Stress Test

  I wish I could say I was being strategic, but it was just a frustrated rant, and, of course, it had no positive effect. Three days later, Neal forwarded me an email from Elizabeth Warren, reporting that President Obama’s SEC Chair, Mary Schapiro—usually one of the most cooperative regulators, and a supporter of our overall reforms—had lobbied Republican Senator Susan Collins against our proposed consumer agency.

  “If true (who knows), egregious,” Neal wrote.

  ONCE WE released our legislative draft, the House of Representatives, as they say in Washington, had to work its will.

  The House is a majoritarian institution, and Democrats had a solid majority, so we knew we could pass something. We also had a great ally in Chairman Frank, one of the sharpest members of Congress. I had first met Barney while working on Third World debt relief in the Clinton administration; I remember he once pulled me out of a meeting in the majority leader’s office late at night to shout at me about something the IMF had done. He was not going to be overly deferential to us on financial reform, either, but fortunately, we agreed on most of the substance. He had to be attuned to the political needs of Democrats on his committee—liberal populists who wanted to burnish their anti–Wall Street credibility as well as moderates with major financial interests in their districts—but when we had differences, we tried to work them out.

  In September 2009, for example, Barney was about to release draft language for the consumer agency, and Assistant Treasury Secretary Michael Barr, a law professor and former Rhodes scholar who ran point for us on reform, thought it was riddled with problems. “Important areas of consumer protection would literally disappear,” he wrote to Barney’s staff director. Barr emailed me as well: “I don’t want to slow things down, but this thing is a real mess.” But Barr went over to the Hill the next day and smoothed out the more damaging wrinkles with Barney’s staff.

  Barney was ideally suited to carry such a politically fraught bill. After nearly three decades in Congress fighting for liberal causes, he had enough credibility with the left to resist extreme populist measures that could undermine the financial system, but he was not swayed by overwrought industry warnings that any stricter regulations would kill jobs and strangle businesses in red tape. He had no illusions about cooperation from House Republicans, who had marched in lockstep against the stimulus and would do the same against health reform, but he also made it clear to his fellow Democrats that they couldn’t all get everything they wanted and still pass a bill. Barney was a realist who understood the politics of the Hill and wouldn’t let the perfect be the enemy of the good.

  These politics were unusually complex. It usually takes several hours for a congressional committee to “mark up” legislation so it can be considered by the full House. Barney’s financial reform markup in the fall of 2009 took seven weeks. The special interests were out in full force, and the big Wall Street banks, despite their deep pockets and fearsome reputation, were not even the most influential. The smaller community banks, with members in every congressional district, got themselves largely carved out of the new consumer agency’s direct supervision, despite our resistance. They also helped engineer a shift in the FDIC’s insurance fund to make the bigger banks pay a bigger share of the premiums, which we supported. The big banks had become so politically toxic that they had to recruit other special interests to advance their objectives, such as the U.S. Chamber of Commerce, as well as specific industrial companies and agricultural businesses that used derivatives.

  The combination of lobbyist warfare, regulatory infighting, Republican intransigence, and Democratic divisions would make Barney’s legislative sausage-making a real challenge. One painful example was a giveaway to the influential auto dealers lobby, which also had a presence in every congressional district. Even though House Republicans had no interest in supporting the overall Dodd-Frank bill, they united behind an amendment by Congressman John Campbell, a former auto dealer from California, to exempt his old profession from the consumer agency’s oversight. That was terrible policy; for most families, vehicles are the most important purchases other than homes, and the amendment left them vulnerable to scams. But enough Democrats bent to pressure from car salesmen back home to get it through the committee.

  The lockstep Republican opposition to the legislation also meant that subsets of the Democratic majority could make ransom demands in exchange for their votes. The Congressional Black Caucus threatened to oppose reform until Barney agreed to add $3 billion for mortgage relief for the unemployed and $1 billion to help cities buy foreclosed properties; those were worthy causes, but they illustrated our political tightrope. The centrist New Democrat Coalition, which had some members with close ties to the financial industry, then threatened to block the bill unless we barred states from passing consumer regulations tougher than federal rules. They backed down after Neal Wolin deftly brokered some compromise language, but again, the impossibility of Republican cooperation gave lawmakers on the Democratic side enormous power to extract concessions.

  Nevertheless, House Democrats passed a bill in December—again, with zero Republican votes—that generally aligned with most of our proposals. It required supervisors to impose tougher regulatory requirements on the large, systemic banks than on regional and community banks. It created new powers for monitoring systemic risks, although it bestowed those powers on an interagency council instead of the Fed. It required a broad swath of derivatives to be centrally cleared, traded with more transparency, and subjected to tough margin requirements, although it allowed too many exceptions for specific interests. And it approved a strong stand-alone consumer agency, despite the carve-outs for auto dealers and community banks.

  The House bill also created new resolution authority for big failing firms, but the result was a confused combination of anti-bailout fever and some misguided FDIC ideas. The bill envisioned 10 percent haircuts for secured creditors of firms that had to be unwound, which was a surefire panic accelerant. It also curtailed the FDIC guarantee authority that had been so crucial to the success of our crisis response, compromising a vital tool in the government toolbox. And instead of financing the bankruptcy-like process with an open-ended government credit line and recouping the costs from the industry afterward, the bill created a $150 billion fund that would be financed in advance and fully controlled by the FDIC. This was awful policy; the fund wasn’t even close to big enough to unwind multiple trillion-dollar banks during a crisis. It was awful politics as well, enabling Republicans to mock the entire bill as a “bailout fund.”

  Still, we were pleased the House had passed the most ambitious financial rules reform since the New Deal. We hoped the Senate could fix its shortcomings.

  WE WERE also making progress internationally.

  In London in April 2009, we had proposed the creation of a stronger global coordinating body for financial reform, called the Financial Stability Board. I envisioned it as a new “fourth pillar” of international economic coordination, joining the International Monetary Fund, the World Bank, and the World Trade Organization. We gave the major emerging-market economies, such as China and India, a seat at the table so that they would be part of designing the new rules, and therefore more willing to impose them on their own growing financial markets. At a G-20 summit in Pittsburgh in September, we helped forge a consensus for significantly tougher worldwide capital standards—with even higher levels required for systemically important firms—along with stronger liquidity buffers and new leverage requirements. We were the main source of initiative, though we had a lot of support among other countries damaged by the crisis. By the start of 2010, the international community had agreed on reforms that would dramatically strengthen the system’s shock absorbers.

  This was pretty amazing. The last new international capital rules had taken six years to negotiate. We had reached consensus on much stronger, more complex, and more comprehensive reforms in less than a year. Much of the detailed negotiations of specific numbers and formal regu
lations still lay ahead, along with the challenge of implementation, but this was lightning speed for an international endeavor.

  Amid all this global progress and cooperation, our occasional disputes got much more attention, especially my minor spat with British prime minister Gordon Brown, a Scottish Labour Party politician whom I had first met when he was the United Kingdom’s finance minister and I was a midlevel Treasury official. In November 2009, mired in a tough campaign for reelection, Brown had his political advisers reach out to David Axelrod to try to get the administration to support a global tax on financial transactions. The so-called Tobin tax was a perennial populist favorite, conceived as a way to reap revenues from financial interests and discourage financial speculation. It had been tried in many countries, and the United States even had a very small tax on equity transactions to help fund the SEC. But Brown’s proposal would have been easily evaded by sophisticated investors, would hurt mostly retail investors, wouldn’t raise much revenue, and would have no effect on speculation. I told Axelrod we couldn’t support it. He wasn’t eager for the President to endorse a global tax increase, anyway.

  Later that month, Brown and I met privately before a G-20 summit in St. Andrews, Scotland, and he again pitched the Tobin tax. I told him we couldn’t back it, but we were open to other ways of recovering the costs of financial rescues. I said we were already considering a tax on bank leverage, which we thought would be much more effective in discouraging risky behavior as well as raising revenues to make taxpayers whole. I tried to make it clear I wanted to help him avoid a public conflict with the United States, but he wanted a Tobin tax.

  Later that day, I sat for an interview with Sky News, the British version of Fox News—also owned by Rupert Murdoch, consistently hostile to Brown and Labour. They asked if I would support Brown’s financial transaction tax, and although I expressed support for his broader objective of getting the financial industry to pay for its rescues, I said we wouldn’t back a Tobin tax. This set off a press frenzy; Brown’s top adviser told Axelrod that I had delivered “quite a hard slapdown.” Brown called me to complain that I had embarrassed him on right-wing TV, but I had warned him where I stood. He said he really needed me to support him. I again said I couldn’t do that. Brown’s people pressured the White House to walk back my public statement, and my team in Washington asked me if I wanted to clarify it.

  “Clarify what?” I asked.

  There was no realistic prospect of a global Tobin tax. It certainly had no chance without our support, so we became a convenient villain. President Sarkozy later told a group of world finance officials in my presence: “We could do it if it wasn’t for Tim!” But even the continental Europeans couldn’t agree on one for Europe.

  Many G-20 countries would end up embracing the better-designed bank leverage tax that we proposed in the United States to cover the expected losses in TARP. But we got no traction in Congress, even among Democrats, even though we called it a “fee” to try to avoid anti-tax hysteria. Ultimately, it didn’t really matter, since the estimated cost of TARP, more than $100 billion at the time, would gradually dwindle to zero.

  POLITICALLY, WE were still facing a tough road ahead on financial reform. In late December, Axelrod sent me some polling data: 61 percent of Americans thought banks had too much influence over our administration. The banks certainly didn’t think so, but that didn’t matter. We were still in political no-man’s-land, doing enough for the right to hate but not enough for the left to like. Conservatives thought we were profligate socialists, and liberals thought we were in bed with the banks.

  In fact, we were at war with the banks and other special interests that were trying to water down our reforms. Payday lenders didn’t want to be regulated by the new consumer agency; insurance companies didn’t want to be designated as systemic firms; corporations (often fronting for Wall Street) argued that they shouldn’t have to trade their derivatives on exchanges. My team, led by Neal Wolin and Michael Barr, fought back, and the President and I backed them at every turn. I remember Boeing’s CEO came to tell me that the status quo was better for Boeing because they could get better terms through private arrangements with their derivatives dealers. “Look, if everyone is coming in and telling me they’re getting special deals from their dealers, maybe nobody is getting a good deal,” I told him. After Neal’s confrontational speech about the consumer agency, lobbyists for the chamber and several major financial trade groups came to see me to complain that Treasury officials were fighting them on everything.

  “My team is beating back your proposals because they’re bad for the country,” I told them. “And we’re going to keep doing it.”

  From my perspective, the flak we were taking from every side reflected the impressive extent to which policy trumped politics in the Obama administration. The President repeatedly made it clear that he wanted us to do the right thing even if it wasn’t the popular thing, to be guided by evidence rather than polls. He showed a remarkable degree of deference to our substantive policy judgments. We discussed the political ramifications of our decisions, but on the central questions of economic and financial policy, politics didn’t drive our decisions. I admired the President’s conviction that we should do whatever we thought was necessary to end the crisis, fix the economy, and reform the financial system, then let the public judge the results.

  Of course, where we had to legislate to achieve results, where it was not just a question of how best to use authority Congress had already given the President, we had to be more sensitive to the politics. This was especially true on financial reform. The widespread perceptions that we were too close to financial interests were harming our efforts to craft a legislative coalition. As the MSNBC host Rachel Maddow once told me, it was hard for many Democrats to trust me as the architect of tough reforms, since to them I was the face of the unjust Wall Street bailouts.

  The President, annoyed and baffled by the suspicion of our motives, was eager to push back against the dominant narrative. We were fighting for sweeping reforms, including a new consumer agency that advocates had considered a pipe dream, but the public and the press seemed to take it for granted that we were doing the bidding of banks. “They really think we’re bent,” the President once marveled after telling me about a critical column he had just read.

  I advised him to stop reading that stuff, but he was a voracious consumer of news, and he knew that looking bent wouldn’t help us keep Senate Democrats on our side. President Obama never pushed me to support bad policy for political reasons, but he did ask us to try to avoid gratuitous attacks on Democrats when we fought bad proposals with popular appeal. And he did keep asking me whether we were being tough enough on the major banks. He was particularly interested in a proposal by Paul Volcker to prohibit traditional banks from engaging in “proprietary trading,” from speculating on their own account while enjoying access to cheaper capital as a result of their access to the government safety net.

  Volcker made the case in multiple meetings that banks shouldn’t be able to behave like hedge funds, taking trading risks that could force the Fed or the FDIC to ride to their rescue if the bets went bad. He believed that the high-flying investment bank culture, fueled by surreal compensation packages that in some ways rewarded short-term risk-taking, had infected traditional banks that now competed for their business. He sketched out a proprietary trading ban on a single page, and pitched it as a simple way to rein in the speculation that he thought had turned Wall Street into a casino. It would be a partial substitute for the old Glass-Steagall restrictions on banks engaging in nonbanking financial activities, an effort to restore the conservative ethos that Volcker recalled from his days as a commercial banker.

  Larry and I were skeptical. Proprietary trading by banks played no meaningful role in the crisis. For traditional banks that failed, the main problem was traditional loans, mostly mortgage loans. And the firms that caused the most damage—the investment banks, the GSEs, an out-of-control insurance compa
ny—were not traditional banks with insured deposits. It was true that some banks—Citi and Bank of America after its purchase of Merrill—put a lot of risk in their investment bank affiliates, risk that increased their vulnerabilities. But we thought a proprietary trading ban would be hard to define, and might end up impairing a valuable source of liquidity to markets. We didn’t want to stop banks from hedging risks or matching up buyers and sellers of securities, and it would be hard to distinguish these hedging and “market making” activities from mere speculation.

  But in January 2010, even before Scott Brown scuttled the filibuster-proof Democratic majority, the prospects for reform passing the Senate seemed bleak. Just when we could finally use some populist energy to build support for our bill, it had morphed into disillusionment about our efforts to reduce unemployment and foreclosures, along with cynicism about our desire for real reform. Volcker had a lot of credibility with the left, and he was regarded as less than enthusiastic about the reform legislation, even though he supported most of what we were doing. His concerns—and the perception that those concerns were not getting traction in the Treasury or the White House—were seen as evidence that we were soft on reform.

  I was usually an internal voice against conceding to political imperatives, but I thought the benefits of getting Volcker more fully committed to the Dodd-Frank cause were compelling enough to try to make the substance of his idea work. I didn’t know if it would do much to make the system more stable, but I thought we could design it in a way that would minimize the potential damage to useful financial activity. After a lunch with Volcker on Christmas Eve, I went to the President and told him I thought we could put together a proposal that might get Volcker on board. For me, this was purely legislative calculation. I neglected to tell Larry that I had evolved on the issue, and he was not happy; he thought I was making a stupid and craven concession to populism. But the President was pleased. We drafted some legislative language, and Axelrod came up with the idea of calling it the Volcker Rule.