Bull by the Horns

by Sheila Bair

  But we knew that Tim and some of the big banks would make another run at the Collins Amendment when the House and Senate met to reconcile their two bills. Indeed, I was summoned to a meeting with Tim and Ben at the Treasury on the day the Collins Amendment passed the Senate and subjected to a stern lecture from Tim about being a team player and that capital standards should be set by regulators, not Congress. Fortunately for the future stability of our financial system, that view did not prevail. I believe that the Collins Amendment will stand as one of the crucial reforms of the Dodd-Frank Act.

  A war was also brewing over the Volcker Rule, named for its chief proponent, Paul Volcker, the legendary former chairman of the Federal Reserve Board. The Volcker rule was designed to ban FDIC-insured banks and their affiliates from making speculative bets on the markets, instead of serving customers.

  Here again, Michael Barr, under Tim’s direction, was trying to water it down. Fortunately, the two chief sponsors of the provision, Senators Carl Levin (D–Mich.) and Jeffrey Merkley (D–Oreg.), held their ground.

  Tim and the Fed’s general counsel, Scott Alvarez, continued trying to sneak bailout language into the bill, and they succeeded in securing one loophole. At their behest, Dodd included in his bill a provision to let securities and derivatives clearinghouses borrow from the Fed at its discount window. We had successfully opposed that provision in the House but were becoming increasingly isolated in the Senate. Both the CFTC and SEC, initially skeptical of the provision as a potential Fed intrusion into their oversight of clearinghouses, came to support it. And the clearinghouses that they regulated were drooling at the prospect of having access to loans from the Fed.

  I thought it was a terrible precedent and still do. It was the first time in the history of the Fed that any entity besides an insured bank could borrow from the discount window. Clearinghouses had performed well during the crisis, and they have never posed a serious threat to financial stability. That is because they are tightly regulated and managed and have high financial qualification standards for their members. In the past, clearinghouses and their regulators understood that if they ran out of money to stand behind their trades, the consequences would be disastrous for both them and their members. But with the bailout loophole, the market discipline that had previously kept clearinghouses tightly and prudently managed was seriously diluted. Now if the clearinghouses run out of money, they can just borrow from the Fed.

  The Fed already had authority under the Dodd bill to make assistance generally available to healthy clearinghouses during a systemic crisis. The provision went further180 and gave it the flexibility to bail out individual outliers that were in trouble due to their own mismanagement. That unwarranted authority created a classic “moral hazard” for clearinghouses, which will be protected from realizing the negative consequences of risky decisions while still able to reap profits. Paradoxically, that increases the likelihood of clearinghouses engaging in risky activity, adding an element of potential instability to an area where it had not previously existed.

  The consumer agency proved to be the biggest fight of all. The Senate GOP had insisted that the responsibility for consumer issues stay with one of the bank regulators, citing the concern that an overly zealous consumer agency would not be sufficiently attentive to safety and soundness issues and risks to the Deposit Insurance Fund. So Dodd cleverly made the consumer agency a division of the Fed and required the Fed to fund it, but he also wrote the law so that the director of the new agency had near-complete discretion to run it as he or she saw fit. The chairman of the Fed and the Fed board were forbidden from interfering with the new agency, called the Consumer Financial Protection Bureau (CFPB). So the CFPB was technically a part of the Fed, a banking regulator, but it had the same degree of autonomy as an independent agency.

  The proposal, while clever, outraged the Republicans and made it all the harder to get the 60 votes needed to bring the bill to a vote on the Senate floor. To this day, I wonder if perhaps consumer advocates and their congressional allies were a little too clever with the proposal, given continued GOP opposition, even among moderates, to the consumer agency as it is currently constituted. We had suggested that the new consumer agency be run by a five-person board, with two bank regulator representatives. We also suggested that though the new agency should have exclusive authority to write consumer rules, it should share responsibility with the bank regulators for examinations and enforcement of those rules on banks. Sharing examination and enforcement functions for FDIC-insured banks would have allowed the new bureau to focus greater resources on examining nonbank financial services providers, such as payday lenders and check cashers, which had had no federal oversight. We had prevailed with that argument at least with the community banks. Both the House bill and the Dodd bill gave the banking regulators responsibility for examinations of and enforcement for banks with less than $10 billion worth of assets. The CFPB was given backup authority to enforce its rules if we didn’t do our job. But given the OCC’s past abysmal record on consumer protection, the consumer groups were bound and determined not to let it have any role in enforcing consumer rules against big banks. Who could blame them?

  Dodd persevered, and he was able to convince four Republicans and 56 Democrats to secure the 60 votes necessary to end debate and bring the bill to a Senate vote. Republican Senators Chuck Grassley of Iowa, Susan Collins and Olympia Snowe of Maine, and Scott Brown of Massachusetts—the late Ted Kennedy’s surprise successor and the first Republican to win a Massachusetts Senate seat since 1972—voted with Dodd. On May 20, the Senate passed the bill.

  But the fight was far from over.

  Tim was still unhappy with the restrictions on bailouts in the bill and was hoping that in the conference, Michael Barr would be able to rewrite the resolution authority more to his liking. That was a very real threat to us. House-Senate conferences—when key members of the House and Senate meet to reconcile differences in the bills they have passed—are notoriously opaque, closed-door processes. Without the bright spotlight of media and public scrutiny, we were fearful that the reform bill would revert to the bailout approach of the white paper Tim had released a year earlier.

  Fortunately, we had excellent relationships with Dodd and Frank, as well as a number of other Republican and Democratic conferees. Our legislative and legal team attended every minute of the two-week conference. Kym Copa and Roberta McInerney from our general counsel’s office worked around the clock, providing technical help and answering questions for the conferees. Fortunately, Dodd, Frank, and most of the conferees were aligned with us and our antibailout perspective. They kept us plugged in, and we were able to fend off further efforts to dilute the bailout ban in the bill.

  We had a real fight on our hands to fend off Tim’s and the industry’s attempts to eviscerate the Collins Amendment. The American Bankers Association lobbyists were bordering on hysteria, going so far as to send my board members an inflammatory analysis181 basically saying that the amendment would destroy community banks. My board ignored them.

  So did the House.

  As The Wall Street Journal’s Damian Paletta reported on June 17:

  You might hear a collective182 “Uh Oh” on Wall Street today.

  Big banks had figured surely lawmakers would strip out a controversial provision in the Senate bill that would force bank holding companies to hold more capital and essentially prohibit them from counting hybrid securities as Tier 1 capital. . . .

  So on Thursday, there were collective gasps when the House came back with their proposed changes to the provision and instead of offering to kill it, they are essentially proposing to tailor it in such a way that it would only affect banks with more than $15 billion of assets.

  In an apparent act of desperation, Bob Diamond, at the time a top official183 of Barclays, one of the biggest banks in the United Kingdom, made the outrageous accusation that the Collins Amendment would cut credit to U.S. bank customers by “as much as $1.5 trillion.”184 There w
as no basis in fact for the assertion, and it surprised me as I’ve always viewed Diamond as a levelheaded CEO. But in that instance, his arguments were over the top, even compared to the exaggerated claims of other industry groups. For example, a leading international trade association had been arguing that eliminating hybrid debt and substantially raising capital ratios globally for all banks would contract lending worldwide by $1.3 trillion. All of that was self-serving nonsense too. Numerous government and academic studies185 have shown that stronger capital standards will have, at best, a negligible impact on lending while producing tremendous benefits by reducing the risk of large-bank failures and the huge credit contractions we experienced in 2008.

  The conferees ignored Diamond’s hyperbole. We were ecstatic. In the face of opposition from Tim, the Fed, the big banks and their trade groups, the provision stayed in with only minor modifications. Recognizing the importance of Senator Collins’s support for the overall legislation, Chairman Dodd instructed his staff to keep her amendment intact. Though she was not a conferee, Dodd would oppose any changes to her amendment that Collins herself did not support. The House and Senate conferees both understood that Senator Collins was a “must-have” vote for final passage of the reform bill. She played that card masterfully, but not to appease Wall Street bigwigs or fill her campaign coffers with financial industry money; she used the leverage for the public benefit, to secure what was really the only concrete provision in the bill to improve the quality and quantity of capital held by large U.S. financial institutions.

  Indeed, most of the provisions of the House and Senate bills that we supported were approved by the conference committee.

  The conferees agreed to several provisions to permanently raise the deposit insurance limit to $250,000 and provide a two-year authorization of the Transaction Account Guarantee (TAG). That was the program we put into place during the crisis to provide unlimited coverage for large, non-interest-bearing checking accounts held by businesses and local governments. I was a bit ambivalent about those provisions, as they expanded the government safety net. At the same time, they were important to the stability of community banks, which rely heavily on insured deposits for their funding. The conferees also agreed to give the FDIC discretion to build our reserves to high levels during the good times, to provide more of a cushion to draw on them during downturns. Under prior law, we had to manage our fund within a range of 1.15 to 1.5 percent of insured deposits, which was too low.

  The conferees further agreed to provisions in both the House and Senate bills that changed the base we use to calculate assessments. Under the old system, we could look only to insured deposits in charging premiums. That gave large institutions incentives to game their premiums by obtaining funds from other sources, such as foreign deposits, which are highly volatile, or secured loans, which are costly to us in the event of a failure because they tie up good assets. Under the new law, we could look to all of a bank’s borrowings in determining its premium. The effect of that change was to shift a much higher portion of the FDIC assessment burden to banks with more than $100 billion in assets, providing a significant reduction in community banks’ FDIC premiums.

  The conferees preserved all of the FDIC’s safety and soundness regulatory authorities, as well as our ability to examine and enforce consumer rules for institutions with less than $10 billion in assets. And thanks to Senator Dodd and his chief staff aide, Amy Friend, the conferees included the House provision that gave us backup authority over bank holding companies and other systemic institutions, notwithstanding vigorous opposition by the Fed.

  But we lost the battle on the resolution fund, again primarily to the relentless efforts of Tim Geithner and Michael Barr. The House strongly advocated for the fund, and Dodd, working with Bob Corker, valiantly tried to keep a small fund in the bill. On June 25, Paul Nash reported to me that it looked as though there would be agreement on a $19 billion fund. That would give us some ability to impose assessments on the high-risk nonbanks, while the interest we earned on the fund would provide enough money to support staff salaries and other operational expenses for the new office we would need to create that would be dedicated to nonbank resolutions. But Geithner and Barr fought tooth and nail against that as well, at one point even suggesting that we would have to seek appropriated funds to support resolution authority. They didn’t want us to have any autonomy in carrying out our new resolution responsibilities.

  Even though Shelby’s staff was working in tandem with Geithner, other key Republicans, including Corker, were not opposed to a small fund to support FDIC operations. So Geithner went to Senator Scott Brown, a key swing vote, and, in a true devil’s deal, reached an agreement with him to delete the $19 billion fund and to water down the Volcker Rule as well. Specifically, Geithner agreed186 to support an exception from the Volcker Rule to allow insured banks and their affiliates to invest in speculative hedge funds and private-equity funds so long as those investments did not exceed certain limits. Tim was eager to make the changes, and he used Brown as the vehicle for doing so. Brown could then claim victories for Boston’s financial sector, while President Obama’s secretary of the Treasury would give him cover with the Democrats.

  On Monday, July 12, Brown announced that he would support the financial reform bill with that change to the Volcker Rule and the elimination of the $19 billion “bank tax.”

  Of course, the assessment would not have been a “tax” on “banks,” which already paid fees to the FDIC. It would have been a risk-based assessment on large nonbank financial players.

  Dropping the fund created a new complication: there was no way to pay for the implementation costs of the bill without relying on taxpayers. Under congressional rules, new legislation must contain sources of additional revenues to offset any costs associated with it.

  So how did Congress decide to pay for the financial reform bill? It raised the FDIC’s minimum reserve requirements. That’s right—the costs of the new resolution authority and other provisions of the bill, now known as “Dodd-Frank,” would be offset by raising the minimum amount we had to assess insured banks with more than $10 billion in assets. Investment banks, finance companies, hedge funds, and other “shadow bank” highflyers who contributed to financial instability would not pay a dime.

  Some Republicans balked at that accounting artifice, and rightfully so. I did not have an objection to the policy behind raising the minimum reserve requirements for FDIC insurance. We should have had more of a cushion going into the crisis, and we were planning to build our reserves substantially higher over time. The existing statutory minimum of 1.15 percent was far too low. But I did object to using the Deposit Insurance Fund to pay for reforms that were targeted mostly at the nonbank sector. You would have thought that the groups representing insured banks would have supported an assessment on nonbanks to pay for the bill, but did they? No, they did not. The American Bankers Association, which is supposed to represent the interests of traditional, FDIC-insured banks, vigorously lobbied against the resolution fund, making me wonder who it was representing.

  Dodd pressed me hard for a letter supporting the higher minimum reserve requirement. He was afraid that if I did not support it, he wouldn’t be able to keep all of his swing Republican votes, and the whole bill would fall on the issue. I thought it was better to have a bill than not have a bill, so I reluctantly wrote him the letter he requested but gave him only half a loaf: I told him in the letter that I supported raising the FDIC’s reserve minimum but did not express a view on whether that was the appropriate way to pay for the bill.

  The conferees finished their work in late June. On June 20, the House approved the bill reported by the conference committee on a 237–192 vote. The Senate did not vote until July 15, as Chairman Dodd struggled to line up the 60 votes he needed to bring the report to a vote. In the end, Senators Collins, Snowe, and Brown were the only three Republicans to vote with him and all but one Democrat, Russ Feingold, who opposed the bill because he thought
it was too weak.

  On July 21, the president signed the bill in a widely attended ceremony. It was held in a large auditorium at the Ronald Reagan Building and International Trade Center, but notwithstanding the bipartisan venue, only one Republican member of Congress attended: Joseph Cao, a newly elected congressman from New Orleans. I was invited, as were all the other major agency heads. Only two industry CEOs attended, and guess who they were? Vikram Pandit, the head of Geithner’s favorite bank, and Bob Diamond, who had carried Tim’s water in savaging the Collins Amendment.

  Ben Bernanke and I sat side by side in the front row as the president extolled the legislation. No, it was not a perfect bill. Legislation never is. But it gave the government important new tools and authorities that had been missing during the crisis and that, if properly used, could prevent a repeat of the terrible events of late 2008. I was particularly pleased that in speaking about the importance of the legislation, the president highlighted the resolution authority we had worked so hard for:

  And finally187, because of this law, the American people will never again be asked to foot the bill for Wall Street’s mistakes. (Applause.) There will be no more tax-funded bailouts—period. (Applause.) If a large financial institution should ever fail, this reform gives us the ability to wind it down without endangering the broader economy. And there will be new rules to make clear that no firm is somehow protected because it is “too big to fail,” so we don’t have another AIG.

  That sounded like the president I had heard during the meeting in the Oval Office on AIG more than a year before. I believed that was how he felt, but I didn’t think his Treasury secretary felt the same way. As I sat there, I couldn’t think of one Dodd-Frank reform that Tim strongly supported. Resolution authority, derivatives reform, the Volcker and Collins amendments—he had worked to weaken or oppose them all. Yet Obama had left the legislative battles to him. For instance, Senator Dodd had spoken188 to Obama only three times during the entire legislative process. Dodd-Frank was a good bill, but for that President Obama had to thank Chairmen Dodd and Frank and legislators such as Senator Collins, who were willing to rise above partisan posturing and industry pressure to protect the country.