How Congress and the Courts Are Closing in on Dodd-Frank

Apr 4, 2013Mike Konczal

What are the serious threats to Dodd-Frank? Last month, Haley Sweetland Edwards wrote "He Who Makes the Rules" at the Washington Monthly, which is the best single piece on Dodd-Frank implementation I've seen. In it, she identifies "three main areas on this gauntlet where a rule can be sliced, diced, gouged, or otherwise weakened beyond recognition." The first is "the agency itself, where industry lobbyists enjoy outsized influence in meetings and comment letters, on rule makers’ access to vital information, and on the interpretation of the law itself." The second is the courts, "where industry groups can sue an agency and have a rule killed on a variety of grounds." And the third is Congress, "where an entire law can be retroactively gutted or poked through with loopholes."

How important have those three areas been? Looking at the first two and a half years of Dodd-Frank, the courts turned out to be the unexpected danger for financial reform. I have a piece in Bloomberg View today arguing this, as well as the fact that the courts are structurally biased against reform in some very crucial ways.

That's not to say the lobbying battle is going well. But when the bill passed, people understood that rulewriting would be a difficult battle, and some groups like Americans for Financial Reform and Better Markets could at least help balance the lobbying efforts of financial industry groups. What was less understood was that the D.C. Circuit Court would have so many vacancies, and thus tilted to the far right and a radical agenda. I hope you check out the piece.

But what about Congress? Erika Eichelberger at Mother Jones has an excellent piece about the ongoing, now biparistan, efforts to roll back parts of Dodd-Frank's derivative regulations that are starting up in the House Agriculture Committee. (I wrote about this effort for Wonkblog here.) This third area Edwards identifies, Congress, is only now becoming a serious battlefield. But isn't the timing off? President Obama and the Democrats lost in 2010 but won in 2012. Yet while the threat of Congress rolling back Dodd-Frank, one of President Obama's major achievements, with new bills wasn't on the radar in 2011, it may be in 2013. Isn't that backwards?
 
Part of the answer is that the rules are becoming clearer, so financial industry lobbyists have more concrete targets to bring to Congress. But there's a political dimension as well. The general shutdown and polarization that dominated Congress after 2010 made a congressional threat to Dodd-Frank less likely. And ironically, the rise of the Tea Party within the conservative movement, even with its anti-Obama and anti-regulatory zeal, made bills to weaken Dodd-Frank less likely to pass. One reason is that the Tea Party wanted a full repeal of the bill or to gut entire sections, rather than more targeted interventions. Another is that the biggest losers in the 2010 shellacking were centrist “new Democrats,” those that would be more responsive to the needs of the financial industry than the progressive caucus that gained in relative strength afterwards.
 
It’s possible many more centrist Democrats could have moved a bill through Congress weakening Dodd-Frank as it was being implemented, especially if conservatives were looking to compromise. But remaining centrist Democrats were not going to remove the FDIC's new resolution authority to end Too Big To Fail, which is what the Ryan budget calls for, or knee-cap the CFPB out the door, which is what the Senate GOP wants in exchange for nominating a director, or vote to repeal the bill in its entirety, which was a litmus test for the 2012 GOP presidental candidates. Especially after they just took a lot of heat to pass the bill. Deficit hysteria was the only thing that got momentum, with both parties doing serious damage by cutting the budget of the CFTC.
 
(The unpopularity of the financial industry probably didn't help either. The congressional change that the financial industry most wanted, the delay of a rule designed to limit the interchange fees associated with debit cards, failed to clear 60 votes in the Senate.)
 
Now that the GOP is realizing that Dodd-Frank is here to stay, we might see more effort to reach across the aisle to dismantle smaller pieces of it in accordance with what the financial industry wants. Health care is facing a similar situation, where conservatives policy entrepreneurs are currently debating whether or not to work within the framework of Obamacare or continue trying to repeal it. Sadly, conservatives will probably do far more damage if they get to the point of accepting that Dodd-Frank is the law of the land and try to do more targeted repeals rather than wage all-out war.
 
Follow or contact the Rortybomb blog:
  

 

What are the serious threats to Dodd-Frank? Last month, Haley Sweetland Edwards wrote "He Who Makes the Rules" at the Washington Monthly, which is the best single piece on Dodd-Frank implementation I've seen. In it, she identifies "three main areas on this gauntlet where a rule can be sliced, diced, gouged, or otherwise weakened beyond recognition." The first is "the agency itself, where industry lobbyists enjoy outsized influence in meetings and comment letters, on rule makers’ access to vital information, and on the interpretation of the law itself." The second is the courts, "where industry groups can sue an agency and have a rule killed on a variety of grounds." And the third is Congress, "where an entire law can be retroactively gutted or poked through with loopholes."

How important have those three areas been? Looking at the first two and a half years of Dodd-Frank, the courts turned out to be the unexpected danger for financial reform. I have a piece in Bloomberg View today arguing this, as well as the fact that the courts are structurally biased against reform in some very crucial ways.

That's not to say the lobbying battle is going well. But when the bill passed, people understood that rulewriting would be a difficult battle, and some groups like Americans for Financial Reform and Better Markets could at least help balance the lobbying efforts of financial industry groups. What was less understood was that the D.C. Circuit Court would have so many vacancies, and thus tilted to the far right and a radical agenda. I hope you check out the piece.

But what about Congress? Erika Eichelberger at Mother Jones has an excellent piece about the ongoing, now biparistan, efforts to roll back parts of Dodd-Frank's derivative regulations that are starting up in the House Agriculture Committee. (I wrote about this effort for Wonkblog here.) This third area Edwards identifies, Congress, is only now becoming a serious battlefield. But isn't the timing off? President Obama and the Democrats lost in 2010 but won in 2012. Yet while the threat of Congress rolling back Dodd-Frank, one of President Obama's major achievements, with new bills wasn't on the radar in 2011, it may be in 2013. Isn't that backwards?
 
Part of the answer is that the rules are becoming clearer, so financial industry lobbyists have more concrete targets to bring to Congress. But there's a political dimension as well. The general shutdown and polarization that dominated Congress after 2010 made a congressional threat to Dodd-Frank less likely. And ironically, the rise of the Tea Party within the conservative movement, even with its anti-Obama and anti-regulatory zeal, made bills to weaken Dodd-Frank less likely to pass. One reason is that the Tea Party wanted a full repeal of the bill or to gut entire sections, rather than more targeted interventions. Another is that the biggest losers in the 2010 shellacking were centrist “new Democrats,” those that would be more responsive to the needs of the financial industry than the progressive caucus that gained in relative strength afterwards.
 
It’s possible many more centrist Democrats could have moved a bill through Congress weakening Dodd-Frank as it was being implemented, especially if conservatives were looking to compromise. But remaining centrist Democrats were not going to remove the FDIC's new resolution authority to end Too Big To Fail, which is what the Ryan budget calls for, or knee-cap the CFPB out the door, which is what the Senate GOP wants in exchange for nominating a director, or vote to repeal the bill in its entirety, which was a litmus test for the 2012 GOP presidental candidates. Especially after they just took a lot of heat to pass the bill. Deficit hysteria was the only thing that got momentum, with both parties doing serious damage by cutting the budget of the CFTC.
 
(The unpopularity of the financial industry probably didn't help either. The congressional change that the financial industry most wanted, the delay of a rule designed to limit the interchange fees associated with debit cards, failed to clear 60 votes in the Senate.)
 
Now that the GOP is realizing that Dodd-Frank is here to stay, we might see more effort to reach across the aisle to dismantle smaller pieces of it in accordance with what the financial industry wants. Health care is facing a similar situation, where conservatives policy entrepreneurs are currently debating whether or not to work within the framework of Obamacare or continue trying to repeal it. Sadly, conservatives will probably do far more damage if they get to the point of accepting that Dodd-Frank is the law of the land and try to do more targeted repeals rather than wage all-out war.
 
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Why the U.S. Could Use a Financial Transaction Tax

Feb 11, 2013Greg Noth

Taxing speculation would raise revenue and make markets safer for everyone.

Taxing speculation would raise revenue and make markets safer for everyone.

In January, 11 European countries implemented a Financial Transaction Tax (FTT), which places a small tax on stocks, bonds, and other products traded in financial markets. They expect to raise billions of dollars in revenue, and there are signs the idea for a similar tax may be gaining traction in the United States. Senator Tom Harkin and Rep. Peter DeFazio are reviving their Wall Street Trading and Speculators Tax Act, which includes an FTT but died in committee in 2011.

The purpose of a Financial Transaction Tax is to raise revenue by requiring buyers and sellers to pay a very small fee for each trade they make. The FTT proposed by Harkin and DeFazio, for example, places a three-basis-point charge on most stock, bond, and derivative trades. (In comparison, the European FTT taxes stock and bond trades at 0.1 percent of their value.) A basis point is one-hundredth of one percent, meaning a tax of just 3 cents would be paid for every $100 traded, $3 for every $10,000 traded, and so on. It would apply to any trade in the U.S. and by any U.S. individual or company, so corporations’ offshore subsidiaries would not be able to get around it.

The bipartisan Joint Committee on Taxation projects a three-basis-point FTT could raise as much as $352 billion over the course of 10 years – an average of $43 billion a year. This is a significant amount of money. With it, many of the harsh across-the-board cuts put in place by the 2011 Budget Control Act (BCA) (also known as sequestration) could be alleviated. For example, the $38 billion scheduled to be cut from non-defense discretionary spending – for things like housing assistance and community development – could be avoided entirely.

The FTT is a very low-risk bet, and, as mentioned, the returns could be huge. Most Americans are not trading derivatives or credit-default swaps, and thus would have nothing to worry about. The International Monetary Fund (IMF) examined Europe’s FTT and said it was “quite progressive.” According to the European Tax Commissioner, banks and other financial institutions, such as hedge funds, carry out as much as 85 percent of taxable transactions. In practice, the FTT would function in a similar way to the capital gains tax, which affects a very small number of people, most of whom are already wealthy. It would not be like the sales tax, which is regressive and falls disproportionately on the poor.

A Financial Transaction Tax would create a less volatile and speculative stock market, something few Americans would have a problem with. Because trades would be taxed (albeit at a very low rate), investors and financial managers would have an incentive to think long-term when making investments. This would discourage high-frequency trading (HFT), which offers very little to normal investors and has exploded in recent years, making the market more volatile  and dangerous. If HFT did not decline, however, it would simply result in more revenue.

Opponents of the FTT say it would harm financial markets and companies looking to raise money. However, smart legislation can avoid that problem rather easily. For example, the Harkin-DeFazio FTT would exempt the initial issuance of stocks, bonds, and other debts. Loans from financial institutions, companies’ initial public offerings (IPOs), and a city’s sale of municipal bonds, for example, would all be exempt from the FTT the first time they are sold. If a financial institution decided to trade a company’s debt after issuing it a loan, however, the FTT would come into effect.

Those arguing against the FTT also say the costs incurred by the tax would be passed on to retail investors -- through increased ATM fees, for example. But this is entirely avoidable with the right legislative language. The law could simply ban the practice, but even without an explicit ban, it is unlikely banks would take that course. Since some banks’ activities would fall under the FTT more than others’, not every bank would have the same incentives to raise fees on customers. As a result, if only a select few banks did so while others did not, marketplace competition would drive consumers to institutions without FTT-related fees.

In the wake of the 2008 financial disaster, which banks and financial institutions played a large role in creating, it makes sense to have policies designed to incentivize responsible trading practices and reign in reckless behavior. A Financial Transaction Tax would result in a more stable and less volatile stock market. It would also raise billions of dollars that could help avoid the harsh cuts set to begin March 1 – and it would do it all without touching the vast majority of Americans’ wallets.

Greg Noth is an intern in the House of Representatives and has formerly worked with the Center for American Progress and Iowa Senate Democrats. He is a graduate of Knox College in Galesburg, IL.

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Why the Republican CFPB Arguments Are Wrong

Feb 5, 2013Mike Konczal

It's been almost two years, and the GOP still refuses to approve a Consumer Financial Protection Bureau (CFPB) director without a significant overhaul of the agency. Check out Adam Serwer at Mother Jones as well as Jennifer Bendery at Huffington Post for more on this story. Forty-three Republican Senators signed a letter last week, one that is almost exactly the same as the one they signed in July 2011, blocking Cordray's nomination because they want major legislative changes to Dodd-Frank and the CFPB.

As congressional scholar Thomas Mann told Jonathan Cohn, this should be viewed as a form of modern day nullification. Dodd-Frank is the law of the land. Congress legitimately passed this law containing a CFPB designed to have certain features. Even though the GOP doesn't like it doesn't mean they can sabotage it or prevent it from working. And the CFPB needs a director to work.

The letter features a high-level complaint along with three specific changes they want. Beyond the letter, these three points are so common on the right that it is probably useful to point out that they are wrong. This is drawn from Adam Levitin's Congressional testimony on the matter as well as other CFPB analysis over the years. Bold is from the letter.

"...we have serious concerns about the lack of congressional oversight of the agency and the lack of normal, democratic checks on its sole director, who would wield nearly unprecedented powers."
 
The CFPB must regularly make reports and appear before Congress. The CFPB is subject to a veto of its actions by other financial regulators as represented by the Financial Stability Oversight Council (FSOC), a completely unique accountability feature that does not apply to any other regulators. The CFPB is subject to an annual audit by the GAO, which is then turned over to Congress, another unique form of accountability. It is also subject to the Small Business Regulatory Enforcement Fairness Act of 1996 (SBREFA), a feature of OIRA that doesn't apply to other financial regulators.
 
The CFPB is also limited in its actions by the text of Dodd-Frank itself. It can't mandate the offering of any financial product, force the extension of credit, regulate non-financial businesses, require businesses to offer products or credit, impose usury caps, or force consumers to take products. See, among other places, Section 1027 of Dodd-Frank for further restrictions. If you'd like to go further, you can see a list of 19 ways the CFPB is accountable here. Rather than having unprecedented powers, this agency is as accountable and has more checks than any other federal financial regulator.
 
"We again urge the adoption of the following [three] reforms:
 
1. Establish a bipartisan board of directors to oversee the Consumer Financial Protection Bureau."
 
The Office of the Comptroller of the Currency (OCC) and the former Office of Thrift Supervision (OTS), both federal financial regulators, both have single directors, so this is neither odd nor unprecedented. Some other agencies have boards, like the FDIC. There are some reasons to use one model over the other, but the GOP is not making a clear case for why a board of directors is superior to a sole director, much less a case sufficient to justify nullifying parts of Dodd-Frank. A single director encourages direct action, streamlined agency, and more accountability. Given what we've seen in the past 10 years with subprime, action is better than inaction.
 
Five directors can blame each other when things go wrong. Given the concern over accountability in the GOP's letter, a single director strikes me as the right way to go. There's more on oversight here.
 
"2. Subject the Bureau to the annual appropriation process, similar to other federal regulators."
 
Other federal banking regulators have their own independent budgets and are not subject to the appropriations process. The OCC, the FDIC, and the former OTS get their budgets from assessments from the financial institutions they regulate. The CFPB gets its budget from the Federal Reserve in order to avoid the capture that comes with being dependent on industry assessments. However, unlike those institutions, the CFPB has a statutory budgetary cap of 12 percent of the Federal Reserve's budget.

Congress consciously decided to fund the CFPB this way to prevent them from subjecting the important work that needs to be done to the annual appropriations process. This is normal in financial regulation and appropriate for the CFPB. You can read more about how this funding is designed to take the political economy of regulation into account here.

"3. Establish a safety-and-soundness check for the prudential regulators."
 
There is already a safety-and-soundness check at the OCC, which, through the FSOC, can vote on vetoing CFPB actions. Beyond that, safety-and-soundness is often synonymous with profit-making. The broken servicing model at the largest banks, for instance, is an abuse-ridden disaster for borrowers and lenders, but they are profitable activities that, de facto, boost the banks' safety-and-soundness via profits. The CFPB is meant to be a balance against this regulatory impulse. This was debated at length during the Dodd-Frank process, and Congress still decided to mandate the CFPB with its current mission.
 
Immediately after Obamacare passed, conservative David Frum argued, in a now famous piece called "Waterloo," that the GOP could have turned the bill into one far more favorable for conservatives with just a few GOP votes. But they didn't, and now they are stuck with a law they hate. The same dynamic is true for Dodd-Frank. If a dozen Senators and House GOP members decided to make a bipartisan bill in 2009, they could have likely gotten a CFPB that they would like better. But they didn't. And now they want to retroactively try and get that bill they chose not to enact.
 
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It's been almost two years, and the GOP still refuses to approve a Consumer Financial Protection Bureau (CFPB) director without a significant overhaul of the agency. Check out Adam Serwer at Mother Jones as well as Jennifer Bendery at Huffington Post for more on this story. Forty-three Republican Senators signed a letter last week, one that is almost exactly the same as the one they signed in July 2011, blocking Cordray's nomination because they want major legislative changes to Dodd-Frank and the CFPB.

As congressional scholar Thomas Mann told Jonathan Cohn, this should be viewed as a form of modern day nullification. Dodd-Frank is the law of the land. Congress legitimately passed this law containing a CFPB designed to have certain features. Even though the GOP doesn't like it doesn't mean they can sabotage it or prevent it from working. And the CFPB needs a director to work.

The letter features a high-level complaint along with three specific changes they want. Beyond the letter, these three points are so common on the right that it is probably useful to point out that they are wrong. This is drawn from Adam Levitin's Congressional testimony on the matter as well as other CFPB analysis over the years. Bold is from the letter.

"...we have serious concerns about the lack of congressional oversight of the agency and the lack of normal, democratic checks on its sole director, who would wield nearly unprecedented powers."
 
The CFPB must regularly make reports and appear before Congress. The CFPB is subject to a veto of its actions by other financial regulators as represented by the Financial Stability Oversight Council (FSOC), a completely unique accountability feature that does not apply to any other regulators. The CFPB is subject to an annual audit by the GAO, which is then turned over to Congress, another unique form of accountability. It is also subject to the Small Business Regulatory Enforcement Fairness Act of 1996 (SBREFA), a feature of OIRA that doesn't apply to other financial regulators.
 
The CFPB is also limited in its actions by the text of Dodd-Frank itself. It can't mandate the offering of any financial product, force the extension of credit, regulate non-financial businesses, require businesses to offer products or credit, impose usury caps, or force consumers to take products. See, among other places, Section 1027 of Dodd-Frank for further restrictions. If you'd like to go further, you can see a list of 19 ways the CFPB is accountable here. Rather than having unprecedented powers, this agency is as accountable and has more checks than any other federal financial regulator.
 
"We again urge the adoption of the following [three] reforms:
 
1. Establish a bipartisan board of directors to oversee the Consumer Financial Protection Bureau."
 
The Office of the Comptroller of the Currency (OCC) and the former Office of Thrift Supervision (OTS), both federal financial regulators, both have single directors, so this is neither odd nor unprecedented. Some other agencies have boards, like the FDIC. There are some reasons to use one model over the other, but the GOP is not making a clear case for why a board of directors is superior to a sole director, much less a case sufficient to justify nullifying parts of Dodd-Frank. A single director encourages direct action, streamlined agency, and more accountability. Given what we've seen in the past 10 years with subprime, action is better than inaction.
 
Five directors can blame each other when things go wrong. Given the concern over accountability in the GOP's letter, a single director strikes me as the right way to go. There's more on oversight here.
 
"2. Subject the Bureau to the annual appropriation process, similar to other federal regulators."
 
Other federal banking regulators have their own independent budgets and are not subject to the appropriations process. The OCC, the FDIC, and the former OTS get their budgets from assessments from the financial institutions they regulate. The CFPB gets its budget from the Federal Reserve in order to avoid the capture that comes with being dependent on industry assessments. However, unlike those institutions, the CFPB has a statutory budgetary cap of 12 percent of the Federal Reserve's budget.

Congress consciously decided to fund the CFPB this way to prevent them from subjecting the important work that needs to be done to the annual appropriations process. This is normal in financial regulation and appropriate for the CFPB. You can read more about how this funding is designed to take the political economy of regulation into account here.

"3. Establish a safety-and-soundness check for the prudential regulators."
 
There is already a safety-and-soundness check at the OCC, which, through the FSOC, can vote on vetoing CFPB actions. Beyond that, safety-and-soundness is often synonymous with profit-making. The broken servicing model at the largest banks, for instance, is an abuse-ridden disaster for borrowers and lenders, but they are profitable activities that, de facto, boost the banks' safety-and-soundness via profits. The CFPB is meant to be a balance against this regulatory impulse. This was debated at length during the Dodd-Frank process, and Congress still decided to mandate the CFPB with its current mission.
 
Immediately after Obamacare passed, conservative David Frum argued, in a now famous piece called "Waterloo," that the GOP could have turned the bill into one far more favorable for conservatives with just a few GOP votes. But they didn't, and now they are stuck with a law they hate. The same dynamic is true for Dodd-Frank. If a dozen Senators and House GOP members decided to make a bipartisan bill in 2009, they could have likely gotten a CFPB that they would like better. But they didn't. And now they want to retroactively try and get that bill they chose not to enact.
 
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Republican with tie image via Shutterstock.com.

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Live at the American Prospect: On the Treasury's Second Term Financial Reform Agenda

Feb 4, 2013Mike Konczal

I have a new piece at The American Prospect, on what Treasury will need to do in the 2nd term when it comes to financial reform:

Nevertheless, the Treasury secretary will be responsible for the overhaul of the legal and regulatory framework that governs the financial sector. The incoming Treasury secretary will have three chief responsibilities: complete the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act, determine how many of the new parts will work together going forward, and parry with congressional efforts to repeal parts of that law.

I hope you check it out.

I have a new piece at The American Prospect, on what Treasury will need to do in the 2nd term when it comes to financial reform:

Nevertheless, the Treasury secretary will be responsible for the overhaul of the legal and regulatory framework that governs the financial sector. The incoming Treasury secretary will have three chief responsibilities: complete the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act, determine how many of the new parts will work together going forward, and parry with congressional efforts to repeal parts of that law.

I hope you check it out.

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Is the Right Shifting Course on Dodd-Frank?

Feb 4, 2013Mike Konczal

During the 2012 election, conservatives' main goal was to either repeal Dodd-Frank completely or remove such large sections of it that it was a completely different bill. There was very little engagement with the content of Dodd-Frank itself and how to make them work better. One important example was Republican candidates like Jon Huntsman calling for bold new financial reforms that were already part of Dodd-Frank

It now appears that the flagship policy journal on the right, National Affairs, is moving towards a reform rather than replace agenda for Dodd-Frank and financial reform. The latest issue featured an large, 7,000+ word article, "Against Casino Finance," by Eric Posner and E. Glen Weyl of University of Chicago law school. What's fascinating about the piece is less the authors' counter proposals for reform, which are lacking, than the fact that they accept two of the ideas put forward by financial reformers that have generally been resisted on the right. The first is that derivatives require regulation and the second is that prudential regulation of the largest systemically risky financial firms is necessary.

Let's take those in order. First the authors argue, "[I]n today's derivatives market...no such sensible restriction exists to separate the use of the instruments as insurance from their use as gambling devices." They describe these instruments as "pure gambling," or a transaction in which "one party loses exactly what the other party gains, and both are made worse off by the additional risk they take on in this bargain." They argue that these instruments can increase pure risks and are zero-sum, differentiating them from other trades. They go as far as to argue against the Commodity Futures Modernization Act of 2000.

It isn't clear what they think of the general Dodd-Frank approach to derivatives, which emphasizes transparency through exchanges and clearinghouses, capital adequacy, private enforcement, and regulation of intermediaries. Their focus is partially on the "insurable interest doctrine" of common law as it relates to insurance, which requires that a party to an insurance contract have a stake in the event. If you can't buy fire insurance on your neighbor's house, why can you buy credit insurance on his business if you don't have an ownership claim on it? That's a dog whistle for either banning so-called "naked" derivatives or running them under state-level insurance law. The vote to ban naked credit default swaps, proposed in the Senate by Bryan Dorgan, failed (and was generally opposed on the right). 

The other regulations relate to bailouts and prudential regulations. As they put it:

When banks fail, the government must act as lender of last resort.

Today, the government serves this role in two ways. First, it compels banks to buy government-supplied deposit insurance, which covers depositors up to $250,000. Second, it provides emergency loans at below-market rates -- bailouts -- to any financial institution whose collapse would take down enough banks with it to endanger the entire economy.

Few seriously doubt that governments must play this role.

Bagehot’s rule is usually summarized as, “Lend without limit, to solvent firms, against good collateral, at high rates." In exchange for this, certain regulations are necessary. Dodd-Frank includes higher capital and liquidity requirements for larger and riskier firms, as well as certain organizational requirements (loosely referred to under the term "living wills") to help with collapsing the company in question via FDIC's resolution powers.

Again, it would be interesting if they addressed the specific reforms to lender of last resort functions included in Dodd-Frank, or the combination of regulation and resolution. Section 13(3) of the Federal Reserve Act was amended so that "any emergency lending program or facility is for the purpose of providing liquidity to the financial system, and not to aid a failing financial company." and any such lending program has to have "broad-based eligibility.” Some have argued this is too loose to deal with a liquidity crisis. Do these authors agree? Are the regulations and FDIC's resolution powers sufficient in this case, or do we need a different approach?

Their specific recommendations for how the right should tackle Dodd-Frank, which is the last third of the piece, involve applying stricter cost-benefit analysis to all rules. There's no talk about repeal, or huge changes to the framework, or long court battles. Cost-benefit has significant problems, but that's a debate for another day. Conceptually, it is tinkering with Dodd-Frank rather than repealing it, which has dominated the conversation on the right. Will this signal a larger change?

Follow or contact the Rortybomb blog:

  

During the 2012 election, conservatives' main goal was to either repeal Dodd-Frank completely or remove such large sections of it that it was a completely different bill. There was very little engagement with the content of Dodd-Frank itself and how to make them work better. One important example was Republican candidates like Jon Huntsman calling for bold new financial reforms that were already part of Dodd-Frank

It now appears that the flagship policy journal on the right, National Affairs, is moving towards a reform rather than replace agenda for Dodd-Frank and financial reform. The latest issue featured an large, 7,000+ word article, "Against Casino Finance," by Eric Posner and E. Glen Weyl of University of Chicago law school. What's fascinating about the piece is less the authors' counter proposals for reform, which are lacking, than the fact that they accept two of the ideas put forward by financial reformers that have generally been resisted on the right. The first is that derivatives require regulation and the second is that prudential regulation of the largest systemically risky financial firms is necessary.

Let's take those in order. First the authors argue, "[I]n today's derivatives market...no such sensible restriction exists to separate the use of the instruments as insurance from their use as gambling devices." They describe these instruments as "pure gambling," or a transaction in which "one party loses exactly what the other party gains, and both are made worse off by the additional risk they take on in this bargain." They argue that these instruments can increase pure risks and are zero-sum, differentiating them from other trades. They go as far as to argue against the Commodity Futures Modernization Act of 2000.

It isn't clear what they think of the general Dodd-Frank approach to derivatives, which emphasizes transparency through exchanges and clearinghouses, capital adequacy, private enforcement, and regulation of intermediaries. Their focus is partially on the "insurable interest doctrine" of common law as it relates to insurance, which requires that a party to an insurance contract have a stake in the event. If you can't buy fire insurance on your neighbor's house, why can you buy credit insurance on his business if you don't have an ownership claim on it? That's a dog whistle for either banning so-called "naked" derivatives or running them under state-level insurance law. The vote to ban naked credit default swaps, proposed in the Senate by Bryan Dorgan, failed (and was generally opposed on the right). 

The other regulations relate to bailouts and prudential regulations. As they put it:

When banks fail, the government must act as lender of last resort.

Today, the government serves this role in two ways. First, it compels banks to buy government-supplied deposit insurance, which covers depositors up to $250,000. Second, it provides emergency loans at below-market rates -- bailouts -- to any financial institution whose collapse would take down enough banks with it to endanger the entire economy.

Few seriously doubt that governments must play this role.

Bagehot’s rule is usually summarized as, “Lend without limit, to solvent firms, against good collateral, at high rates." In exchange for this, certain regulations are necessary. Dodd-Frank includes higher capital and liquidity requirements for larger and riskier firms, as well as certain organizational requirements (loosely referred to under the term "living wills") to help with collapsing the company in question via FDIC's resolution powers.

Again, it would be interesting if they addressed the specific reforms to lender of last resort functions included in Dodd-Frank, or the combination of regulation and resolution. Section 13(3) of the Federal Reserve Act was amended so that "any emergency lending program or facility is for the purpose of providing liquidity to the financial system, and not to aid a failing financial company." and any such lending program has to have "broad-based eligibility.” Some have argued this is too loose to deal with a liquidity crisis. Do these authors agree? Are the regulations and FDIC's resolution powers sufficient in this case, or do we need a different approach?

Their specific recommendations for how the right should tackle Dodd-Frank, which is the last third of the piece, involve applying stricter cost-benefit analysis to all rules. There's no talk about repeal, or huge changes to the framework, or long court battles. Cost-benefit has significant problems, but that's a debate for another day. Conceptually, it is tinkering with Dodd-Frank rather than repealing it, which has dominated the conversation on the right. Will this signal a larger change?

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Mike Konczal: How Would a Socialist Wall Street Work?

Jan 30, 2013

In the latest episode of the Roosevelt Institute's Bloggingheads series, Fireside Chats, Fellow Mike Konczal talks to Jacobin editor Seth Ackerman about Seth's recent article "

In the latest episode of the Roosevelt Institute's Bloggingheads series, Fireside Chats, Fellow Mike Konczal talks to Jacobin editor Seth Ackerman about Seth's recent article "The Red and the Black," which asks what kind of mechanisms would replace the pursuit of profit in a socialized economy. In the clip below, they discuss Seth's proposal for socializing the financial sector, transforming the heart of capitalism to give the public ownership over the means of production.

Mike summarizes the idea by noting that "if the government used eminent domain to purchase all the stocks" then "the public would run all the firms," allowing it to distribute the dividends of their success more equally throughout society. Critiquing the idea from a liberal perspective, Mike notes, "We don't tax wealth directly, but we tax the surplus that goes to corporations" and put it towards various public goods. If we want to create a more fair distribution of wealth, why not just do it through the tax code? Seth argues that this kind of "social democratic solution" attempts to mitigate the negative effects of capitalism but doesn't solve the underlying problems. 

For more, including how Seth's ideas apply to public education and what we can learn from past failures in both centrally planned and market economies, check out the full video below:

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Mike Konczal: How Would a Socialist Wall Street Work?

Jan 30, 2013

In the latest episode of the Roosevelt Institute's Bloggingheads series, Fireside Chats, Fellow Mike Konczal talks to Jacobin editor Seth Ackerman about Seth's recent article "The Red and the Black," which asks what kind of mechanisms would replace the pursuit of profit in a socialized economy.

In the latest episode of the Roosevelt Institute's Bloggingheads series, Fireside Chats, Fellow Mike Konczal talks to Jacobin editor Seth Ackerman about Seth's recent article "The Red and the Black," which asks what kind of mechanisms would replace the pursuit of profit in a socialized economy. In the clip below, they discuss Seth's proposal for socializing the financial sector, transforming the heart of capitalism to give the public ownership over the means of production.

Mike summarizes the idea by noting that "if the government used eminent domain to purchase all the stocks" then "the public would run all the firms," allowing it to distribute the dividends of their success more equally throughout society. Critiquing the idea from a liberal perspective, Mike notes, "We don't tax wealth directly, but we tax the surplus that goes to corporations" and put it towards various public goods. If we want to create a more fair distribution of wealth, why not just do it through the tax code? Seth argues that this kind of "social democratic solution" attempts to mitigate the negative effects of capitalism but doesn't solve the underlying problems. 

For more, including how Seth's ideas apply to public education and what we can learn from past failures in both centrally planned and market economies, check out the full video below:

 

Stock exchange image via Shutterstock.com.

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The Path to the Next American Economy: The Cult of Scale

Jan 22, 2013Bo Cutter

An obsession with the largest economic players distracts us from the smaller companies that should drive our future economy.

An obsession with the largest economic players distracts us from the smaller companies that should drive our future economy.

Both Richard Fisher, the president of the Dallas Federal Reserve Bank, and Alan Blinder, arch-economist and former vice-chair of the Federal Reserve Board, had fascinating commentaries last week on "too big to fail," the big banks, and financial stability. Fisher's was a reform proposal; Blinder's a set of lessons to remember. Both dealt explicitly or implicitly with our cult of scale. 

The business, popular, political, think tank, and NGO cultures of America are all infatuated with big enterprise and its leaders. As a society, we pay ritual and theoretical attention to small business and entrepreneurs, but with a very few exceptions we court big company CEOs almost exclusively. Every presidential economic statement or study has its requisite CEO centerpiece. When presidents (of all political persuasions) want to show that they are really, really serious about the economy, they have pictures taken of themselves with big company CEOs. The most frequently quoted business organization, the one whose policy pronouncements are taken as the last word in economic wisdom, is the Business Roundtable -- the insiders club for big business CEOs. The big news talk shows always have big business CEOs as their private sector representatives. The lobbyists whom congresses and governments pay attention to are from the biggest businesses. The same set of CEOs are always invited to presidential state dinners for visiting heads of state. The board development committees of think tanks, NGOs, and foundations covet the same set of CEOs. 

Why? 

Certainly not because big businesses play an actual dominant and dynamic role in our economy. Essentially 100 percent of all new jobs in America are created by new medium and small businesses. Even though large companies dominate R&D spending, revolutionary breakthroughs come almost exclusively from small entrepreneurial companies. If you look back just at the business history of the last 20 years, the pathbreaking innovations were always driven by small and medium companies -- never by the giant incumbents of an industry. 

So what benefits does scale bring us? Richard Fisher raises this question dramatically in the case of banking. Banks with less than $10 billion in assets -- 98 percent of all banks -- held only 12 percent of total bank assets in America but they made 51 percent of all small and medium business loans. Banks with less than $10 billion in assets continued lending to these businesses during the financial debacle; the big banks stopped. Lending, I'll remind you, is basically what banks are supposed to do.

And of course big banks are the riskiest and most costly part of the banking sector. Their failures or near failures nearly cratered our economy, they received the vast bulk of the bailout money, and they continue to hold the riskiest assets. The five largest banks in America hold $4 trillion in non-deposit liabilities, 26 percent of U.S. GDP. Among other problems posed by these liabilities -- for example, that virtually no one understands them -- they are the reason for the excess leverage of the big banks.

Blinder usefully underlines 10 commandments for avoiding the next financial crisis. They all make sense. But when you look closely at his commandments, at least eight out of 10 are directly linked to unavoidable problems of scale and complexity. Consider this: the five biggest banks operated through over 19,000 subsidiaries in a minimum of 50 countries each. The simple fact is that Blinder's very intelligent commandments can't work in this world. I begin with a prejudice: compared to the directors of the five giants (and these are highly sought after and highly compensated directorships), directors of America's smaller community banks are every bit as smart,  know more about the banks they direct, hold the CEOs of their banks in far less awe, are much more likely to discipline their management effectively, and are closer to the customers. None of this is just a role of the dice. According to Richard Fisher, J.P.Morgan Chase has about 5,000 subsidiaries. I'll grant that many of these are meaningless. But no set of directors on earth can really understand or guide well an entity with thousands of subsidiaries. In these circumstances, the amount of arbitrary, mostly unchecked authority given to senior management and the CEO is enormous. A single director is rarely going to risk either losing his or her directorship or simply being humiliated in the club by challenging the CEO on anything.

Which gets me back to the general problems of mega scale in business. While the biggest banks pose particular problems and the biggest dangers, all the evidence seems to say that as businesses get very, very big, four developments are inevitable. The businesses become sclerotic and bureaucratic. The businesses lose the creativity and dynamism that initially drove them. The businesses become extraordinarily complex. The businesses become less market-driven and more dominated by CEOs with a fair amount of arbitrary power. Some businesses and some extraordinary leaders -- Steve Jobs -- delay all of this, but the trends are inevitable. 

So once again, why the fascination with big companies and their chiefs? Awe, power, and money. The heads of the biggest companies are the real masters of our universe. They are treated like heads of sovereign states. A lot of them think of themselves that way and, in fact, a heck of a lot of big company CEOs have more actual power than the heads of government of all but 30 to 50 countries. And within a range the power is fairly arbitrary. The biggest companies have the widest range of  choices about products, locations, suppliers, public and community relations money, and foundation money. There is lots of economic "rent" buried among all those choices and everyone wants a little bit of it. I think the resources most big companies allocate through these choices mostly do an enormous amount of good and have a significant function in our strange society, but that's not the same thing as believing these companies are the future of our economy.

To be clear, big companies play big, real, valuable roles in our economy. We need a mix. But the balance has gone too far in our infatuation with bigness. The true path to the Next American Economy does not go in that direction. We will not grow as fast as we must with an increasingly big company economy. Equity and social mobility won't increase that way. We will need more breakthrough innovation, more new companies creating good jobs, more highly specialized value-added products and services, and more diversity and localization of businesses. The dream should be an economy driven by thousands of companies growing from dozens of very different urban platforms, not by a few dozen giants. But achieving that dream will be much harder if our political and intellectual culture is perpetually fascinated and seduced by the non-economic glamor of the wrong part of the private sector. 

Roosevelt Institute Senior Fellow Bo Cutter is formerly a managing partner of Warburg Pincus, a major global private equity firm. Recently, he served as the leader of President Obama’s Office of Management and Budget (OMB) transition team. He has also served in senior roles in the White Houses of two Democratic Presidents.

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What Was Just Watered Down in Basel's Liquidity Requirements?

Jan 8, 2013Mike Konczal

Let’s say you were trying to make a personal budget. We can imagine two reasonable ideas you would want to incorporate into this budget. The first is that you want to make sure you can pay your bills if your income suddenly freezes up or you suddenly need cash. You want to make sure your savings are sufficiently liquid in case there is an emergency.

Another rule is that you want your time horizon of your debts to match what you are buying with those debts. You don’t want a 4-year mortgage and a 30-year auto loan; you want a 4-year auto loan and a 30-year mortgage. And for our purposes, you really don’t want to buy either on a credit card, since the payment terms can fluctuate so often in the short term.

These two ideas are behind two of the additional special forms of capital requirements designed by the Basel Committee on Banking Supervision in Basel III. The first is a “Liquidity Coverage Ratio” (LCR), which is designed to make sure that a financial firm has sufficiently liquid resources to survive a crisis where financial liquidity has dried up for 30 days. The second is a “Net Stable Funding Ratio,” which is designed to complement the first rule and seeks to incentivize banks to use funds with more stable debts featuring long-term horizons.

Basel has just introduced some changes into their final LCR rule, so let’s take a deep dive into this capital requirement rule. Before we introduce some headache-inducing acronyms, remember that the basics are simple here. Banks have a store of assets and they have obligations that they have to make. Or, at the simplest level, banks have a pile of money or things that can be turned into money and people and firms who are demanding money. So any watering down of the rule has to impact one of those two things.

Remember that in a crisis it is hard to sell assets to get the cash you need to make your payments. Also, crucially, others will want to take out more from the bank if they are worried about the bank’s assets, like in a bank run. So both of these items are stressed in the rule to get numbers sufficient to survive a crisis. Banks would prefer to count riskier kinds of things as those safe assets, and assume that firms would want to take less in times of crisis. Each allows them to have to hold less high-quality capital.

There are three major changes announced. The first is that the requirements will be slowly phased in each year for the next several years, fully online by 2019. This is to avoid putting additional credit stresses on the financial system right now. There's also a clarification that assets can be drawn down in times of crisis. But how will these regulations look when they are online? The other two changes are the way the actual mechanisms are calculated.

Let’s chart out those last two changes that were just introduced:

Originally there were just two levels of assets, level 1 and level 2. The second change is to create a new level of assets, called “Level 2B.” Level 1 is unchanged, as well as the old Level 2, which is now Level 2A. Level 2B will be no more than 15 percent of total assets, but it will include lower rated corporate debt (BBB- or above) and, more shockingly, equity shares. Equity is not what you want as a liquidity buffer, as its value will plummet and volatility will skyrocket during crises. In a crisis all correlations go to 1, and that’s especially true in a financial crisis. The fact that it might have done well in the 2008 crisis is no excuse because, as Economics of Contempt pointed out on this topic, there were massive government bailouts and interventions in the market, which is what we want to avoid.

On the plus side, rather than just putting equities in “Level 2,” they created a separate bucket with harsher penalties. Equities will receive a 50 percent haircut toward qualifying, much larger than the 15 percent haircut Level 2A assets get.

The third change is the lower outflow rate for liquidity facilities, corporate deposits as well as other sources of outflows. To get a sense of this, stable deposits with a serious system of deposit insurance – think of your FDIC savings account – originally had a 5 percent outflow. A bank would have to be prepared for 5 percent of its deposits to leave during this financial crisis. That has been reduced to 3 percent in the new rule.

These changes are particularly large for liquidity facilities. Instead of the assumption that firms will go gunning for any emergency liquidity that they can find, and as such use up most of these outlines, there are much more financial-friendly outflow estimates. In fact, many of these rates have been cut by more than half, with Basel now estimating that liquidity facilities, for instance, will only be drawn down 30 percent instead of 100 percent.

These are dramatic reductions. If they are predicated on more closely aligning with 2008 numbers, backstopping the entire liquidity of the financial markets was the whole point of the bailouts and the Federal Reserve’s emergency interventions. The numbers should be much worse in this case.

There is finally a global rule declaring a necessary, but not sufficient, minimum level of liquidity in financial firms. Liquidity does nothing if a firm is insolvent, but it by itself can generate panics. However these rule changes almost all entirely benefit the financial system, and call for less liquidity than in the first drafts. Undercounting the liquidity facilities, as well as letting more of the HQLA consist of assets like stocks and MBS, is a major change from the previous version.

The Basel committee notes that its Liquidity Coverage Ratio is an absolute minimum rate, and that “national authorities may require higher minimum levels of liquidity.” Authorities within the United States should take this seriously. Dodd-Frank calls on regulators to put in sufficient liquidity regulations for large financial firms. Basel III provides a baseline, but regulators could go further by themselves if necessary via their Dodd-Frank mandate. Understanding why the outflow assumptions have so dramatically changed will be one point to follow.

Follow or contact the Rortybomb blog:

  

Let’s say you were trying to make a personal budget. We can imagine two reasonable ideas you would want to incorporate into this budget. The first is that you want to make sure you can pay your bills if your income suddenly freezes up or you suddenly need cash. You want to make sure your savings are sufficiently liquid in case there is an emergency.

Another rule is that you want your time horizon of your debts to match what you are buying with those debts. You don’t want a 4-year mortgage and a 30-year auto loan; you want a 4-year auto loan and a 30-year mortgage. And for our purposes, you really don’t want to buy either on a credit card, since the payment terms can fluctuate so often in the short term.

These two ideas are behind two of the additional special forms of capital requirements designed by the Basel Committee on Banking Supervision in Basel III. The first is a “Liquidity Coverage Ratio” (LCR), which is designed to make sure that a financial firm has sufficiently liquid resources to survive a crisis where financial liquidity has dried up for 30 days. The second is a “Net Stable Funding Ratio,” which is designed to complement the first rule and seeks to incentivize banks to use funds with more stable debts featuring long-term horizons.

Basel has just introduced some changes into their final LCR rule, so let’s take a deep dive into this capital requirement rule. Before we introduce some headache-inducing acronyms, remember that the basics are simple here. Banks have a store of assets and they have obligations that they have to make. Or, at the simplest level, banks have a pile of money or things that can be turned into money and people and firms who are demanding money. So any watering down of the rule has to impact one of those two things.

Remember that in a crisis it is hard to sell assets to get the cash you need to make your payments. Also, crucially, others will want to take out more from the bank if they are worried about the bank’s assets, like in a bank run. So both of these items are stressed in the rule to get numbers sufficient to survive a crisis. Banks would prefer to count riskier kinds of things as those safe assets, and assume that firms would want to take less in times of crisis. Each allows them to have to hold less high-quality capital.

There are three major changes announced. The first is that the requirements will be slowly phased in each year for the next several years, fully online by 2019. This is to avoid putting additional credit stresses on the financial system right now. There's also a clarification that assets can be drawn down in times of crisis. But how will these regulations look when they are online? The other two changes are the way the actual mechanisms are calculated.

Let’s chart out those last two changes that were just introduced:

Originally there were just two levels of assets, level 1 and level 2. The second change is to create a new level of assets, called “Level 2B.” Level 1 is unchanged, as well as the old Level 2, which is now Level 2A. Level 2B will be no more than 15 percent of total assets, but it will include lower rated corporate debt (BBB- or above) and, more shockingly, equity shares. Equity is not what you want as a liquidity buffer, as its value will plummet and volatility will skyrocket during crises. In a crisis all correlations go to 1, and that’s especially true in a financial crisis. The fact that it might have done well in the 2008 crisis is no excuse because, as Economics of Contempt pointed out on this topic, there were massive government bailouts and interventions in the market, which is what we want to avoid.

On the plus side, rather than just putting equities in “Level 2,” they created a separate bucket with harsher penalties. Equities will receive a 50 percent haircut toward qualifying, much larger than the 15 percent haircut Level 2A assets get.

The third change is the lower outflow rate for liquidity facilities, corporate deposits as well as other sources of outflows. To get a sense of this, stable deposits with a serious system of deposit insurance – think of your FDIC savings account – originally had a 5 percent outflow. A bank would have to be prepared for 5 percent of its deposits to leave during this financial crisis. That has been reduced to 3 percent in the new rule.

These changes are particularly large for liquidity facilities. Instead of the assumption that firms will go gunning for any emergency liquidity that they can find, and as such use up most of these outlines, there are much more financial-friendly outflow estimates. In fact, many of these rates have been cut by more than half, with Basel now estimating that liquidity facilities, for instance, will only be drawn down 30 percent instead of 100 percent.

These are dramatic reductions. If they are predicated on more closely aligning with 2008 numbers, backstopping the entire liquidity of the financial markets was the whole point of the bailouts and the Federal Reserve’s emergency interventions. The numbers should be much worse in this case.

There is finally a global rule declaring a necessary, but not sufficient, minimum level of liquidity in financial firms. Liquidity does nothing if a firm is insolvent, but it by itself can generate panics. However these rule changes almost all entirely benefit the financial system, and call for less liquidity than in the first drafts. Undercounting the liquidity facilities, as well as letting more of the HQLA consist of assets like stocks and MBS, is a major change from the previous version.

The Basel committee notes that its Liquidity Coverage Ratio is an absolute minimum rate, and that “national authorities may require higher minimum levels of liquidity.” Authorities within the United States should take this seriously. Dodd-Frank calls on regulators to put in sufficient liquidity regulations for large financial firms. Basel III provides a baseline, but regulators could go further by themselves if necessary via their Dodd-Frank mandate. Understanding why the outflow assumptions have so dramatically changed will be one point to follow.

Follow or contact the Rortybomb blog:

  

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Lifestyles of the Rich and Frustrated: How Much is Enough to Make a Banker Happy?

Jan 4, 2013John Paul Rollert

Greg Smith's tale of exile from Wall Street shows that even the rich can feel inadequate compared to the super-rich.

Greg Smith's tale of exile from Wall Street shows that even the rich can feel inadequate compared to the super-rich.

Last winter, Bloomberg published a much-discussed account of belt-tightening in the brave new economy. Notable for featuring Wall Streeters, not Walmart greeters, the suffering depicted was sepia-toned. One poor soul described driving all the way to outer Brooklyn to buy discounted salmon, another the indignity of doing his own dishes, and a third dismissed his Porsche 911 Carrera 4S Cabriolet as “the Volkswagen of supercars.”

Among the lingering calamities of the financial crisis, the sorrows of young bankers don’t exactly cry out for remedy. This is not Les Miserables but the hardships of the haute bourgeoisie. Yet the afflictions of affluence are afflictions nonetheless, and this particular one can teach us an awkward but essential truth in the ongoing debate over income inequality—if we can only bear to listen.

Consider the inadvertent testimony of Greg Smith. Doubtless you have heard of Smith, who vaulted to fame last March with an op-ed in The New York Times published the day he parted ways with his long-time employer, Goldman Sachs. The piece reads like the précis for some revelatory work. During his 12 years at Goldman, Smith says he had seen the interests of the customer “sidelined” in favor of an approach that sees the bank “ripping their clients off.” Their trust is taken advantage of, their naïveté exploited, their ignorance scorned. Goldman is no longer the client-centered institution Smith joined after college, and blame is placed at the feet of the bank’s leadership, whom he accuses of having “lost hold of the firm’s culture on their watch.”

Given the anger directed at Goldman in the aftermath of the financial crisis, Smith knew that his op-ed would be greeted with some interest. Here was an insider who affirmed the bank’s bad behavior and promised to illustrate it, at length, if given the opportunity.

He was, of course—in the form of $1.5 million book deal. Published at the end of October, the attempted tell-all was widely panned for falling short of its promise. The criticism is not unfair, though the publisher shares blame for rushing to print a work that would have benefited from sharper focus and the self-criticism of sustained introspection. Why I Left Goldman Sachs is Greg Smith’s first book, and its 250+ pages were written in less than seven months. If it feels like a first draft, that’s almost certainly because it is, and all parties (except Goldman, perhaps) would have benefited from the careful editing that made the original op-ed an astonishing success.

But that does not mean the book doesn’t have an intriguing story to tell, if one that is also unintended. The chronicle form lends itself to the task of writing an inevitably personal book on extremely short notice, and while Smith might have done without the convenience, preferring instead to dwell on the conflicts of interests he spends too little time on in the book, he ends up presenting a timely self-portrait of a rich man in a much richer man’s world.

When he left Goldman Sachs, Greg Smith had been making in the ballpark of $500,000 for at least six years, and the book provides ample evidence of the consolations afforded the young bachelor by his considerable income. There are the fine restaurants Smith frequents (“we went to the Frisky Oyster in Greenport”), the premier sporting events he attends (“I was lucky to be courtside in Paris to see Rafael Nadal beat Roger Federer for his sixth French Open title”), and the fashionable neighborhood he moves into when he transfers to London (it “had become trendy because Gwyneth Paltrow and Chris Martin (of Coldplay) had moved there”). There is even the 30th birthday dinner he throws for himself and his then-girlfriend (“at Freeman’s, a place with a vintage speakeasy vibe”) for which Smith graciously picks up the tab (“[t]he bill came to over $3,000, but I was happy to do it—I like treating people”).

Smith never reveals how much he has salted away for hard times, but it is not enough to stave off a minor panic when the financial crisis hits. Faced with the possibility of post-Goldman penury, he describes not one but two instances of taking public transportation, noting as an aside that “[m]any Wall Streeters can spend north of $10,000 a year on taxis alone.” The accounts are rueful—“I saved sixty bucks”—but juxtaposed with his birthday largesse, which is subsequent to these accounts and conspicuously so, a central preoccupation of the book comes into relief. The problem is not having money, but not having nearly enough.

If you take a step back, this seems absurd. From the vantage point of most Americans, not to mention the broader world, Greg Smith is rich. Indeed, according to the U.S. Census Bureau, the median household income between 2006-2011 was in the range of $50,000, or roughly one tenth of what Smith was making during that time. But Smith is not most people, and he doesn’t have the luxury of stepping back without also stepping beyond his social world. That world includes people who are not only making double or triple what Smith made, but also individuals like Gary Cohn, the president of Goldman, who made just over $53 million in 2006, or more than 100 Greg Smiths.

As a financial matter, being rich in a much richer man’s world has a tendency to bury you in what Cornell economist Robert Frank calls an expenditure cascade. In a paper he co-authored with Adam Seth Levine, Frank starts from the curious fact that “aggregate savings rates have fallen even though income gains have been largely concentrated in the hands of consumers with the highest incomes.” He explains this by showing that that wealthy scale their consumption not by the expenditures of the broader public—a benchmark that would leave their bank accounts flush—but by the people at the very top of their social group. This is the time-honored tradition of keeping up with the Joneses, but when the Joneses can afford 100 times what you can, the race can lead you right of a cliff. 

Still, while Smith’s need to make more money occasionally announces itself by way of some pressing financial concern—on same day the stock market bottoms out, Smith splits with his long-time girlfriend who had been “adamant that she didn’t want to work when she had kids”—he is well aware that his frustration has less to do with how much he actually makes than what that number says about him. Reflecting on the significance of “bonus day,” the day in December on which bankers meet with their bosses to discover the full amount they will make for the year, Smith admits that there is “an absurd amount of emphasis placed on these meetings. For many people, the session determined a person’s entire self-worth.” And yet, he continues, “however arbitrary the number handed down by the partner might be, there was also a real poignancy to the bonus meeting. Many people had spent the year working eighty-five-hour weeks, killing themselves for the firm. They expected something in return.”

By late 2011, Smith had come to expect more from Goldman than Goldman was willing to give him. At his last bonus meeting, he requested a promotion to Managing Director and a million dollar payout. Both requests were denied.

Smith does not disclose these details in his book—they were leaked by Goldman to discredit him in advance of its release—but they come as no surprise to anyone who reads it. They merely underscore the salient psychological fact of Greg Smith’s experience and the essential lesson of income inequality among the economic elite. Namely, that beauty is in the eye of the beholder, but wealth is a matter of whom you behold.

John Paul Rollert teaches business ethics and leadership at the Harvard Extension School.

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