The Future of Financial Regulation and the Role of Politics

During the 2008 financial crisis, after bankers intentionally created “garbage-quality housing loans” and sold them on to investors by advertising them as safe bets, millions of Americans lost their homes, and the unemployment rate rose to almost 10%. Only one top banker went to jail after the crisis compared to 1,100 after the “savings-and-loan scandals” of the 1980s and the imprisonment of the head of the New York Stock Exchange after the crash of 1929. The US government’s history of financial regulation is a cautionary tale against deregulation in the banking industry, and a story that seems dangerously likely to include a new chapter in the coming years.

During the aftermath of the 1929 stock market crash and the Great Depression that immediately followed, President Franklin D. Roosevelt signed the Glass-Steagall Act in order to separate commercial banking from investment banking. In other words, Glass-Steagall signified that banks would be more regulated in order to prevent them from diverting people’s money into “speculative operations,” as well as giving the Federal Reserve more power to oversee the operations of the banks. The bill also created the Federal Deposit Insurance Corporation (FDIC), which insures people’s bank deposits, and guarantees that their money won’t vanish into thin air inside of the banks, as it had done in the crash. Large banks began to push back against Glass-Steagall in the 1970s, claiming that the legislation was making them “less competitive” against foreign firms. The banks’ argued that if they were able to merge commercial banking and investment banking again, the very system that perpetuated the 1929 crash, they would be able to make more money for their customers while avoiding risk by diversifying their portfolios with various investment strategies. Ronald Reagan’s Federal Reserve Chairman, Alan Greenspan, was receptive to the notion. In 1999, President Clinton signed the Financial Services Modernization Act after intense lobbying of Congress by the banks. The act allowed banks to merge commercial and investment interests, rendering Glass-Steagall mute. The change in the legislation allowed for massive merger deals, including a $33 billion deal between J.P. Morgan and Chase taking place in September 2000. While it would be hasty to say that Glass-Steagall’s 1999 neutering allowed for the initiation of questionable practices that stimulated the 2008 crisis, it is certainly indisputable that the change in the law allowed for banks to grow exponentially. This change was one element of a crisis brought on by incredibly risky investments made by the big banks, decisions that were financially backed by a housing market that existed in a bubble. Thus, when the entire system came crashing down, the banks were so big and held so much of America’s money that they could not be allowed to fail, and therefore received massive government bailouts that cost around $498 billion.

Akin to the wake of the Great Depression, financial legislation followed the 2008 crisis. The Dodd-Frank Wall Street Reform and Consumer Protection Act was signed by President Obama in 2010. Dodd-Frank is incredibly complicated, but essentially serves to stop the banks from becoming “too big to fail” again, as well as make sure that banks are prepared enough to handle a recession through “stress tests.” Dodd-Frank also created the Consumer Financial Protection Bureau (CFPB), which protects consumers from risky investments, as well as preventing banks from “engaging in speculative trading activities”. Additionally, it forces hedge funds to provide information about their trades and the risk of their portfolios. The law also makes specific changes to the way that certain institutions that were instrumental in the creation of the housing crisis are more heavily regulated by government agencies. Following the previous pattern of American financial regulation, Donald Trump signed a law in 2018 that removed provisions intended to “protect big banks from collapse,” as well as lessen the number of banks for which Dodd-Frank rules apply. He stated that the “one size fits all” nature of the law doesn’t work for smaller banks. Under the law, the threshold for a bank being too big to fail leaped to $250 billion from the previous $50 billion and lowered reporting requirements on mortgage data from banks. The bill was passed with bipartisan support despite the fact that many Democrats support Dodd-Frank. The Trump administration also made significant moves to lessen the power of the CFPB with regard to the financial system. Mick Mulvaney became the first Republican to run the Consumer Financial Protection Bureau in 2017, overseeing a steady decline of fines against big banks after his declaration that “the days of aggressively pushing the envelope are over.”

Rachel Rodman, a former CFPB lawyer, stated that “Banks should be prepared for more aggressive enforcement” under the Biden administration, given that the President has the authority to decide who directs the organization. President Biden replaced the Trump-era director the day after his inauguration, as well as reversed a Trump-era executive order that targeted the law. However, certain elements of Trump’s deregulatory legacy linger in positions of power. Vice-Chair for Supervision at the Federal Reserve Randal Quarles, whose term has now ended, spent the end of his term “cutting holes in the safety net,” according to Elizabeth Warren, who added that “our financial system will be safer when [Quarles] is gone.” With Quarles gone, Democrats see an easier path to police and regulate banks, something that seldom happened under the Trump administration. In the six years that Obama CFPB chief Richard Cordray led the policing body, the banking industry was made to pay $12 billion in fines, while Trump’s chief made headlines after imposing thirteen fines for $10 or less and ten $1 fines.

With the policy choices and appointments made to key offices by the Republican party during their previous control of the White House, it is clear that they are more committed than ever to deregulation and, by proxy, receptive to the desires of the banks. So, what do the banks want? To put it simply, a complete gutting of Dodd-Frank is something that would be beneficial for the banks. After realizing that this would be very difficult to achieve, banks are interested in targeting specific elements of the legislation. This includes a repeal of the rule that stops banks from using “consumer and business deposits for speculative investments,” as well as a restructuring of the CFPB. Walter Frick of The Harvard Business Review writes that it is “completely unclear to me how to justify this,” comparing it to removing the Food and Drug Administration. To remove the CFPB would be a “pure transfer of risk from the financial sector to American households,” seemingly identical to the transfer that went unpunished in 2008. Since the Republican party is largely on the defensive during this current session of Congress, given that they don’t possess a majority in the Senate or House, they have been spending their time playing defense, ultimately stalling the Biden administration’s agenda. However, if they take back the House in 2022, as many believe they could, an attack on financial regulations is something to watch out for. 

Returning to Glass-Steagall, we see a pattern form, one that is completely ignored by politicians in support of deregulation. First, we experience a crash in the stock market and a subsequent recession. Subsequently, we enact legislation designed to prevent such a catastrophic event from ever happening again. Next, the banks lobby to remove the legislation, and the cycle repeats itself. Granted, this may not have happened enough to be considered a pattern, but it is something for voters to be aware of when candidates advocate for drastic deregulation of the banking system. Americans must be steadfast in their support for continued regulation of the banking industry because it is clear that the banks, and to a certain extent, Congress, don’t care for their needs. In pursuing deregulation of banks, Congress allows banks to engage in risky practices and massive mergers that make them big enough to require federal bailouts when one of their bets inevitably doesn’t pay off. This federal bailout will not come out of thin air, but out of the pockets of the American people. This issue is too real, too dangerous, and too close, to not consider when choosing who to vote for. Irresponsibility has led to our financial ruin in the past and will do so in the future if we, the voters, are not careful.