FINANCE DECEMBER 29, 2013
2013 was a not-awful year for financial reform. If you aren’t terrified of jinxing even the smallest good news, you might even say it was pretty good. The multi-year implementation of 2010’s Dodd-Frank bill made several final advancements this year, and compared to where people thought we’d be a year ago, we are in a pretty solid place.
Last year, nobody thought that banks would face tougher holding requirements for capital, that regulations of the financial derivatives markets would advance, or that the final Volcker would be a pretty good start instead of an incoherent mess. Yet that is what appears to have happened in 2013. So what caused it? And how it might apply to future political goals?
The successes of 2013 were partially driven by the failures of Wall Street in 2012. The multi-billion dollar trading losses from JPMorgan Chase known as the “London Whale” changed the dynamics for financial reform in a way that took a year to realize. JPMorgan had been leading the charge against reform, arguing that the effort was over-harsh and destructive, and that Wall Street had already cleaned up its act on its own. Indeed, the big concern in 2012 was that Wall Street would convince enough moderate Democrats that Dodd-Frank had gone too far in certain respects, and that Congress would stop regulatory action before it was even completed. This fell apart right alongside the multi-billion dollar losses in JPMorgan’s position. Though various bills to remove parts of Dodd-Frank would pass the House by Republican votes, these efforts failed to generate moderate Democratic votes in the Senate after the Whale trade became public.
JPMorgan’s London Whale trades also drew clear lines on whether reform would work. In 2012, one of the major battles had been over how aggressively to make foreign affiliates of U.S. banks follow U.S. rules. The London Whale helped the chairman of the Commodity Futures Trading Commission, Gary Gensler, push for aggressive implementation over European criticism; he argued that the London Whale was a continuation of the supposedly bygone practices that led to the financial crisis. JPMorgan’s failure also gave new energy to, and a clear target for, the stalled Volcker Rule, which was designed to split hedge funds from banks.
Financial reform benefitted as well from engaged activism that proposed tougher reforms, which pressured regulators to hit the mark and kept the financial industry on the defensive. This is clearest in the case of capital requirements, which require banks to hold a set percentage of their assets and which the finance industry fights consistently. To many people’s surprise, the U.S. ended up with tougher capital requirements than people anticipated, with more to come next year. Ideally we’d see double-digit capital requirements with extra requirements for larger firms that fund themselves with panic-prone funding. Regulators didn’t get there on the first try, but still came in stronger than originally proposed. And they are making stronger steps on the second part.
One of the major reasons for this was an intellectual movement that argued high capital requirements would both be an excellent way to stabilize the financial system at a minimal cost to society. Professor Anat Admati of Stanford formalized this argument in her book with Martin Hellwig,The Bankers New Clothes. Admati also responded in detail to her critics.
These arguments led Senators Sherrod Brown and David Vitter to release a plan earlier this year significantly increasing capital requirements. Though it did not receive many cosponsors, it signaled to regulators that legislators were paying attention, and that they’d have to be more aggressive than they otherwise planned.
Senators Elizabeth Warren and John McCain also pushed a new version Glass-Steagall earlier this year. It also didn’t gain much support, but still put some steel in the spines of the Volcker Rule’s authors, as Glass-Steagall was being proposed by many as an alternative reform if the Volcker Rule failed.
The last reason reform worked in 2013 was the result of insider and outsider actors committed to pushing reform on the agenda. Senator Warren used her new position on the Senate Banking Committee to raise the profile of financial reform. She completely restarted the conversation about criminal settlements and trials for Wall Street wrongdoing. It also became clear that the implementation of several rules had been dragged out not because banks were undermining them, but because, in fact, regulators were fighting for tougher rules. The CFTC’s Bart Chilton, for instance, threatened to vote against a weak Volcker Rule, holding out for a stronger rule.
Meanwhile, outside groups kept up the pressure through the democratic rule-writing process. Ever since the mid-2000s, when liberal groups “discovered” the infrastructure of conservative think tanks, there’s been a push to duplicate that on the left. Though small compared to Wall Street and the right, groups like Americans for Financial Reform and Better Markets show up extensively in the comments on the Volcker Rule. In the final rule, there are hundred of references to the detailed comment letter the Occupy the SEC group sent. These groups didn’t exist before the crisis, and their existence is a major piece of what makes solid final rules happen.
This is in no way to sugar coat the problems that still exist. The battle will go to the courts next year—courts that need liberal judges appointed immediately to balance their conservative bent. (Thanks to the end of the filibuster for judicial nominees, this is an achievable goal.) Personnel is key to policy, and everyone needs to be very concerned about the next wave of appointees. And the next Federal Reserve chair Janet Yellen will have a huge influence over how well these rules are actually enforced.
But 2013 does provide one path forward. Clearly identifying what has gone wrong, providing strong, unapologetic reforms, and developing leaders inside and outside of Washington worked this year, and it will work going forward.