kai Wright, let’s begin with you. This whole issue of this consumer agency that was, or the one that’s being now put into the Fed, explain it. What’s happened to it?

KAI WRIGHT: Well, the idea was to create somebody in Washington who is explicitly tasked with looking out for consumers. The authority already exists. But the whole host of regulators that are there, their concern has been with the health of the banking sector, not with their customers. And so, the idea was to create an agency that had broad authority and that was independent. That was where we started, probably about a year ago.

What we have in Senator Dodd’s bill is an — it is an agency that — or it’s a bureau that has broad authority, so it can police the large banks and it can police the non-bank players — payday lenders and the mortgage brokers that peddled these subprime loans — but it’s not independent. It is inside the Fed. And it has an oversight board that is made up of the very regulators who failed to act for the last decade, can overrule its decisions. And so, there’s a question about —-

AMY GOODMAN: Why does this matter to you?

KAI WRIGHT: Well, because the bottom line is that the consumers were the kindling for this fire in the first instance. If somebody had been able to stop the predatory products that they were peddling in neighborhoods all over the country, particularly these subprime loans, then -— and frankly, before the subprime loans, all the things that drove up credited debt to lead consumers to be vulnerable for these subprime loans, then we would have never gotten this far down the road. And there were people who saw it at the time, but they didn’t have the power to act. And so, we need to create somebody who has the power to act.

JUAN GONZALEZ: Well, what does the legislation do in terms of actual real teeth in regulation of these kinds of loans?

KAI WRIGHT: Well, so, the bureau that will be inside the Fed will have the ability to write and enforce new rules. So they can see a new product coming and say, “Hey, that’s a predatory product. You have to — you can’t do that, or you have to do it this way.” The problem is that the oversight board, which will be made up of, you know, Secretary Geithner and the chair of the Fed and all of the existing bank regulators, has the ability to say, “No, you can’t do that.” And so, to the degree that you have a really strong head of this bureau, you know, that person will stand up and fight. But the minute you don’t have a strong head, then you’ve got just another bureau that has no power.

AMY GOODMAN: Rob Johnson, you were the chief economist on the Senate Banking Committee. The significance of the shift from being independent to being inside the Fed and what this overall means?

ROBERT JOHNSON: Well, it’s enormously significant. It’s designed to neuter the consumer financial protection initiative. You put it inside the Fed, and the Fed’s primary responsibility is safety and soundness of large financial institutions, protecting the system from the kind of failure we just had. They need to collect information from those large banks. If those large banks are angry with them, they’ll have a fight on their primary mission. And it’s certain that the consumer financial protection frontier will anger those banks. So the missions are incompatible. It should not be inside the Fed. And furthermore, the Fed should not be rewarded for the kind of failure it did in supervision, examination and its role in the unfolding crisis.

JUAN GONZALEZ: And in terms of the overall bill, especially on the situation of dealing with the banks that caused this crisis, Senator Dick Durbin, in a radio interview a few days ago, said that it’s “hard to believe in a time when we’re facing a banking crisis that many of the banks created [that the banks] are still the most powerful lobby on Capitol Hill. [And] they frankly own the place.”

ROBERT JOHNSON: Yes. As we approach the election, elected officials know the American people are enraged, particularly about the question of “too big to fail” — large institutions that aren’t subject to the same rules as everyone else. At the same time, they need money for their reelection in this money-gushed politics system that we have. So we’re engaged in a Kabuki theater right now, hoping the material is too complex for the American people to understand, declaring victory, and yet basically encoding into law current practices of the banks.

Every one of your listeners should ask the question, given this legislation, if the President, House and Senate pass it, will we be in a place where AIG couldn’t have happened, Lehman Brothers couldn’t have happened, Bear Stearns couldn’t have happened, and, more importantly, nine, ten percent unemployment caused by the banking crisis couldn’t have happened? I argue this bill does very little, and even Gary Gensler, who’s probably the strongest element of the administration at the CFTC, argued yesterday at the Chamber of Commerce that it does not do the job, the end-user loopholes in derivatives regulation, which is, to my mind, the San Andreas Fault of the financial system.

AMY GOODMAN: We’re going to continue this conversation after break. We’re talking to Rob Johnson — he is the former chief economist at the Senate Banking Committee, now director of the Economic Policy Initiative at the Franklin and Eleanor Roosevelt Institute — and Kai Wright, editorial director of ColorLines Magazine and a fellow at the Nation Institute. This is Democracy Now! We’ll be back in a minute.


AMY GOODMAN: Our guests, Kai Wright, editorial director of ColorLines Magazine, fellow at the Nation Institute, and Rob Johnson, director of the Economic Policy Initiative at the Franklin and Eleanor Roosevelt Institute. Juan?

JUAN GONZALEZ: Rob, I wanted to follow up on what we were talking about before the break. You were mentioning the regulation of derivatives as the “San Andreas Fault” of this legislation. Could you expound on that? What is the bill proposing to do, and what really should be done in terms of this time bomb, this continuing time bomb, of derivatives in our economy?

ROBERT JOHNSON: The derivatives are traded what’s called over the counter, which means embedded on the balance sheets of the large “too big to fail” banks. “Too big to fail” is intimately connected, therefore, to derivatives. Derivatives that are complex, opaque, difficult to price, put the system at risk, but they make enormous profits for the five largest banks. Five largest banks control about 97 percent of the derivatives market. You get to a place where they allow these complex things to continue, the next time the system is shocked everybody will scurry around not knowing what they’re worth, not knowing what the other banks are worth, and the credit market can continue to freeze up.

They need to make very substantial changes, where all derivatives are put on exchanges and cleared, prices marked twice a day, and customers can see what is a derivative contract trade for. They can look up on an electronic screen, just like they do for foreign exchange or interest rates. The opaqueness is directly connected to the profitability of the banks, and it’s directly connected to the risk of the system.

JUAN GONZALEZ: And most people don’t realize how big the derivatives market is, compared to the regular banking system.


JUAN GONZALEZ: Could you give our viewers and listeners a sense of the proportionality we’re talking about?

ROBERT JOHNSON: Yeah, the notional value of derivatives by the top twenty-five banks is about thirty — no, excuse me, $300 trillion. American GDP is $15 trillion. So I think that’s roughly twenty times the size of the American economy. It is the biggest dimension of the balance sheets of all the major banks.

JUAN GONZALEZ: And it’s largely unregulated.

ROBERT JOHNSON: And it’s largely unregulated. And if they were going to tolerate these so-called end-user exemptions, they should pay a huge capital surcharge for the right to put the system at risk. And that’s not what’s happening.

AMY GOODMAN: Rob Johnson, I almost missed your testimony in October, because I blinked. But you were the only non — what? — non-industry expert who was invited to testify before the House Financial Services Committee on the derivatives market.


AMY GOODMAN: Talk about what happened in October.

ROBERT JOHNSON: What happened in October is that, with about fourteen hours to go, Americans for Financial Reform and other consumer groups and labor unions became upset. They didn’t have anybody being represented with a point of view. Michael Greenberger, who’s a greater expert than I am on this, was considered someone they wouldn’t accept. I have worked both for the Republican and Democratic Party earlier in my career, so both parties would accept me.

I came in, testified. Melissa Bean was in the chair, a congressperson from Illinois who’s very friendly with the banks, and she gaveled down my opening statement. I asked if I could submit the rest for the record. And prior to the testimony, I said, “I’d like to be able to put this in the record, because you’re asking me to testify on a 142-page bill with about fourteen hours’ notice.”

AMY GOODMAN: How much time did you speak?

ROBERT JOHNSON: Fourteen hours — I spoke for about four minutes before I got cut off, after listening for an hour-and-a-half to eight different industry group representatives. Subsequently, there was a rough-and-tumble, and eventually Barney Frank was cornered by the Christian Science Monitor and, I believe, Harper’s Magazine in a press conference, and he said, “mea culpa.” He called me. I met with him, and he apologized. And he put things on the website and in the record.

AMY GOODMAN: So your entire testimony that you didn’t get to give was put into the record?

ROBERT JOHNSON: Yes, it’s available on their website from October 7th of 2009. It’s there now.

AMY GOODMAN: It’s easier to understand now this issue of people not really understanding what’s going on. Kai Wright, the significance of this? And what is able to be gotten away with? And who really gets hurt in the long run?

KAI WRIGHT: Well, I mean, I think we can’t underestimate the problem of it being so complicated on its — it sounds complicated right when we start talking about it, but it’s actually really quite simple. When I started reporting on the subprime crisis, what struck me probably the most was how unsurprised anybody who had been working in communities where all of this predatory lending had been taking place for fifteen years —-

AMY GOODMAN: What are those communities?

KAI WRIGHT: They’re largely black and Latino communities, but they’re working-class communities all over the country, places where we had run up -— where credit card companies and payday lenders and the whole swarm, I would call it, of financial players had run up a bunch of debt and put people with their backs against the wall and made them — left them vulnerable to these come-ons from mortgage markets. Keep in mind, again, that it’s, you know, something like 60 percent of subprime borrowers that were steered into these loans. So the people who were working in these communities were not at all surprised. When the world looked up and said, “Oh, my god! We could have never seen this coming,” they said, “Yeah, we could. We said it was coming. We told you it was coming. Here’s the testimony that we gave to our state legislatures, the community advisory board of the Fed. Here’s the testimony we gave to the Fed saying that this was going to be a problem.”

The problem is nobody acted. And nobody acted because it wasn’t in anyone’s interest to protect consumers. All of the existing regulators, their interest is in protecting the health of the banking sector. That doesn’t mean they’re bad people. Well, they may or may not be bad people. But their job is not protecting consumers. And so the goal here is to create something that actually protects consumers. And if that thing has to answer to the regulators who ignored all the people who were talking about this is a problem for consumers ten years ago, then it’s not going to do it. And that’s simple. That’s straightforward. People knew this was going to happen. They said it was going to happen. The people responsible for stopping it didn’t do it. And now we’re putting those same people in charge of stopping it again.

JUAN GONZALEZ: And Rob Johnson, in terms of warnings, the last couple of weeks there have been — a lot of the influential publications in the nation have been resurrecting the discussion about the dangers faced by the Social Security system. A front-page article in today’s New York Times saying for the first time this year it appears that Social Security will pay out more to recipients than it will be taking in, and they’re claiming that the economic crisis, the number of people that are unemployed are exacerbating the situation, because there are not as many people paying into the system. Your sense — it appears that the Obama administration has been sending signals for quite awhile that it intends to tackle the, quote, “Social Security crisis.” And I’m wondering your thoughts on that — the crisis and its relationship to the general economic crisis the country is facing.

ROBERT JOHNSON: Juan, you’re right that a drumbeat is building. A bipartisan deficit reduction community is building. I experience a great deal of outrage, for us to look at the debt growth from this banking crisis, what economists call the debt-to-GDP ratio. It’s gone from about 40 percent, they predict it will go to 85 percent, more than doubling. The deficit hawks, when we were doing bank bailouts, took a vacation under water. They’re now talking as though grandma in 2049 is risking our financial health. I don’t see any of those same people on deck as deficit hawks saying, “We need financial reform of a really profound form, because we can’t afford to go from 85 to 125 percent of GDP with our debt.”

And this stuff really does matter. It matters to roads, bridges, schools, senior aid, and healthcare, just like the healthcare bill, which pads the profits for all of industry, then we’ll complain that Medicare costs are out of control. It’s not because grandma is consuming too much medicine; it’s that we don’t have a competitive system in healthcare provision, healthcare insurance or in pharmaceuticals. This is a problem of governance. It is a problem mathematically, but the problem isn’t with Social Security.

AMY GOODMAN: And yet, as we were talking before the show, Juan, we are seeing a drumbeat of newspaper articles now. On television, you see all the pundits saying, “Have you seen Social Security? It looks like more is being paid out than we’re taking in.” The drumbeat is developing.

JUAN GONZALEZ: Right. But my question, obviously, as we’ve discussed this before, the idea that a particular part of government services is costing more, it’s never, for instance, raised about the Defense Department, that the Defense Department is costing too much or we need to cut back on defense spending.

ROBERT JOHNSON: Well, my alma mater, the hedge fund industry, pays 15 percent income taxes under what they call “carry interest” provisions, rather than true income taxes. Warren Buffett even jokes about this. He says his income tax rate is lower than his secretary’s.

AMY GOODMAN: If Bush’s privatization of Social Security had gone through, would it have been wiped out in the financial crisis?

ROBERT JOHNSON: Well, it would have taken the same magnitude of losses that, say, the equity market did, so a substantial amount of losses, yes.

AMY GOODMAN: Lehman Brothers head Bryan Marsal was just in Berlin at a bankruptcy conference, and in an interview with a British — with a German business daily, he said that the Wall Street — that the banks are in for another megabank bankruptcy. Is this true?

ROBERT JOHNSON: I don’t think it’s imminent, but I do think it’s true. And where I think it’s —- where it’s hidden right now is that you have a whole bunch of second mortgages and equity lines of credit that are embedded in the big banks that are being priced at about 85 cents on the dollar. They’re probably worthless. But no one in the accounting profession or at the Treasury or the Fed is forcing these people to realize those losses. Now, what does that mean? If you overstate the value of your assets and you don’t take your losses, then you could overstate your earnings, and then you can pay big bonuses. So -—

JUAN GONZALEZ: And Kai, finally, I’d like to ask you what the — what can the consumers, who will be affected by this consumer —- this new consumer protection agency, do now as this bill is moved through the Senate?

KAI WRIGHT: Well, same thing that all of us are going to have to do, which is continue to hold elected officials accountable. You know, it’s tough. You know, we saw it for healthcare. We’re seeing it now on financial reform. We’ll probably see it when they get to immigration reform. It is difficult these days to get voters’ voices heard by their elected officials. And I think we have to do the same things we always have to do: we have to let them know we’re out there, we have to let them know we’re paying attention and try to stop it. It’s barreling ahead, and it’s clear that they don’t want to accept a whole lot of amendments. They want to get this thing passed fast.

AMY GOODMAN: And the banks are very happy, is that right? I mean -—

ROBERT JOHNSON: Well, my colleague Mike Konczal at the Roosevelt Institute put on the blog at New Deal 2.0 the other day, “What would Goldman Sachs dislike about this?” And the answer was nothing, really. And he did some research. He called people behind the scenes. They’re not opposing this bill, because there’s nothing in it takes a bite out of them.

AMY GOODMAN: Rob Johnson, we want to thank you for being with us. Rob Johnson is director of Economic Policy Initiative at the new Franklin and Eleanor Roosevelt Institute. And Kai Wright, editorial director of ColorLines Magazine and a fellow at the Nation Institute. Thank you both for being with us, as we continue on this issue of finances, especially when it comes to young people and student loans.

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