Essentials For Financial Reform

The Senate version of a major financial reform bill—the Restoring American Financial Stability Act—was the subject in late April of behind-the-scenes negotiations between Senate Banking Committee Chairman Christopher Dodd and key Senate Republicans. Largely as a result of efforts to win enough Republican votes to overcome a threatened filibuster, this bill has been critically weakened in five key areas. In order for this legislation to be effective in preventing another financial crash that would touch off a series of expensive Wall street bailouts, here are five changes that a coalition of financial reform activists are supporting.

Weakness: The Dodd bill leaves too-big-to-fail banks even bigger.
Response: Shrink the biggest banks through the Brown-Kaufman amendment.

Three of the nation’s four largest bank holding companies—Bank of America, Wells Fargo, and JP Morgan Chase—each have liabilities that are more than 2 percent of the nation’s gross domestic product. In fact, Bank of America’s liabilities equal 7 percent of the country’s GDP. Add the fourth bank holding company, Citigroup, and together these banks control 35 percent of all of the bank deposits in the country.

This is too much risk concentrated in too few institutions. Even with the provision in the Dodd bill that would create a banking industry-financed resolution fund to cover the costs of dissolving a failed institution, the impact of one of these bank failures on the economy would still be so great that even if Congress did not authorize another bailout, the Federal Reserve might be compelled to act on its own.

Sens. Sherrod Brown, D-Ohio, Ted Kaufman, D-Del., and three other Senate Democrats have introduced a bill to cap big bank liabilities at 2 percent of gross domestic product (about $300 billion) and non-bank financial institutions to 3 percent of GDP. Brown intends to offer it as an amendment to the Dodd bill.

Weakness: Consumer protection gets trumped by big-bank interests.
Response: Create an independent, stand-alone Consumer Financial Protection Agency.

The most significant proposal President Obama asked for when he rolled out his reform plans in June 2009 was the establishment of a new Consumer Financial Protection Agency. Existing regulators are charged with both ensuring bank profitability and keeping consumers safe from abuses. In practice, this has meant that regulators look the other way on predatory lending, so long as it creates big short-term profits for banks.

The solution to this problem is a new agency with the power to write and enforce consumer protection regulations for anybody who offers consumer loans. Dodd essentially gutted the proposal in the Banking Committee, by placing the consumer agency inside the Federal Reserve and giving the Fed broad authority to block the agency’s actions, in an effort to garner Republican support that ultimately never materialized.

Sen. Jack Reed has indicated he will offer an amendment to the Dodd bill that would restore President Obama’s original intent for a consumer-focused agency with real teeth. For more on why we need a Consumer Financial Protection Agency, see our fact sheet.

Weakness: Banks will still be able to gamble on high-risk financial products and compel a bailout if those gambles go bad.
Response: Reinstate the Glass-Steagall Act and wall off Main Street banking from Wall Street speculation.

Commercial banks that accept deposits and extend consumer and business loans are the core of the financial system. If they go down, the payments system dissolves and people cannot use money to pay for goods and services. We shouldn’t be subjecting such a critical economic function to the risks inherent in the securities markets.

Former Federal Reserve chairman Paul Volcker, now an Obama administration economic adviser, has said that banks that benefit from federal deposit insurance shouldn’t be going out and gambling with taxpayer money. Volcker has argued for ending dangerous speculation by cracking down on "proprietary trading"—pure bets that are unrelated to serving any clients a bank works with. Efforts to codify that principle in the Dodd bill have been left in tatters. And even if the bill had a robust implementation of what’s become known as "the Volcker rule," the fact is the proprietary trading that Volcker targets is very difficult to distinguish from other "client-related" trading, and in many cases, client-related trading is just as dangerous.

We need to go further. From the Depression until conservatives in Congress got it repealed in the 1990s, the Glass-Steagall Act banned banks that accepted deposits from playing around in the securities markets in any way, whether for clients or themselves. Banks can profit serving the needs of consumers and businesses; other financial institutions are essentially free to engage in whatever trades they wish but bear 100 percent of the risks. Sens. Maria Cantwell, D-Wash., and John McCain, R-Ariz., are co-sponsoring an amendment that would enact a 21st -century version of Glass-Steagall.

Weakness: The derivatives "casino" is still open, still in the shadows, and still has the power to bring down the financial system.
Response: Separate commercial banking from derivatives trades and put derivatives on the open market.

Derivatives are extraordinarily dangerous. They brought down AIG, and AIG nearly brought down our economy. The market is huge—the trading value of derivatives is $3.3 trillion, and the value of the goods that are the subject of those derivatives trades is $500 trillion. A whopping 96 percent of this market is housed in just five banks. Indeed, the three biggest derivatives traders are also three of the biggest commercial banks: Bank of America, Citigroup and JP Morgan Chase. It is significant that the fact that these institutions have Federal Deposit Insurance Corporation protection on most of their deposits makes the derivative contracts these banks sell attractive to investors, even though federal deposit insurance was never even remotely intended to protect banks that use their deposit base to engage in unregulated Wall Street speculation.

The Senate Agriculture Committee has approved language authored by Sen. Blanche Lincoln, D-Ark. in the financial reform bill that would bar federal bailout money to institutions dealing in derivatives trading and force banks to spin off their derivatives units from their commercial banking. It would also require all derivatives trades to be done in open exchanges, where everyone can see what risks everyone else is taking on. Chances are investors would have thought twice in the run-up to the financial crisis if they had full and meaningful disclosure of the trillions of dollars in subprime-mortgage risk that was being taken on by companies such as AIG.

Weakness: The Federal Reserve retains broad authority to prop up too-big-to-fail institutions with almost no public accountability.
Response: Add the Sanders "Audit the Fed" amendment to financial reform.

The Federal Reserve has pumped out $4.7 trillion in bailout money for the financial sector over the course of the crisis. But it has refused to tell the public who is receiving that money and on what terms it is being extended. The House financial reform bill contains a provision authored by Reps. Ron Paul, R-Texas, and Alan Grayson, D-Fla., that would require a full audit of the Fed’s activities.

Sen. Bernie Sanders, I-Vt., has been a forceful advocate for Fed accountability and plans to offer the same amendment in the Senate. It’s our money. We deserve to know where it’s going.