Interview with Nicholas Levis
by Oriana P. Roerkraeyer
NL: My name is Nicholas Levis, I’m a writer and a researcher. I did not write chapter 4, it was written by financial lawyers who would prefer not to be on camera today. I have read it, I know the issues and I will be summarizing what’s in chapter 4.
Chapter 4 is called “A Little History to Explain a Lot of Tragedy.” The history is that of capitalism in the United States and in the world, where prior to 1929 you had gigantic financial crashes wherein banks would fail due to gambling and speculation about once every fifteen years. And you’d get an economic disaster as a result, and the biggest one happened in 1929 with the Wall Street crash. This caused what we call The Great Depression. In the wake of this unprecedented economic disaster, with 25 percent unemployment in the US, a commission was appointed, the Pecora committee of the Senate, to investigate the causes of the crash. What they decided, first of all, was that banks were gambling with money that was not secured, with depositors’ money, and they ended up in this disaster. So they recommended what then became the Glass-Steagall Act of 1934. It was passed right away after the election of Franklin D. Roosevelt. It’s an interesting contrast with today. Five years after the election of Obama in the wake of the 2008 crisis, we still don’t have the Dodd-Frank Act implemented.
Glass-Steagall by comparison was much stronger and very simple. What it said is banks can’t gamble with depositor’s money. If a bank takes money from the people, they cannot engage in high-risk speculative activities. They have to engage in normal commercial activities, such as loansto businesses, mortgages, and so forth. What they also set up at that time was the FDIC, which insures deposits of normal depositors, and those banks that receive these insured deposits cannot engage in speculative activities. What you had from then on was [a division between] normal commercial and consumer banks, where the deposits were insured. These could not speculate. And you also had what are called investment banks. These could do whatever they liked, but had no security. They could not be bailed out by the people, by the taxpayers. So, [again], you had this firewall set up by Glass-Steagall from 1934 forward between commercial banks and investment banks, and you had deposit insurance for the commercial banks. The commercial banks also had access to the low interest prime rate loans from the Federal Reserve, which investment banks did not. This created a much more stable financial system that did not have major crashes for fifty years, which was unprecedented in the history of capitalism or the US.
However there was always opposition to the Glass-Steagall rules because banks really wanted access to that low-interest money from the Federal Reserve. Commercial banks would like to engage in this kind of high-risk speculation that brings higher returns. So you always had massive pressure from the banking lobbies to break it down, and this started in the 1980s with the election of Ronald Reagan and the turn towards the neoliberal policy and deregulation across the board of most industries. You started having the first steps towards deregulation and loopholes in Glass-Steagall, and there was a massive run of speculation in the 1980’s on Savings and Loans institutions, which started getting into very high risk and sometimes scammy real estate deal and losing billions and billions of dollars. So you had an unprecedented number of bank failures, but thebanks were generally small, there were something like 600 bank failures in the 1980s.
One difference in the 1980s from today is that you also had massive prosecutions of the miscreants. If bankers engaged in criminal activity and they were caught they were prosecuted, and a thousand went to prison. Today, in the wake of the massive scams of 2002-2008 with the mortgage backed securities, zero bankers have gone to prison for those frauds. The rating agencies who called everything triple A that was rotten securities, they have not been touched.
The 1980s wave of bank failures [did not cause a failure of] the economy however, at the same time you had growth because this was happening in a fairly limited sector, the Savings and Loans… where there was less regulation and less opportunity for these speculators to get in. You started getting more and more loopholes and more and more financial innovations that found ways to get around rules, so you started having some spectacular failures in the 1990s that however did not set off the domino effect. The [failure of the] hedge fund, Long Term Capital Management, did require a big injection of money into the markets from the Federal Reserve. At the time, this was said to prevent a general crash. So already you had the outlines for what we were going to get in 2007-2008.
But two more key steps [followed]: In 1999, the Glass Steagall Act was finally repealed. So from 1934 to 1999 you had this firewall and from 1999 forward it became legal for any institution to take depositors’ money, too engage in standard commercial business and mortgage activities and [at the same time] to engage in the equities markets and the bonds markets and derivatives and everything that is risky and potentially high-yield. And this came about because Citibank wanted to merge with the Travellers Insurance company and [also] act as an investment bank, and they actually had this merger before the law was repealed. They merged first, and then they lobbied to get the law repealed. Congress responded. This was a Republican and Democratic sponsored act, the Gramm–Leach–Bliley Act (the Financial Services Modernization Act of 1999) that repealed Glass Steagall, signed by President Clinton.
So you had a bipartisan consensus and backed especially by Clinton’s economics advisers who are still around today and haave at times advised Obama, Larry Summers and Robert Rubin especially. And you had Greenspan. These were kind of the Trinity, the men who were gonna “save the world” according to a Time magazine cover. Well, they set up the burning of the world, but [it was also] an opportunity for men of their class to really enrich themselves.
And then in 2000, the next year, after the repeal of Glass-Steagall and an announcement in effect that the banks could have a free for all, you had the Commodity Futures Modernizations Act, and this was really fascinating. Because the market in derivatives was growing to absolutely epic proportions where all the bets on [the futures of the] various values, interest rates and you know, stocks, bonds, sovereign bonds, all these bets actually amount to something like to ten to twenty times the value of all assets on earth. So these are unpayable bets, and enormous risks that are being carried. If these bets fail a certain way, you would have a general economic crash, no one would be able to pay. So Brooksley Born, who was the head of the commodities regulation agency, the CFTC, she said at that time, she warned that the derivatives market needed to be regulated. At the very least it needed to be brought to light because derivatives consist of contracts between private parties that are not public, so they can be kept in the dark. No one actually knows how large and what kind of risks are being taken. So one of Brooksley Born’s proposals was to bring it out into the open, to have an open exchange of derivatives and to ban especially risky activities such as you have with the stock market. You would have, in effect, a stock market for derivatives.
Well the banks went insane at the idea and the Holy Men came out, Summers, Rubin and Greenspan all attacked Brooksley Born. She was treated like the devil in the pages of the Wall Street Journal and they actually passed a law that not only didn’t regulate derivatives but said you may not regulate derivatives. It banned the regulation of derivatives. So you would set up the situation now for a total free-for-all where any institution can take depositors’ money or money from wherever it can get, borrow from anybody else, lend out a lot of bad risk mortgages, package them as triple A securities, you know the whole story that led to the mortgage backed securities crash in 2007-2008. Which we can into more detail if you like.
So this is how the crash was set up, in 1999 with the repeal of Glass-Steagall and in 2000 with the ban on regulating commodities. After 2008, you had the crash, and the government feels compelled, the Federal Reserve feels compelled to bail out these enormous institutions who were responsible for the crash, the big Wall Street banks, because if one of them fails all of them are gonna fail and there was gonna be a domino effect around the world. You’re gonna have a giganticbanking crash. As far as I’m concerned, that’s exactly what should have happened. They should have been liquidated, reorganized, taken in under the laws that exist for such situations, and by now we would have a new system set up where the banks were a lot smaller and you would have some version of Glass-Steagall again. But instead, of course, what they did was the bail-out and in a kind of weak way they implemented the Dodd-Frank Act.
I shouldn’t say they implemented it, they passed it. The Dodd-Frank Act of 2010 is the new bankingregulation and one of the provisions that it has is called the Volcker Rule, written by Paul Volcker [aformer chairman] of the Federal Reserve in the 1980s. Volcker wrote a kind of lite version of the Glass-Steagall rules, that would limit what kind of speculations banks that take money from depositors engage in. And what happened is, the regulators and the lobbyists got their hands on it and turned it into something like a 1,000 pages of loopholes, and they basically made it that it’s never actually going to provide protection against a repeated crash because banks can basically claim… they can continue to engage in high risk activities by claiming that it is a hedge against a failure of one deal or another, the market makers can do this.
What does this mean? This means Citibank, let’s say, is going to issue shares in Microsoft, and they’re holding the shares in Microsoft and underwriting them until these get sold to shareholders on the market. So meanwhile they’re holding some kind of hedge against a possible failure of Microsoft. Okay, this is supposed to be a legitimate form of insurance against them getting caught with their pants down, if there’s a sudden drop in Microsoft by 50 percent, Citibank would go out of business. So they need some kind of hedge. However they can also claim they need some kind of hedge against very high risk derivatives deals and thus justify holding derivatives that they’re never actually going to sell because these might be very exotic products, high-risk/high-return, that the bank wants to hold itself and no one is gonna come and buy it, but through this loophole they can hold as many derivatives as they like basically. So the Volcker rule is not going to do the job.
Furthermore it hasn’t been implemented yet, there have been constant delays. Our sister group from Alternative Banking, which is called Occupy the SEC, actually sued in Federal Court to say hurry up and impose the Volcker rule, it’s in the interest of everyone to not have a new crash and the Volcker rule will provide some kind of protection against it. A federal court ruled that the lawsuit has no standing. That means that the people bringing it are not actually participants in this economy, or not sufficiently participants in this economy. So you and I have no interest in not seeing a new banking crash and a new economic disaster with unemployment back up at 18 percent. Only banks and legitimate one-percenters could bring such a lawsuit. So that’s been squashed, and that’s the situation today.
The banks that caused the crash are larger than ever, their executives have not been prosecuted for criminal activities, they have not been limited in engaging in the kind of speculation that led to the crash in the first place, and they are [still] engaging in this kind of speculation and in constantly new and innovative forms, and we’re just setting up for the next crash.
Again, prior to Glass Steagall there was a huge economic crash due to banking failures, every time banking crash followed by economic disaster, once every fifteen years on average. And that’s where we’re heading now, we are seven years since the last crash now.
OPR: How come it was fairly easy to get the Glass-Steagall Act back then?
NL: I think it was a more innocent time where the system was not as self-aware as it is today. I think the bankers were more surprised, whereas today they know what… really they work to create these crashes, because that where the big money gets made. The winners of these crashesend up bigger, they can buy up all the losers. They can buy up all these assets on the cheap, that’sreally what this is about. Well, that’s my own opinion on how the dynamics are always gonna play out. It’s partly a function of human nature and partly a function of this is what you get when you have private capital disposing of itself and always looking for the highest possible yield in a competitive environment. There’s always gonna be enormous incentives to engage in high-risk behavior and they don’t want regulation.
So sorry, back in the thirties they were just caught by surprise, the disaster was so enormous, you didn’t have social security, you didn’t have unemployment insurance, the US was in a genuine pre-revolutionary phase. I mean, union membership jumped by something like 10 times in just a couple of years and you had a much more, if not radical… a much more militant working class, and there was genuine fear in the ruling class that the US could go the way of the Bolsheviks, it was theRed Scare of that time and Roosevelt was a genuine reformer. He said, “I’m gonna save the capitalists from themselves” and that’s what he ended up doing. He put rules in place that kept the system stable for the next 50 years.
OPR: You said they caused these crashes, but that must be short term thinking. I mean, yes, on a short term basis they will have benefits but in the longterm, it has to be suicide for them also.
NL: I shouldn’t say they caused these crashes, or [that they] plan out when these crashes are going to come. I should say, they set up the situations where they know these crashes are going to come, and they also prepare for the inevitability of a crash, and [prepare] to make money from it. They are veery skilled at pursuing their own interest and getting rid of obstacles to enrich themselves as individuals and as small groups, as businesses. But they are particularly skilled, or they don’t particularly care if the world will burn and maybe it will turn on us, they don’t really fear that because, check it out, we just had this massive crash and this economic misery. In many othercountries that’s meant millions of people on the street. In this country it does not, it feels secure. The people in the US still believe in this system. I think this is what it comes down to. Or enough in this system.
Or they feel trapped in it, you know? Maybe that’s more the truth. They don’t know what the alternative is going to be… “I’m in precarity, I have to work two jobs just to pay the rent and feed the children, and I don’t really have time to organize this kind of resistance.” So you really have a lot less class consciousness and [less of] this readiness of the people to come together as a mass. And you have a lot of confusion today. You’ve got media telling people constantly this kindof libertarian line, that it’s all your fault, there’s too many goodies coming from the public sector, thereal problem is the government deficit. When in fact it’s the deficits that have kept the economy afloat at all in the last five years.
OPR: As a movement what can Occupy do? And what can be done in general I should ask? And as a movement what can we do?
NL: ell, we are not even in a pre-revolutionary phase, and I’m sorry to be speaking of revolution. That doesn’t necessarily mean storm the institutions, burn down the buildings and chop off all the heads. It means we need a different system. We need a change so radical that the system will no longer be recognizable to us today. And for this to happen, we need a long phase still of just talking about it. This is still a big part of the problem. We still need to educate ourselves and to come up with the right ideas for alternatives. And we need to fight together, and do things like being prepared to occupy factoriies.
The next factory closure… will the workers be able to take it over, or the next workplace closure? What will they do with it? We’ve seen this kind of thing in Argentina after the crisis in 2002where you had a lot of workers controlled businesses suddenly arising that had failed. The workerssaid no, we’re not fired, we are taking it over. A lot of these still survive. You got a couple of examples in Greece. You don’t have many examples, or any examples in the US of such a thing. So I think it’s gonna be a long process and we don’t necessarily have time for this. We live inurgent times, we really need to reform a lot more than the financial system, we’ve got a disaster with energy, we are burning the planet to keep the lights on and today it’s the warmest day I’ve ever seen on the first day of winter, it’s 65 degrees outside in NY. That could be just the normal variation in weather patterns, but damn they’ve been varying one way for many years and all the scientific evidence is saying that’s us, that’s our civilization I should say, not each of us individually equally responsible, but our civilization is pumping all this carbon into the air and not really paying attention to the consequences. [Note: the interviewee acknowledges this was followed by the coldest winter in 30 years in New York, although it was a new record warm for the world as a whole.]
So how do you get people motivated? I don’t know. I’ve been asking myself that question for thirty years, and trying what I can. Sometimes I lose my motivation too, so maybe I’m not the greatest revolutionary in the world. Philosophers have tried to understand the world but the point is to change it, right? I would say, come to the Alternative Banking Group with your ideas and your concerns. Right now, one very encouraging thing that is happening is that people are understanding that you can’t have people on starvation wages. All this stuff like Walmart asking its workers to pay so that other workers can eat during the holidays… and they are workers at Walmart! They are not making enough to eat, they are not making enough for insurance. This kind of thing is coming out, so you got the fight for $15, I think that’s an excellent start. That’s the kind ofissue we really need to be focused on, raising the minimum wage to a living wage, to aa wage with dignity so that people that are working can actually pay for themselves. It’s ridiculous, this situation.
OPR:: Thank you.
Section 2. How We Got Here
Chapter 4. A Little History to Explain a Lot of Tragedy
(a short history of the principal legislative failures that caused the crisis and make another one likely)
“This bill will also, in my judgment, raise the likelihood of future massive taxpayer bailouts. It will fuel the consolidation and mergers in the banking and financial services industry at the expense of customers”. Senator Byron Dorgan
Expressing opposition to the bill that removed Glass-Steagall restrictions in 1999
Our recent and current crisis was the worst economic downturn since the Great Depression and has been aptly named the Great Recession. Experts and talking heads have credited a wide variety of factors as causes of the crisis. But there are three key dates that actually tell much of the story. Those are 1933, when the Glass-Steagall Act (“Glass-Steagall”) was passed, 1999, when it was repealed, and 2000, when Congress effectively banned the regulation of derivatives. Sometimes, history does come darn close to repeating itself.
The 1929 Crash and Glass-Steagall
The stock market crash of 1929 was arguably the worst disruption ever of American financial markets, and it soon led to the catastrophic Great Depression, in which unemployment ballooned from 3.2% in 1929 to 25.2% in 1933.2The capital markets similarly floundered after the market crashed, when issuance of corporate securities shriveled from $9.4 billion in 1929 to a mere $380 million in 1933.3
In 1932, Congress commissioned Ferdinand Pecora to lead a thorough investigation of the 1929 crash, with the hope of providing guidance to lawmakers on what kind of legislation might avert similar outcomes in the future. One of the Pecora Commission’s key findings was that, leading up to the crisis, investment banks were precariously involved in speculative securities, effectively using the deposits of the ordinary people and businesses who were their customers. Rather than keeping depositors’ money in a vault (or at least in a safe financial instrument), banks were essentially gambling with it and keeping the profits for themselves.
The Commission’s conclusion that the conflict “between the business of marketing securities and the business of protecting depositors’ money” was a key support for the cause of reform,4which, not long afterward, led to the passage of the Glass-Steagall Act of 1933 (Glass-Steagall). Generally speaking, the Act restricted commercial banks (i.e.banks that take deposits and issue loans) from engaging in securities dealing as investment banks do (i.e. trading securities for profit).
Glass-Steagall was an unqualified success. From 1797 to 1933, the American banking system crashed about every 15 years. In contrast, during the first half-century after Glass-Steagall, there were barely any bank failures at all.5And yet despite this unprecedented financial stability, Glass-Steagall continually provoked fierce detractors who pined for access to the trillions of dollars of depositor money that was sitting in relative safety at commercial banks. In addition, these detractors jealously eyed the flood of capital flowing to banks through the Federal Reserve’s discount window and other monetary programs. At the same time, commercial banks became bored with the incremental profit margins that they could earn from traditional banking and craved the higher earnings that riskier investments offered. But, of course, it was precisely to prohibitsuch mixing of bank speculation and depositors’ capital that Glass-Steagall had been enacted.
Undeterred, banks kept pushing, and in the 1980s, with the advent of President Reagan’s pro-business supply-side economic policies (known as “Reaganomics”), the bankers began to get their way. Reaganomics brought widespread financial deregulation, including, perhaps most significantly, the financial lobby’s success in convincing the nation’s banking regulators to puncture Glass-Steagall with numerous loopholes and exemptions. As a result, commercial banks began engaging in riskier activities, and, not surprisingly, the late 1980s brought a sharp spike in bank failures. This trend can be seen in the chart below, which chronicles the number of bank failures since 1934, as reported by the Federal Deposit Insurance Corporation.
The steady gutting of Glass-Steagall continued from the 1980s until its final death knell in 1999, which is when the Gramm-Leach-Bliley Act officially repealed Glass-Steagall, allowing investment banks and commercial banks to once again merge, pool assets, and co-mingle the monies of ordinary depositors with speculative trading operations, as in the pre-Great Depression days. Banks could (and did) return to the good old days of treating assets they held in trust for common depositors as resources available to underwrite higher yielding, riskier securities transactions, with no obligation to share the upside. The problem was that, once again, all the risk on the downside would be everyone’sproblembecause we are still likely to be called on to bail them out if needed. Freed from the regulatory shackles of Glass-Steagall, banks took risks of increasing magnitude and complexity. And just in case more cheap (virtually free) cash was needed, the Federal Reserve, under the Chairmanship of Alan Greenspan, made absolutely no effort to pushback against the growing speculative tide. Instead, the Fed fueled speculation by lending to banks at very low rates.
Deregulation, Derivatives, and Brooksley Born
Perhaps needing to shield a more sophisticated public from the degree of risk associated with its behaviors (after all, perhaps folks still remembered some of the lessons from 1929), the banks’ betting strategies increasingly relied on “financial innovations” which mainly served to conceal what they were up to.
As has been discussed in previous chapters, the concept of a mortgage changed from a relatively simple two-party contract into a multi-party apparatus involving layers upon layers of transactions, pass-through entities, and servicers. Bundles of mortgages were pooled together, forming the collateral for new “mortgage backed securities” (MBS). These, and various other instruments that “derived” their value from other financial arrangements, became known as “derivatives.” The risk associated with these and other new-fangled financial products could often be sold in the form of credit derivatives, which further shifted risk away from the original mortgage lenderto unknown, distant parties.
Needless to say, the more complex the transactions grew, the more lucrative this was for the investment banks, such as Bear Stearns and Goldman Sachs, which had created them. Like the cost of any highly technical thing, banks charged higher commissions for each level of added complexity. While there is a story that bankers liked to tell about how these products grew the economy by lowering the risk of individual bad loans through their “pooling” with hundreds of other good and (even more) badones, a comprehensive survey of empirical economic data has revealed little evidence of such a benefit.6
Paul Volcker, the former head of the Federal Reserve Board, may have expressed it best when he quipped that the most important innovation in finance over the last twenty years was actually the ATM. Volcker lamented: “I wish someone would give me one shred of neutral evidence that financial innovation has led to economic growth—one shred ofevidence.”7And the nation’s leading private investor, Warren Buffett, memorably labeled the new derivative instruments “weapons of mass destruction.”
Much, but not all, of the risk of derivatives came from the fact that banks had virtually no obligation to disclose how many of them they held. As a result, they were able to massively shield their financial health from their many creditors. Derivatives are typically traded off the market, in an agreement between two parties that remains known only to them. This is known as “over-the-counter trading.” These derivative trades are not on exchanges and, typically, nobody (except, just maybe, the parties) knows who owns what or how much anything is currently “worth.” In short, there is absolutely no transparency.
These off-exchange transactions began accounting for an increasing percentage of all trading done by major banks and other financial entities like AIG. Since nothing about them has to be reported, it becomes impossible to know how heavily involved a particular bank or hedge fund might be in a risky deal.
It was not just Paul Volcker and Warren Buffett who recognized the potential for systemic disaster lurking in these hidden trades. In the late 1990s, Brooksley Born was the Chairperson of a small federal agency, the Commodity Futures Trading Commission (CFTC). She had an understanding of derivatives from her work as a lawyer in the financial world and believed that the sheer volume of derivatives trades coupled with the government’s complete ignorance of what was taking place presented a serious problem. Indeed, it lay at the heart of the unexpected 1998 collapse of the hedge fund, Long Term Capital Management.
Brooksley Born proposed that the CFTC, which regulated other derivatives, create regulations which would permit authorities to at least know what was happening and outlaw certain practices which contributed to instability. In a remarkable narrative of power overcoming good faith and reason, the story ended poorly. She was setupon by the biggest guns of the governmental financial establishment, most notably Robert Rubin and Lawrence Summers, then Secretary and Deputy Secretary of the Treasury, respectively, and Allen Greenspan, then Chairman of the Federal Reserve. Her proposal was decisively defeated.
Born resigned in June 1999. Not long afterward—and with the staunch support of the just-mentioned Clinton-era financial gurus—Congress, as if responding to a national emergency, hastily passed The Commodity Futures Modernization Act of 2000. The CFMA is a remarkable piece of pro-business legislation that virtually bans government regulators from gathering information on, investigating, or making rules pertaining to, derivatives. The law essentially mandates a complete “Hands Off” approach to these transactions despite the fact that a core principle of Wall Street free-market champions is that only with full and free information can markets ever be expected to function productively in the first place!
Indeed, only a few years later derivatives, and the inability of financial institutions to assess the risk posed by them were main contributors to the freezing of international credit markets and the resulting economic meltdown of 2008. And yet even today, the derivative market remains opaque and largely unregulated.
Thus, in the run up to 2008—with Glass-Steagall gone and the effort to create even a modest regulatory structure for derivatives crushed—banks were engaging in more complicated, riskier, and less transparent behavior than ever before.8And so, in retrospect (as understood by a very small community of economists), the crisis was not just the kind of thing that is going to happen now and again as a result of the haphazard economic forces in a capitalist society. Rather, the gutting of theGlass-Steagall Act and other deregulatory maneuvers would be equivalent to the blind mismanagement of a forest system left to grow dense fire-sensitive ground cover. We might not know just when the spark is coming, but can we really act surprised when it hits or feign shock at the extent of the catastrophe it unleashes?
Recent Attempts to Approximate the Glass-Steagall Standard
In 2010, in response to the crisis, Congress did do something: it passed the Dodd-Frank Act (Dodd-Frank) to implement some restraints on banking and financial activities. We should point out the Dodd-Frank fell far short of what many felt was needed. Nonetheless, there were useful parts to and a key provision was Section 619, commonly known as the “Volcker Rule,” named, yes, after the same former Fed Chairman, Paul Volcker, noted above.
Volcker had been one of the most prominent critics of the repeal of Glass-Steagall, perhaps because he had been around long enough to live the history we just described. Volcker began working as an economist at the Fed in 1949, led the organization during the tumultuous stagflation days of the 1970s, and, in his old age, had become a “wise man” of sorts on Wall Street (however oxymoronic that may sound). In an uncharacteristic choice of someone outside the core community of the revolving door group of “bankers-today-regulators-tomorrow,” Obama brought Volcker to the White House during his first term to serve as the head of his Economic Recovery Advisory Board.
In 2009, Volcker presented Obama with a two-page white paper that outlined a modern-day version of Glass-Steagall. The proposal involved placing limits on proprietary trading (e.g, self-interested securities trading, or speculation) by regulated commercial banks. Obama actually adopted Volcker’s idea in January 2010 and christened it the “Volcker Rule.” It is vital to note that neither Glass-Steagall nor the Volcker Rule ever put limits on securities trading by traditional broker dealers or investment banks. Rather, these laws only sought to address the glaring conflict of interest recognized by Ferdinand Pecora eighty years ago: a bank that benefits from public money (whether in the form of customer deposits or Federal Reserve loans) should not be permitted to gamble with that money in the highly speculative manner characteristic of investmentbanks or securities traders.
By the time the Volcker Rule made its way from the President to Congress in the summer of 2010, deregulatory interests had already prevailed in riddling it with numerous loopholes and exemptions. As a result, the final version of the Rule that was passed as Section 619 of Dodd-Frank in July 2010 bore little resemblance to the simple proposal that Volcker had originally presented. For instance, while the Rule prohibited proprietary trading by commercial banks, it permitted such banks to engage in “market-making,” which involves taking the opposite position on a customer’s securities order in order to prop up the market for that security. Unfortunately, the market-making exemption can be easily exploited, especially in cases of highly illiquid over-the-counter (OTC) securities that have no real market. For such securities, a purely speculative trade by a bank can be easily disguised as an attempt at “market-making.” The Volcker Rule’s exemption for “hedging activities” presents a similar problem.
The five federal agencies charged with implementing the Volcker Rule—the Fed, the SEC, the CFTC, the OCC, and the FDIC (the Agencies)—issued proposed regulations in October 2011, shortly after the inception of the Occupy Wall Street movement.Under the Administrative Procedure Act (APA), any “interested party” affected by a federal agency’s proposed rule can submit a public comment to the agency, and, by law, the agency is required to consider such a comment before finalizing the rule. A significant amount of corporate lobbying exists at this level of would-be lawmaking, which, given the obligation of the Agencies to consider everything submitted to them, can pretty much drown the process in paperwork. As recently reported inThe Nation, the flood of such comments from the financial industry, along with the crushing flow of financial sector lawsuits the government has had to defend (at taxpayer expense) has pretty much thwarted implementation of the 2010 law.9
One Occupy group, Occupy the SEC (OSEC), has recognized the inordinate lobbying pressure that was being placed on the Agencies (from banks, politicians, and even foreign countries) to gut the Volcker Rule, so it decided to fight fire with fire by submitting its own 325 pages of comments, which were submitted in February 2012. Those comments took issue with loopholes and exemptions that could be found in the proposed regulation and suggested regulatory changes that would strengthen the Volcker Rule’s containment of bank excesses. As of this writing, the Agencies have yet to issue final rules implementing Section 619, which means that banks continue to pose many of the same systemic risks that caused the 2008 crisis. In addition to submitting comments, OSEC brought a federal lawsuit in the Eastern District of New York against the Agencies (and also the Department of the Treasury) for their delay in finalizing the Volcker Rule.10
If implemented in a form that is similar to the proposed version that came out in October 2011, the Volcker Rule would merely be a middling half-step towards reinstituting the sweeping safeguards that Glass-Steagall originally imposed. That is, the Rule would certainly improve the status quobecause many types of overt proprietary trading would be prohibited, but it would notbe the case that we have successfully re-learned the lesson of the 1929 crash and kept banks from betting widely with consumer deposits and the essentially public monies made available to them at the Fed’s discount window. Given the breadth of the Rule’s market-making, hedging, and securitization exemptions, many unsafe banking practices would still continue unabated. Of course, as noted, even the watered-down text of 2010 financial reform legislation has come to naught because of massive bank obstructionism, led by none other than Eugene Scalia, son of Supreme Court Justice AntoninScalia, and a Washington DC partner at the global law firm of Gibson, Dunn & Crutcher. Unfortunately, we stand hardlybetter protected today than we did before the 2008 collapse.
Senator Elizabeth Warren has tried to address the Volcker Rule’s deficiencies by proposing a new version of the Glass-Steagall Act. Remarkably, Republican Senator John McCain is a co-sponsor of her bill.11As of this writing, the bill seems very unlikely to pass, despite tepid support from some Wall Street veterans like Sanford “Sandy” Weill, former Chairman of Citigroup, who is widely credited as the mover-and-shaker behind the repeal of Glass-Steagall during the late 1990’s.
The nation’s financial system continues to be at risk so long as the Volcker Rule—Section 619—is a weak substitute for Glass-Steagall and, even in that watered-down form, remains unimplemented. Unfortunately, even if the Volcker Rule eventually becomes law in a form vaguely resembling the 2010 Congress’ intent, banks will, to a considerable extent, still be able to engage in speculative trading funded by public money. Only a full return to the Glass-Steagall standard originallychampioned almost a century ago would appropriately safeguard the interests of depositors, average investors, and the public generally as the true intended beneficiaries of Federal Reserve lending activities. Such a return seems unlikely at this stage, which means that the 99% has yet to adequately express its indignation and outrage about the regulatory work that needs to be done to avert the next Great Recession.
1. James Lavin, “Many warned deregulation would cause financial crisis & taxpayer bailouts”, jameslavin.com, March 26, 2009
2 Steven A. Ramirez, Arbitration and Reform in Private Securities Litigation: Dealing with the Meritorious as Well as the Frivolous, 40 Wm. & Mary L. Rev. 1055, 1066 (1999).
4 Statement by Senator Frederic Walcott, 75 CONG. REC. 9904 (1932))
5 Interview with Senator Elizabeth Warren, CNBC, Jul. 12, 2013, available at
6 See W. Scott Frame & Lawrence J. White, “Empirical Studies of Financial Innovation: Lots of Talk, Little Action?”, 42 J. Econ. Lit. 1 (2004).
7 “U.S.financial services increased its share of value added from 2% to 6.5% but is that a reflection of your financial innovation, or just a reflection of what you’re paid?” Interview with Satyajit Das,
“The Financial Zoo: An Interview with Satyajit Das –Part I”, Naked Capitalism, Sep. 7, 2011, nakedcapitalism.com/2011/09/the-financial-zoo-an-interview-with-satyajit-das-%E2%80%93-part-i.html
8 Even sophisticated parties may not be aware of or fully appreciate the risks involved in their own activities. For example, Long Term Capital Management was managed by Nobel-prize winning economists and financial modeling experts, and yet it failed in epic fashion in 1998, almost taking the economy down with it. See Roger Lowenstein, When Genius Failed: The Rise and Fallof Long-Term Capital Management,Random House(2001).
9 Gary Rivlin, “How Wall Street Defanged Dodd Frank”, The Nation, May 20, 2013
10 Paul McMorrow, “Occupy the SEC Takes on Big Banks on Their Own Turf”, Boston Globe, Mar. 5, 2013, available at
11 Carter Dougherty & Cheyenne Hopkins, “Warren Joins McCain to Push New Glass-Steagall Law for Banks”, Bloomberg, Jul. 12, 2013,