Stress Test

  On January 21, 2010, President Obama announced our new proposal in the Diplomatic Reception Room in front of Dodd, Frank, our economic team, and Volcker himself. We had informed Dodd and Frank, but we had not consulted them. Dodd was irritated because he thought we were going to screw up his negotiations in the Senate. Frank was irritated because it made our approach look “tougher” than his, when he had left similarly populist provisions out of the House bill out of deference to our opposition. Larry was irritated because he thought I was surrendering on substance to appease the Old Testament crowd. But there was a decent policy argument on moral hazard grounds against allowing banks backed by the government to run hedge funds and private equity funds. And the President used the ceremony to try to jump-start momentum for our broader reforms.

  “What we’ve seen so far, in recent weeks, is an army of industry lobbyists from Wall Street descending on Capitol Hill to try and block basic commonsense rules of the road that would protect our economy and the American people,” the President said. “If these folks want a fight, it’s a fight I’m ready to have.”

  At the time, the announcement was mocked as a cynical reaction to Scott Brown’s victory the day before; we had planned it before we knew about Brown, but no one believed that. My newfound support for the Volcker Rule was certainly political, but it was driven by my desire to pass the broader reforms, and the timing really was a coincidence. Because my lack of enthusiasm for earlier versions of Volcker’s proposal was not a secret—and a photo of the announcement caught me staring at the floor—the President’s embrace of the Volcker Rule was also seen as a rebuke to me. That was comical but convenient, because if I had been viewed as its champion, it would have had less power with the Democratic left.

  I remember Bob Rubin, who was always suspicious of populism, told me he didn’t think the Volcker Rule was a good idea.

  “I assure you that if you were sitting in my seat, you’d think it’s an excellent idea,” I told him.

  THE SENATE tends to be somewhat less majoritarian and partisan than the House, partly because of the sixty-vote hurdle to overcome filibusters, partly because six-year terms give senators at least some relief from the permanent campaign, partly because they represent entire states rather than gerrymandered and often homogeneous House districts. Long before Scott Brown’s election meant we’d need at least one Republican senator to pass financial reform, Chairman Dodd, who had spent thirty years in the Senate, was trying to build bipartisan consensus on the banking committee. He announced early on that he would try to negotiate terms with his ranking member, Richard Shelby, a conservative Republican from Alabama. We were worried about the potential price of accommodation, but Dodd knew the Senate better than we did, and he said he had never passed major legislation without a Republican partner.

  I didn’t know Dodd well, and we had gotten off to a rocky start during the AIG flap; our staffs had blamed each other for his Recovery Act language that barred us from going after bonus contracts retroactively. He was a savvy and seasoned Washington insider, but he faced an uphill reelection battle. We worried that would make it hard for him to hold the line against populist pressure, and might make him cautious about moving the bill. After he decided not to run for reelection in January 2010, we sometimes worried he would be too anxious to pass a bill that would burnish his legacy, cutting deals at the expense of the President’s priorities. And in the White House, there was some skepticism about Dodd’s efforts to find common ground with Republicans. We hadn’t seen a lot of hope yet for bipartisan consensus in Washington, and among other roadblocks, Republicans were making it pretty clear they could never support legislation that included an independent consumer agency, which we considered non-negotiable.

  At times, Senator Shelby could seem genuinely interested in bipartisan reform. At one early dinner at Treasury, he expressed enthusiasm for higher capital requirements, central clearing of derivatives, and other administration priorities. But after the Tea Party summer put Republicans on notice that their base would rebel against any compromise with a tyrannical socialist President, Shelby became much more antagonistic. Even behind closed doors, we could sense his staff pulling him back from engagement. At one meeting in Dodd’s hideaway in the Capitol, Shelby was edging toward a compromise on some contentious issue when he suddenly stopped in midsentence. He had caught the eye of one of his top aides, who was glaring and shaking his head.

  “But, of course,” Shelby hastened to add, “the outcome would depend on what my caucus is willing to do.”

  We doubted the Republican caucus would do much. We had seen Senator Baucus spend precious months wooing Republicans to support Obamacare; in the end, not one Republican voted yes. The Senate was still marginally less partisan than the House, but during the Obama years, the margin was shrinking rapidly. Senator McConnell, who was heralding Republican opposition to reform on fund-raising trips to Wall Street, would later declare that his number one goal was to limit President Obama to one term, an admission surprising only for its candor.

  Sure enough, in early February 2010, Dodd announced that he and Shelby had reached an impasse. Dodd then announced he would begin new negotiations with Republican Senator Bob Corker of Tennessee; by early March, that courtship had fallen apart, too. We got a sense of how seriously the committee’s Republicans wanted to engage when they filed hundreds of amendments before Dodd’s markup—including dozens to move the bill’s effective date back ten days, eleven days, twelve days, and so on—and then decided not to offer any of them, essentially declaring that they didn’t want anything to do with financial reform.

  Still, Dodd’s patient, persistent bipartisan outreach was critical to persuading the Senate’s moderate Republicans—Brown along with Susan Collins and Olympia Snowe of Maine—to consider supporting the bill. Dodd’s good-faith efforts to find common ground also helped persuade moderate Democrats to support a bill with little bipartisan support; like Baucus on health reform, Dodd showed his caucus that broad bipartisan consensus was impossible. Ultimately, Dodd was a dealmaker, and a very skillful legislator. At times, we disagreed with his accommodations, like when he agreed to scrap new fiduciary requirements for brokers and investment advisers at the request of South Dakota Democratic Senator Tim Johnson. “Bad and pointless loss for investor protection,” Barr wrote to me. “Still waiting for more shoes to drop.”

  But the new fiduciary duties got restored at the end. Senator Dodd worked very closely with us, and when we told him we had a real problem with changes he was considering to build support, he tried to respond to our concerns. At one point, Michael Barr and Laurie Schaffer, Treasury’s banking lawyer, stopped by my office to tell me Dodd wanted to eliminate much of the Fed’s supervisory responsibility. My instant reaction was no way—or, as I sometimes abbreviated it, NFW. The United Kingdom had separated its lender-of-last-resort function from its supervision function, with disastrous results; its central bank, lacking the situational awareness that comes with supervisory boots on the ground, badly underestimated the crisis and allowed a run to cripple Northern Rock. But after the President invited Dodd to the Oval Office and expressed similar NFW sentiments in more polite terms, Dodd changed his mind. He pushed us to be more practical, and to bend where we needed to, but he knew he needed the President to get the bill done.

  We had a similar uh-oh moment, with less satisfactory results, over derivatives regulation. In early April 2010, Senate Agriculture Committee Chair Blanche Lincoln of Arkansas, a moderate Democrat from a deep-red state, sent Barr some weak compromise language on derivatives that did not include mandatory clearing of derivatives and did not require derivatives to be more openly traded. We knew this was politically sensitive—Lincoln was up for reelection, and she was in trouble—but after a weekend of talks with the White House, we let her know the President would oppose her language if she introduced it in its current form. We were stunned when she then replaced her bank-friendly language with a dramatically different proposal, a blast
of populism that essentially would have barred commercial banks from the derivatives business.

  After her tack to the right fizzled, Senator Lincoln was now tacking left. She wanted to outflank a liberal Democratic primary challenger who had been bashing her as a tool of the banks. Her staff was also trying to get back at us for rejecting her initial language; they called the new provision their “fuck-you-with-a-cherry-on-top.” But we didn’t see how the new Lincoln amendment, so broadly and sloppily written, would reduce systemic risk. Banning FDIC-insured banks from using derivatives would just drive more derivatives into uninsured nonbanks. Banks needed to use derivatives to hedge their risks, and I didn’t see why they shouldn’t be allowed to help their customers hedge risks as well. I explained all of this to the President, and he agreed with the substance of our concerns, but this was one of the times he told me to be careful about how we fought back. The Lincoln amendment quickly became a new rallying cry for the left, and evidence of my opposition would only strengthen their conviction it was necessary and just.

  There was yet another populist spasm that April, after the SEC filed fraud charges against Goldman Sachs and a young trader named Fabrice Tourre, who had written emails calling himself “the fabulous Fab” and mocking the mortgage securities that Goldman was selling its customers. Tourre was charged with failing to disclose critical information to the buyers of a complex security that Goldman had created with input from another customer who wanted to bet against the housing market. I was surprised to see this case become such a symbol of Wall Street’s perfidy; these actions deserved sanction, but the victims were not particularly sympathetic, just large financial interests who were taking opposing bets on the housing market. But Democratic Senator Carl Levin of Michigan created compelling theater by torturing several Goldman executives at a hearing, repeatedly asking them about deals their underlings had described as “shitty.” This was an opportune time for a resurgence of populist anger, and it helped reinvigorate the push for reform, but after worrying for months that Dodd-Frank would be weakened by concessions to the right, we now started to worry it could get torqued too far left.

  On May 10, for example, Senator Levin and fellow progressive Jeff Merkley of Oregon released an amendment they described as a tougher version of the Volcker Rule, along with a supportive statement from Paul Volcker himself. This proved to be a much shinier object than our version, and it became a new litmus test for the left. And our discomfort with Merkley-Levin’s approach to proprietary trading became the latest evidence that we were soft on Wall Street.

  Merkley-Levin did broaden the definition of proprietary trading beyond what we had proposed, but we didn’t think it was better or in fact tougher than our approach. Its sweeping restrictions would be offset by all kinds of loopholes, making the amendment vastly more complicated than Volcker’s one-page synopsis and much more difficult to implement. With admirable candor, Merkley told me he wanted to support a tough Volcker Rule, but to do that he needed to exempt insurance companies and real estate investments because those industries were vital to his state, and to many other pro-reform senators. In an email, Barr said Dodd also wanted to accommodate Scott Brown, fellow Republican Judd Gregg, and Democrats Mark Warner, Evan Bayh, and John Kerry “by carving out trusts, sweep accounts, a broader set of insurance companies & affiliates, feeder funds, hedge funds with seed capital, and most firms in Massachusetts.” The amendment ended up looking like Swiss cheese.

  Dealing with Congress, to put it mildly, did not feel like a careful, deliberative journey in search of the best public policy. I remember going to meet the personable Senator Brown, who had recently arrived in Washington after a campaign spent attacking the “Cornhusker Kickback” that Ben Nelson had procured for Nebraska in the health care bill. We talked about our kids and about triathlons. When the conversation finally turned to substance, he said he liked the idea of financial reform and expected to be with us. But without any irony or self-consciousness, he said he needed to protect two financial institutions in Massachusetts from the Volcker Rule’s restrictions.

  Then he furrowed his brow and turned to his aide.

  “Which ones are they, again?” he asked.

  In a circuitous effort to protect those two companies—the aide identified them as Fidelity and State Street—Brown would later propose a broader weakening of the entire Volcker Rule, allowing banks to invest up to 3 percent of their capital in hedge funds and private equity funds. My staff didn’t like this, and neither did Volcker, but there wasn’t much we could do about it. We needed sixty votes for reform. We didn’t have many Republican options, and a few Democrats were threatening to vote no. These concessions weren’t going to ruin the legislation, but Barr fretted about death by a thousand cuts.

  “Nothing tragic, but signs of fraying similar to House,” he warned me, as the grueling negotiations pressed on. “Need to close this off soon.”

  Despite their impasse on the overall bill, Dodd cut a deal with Shelby that actually improved the House’s language on resolution authority, eliminating the mandatory haircuts for failing banks as well as the pre-financed FDIC “bailout fund.” But they also reached an agreement to scrap the broad FDIC guarantee authority that had helped calm the crisis, a serious problem. As a concession to anti-bailout anger, we had agreed to eliminate the Fed’s ability to engineer firm-specific rescues as it had done with Bear Stearns and AIG, because we thought the combination of effective resolution authority plus FDIC guarantees (as well as the Fed’s general authority to support the system in “unusual and exigent circumstances”) would make one-off rescues, never appealing, less necessary. But I told Dodd that curtailing the guarantees without restoring the Fed’s ability to intervene to save a failing firm would leave the system more vulnerable than ever in a panic.

  Dodd told me not to worry. It was too late to fix the Senate bill, which would pass May 20. But the House and Senate still had to reconcile their different versions.

  “We’ll fix it in conference,” Dodd told me.

  I was worried anyway, and I said so to the President. But we both knew he couldn’t veto reform on the grounds that it would make bailouts too difficult.

  WE HAD a big meeting on the Hill in June to go over our priorities for the House-Senate conference. But by that time, Dodd and Frank didn’t want to hear about anything that would complicate the endgame. My only memory of that session was that the Los Angeles Lakers were playing in the NBA finals on a television behind me, and everyone’s eyes kept straying to the game. At one point Rahm interrupted to point out his brother, a Hollywood agent, sitting in the front row.

  We still hoped that Dodd would restore those FDIC guarantees he said he would fix in conference. But a few days later, our banking lawyer, Laurie Schaffer, attended a follow-up meeting with Dodd’s counsel, who reported the guarantees were off the table.

  “She said we will have to come back in a year or two and fix,” Schaffer wrote. “She said that hopefully there will not be a financial crisis in the interim.”

  Yes, hopefully. On the bright side, the conference adopted the Senate’s version of resolution authority. The Lincoln amendment made it into the final bill, but in a narrower form that only required banks to move a few types of derivatives into affiliates. The consumer agency was technically housed inside the Fed—it became the Consumer Financial Protection Bureau, or CFPB—but the final language fully protected its independence.

  The final piece of real drama took place just after the conference finally wrapped up at 5:30 a.m. on June 25. The Congressional Budget Office had “scored” the cost of Dodd-Frank at about $20 billion, so the conference had approved an equivalent amount in fees on big banks and hedge funds to pay for it. Scott Brown, who had ridden the Tea Party wave into the Senate, suddenly announced he could no longer support the legislation, because it would violate a pledge he had signed not to raise taxes. Democratic Senator Robert Byrd of West Virginia was gravely ill, and his fellow Democrat Russell Feingold of Wisconsi
n was refusing to support the bill from the left, so Brown was our sixtieth vote.

  “Brown statement—did he leave himself room?” I emailed Barr.

  “Brown left himself room, but I’m worried about him,” Barr replied.

  Wolin and Barr suggested the alternative “pay-fors” that lured Brown back on board. The most fitting was a provision eliminating our authority to spend $225 billion in TARP money that we had never touched. At the same time the U.S. government was taking action to reduce the risk of future crises, it was declaring the last crisis over.

  The House approved the Wall Street Reform and Consumer Protection Act on June 30 by a 237–192 vote, with three Republicans switching to yes on final passage. The Senate followed suit in mid-July, 60–39, also with just three Republican votes. GOP leaders blasted the bill as big-government liberalism run amok, an assault on free enterprise, a continuation of the bailout mentality. Meanwhile, many liberals dismissed it as fake reform, a triumph for too-big-to-fail Wall Street banks. Dodd-Frank was messy and complicated. It occupied that shrinking pragmatic center of the American political system. It certainly wasn’t perfect; it’s impossible to get that kind of ship to shore without picking up some barnacles. But it was a major substantive achievement. President Obama had promised to make our Wild West financial system much safer, and he kept his promise.

  ONE REASON this progress has been overlooked is that our top priority for reform was strengthening the system’s shock absorbers, and that was not a primary focus of the legislative fights over Dodd-Frank. I testified that financial stability would depend on capital, capital, capital, but we didn’t set those requirements in Dodd-Frank. That was by design. We gave the responsibility for new restrictions on capital, liquidity, and leverage to the Fed and the other bank supervisors, and pushed for a new international agreement to give them global force. And we succeeded.