THE OCCUPY FINANCE BOOK – CHAPTER 8: "Starting to Re-Build What's Ours"
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Interview with Tamir Rosenblum by Oriana P.
Camera: Oriana P.
Section 3. Things to Do
Chapter 8. Starting to Re-Build What’s Ours
(some proposals for better principles and strategies to develop financial rules)
TR: My name is tamir Rosenblum and I’ve been participating in the Alternative Banking meetings for a year now. I’m a union labor lawyer for my day job in NYC.
ORP: And today we’re gonna talk about Chapter 8, which starts with a quote from Milton Friedman. Milton Friedman was the hero of Reagan and Thatcher, two of the main characters that got us into this mess in the first place. Why start a chapter with him?
TR: I think the reason we did that was because Milton Friedman is really sort of the prophet of neo-liberal economics, which is in some way I think the doctrine that Occupy is in opposition of. It’s almost the token of what its opposition is and Milton Friedman created that movement and yet what the quote shows is that even Milton Friedman understood the need to have rules to a system. That the notion of neo-liberal economics even that is not that it’s just sort of a survival of the fittest, there’s no rules and corporations can do whatever they want in a deregulated environment. Even he understood that markets need to be regiment, they have to have rules, you need to have a sense of a system within which people operate and so I think what we are trying to say is, even he understands that, that that should be something that sort of gets put to the side as something we don’t need to discuss or debate, but the reality is today that we constantly hear “no regulation”, “less regulation”, “there shouldn’t be any regulation” and that wasn’t even what our most staunch opposition says.
ORP: What would be the arguments for deregulations though? Obviously we need regulations, but why would people adhere to the notion of deregulation?
TR: Obviously our point of the book is that there should be a notion of what good regulation is. I am probably not the person to ask to give the other side’s best argument but what we’re told is that any form of restriction that we put on corporations is going to cramp their ingenuity, it’s going to cause them to behave in ways that we call ”inefficient”, and that the end result is gonna be worse for this sort of stupid government coming in and limiting their activities. So we are told this and we are always giving this advertisement that efficiency should be our ultimate goal. I think we all can see from our experience and see intuitively over the last number of years that if you have a system without rules where people can do whatever they want, they are gonna accumulate unfair amounts of wealth and privilege for themselves and not share with the broader population and that doesn’t make sense at all. The analogy we begin the book with, which is football, which is something everybody understands and which is the quintessential American game, having said that, it’s a very rule driven game, there’s a sense of what you can and can’t do. It’s not a better game for the fact that, oh we prohibit the line man for poking the eyes out from the other team, no, there’s things you can’t do within a system but nonetheless has room for ingenuity and imagination and creativity and things that can happen that people are interested in. The notion of this book is to leave aside the question whether regulation is good, regulation is bad,…we need to acknowledge we need regulation and let’s start asking the question what are good regulations gonna look like and get away from the issue of whether there should be regulations in the first place or not.
ORP: And what kind of regulations should we have? In this chapter you offer some kind of framework for regulatory reform. Can you talk about that?
TR: Sure. There’s a number of broad principles we tried to establish and talk about in terms of what are the kinds of things that good regulations look like. Again, getting away from the notion of whether there should be any. For example we talk about the notion that you have to have some level of responsibility and accountability that’s just built into a regulation. It can’t all just be regimented in the sense that you should do this and this point and you should be doing that point but then you’re gonna have this normative behavior that the regulation has to pick up. For example in the context of finance, there’s a striking absence of notions of fiduciary obligations that brokers have towards their clients, which you would expect. They exist for trustees, they exist for lawyers, we almost come to think, well people who are managing our money must have that kind of general norm of behavior that gets applied by the law. Ridiculously it doesn’t exist in the current regulatory framework. One thing we talk about is a substantive direct policy proposal is that you need to have those norms of behavior. It can’t just be a norm of behavior, which we saw with the crisis, anything that makes me money is a good thing because I’m in the game to make money. No, there needs to be rules and standards by how one goes about making money. We do that in all other areas of professional conduct and it needs to apply in finance as well.
ORP: You mentioned “fiduciary obligations”. Exactly what is that?
TR: Fiduciary obligations is a notion that when you are serving as a professional for a client that your duty is entirely to the client, that you are not furthering your own self interest to the extent that you are yourself interested in the project. It’s a simple derivative from your client’s well being. So if you are a trustee for money then you owe a fiduciary obligation to the participants. Suppose that you were managing a pension fund, there’s an established fiduciary obligation and any decision you make with respect to that money has to advance the interests of the retirees whom ultimately benefit from the accumulation of the money in the account. It’s a well defined principle of law and it goes back to England and Common Law. So we know what we are talking about, there’s a cultural development of this norm. Remarkably we don’t apply it in situations of regular money management. So now you have situations where Goldman Sachs is pitching different products to its clients, at the same time as it is betting against those same products through other alternative instruments hoping that those same products that they are selling on the one hand will fail and they will make money from insuring those products in other scenarios. This would be totally inconceivable and inconsistent with a fiduciary obligation. And again, we know what that consists of from having applied it to various other professional endeavors for hundreds of years.
ORP: So in other words it’s a notion that whatever it is that you are doing in the financial world, it has to benefit the public,…
TR: Well even for your client. I mean the fact that we are talking about something that is far more limited than that. It’s not that we are saying that Goldman Sachs has to act as some sort of charitable organization and just act for the public but what we found of what so much of what happened in the leading up to the crisis is that these financial institutions were cheating the clients. It wasn’t just that they were doing something in a more generic public interest, it’s that they were selling loans that were predatory, that were totally not in the interest of the lower income class people who were buying them. They had no obligation to looking out for the interest of the client, let alone the public at large. Likewise when Goldman Sachs was peddling all kinds of products to pension funds claiming that these mortgage backed securities are good for them, at the same time as they are betting against them in another situation. Clearly they are not acting in the best interest of their individual clients, let alone the public.
ORP: In a large part it is up to us to enforce that. You say in the chapter there has to be a change in culture. Right now there seems to be this culture that is rooting for them to do these things, they are the heroes or the winners or something.
TR: And going back to the notion of enforcement, I think we all rightly have become so cynical about any rule that we would create that it would become distorted by the political pressures that come to bear on the regulators and the interests of the regulators and turning around and becoming wealthy by going and subsequently working for all these entities that they at one point regulated. So if we are going to create that culture we need strong suggestions on how we are going to get away from those dynamics. Sheila Bair, the former head of the FDIC, has talked about really having a very strong, even a bar on regulators going back through the revolving door, to work for the entities that they once regulated. It goes to moving away from a culture where the people who are enforcing the rules have an incentive to not really enforce them because they want to be in good favor with the very entities they are supposed to be regulating because the real anticipation is ultimately go make a lot of money by working for them. Likewise when you see that the legislators’ process itself is so imbalanced because the way the rules get made is through this lobbying process where …I think there’s some statistic that the financial industry hires five lobbyists basically for every single federal congress man or senator. You don’t have the counterbalancing public voice, it’s almost completely absent in that scenario. We probably couldn’t even name what the Republican advocacy group is for these kind of financial issues. One proposal we have is, in order to bring back the culture where our governmental representatives are totally beholden to our interests, is that you have some kind of mechanism where the tax system will find popular voices for issues like this. So that you will have a public interest group that gets a level of government funding to be a voice, to counteract the voices that are so deafeningly one sided and overwhelming on issues like finance. And if you think about it, we can all easily name what the big environmental groups are, what the big union groups are. Ralph Nader is probably the only consumer advocate most people can name and he’s covering all consumer advocacy. There are some great groups like Occupy the SEC, that have done work in the financial industry and it’s a great thing but it is so unbalanced at the moment and I think we need some real structural change in how we get voices heard in congress.
ORP: As an example, in the book, you brought up the Libor scandal again and there was this interesting thing “The Rational Actor Model” in the business schools. Basically the people that were part of the Libor scandal, they just applied that model and this goes back to changing the culture.
TR: Right, so what happened in the Libor scandal and now there’s additional market manipulations that we are hearing about in terms of international exchange currency. Generally when you have individual traders who actually make a profit solely based on their success as an individual trader in terms of making money for the firm, which in turn they’re gonna get a robust cut of. They don’t even have an interest in their employer as a whole. They are not interested in Chase succeeding. So Chase has all these individuals it uses and by acting in their own best interest it’s gonna benefit Chase or it’s gonna benefit whatever big bank is engaged in in trading, and it creates this incentive for the individual actors to collaborate, to manipulate markets, to show big profits even though they are overtly engaging in illegalities that ultimately their employer will pay the penalty for because we have seen there’s almost no criminal prosecutions that come out of these enterprises. That whole notion, the way that these organizations are structured, they aren’t causing their own employees to be accountable back,..even to the organizations’ best interest but are just totally driven by their own self interest. It fails even to their own benefit because what they end up with is these horrible scandals that they presumably weren’t anticipating when they are giving this charge to the individual trader to just be solely focused on his own best interest and make as much money as he can.
ORP: And apparently this is taught in business schools through the “Rational Actor Modal”.
TR: Right. Neo-liberal economics very much has this view of our society as the best way to have a just outcome is to have everybody behaving in a totally self interested way and somehow through some miraculous, invisible hand or some magic that happens all of us will play out in a way that we’ll get some really great things done. I think we all know in our hearts and not just as a matter of theory, that that is not what it means to be a good society. What really creates the fabric of a society is not all of us acting totally individually and selfishly but it is the acts that we engage in and are altruistic, that look out for other people, that have concerns for whether it’s an employer, whether it’s a client, whether it’s society as a whole that is beyond ourselves that makes a society worth living in. To the extent that we are literally teaching people that the way you succeed in life is by being an individual actor that only cares about himself and that this is the virtue of life, it is so perverted. A five year old should be able to tell us that this is false.
ORP: Right. I do media and every day we report on enormous uprisings all over the world. These uprisings are because of the austerity measures and the austerity measures are because of neo-liberal policies. When will the people behind these policies realize their policies don’t work and are only causing chaos and revolution? If they continue, where is it gonna end?
TR: If we had the answer to that we will have figured out something really amazing. I think that our view is that there’s a certain logic that is taught to us, whether it’s through business schools, whether it’s through Fox News, whether it’s even from NPR, that there’s a sense that we are working in a basically functioning system and that it’s up to each of us to succeed in this system and to the extent that we fail it’s our own fault and we shouldn’t do anything to complain about it. The reality is that we are working within a system that is very rigged and has the rules that have been developed by people who are winning from the application of those rules. It’s essential for people as a first step to take a step back from what they’ve understood about the system and learn better of how it functions. That’s what the idea of the book is. We’re hoping to do other things to sort of enable people to take a step back and understand the system and understand that if they are failing in the system it’s not something that the Rational Actor’s school tells them, that it’s all their fault, because they haven’t been rational, they haven’t been adequately motivated to be self-interested but they are working within in a system that really hasn’t been designed for them to succeed. Hopefully this is a first step toward doing that. There’s still a lot of work to be done and if people are concerned, we hope they get involved with us or some other group and try to promote that process.
ORP: Thank you.
Section 3. Things to Do
Chapter 8. Starting to Re-Build What’s Ours
(some proposals for better principles and strategies to develop financial rules)
“The existence of a free market does not of course eliminate the need for government. On the contrary, government is essential both as a forum for determining the “rules of the game” and as an umpire to interpret and enforce the rules decided on.”
Sports leagues rely on rules and officials to assure fair competition. When the National Football League tried to break the referees’ union by bringing in inexperienced refs, fans quickly discovered the results of poorly enforced rules. The replacement refs made one glaring mistake after another. Teams that should have won lost. The public outcry led to a quick restoration of capable officials.
Poor financial regulation gets less attention than poor refereeing, perhaps because it is not broadcast on TV, but we have all suffered from the effects of both bad rules and bad enforcement. As earlier chapters have described, bad regulation contributed greatly to the recent financial crisis and its aftermath. Even when the terrible effects became obvious, the regulations were not adequately fixed. In fact, the abuses are continuing. Clearly, those in government are not willing to do what is needed to hold the abusers accountable for their actions. Why? Because the status quo serves the interest of Wall Street and the banks’ influence on politicians and regulators is pervasive.1 So we need public outrage to demand better regulation.
Many people, both in Occupy Wall Street and outside, believe that our current financial/governmental/regulatory system is beyond repair and something very different must replace it. But even those with that ultimate goal must not, in the meantime, simply accede to whatever rules the corporate interests and lobbyists impose. In this chapter, we outline a framework for regulatory reforms that will move toward a system where the rules are enforced fairly, powerful miscreants are brought to justice, and the 99% have a representative voice in the political and regulatory processes.
The suggested reforms are by no means a complete fix of our economic arrangements. But they illustrate that, even within the existing system, the rules could be much fairer, predatory practices could be much less prevalent, power could be much more equitably distributed, and violators could be punished even if they are rich and powerful. These are useful steps toward getting we, the people, involved in deciding what needs to be done and how it should be done. It is a reclaiming of the people's power.
The current problems with financial regulation are not inevitable. The financial system used to be better regulated and it can be again. There are also examples of good regulation that prove it is possible. For instance, those of us who live in Los Angeles or New York City will be familiar
with the letter grades A, B, or C prominently displayed on restaurant windows. This simple measure has improved restaurant hygiene and reduced severe food-borne illness.2 As the Consumer Financial Protection Bureau has shown, better rules and regulation of the financial industry are also possible.
This chapter proposes a framework for what we call “Popular Regulation”. We call this approach “popular regulation” because it will make regulation more transparent, effective, and protective. But, more fundamentally, it will make the people’s interests and the people’s voices more prominent.
Principles of Popular Regulation
Popular regulation is defined by four principles:
Responsible and accountable: Society must expect the regulators and the regulated to behave responsibly. When they don’t they must be held accountable. There are three significant aspects of responsibility:
- At the most basic level, companies and people must be held accountable when they break the rules or abuse the public trust. As described in chapter 5, there have been too many examples of law-breaking going unpunished. In addition to being unfair, this also encourages future misdeeds. But the rules should demand responsible behavior well beyond abiding by the letter of the law. Many financial relationships inevitably involve unequal positions or asymmetric information, such as those between financial adviser and client. The more powerful or well-informed advisers should be prevented from using that information to exploit their less knowledgeable customers.
In addition, for regulation to work, regulators must act in the public interest. Their incentives and career opportunities should support such behavior, not undermine it as these opportunities do today.
- Finally, social norms are also important. For too long, society has lionized selfish behavior in the corporate sector and demonized government regulation. We need to appreciate the need for and the value of good regulation.
Simple and consistent: In general, simpler rules are better because they’re commonly less subject to gaming. Simpler regulations make it harder to embed loopholes or special privileges. Simpler regulations will facilitate democratic involvement in the process, because regular citizens will be able to understand and critique them.
Fair and comprehensive: The rules must be fair and enforced in an equitable manner. Regulation also should be comprehensive. All too often, regulation is fragmented and inconsistent. This has allowed for abuse of the process and/or avoidance of oversight.
Democratic and transparent: our government is intended to be “of the people, by the people, for the people”. This principle should apply to regulation as much as to any other governmental activity. The financial regulatory process today is open in structure. New or revised regulations are available for public comment. But in practice it is all-but-impossible for people, or even their representatives, to have meaningful involvement in the process. We present some ideas to change that.
In the remainder of this chapter, we illustrate these four principles and how they could be applied by proposing some examples of better regulations and improvements to the regulatory process.
Responsible and Accountable
When we visit a physician, we have reason to expect that the doctor will give us advice and treatment that is in our best interest. Doctors know more than we do about medicine and health, and we expect them to use that knowledge for our benefit, not to make a profit from us.3
Financial companies and the professionals who work for them also have informational advantages over most of their customers. There should be similar expectations for them to put their clients first. In finance, this is called a “fiduciary obligation”. As discussed in chapter 1, financial companies currently sell products. The burden of determining which of these products are attractive or beneficial and how to use them is shouldered almost entirely by the individuals who invest, take out a mortgage, use a credit card, or engage with other financial products. But most individuals do not have the expertise to make those decisions well. And, increasingly, many financial products contain traps in terms of hidden fees, adjustments to payment requirements or other features that can make them toxic to customers. Financial products are supposed to serve a useful purpose but instead, all too often, they are used to take advantage of individuals for the benefit of the company selling the product.
Things do not need to be this way. Financial practitioners should be held to standards as doctors are. They should offer products and advice that are truly helpful to their customers or clients or risk being sued for “malpractice”. Higher minimum standards for behavior need to be enacted legally and via regulation. Fiduciary obligations need to be extended more broadly. For example, mortgage brokers should be legally prevented from selling high-cost products to a borrower who would qualify for a lower-cost alternative. In addition, mortgage brokers should be responsible for fully disclosing all aspects of the loan agreement, including the compensation that they will receive, directly and indirectly, for selling different products.
Lock the revolving door
Financial professionals now move seamlessly between regulatory agencies and financial firms as well as the law firms that represent financial interests. This is insidious in both direct and indirect ways. When regulators see the industry representatives lobbying them as potential employers, it undermines efforts for regulation in the public interest.
Perhaps worse, since many of the staff at regulatory agencies such as the Securities and Exchange Commission (SEC) and at the U.S. Treasury Department previously worked on Wall Street and have friends who still do, their mindset is similar as well. The awful consequence of this system has been described by former regulators Sheila Bair and Neil Barofsky in their excellent books Bull By The Horns and Bailout.
This problem should be attacked directly. Sheila Bair has proposed that regulators should be permanently banned from working for the companies they regulated.4 While a permanent ban may sound onerous, Bair spent most of her career in government, ultimately as Chair of the
FDIC, so we respect her judgment that this would be feasible. We also think it can be implemented in ways that will be effective while still attracting capable regulators.
Bair’s point is that locking the revolving door would cause a culture change. People going to work for the government would see it as a career. A permanent ban would attract people who would find government employment a rewarding mix of good compensation and public service — just the sort of attitude we would want in regulators‒rather than what we have today, where working for regulatory agencies is viewed as a stepping stone to a more lucrative job on Wall Street.
Junior regulators need only be subject to a temporary ban of perhaps one year. As people gain tenure and rise in rank, the bans should be lengthened to a few years, and those at the highest levels should be permanently banned from entering private industry. In conjunction with this, the regulatory agencies should be encouraged to hire from within government so that career prospects for regulators would be improved.
There are many insidious effects when people move from Wall Street to Washington. This is particularly true at the highest levels. We were shocked to learn that when Treasury Secretary Jacob Lew left Citicorp to return to Washington, Citigroup paid him a handsome bonus.5 The bonus specifically rewarded him for moving into a high government position — yet another way for corporations to bias the system in their favor. This is unseemly and should be forbidden
After all, public servants in other parts of the government truly do behave as public servants. The diplomatic corps seems quite professional. Federal judges usually act honorably. Judges have explicit life tenure and foreign service officers hold government posts for long periods. We need to promote similar professionalism in financial regulators. Locking the revolving door would be an important step toward achieving popular regulation.
When malfeasance occurs, those involved need to be held accountable. As described in chapters 2 and 5, there were many crimes during and after the subprime crisis that were not prosecuted. Even when there was clear evidence of wrongdoing, the SEC, the Department of Justice, and/or state Attorneys General made agreements with Wall Street firms that permitted these firms to “neither admit nor deny” wrongdoing. The fines that were imposed were typically woefully inadequate to discourage future misbehavior, and in fact did little more than establish the fee for criminality. 6
In addition, fining companies is generally ineffective because it doesn’t sufficiently punish the executives who committed or condoned the wrong-doing and personally benefitted from it.
The SEC has begun, in some cases, to demand that financial firms actually admit to the crimes they have committed. But this is still the exception when it should be the rule. Even in extreme cases, such as HSBC’s admission to years of money-laundering for drug cartels, no criminal charges are pursued. This must change.
Change the culture
Finally, statutory restrictions and prosecutions are necessary but not sufficient. Social and industry norms also play an important role. When Michael Lewis described outrageous behavior on Wall Street in the 1980s in the book Liar’s Poker, he thought it would embarrass people on Wall Street into acting better. Instead, the book was taken as a “how-to” manual! Wall Street became even more brazen in taking advantage of clients, the government, the public, and anyone else they can make a buck from. Society is partly responsible for this since, in addition to money, Wall Street executives get public accolades even when they are caught committing wrongful acts. For instance, JPMorgan Chase CEO Jamie Dimon continues to be respected despite a Senate report that shows he lied to Congress and shareholders.7 Ina Drew, who headed the JPMorgan Chase unit involved in this deceit, was honored as “one of the most successful women on Wall Street” even after the report became public.
The LIBOR scandal is a window into the corruption in the culture of finance.8 Hundreds of people, working for dozens of banks around the world, routinely colluded to manipulate interest rate indices for several years. They did this to increase their bonuses, and were profoundly indifferent to the impact this would have on the public and even on the companies they worked for. In fact, this practice was so well accepted that the perpetrators openly discussed it in e-mails.
How could this go on for so long? Ironically, it is the natural outcome of the “rational actor” model 9 taught in business schools10 — namely, that the LIBOR manipulators were acting in their own best interest given the incentives they faced and the lack of effective oversight or enforcement.
We need to reject the myth that market forces ultimately work for the common good and that selfish behavior is “doing God’s work” 11. We should recognize that hedge funds that exploit regulatory loopholes or front-run other investors do not produce any social value but that good regulation does. In order to understand this better, we recommend reading 23 Things They Don’t Tell You About Capitalism and What Money Can’t Buy (see chapter 9, “Resources”).
Simple and Consistent
Simplicity is another crucial element of popular regulation. Simpler regulation would reduce the potential for inserting loopholes or special provisions. It would also encourage broader participation in the regulatory process.
We originally advocated for the Volcker Rule to prohibit banks from speculating with depositors’ money. In principle we still endorse the idea. But in practice the regulations to implement the rule are thousands of pages long and the process is mired in bureaucracy. What’s worse, the megabanks are manipulating them to their advantage.
Occupy the SEC (OSEC), our sister group within the Occupy movement, has done extraordinary work in an attempt to insure that the regulations are written well and implemented.12 But its effort is not sufficient because there are dozens of rules being proposed; OSEC is only able to comment on a small fraction of them.
Let's face it: regulatory complexity serves the interests of the largest banks. First, it provides opportunities for Wall Street lobbyists to insert special provisions and loopholes. Even when the rules are not written specifically to provide advantages to Wall Street, the regulatory burden works to their advantage. The cost and expertise needed to deal with the regulation acts as a barrier to entry for smaller firms and encourages industry concentration.
Require more bank capital
There is a much simpler alternative to the Volcker Rule. In their compelling book The Bankers New Clothes: What’s Wrong with Banking and What to Do about It, Professor Anat Admati and Dr. Martin Hellwig argue for requiring banks to rely much less on borrowed money and to have a larger cushion against losses. Andrew Haldane, Executive Director of the Bank of England, has also called for greatly simplified rules in his “Dog and a Frisbee” speech.13
Admati and Hellwig’s proposal is simply to require that banks have a larger cushion between what their assets are worth and what they owe. This would reduce both the risk and the consequences of bank failure. It would go a long way toward ending “too big to fail” and stabilizing the financial system. In addition, as Admati and Hellwig show, the only true costs to the banks would be reducing the “too big to fail” subsidy and the exploitation of tax preferences given to debt, which provide them with unfair advantages. That would be costly to the banks but beneficial to society.
They also argue for drastic simplification of the rules. While we agree that a simple measure of assets would have done much better in managing the past crisis, it is far from clear that it would be more effective in the next one. No single measure is perfect. What’s more, Goodhart’s Law,
proposed by a member of the Bank of England’s Monetary Policy Committee, states that any measure used as a policy tool will lose its effectiveness because banks will configure their assets in ways that exploit the measure’s flaws.
We think the only solution is a belt-and-suspenders approach. That is, there should be multiple and different measures to lessen the banks’ ability to game any single one. While we like the Admati/Hellwig/Haldane proposal for a simple measure, we also think more sophisticated measures should be maintained because any one measure is imperfect, and increasingly so as Goodhart’s Law comes into play. In addition, regulators should have the tools to apply their judgment to address problems as they are recognized.14
The approach we recommend should not be burdensome to the banks. As Admati and Hellwig note, many of the banks’ arguments against these proposals have no more substance than the Emperor’s New Clothes. What we recommend is similar to the current regulations except with much higher standards.15
As more capital would allow for easing of what the banks consider more intrusive regulations such as the Volcker Rule, it could reduce the overhead of the banks while making the regulation both more effective and more “popular”.
Simple retail products with clear disclosure
Another example of the benefits of simplicity is the progress that the Consumer Finance Protection Bureau (CFPB) has made toward protecting individuals. Anyone who has received a credit card privacy statement may have noticed that they are much clearer. As opposed to many pages of fine print, the salient aspects are now on the first couple of pages in bold type. It makes clear what the company does with your information, when you can restrict their sharing of your data, and how to do so. While we might want more privacy protection, at least people are made aware of what is being done and can, to a degree, opt out if they wish.
Other credit card and mortgage disclosure language is also being greatly simplified. As the Center for Plain Language has shown, it is possible to write a credit card agreement that a fourth- grader can understand — if you want to. This level of clarity should go a long way toward helping individuals avoid the traps that currently exist in all-too-many financial products.
We also applaud efforts to restrict the use of complex financial instruments. Here too, the CFPB is leading the way. The Qualified Residential Mortgage designation that is applied to simple mortgage structures will encourage their use. While it is still legal to offer the more complex mortgages that created such havoc during the latest crisis, the hurdles to using them are higher compared to using simpler instruments. This should discourage their use.
While we have mixed opinions about the Volcker Rule, we do agree with former Fed Chairman Paul Volcker’s statement that the only useful financial innovation of recent decades is the ATM16 — and as noted in Chapter 1, even that is a mixed blessing. Promoting simpler financial products, simpler regulation, and clearer disclosure is an important part of popular regulation.
Simpler, more open markets
Markets should also be simplified and made more transparent. Forty years ago, most trading was in stocks and took place on public exchanges. Today, derivatives dominate the financial system and trade in opaque over-the-counter markets. Even many products sold to individual investors have become very complex.
Trading should be required to be more public. In addition, there should be review of financial products before they are used. Two professors have proposed an agency that would review products for financial safety and effectiveness, similar to what the Food and Drug Administration does for pharmaceuticals.
Why the parallel? Some financial products are so complex and contain so many hidden traps that it seems clear that they are designed to confuse potential buyers. Creators of new instruments should be required to justify that they serve a useful purpose other than making money for the originators. The “Financial FDA” could outlaw instruments, or it could rule that, like prescription drugs, they can only be used in specific circumstances, or it could allow them to be used more generally.17
Fair and Comprehensive
Clearly, fairness is another essential pillar of popular regulation. As part of that, the rules must be comprehensive. For example, it is unjust that practices that are outlawed for credit cards can still exist for pre-paid cards that are foisted on some of the poorest and least powerful members of society.18
No off-balance-sheet entities
There are many other areas where incomplete or inconsistent regulations hurt society. One egregious example is the use of “off-balance-sheet” entities. Banks contorted the accounting rules to enable themselves to hold large amounts of mortgage securities and other assets that proved toxic but not to list them on their balance sheets. To accomplish this they created entities called “Special Investment Vehicles” (SIVs), which are close cousins to the “Special Purpose Vehicles” used extensively by Enron. SIVs misled regulators and investors about the true risk the banks were taking and also circumvented the regulatory controls. While rules for these entities have been tightened up, that is not enough. SIVs should be abolished.
End “regulator shopping”
Another serious problem is the fact that multiple regulators cover similar activities or the same entities. As a result, banks and other financial institutions can often choose their own regulator. It should come as no surprise that they choose the one that is most lax. Even worse, the agencies’ budgets are often, in part, determined by how many companies choose them. This leads to competition among agencies for who can be the most “attractive” regulator‒meaning the most lax!
One of the worst cases was the Office of Thrift Supervision (OTS), which was supposed to be regulating savings and loan companies, actively promoting itself as being “industry-friendly”.19 As a result, AIG, which was primarily an insurance company, was able to choose the OTS to oversee its London-based Financial Products unit. That is the unit that wrote trillions of dollars in credit guarantees that lead to billions of dollars in losses that were absorbed by U.S. taxpayers in the bailout.
While the OTS has, thankfully, been abolished, there is still enormous regulatory confusion. Both the SEC and the Commodity Futures Trading Commission (CFTC) regulate derivatives. The financial industry is playing these agencies off against each other in order to delay and weaken the rules being implemented as part of Dodd Frank. These two agencies should be combined in order to avoid such practices.
In general, rules need to be written that apply across the board. It is unfair if similar activities are treated differently from a legal, regulatory or tax standpoint. What’s worse, it is an opportunity for what Wall Street calls “regulatory arbitrage” and we call “gaming the system”.
Democratic and Transparent
Democracy is the final pillar of Popular Regulation. Regulation, like all of the U.S. government, is intended to be “of the people, by the people, for the people”. While this may not be practical in its purest form, we believe that important steps are nonetheless feasible to move closer to this ideal.
We know all too well how the regulatory process is biased toward the financial industry. The banks have billions to put into lobbying, campaign contributions and other efforts to influence the process. The Nation magazine recently described this in an article titled “How Wall Street Defanged Dodd-Frank”.20 The article noted that the top five organizations lobbying in the public interest, such as Americans for Financial Reform and the Center for Responsible Lending, were out-resourced by more than 20:1 by the top five industry groups.
But even this drastically understates the imbalance. While the top five public-interest groups constitute basically all of the lobbying on behalf of the 99%, there are dozens of corporations and
industry groups that are actively lobbying for Wall Street. Between the imbalance of funding and the complexity of the regulatory process, people have been deprived of the right, guaranteed by the First Amendment, to petition the government.
We have a simple proposal to address this. The government should create a fund equal in size to the money industry spends on lobbying to be allocated by the people. Each American resident would be entitled to vote on which organization they want to represent them and the money would be allocated pro rata in accord with these votes. While we recognize that much of this money would go to organizations that we might consider either wasteful or objectionable, we'd counter that waste is part of democracy, as we see already in election campaigns. 21 The result would be a large increase in funds going to organizations lobbying on behalf of the people.22
Direct public involvement
Public involvement in the regulatory process should not be entirely delegated to the peoples’ lobbyists.
There are many other ways that people can participate in, or influence, the regulatory process. People should be more outspoken when they see behavior on the part of regulators or industry that they find outrageous. They should demand that abuses such as Jacob Lew’s payment from Citigroup or HSBC’s being let off for money-laundering be addressed. It may seem that the people’s voice is not heard. Certainly it is given less weight than it should receive. But there are times when it does have an impact.
One example is the “Crowdsource the Fed” twitter campaign that called for nominations to the Federal Reserve bank boards. Most of the directors of the New York Federal Reserve Bank, and other regional Fed banks, are intended by law to represent the public. But the process had been corrupted.
Simon Johnson and others publicly called attention to this matter 23 and there was a call to “Crowdsource the Fed” via Twitter.24 While we cannot make a direct connection, the subsequent appointments were a vast improvement on their predecessors. When JPMorgan Chase CEO Jamie Dimon left the board he was not replaced with another megabanker. And the latest class of appointees includes the founder and director of the Freelancers Union. This is a big step forward from the previous class that included the President of the Metropolitan Museum of Art, whose main credential seems to be the ability to toady to bankers and other NY elite.
There is a very long way to go, but this is evidence that public outcry can have an impact. Entrenched interests always win when the public is silent. We can’t allow that. When the people speak out, there is a possibility for progress.
We agree with many on the political right that the current state of regulation is woeful, but we reject their conclusion that regulation should be reduced. Banks can threaten the entire financial system. They can mislead customers. They have been supported by the government even when they made disastrous decisions. Regulation is needed, but not the regulation we have today. Instead we need popular regulation that would protect the 99%.
Our solution is not to get rid of regulations but to fix them. Bringing responsibility, simplicity, fairness and democracy to regulation would go a long way toward making it more effective and equitable. These principles would be mutually-reinforcing. Simpler regulation would facilitate broader involvement in the process. Responsible regulators would be more open to the people’s lobbyists. Comprehensive regulation would be more effective.
Applying these principles would create “popular regulation”. This would be more effective in serving the people’s interest and would not be subject to the disdain that the current regulatory regime both deserves and receives. Most essentially, it would be regulation “of the people, by the people, for the people”.
The task of fixing the financial process is daunting. None of these proposals will be implemented unless the people demand them. But we should not, under any circumstances, accept the status quo. As long as we struggle, there is hope.
Some people believe that it will take another crisis before the public is sufficiently outraged to pressure public officials to do what is needed. They may be correct, but we think it is a mistake to assume that. There are more than enough financial outrages already to provoke action. Even if it will take another crisis, it is better to start the movement now to lay the groundwork for when the time is ripe.
All we need is the political will. That is why all of us are needed. We must demand that these steps are taken to repair financial regulation and the financial system.
1 As Daron Acemoglu and James Robinson discuss in “Why Nations Fail”, Crown Publishers, 2012, countries sometimes follow policies that are very adverse to the overall economy if doing so benefits those in power. We reluctantly believe that the U.S. may be on that path.
2 Ginger Zhe Jin and Phillip Leslie, The Effect of Information on Product Quality: Evidence from Restaurant Hygiene Grade Cards The Quarterly Journal of Economics (2003) 118(2): 409-451 doi:10.1162/003355303321675428, Available at SSRN: http://ssrn.com/abstract=322883
3 We recognize that doctors are far from perfect and this expectation is being eroded. But, it is still considered unethical for doctors to put their own interests ahead of their patients.
4 Chapter 26 of Sheila Bair, “Bull by the Horns”, Free Press, 2012
5 See “Citigroup’s man goes to the treasury department”, Bloomberg News, February 21,2013 http://www.bloomberg.com/news/2013-02-21/citigroup-s-man-goes-to-the-treasury-department.html.
6 See mathbabe.org “Dissolve the SEC” October 6, 2012 http://mathbabe.org/2012/10/06/dissolve-the-sec/.
7 Steve Schaefer, “Senate Report Slams JPMorgan For London Whale Debacle” Forbes, March 14, 2013 http://www.forbes.com/sites/steveschaefer/2013/03/14/senate-committee-takes-jpmorgan-to-task-for-london-whale- debacle/.
8 LIBOR (the London Interbank Offered Rate) is an obscure interest rate but it is extremely widely used in derivatives and other financial agreements. So widely it is thought to be in $350 Trillion worth. This is larger than the entire world economy. See http://en.wikipedia.org/wiki/Libor_scandal
9 The “rational actor” model underlies most economic theory. It assumes that people have all the relevant information and act perfectly rationally. As a non-economist, you might think this is self-evidently false and not in need of study but it took decades for this to be accepted by many economists. Even today most economists assume rational behavior in their models. This is not so much because they believe it but that it makes it much easier to build models.
George Akerloff and Robert Shiller, Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism, Princeton University Press, 2010
10 Long Wang, Deepak Malhotra, J.Keith Murnighan, “Economics Education and Greed”, http://bit.ly/12R9sop.
11 John Carney, “Lloyd Blankfein Says He Is Doing ‘God's Work’”, Business Insider, Nov. 9, 2009 http://www.businessinsider.com/lloyd-blankfein-says-he-is-doing-gods-work-2009-11
12 Josh Harkinson, “In a 325-Page SEC Letter, Occupy's Finance Gurus Take on Wall Street Lobbyists”, Mother Jones, February 14, 2012
13 Andrew Haldane and Vasileios Madouros, “The dog and the Frisbee” Speech given at the Federal Reserve Bank of Kansas City’s 36th economic policy symposium, August 31, 2012. http://www.bankofengland.co.uk/publications/Documents/speeches/2012/spee.... The title refers to the fact that anticipating the path of a Frisbee is a complex physics problem but that dogs can learn to do so using simple strategies.
14 This structure is already in place with the leverage ratio, risk-weighted capital requirements and stress tests. But the leverage ratio and capital requirements are much too low and the stress tests are flawed (especially in Europe). What we recommend is basically to make the current structure more effective.
15 Another proposal we are sympathetic to is to reinstate the restrictions on banking that were in place under Glass- Steagall from the 1930s until the 1990s. Senators Warren, Cantwell, King and McCain have introduced a bill to do so. However, we are concerned that implementing this will be difficult and that there are systemic risks outside the banking industry that it would not address. Overall, while we don’t object to reinstating Glass-Steagall, we believe that it is essential to reduce leverage throughout the financial system, as increased capital requirements would do.
16 Joseph B. Treaster, Paul Volcker: The Making of a Financial Legend , John Wiley & Sons, Inc., 2004.
17 A similar idea was proposed here: Eric Posner and E. Glen Weyl “An FDA for Financial Innovation: Applying the Insurable Interest Doctrine to 21st Century Financial Markets”, Social Science Research Network, June 4, 2012 http://ssrn.com/abstract=2010606 but our proposal is more truly analogous to the FDA.
18 Jessica Silver-Greenberg and Stephanie Clifford, “As Pay Cards Replace Paychecks, Bank Fees Hurt Workers”, New York Times, June 30, 2013 http://www.nytimes.com/2013/07/01/business/as-pay-cards-replace-paychecks- bank-fees-hurt-workers.html
19 Simon Johnson and James Kwak, 13 Bankers, Pantheon Press, 2010, chapter 4.
20 Gary Rivlin, “How Wall Street Defanged Dodd Frank”, The Nation, April 30, 2013
21 We realize this is far from perfect. To paraphrase Winston Churchill in a very similar context, it would be the “worst system, except for the one we have now.” We would be happy to hear other suggestions to achiehttp://ssrn.com/abstract=322883ve the same goal.
22 We call this the “People’s Lobbies” not the “People’s Lobby” to recognize the diversity of voices it would represent.
23 Simon Johnson, “Institutional Flaw at the heart of the Federal Reserve”, New York Times, Economix blog, June 14, 2012. http://economix.blogs.nytimes.com/2012/06/14/an-institutional-flaw-at-the-heart-of-the-federal-reserve/.
24 Jonathan Reiss, “Crowdsource the Fed Bank Boards”, Huffington Post, June 14, 2012 http://www.huffingtonpost.com/jonathan-reiss/crowdsource-the-federal-r_b_1598487.html