In a speech at the Levy Institute’s annual Hyman P. Minsky Conference today, Senator Elizabeth Warren laid out a set of proposals to advance the process of financial reform that began with the enactment of the Dodd-Frank Act of 2010.
Americans for Financial Reform already supports a number of the specific policy ideas in Senator Warren’s speech, including:
- A financial transaction tax to restrain high-frequency trading and wasteful speculation;
- Restoration of the Glass-Steagall division between investment and commercial banking, along with other steps to reduce the size and power of Too Big to Fail banks;
- Limitations on the Fed’s use of its emergency lending authority, in order to keep Wall Street from playing short-term games with low-cost debt; and
- Changes in the tax code to diiscourage excess leverage and recklessness on the part of the big banks and their traders and executives.
“The Unfinished Business of Financial Reform”
Senator Elizabeth Warren
Remarks at the Levy Institute’s 24th Annual Hyman P. Minsky Conference
As Prepared for Delivery
Thank you all for being here today.
We’re here to ask a critical question at a critical time: what are we to make of Dodd-Frank five years later? To answer that question, I think we should start by looking at how the government responded to the last major financial crisis – the Wall Street Crash of 1929.
After the 1929 crash, policymakers diagnosed what had gone wrong and changed the laws to make sure that excessive speculation and risk-taking on Wall Street couldn’t push the economy over a cliff. The new rules were creative and unprecedented:
- First, a new agency – the SEC – charged with enforcing basic marketplace rules. In other words, a cop for Wall Street just like the cops for Main Street;
- Second, a targeted government safety net – FDIC insurance – to make it safe to put money in banks, creating security for depositors and stability for the banking system; and
- Third, a clear division between deposit-taking institutions and investment banks – the Glass-Steagall Act – so that banks couldn’t use government-guaranteed deposits for high-risk speculation.
And for half a century, those creative new rules worked. There wasn’t a single serious financial crisis. No crises and the financial sector did its part to help produce sustained, broad-based economic growth that benefitted millions of people across the country.
Then, in the 1980s, a new political wind swept across the country. “Deregulation” became the watchword of the day – or, to put it more bluntly, fire the cops. Not the cops on Main Street, but the cops on Wall Street. The Fed and other bank regulators looked the other way as big financial institutions found new ways to trick their customers, first through credit cards and then through mortgages, home equity lines of credit, and a raft of new financial products. The SEC was badly outgunned. Regulators were clueless as banks developed creative new trading strategies outside the old rules. Credit rating agencies signed off on the safety of pools of mortgages that were more like boxes full of grenades with the pins already pulled out. The wall between high-risk trading and boring banking was knocked down, and Glass-Steagall was eventually repealed. Washington turned a blind eye as risks were packaged and re-packaged, magnified, and then sold to unsuspecting pension funds, municipal governments, and many others who believed the markets were honest.
Not long after the cops were blindfolded and the big banks were turned loose, the worst crash since the 1930s hit the American economy – a crash that the Dallas Fed estimates has cost a collective $14 trillion.
The moral of this story is simple: without basic government regulation, financial markets don’t work.
That’s worth repeating: without some basic rules and accountability, financial markets don’t work. People get ripped off, risk-taking explodes, and the markets blow up. That’s just an empirical fact – clearly observable in 1929 and again in 2008.
The point is worth repeating because, for too long, the opponents of financial reform have cast this debate as an argument between the pro-regulation camp and the pro-market camp, generally putting Democrats in the first camp and Republicans in the second. But that so-called choice gets it wrong. Rules are not the enemy of markets. Rules are a necessary ingredient for healthy markets, for markets that create competition and innovation. And rolling back the rules or firing the cops can be profoundly anti-market.
Right now the Republicans are pushing an anti-market agenda. They are trying to hamstring the CFPB by slashing its funding, reducing its jurisdiction, and restricting its enforcement authority – steps that would undermine the market by taking financial cops off the beat. With no cops, companies could out-compete one another not by creating value, but by cheating their customers.
Or look at what they did last December: When Republicans rammed through a repeal of Dodd-Frank’s swaps pushout provision, they undermined the market again by handing out taxpayer subsidies to a handful of the biggest banks on the planet and giving those banks a tremendous advantage over their smaller competitors who just don’t get that kind of subsidy.
Republicans claim – loudly and repeatedly – that they support competitive markets, but their approach to financial regulation is pure crony capitalism that helps the rich and the powerful protect and expand their wealth and their power – and leaves everyone else behind.
We need rules – but not all rules promote innovative and competitive markets. So what tests should we use to make sure the rules promote healthy competition and innovation? We can start with the two principles that worked so well for more than fifty years after the 1929 crash:
- First, financial institutions shouldn’t be allowed to cheat people. Markets work only if people can see and understand the products they are buying, only if people can reasonably compare one product to another, only if people can’t get fooled into taking on far more risk than they realize just so that some fly-by-night company can turn a quick profit and move on. That’s true for families buying mortgages and for pension plans buying complex financial instruments.
- Second, financial institutions shouldn’t be allowed to get the taxpayers to pick up their risks. That’s true for using insured deposits for high-risk trading (and the reason we had Glass-Steagall) and it’s true for letting Too-Big-to-Fail banks get a wink-and-a-nod guarantee of a government bailout.
Judged against these two principles, Dodd-Frank made some real progress – and Barney Frank and Chris Dodd deserve an enormous amount of credit for their leadership. But there is more work to be done.
Consider the goal of “no more cheating people.” Dodd-Frank took a powerful step toward honest markets with the establishment of the Consumer Financial Protection Bureau. Instead of a grab bag of consumer protection laws scattered among seven different agencies, none of whom had any real skill or any real interest in enforcing them, Congress created a new agency that had the tools, the expertise, and the responsibility for making sure that consumer financial markets worked fairly. This was a real, structural change.
Is it working? Yes. Mortgages have gotten clearer and easier to read. Some of the sleaziest – and most dangerous – terms have been banned. And work on credit cards, student