06/12/2012 10:40 am ET Updated Aug 12, 2012

The Unfinished Business of the Obama Administration: Bank Reform

As the big five American banks await the downgrading of their credit ratings by Moody's Investors Service -- a downgrading that is apparently due any day now -- it is worth asking: after more than three years of the Obama Administration, where exactly are we on the substance of bank reform? Has it happened? Did we miss it? Is it coming? Or in truth, are we -- like the characters in a Beckett play -- vainly waiting for Godot?

It was all so clear at the beginning. On Inauguration Day 2009, major Wall Street institutions were still teetering on the brink of insolvency and their public standing was at an all-time low. Properly so, since the recklessness of their investment behavior had brought the global credit system to a grinding halt, and their own implosion had been avoided only by an unprecedentedly large injection of public money. When the Obama presidency was new, major bankers summoned before Congressional Committees publicly apologized for the excesses of the institutions they headed, and the over-large bonuses they paid to themselves were the subject of widespread condemnation -- including condemnation by the president. The need to more tightly regulate the future behavior of large financial institutions, and to break up any that were too big to fail, was briefly the conventional wisdom of the age.

It was a conventional wisdom reinforced in January 2011 by the findings of the Financial Crisis Inquiry Commission (FCIC). "We conclude," the majority of the Commissioners reported, that:

... widespread failures in financial regulation and supervision proved devastating to the stability of the nation's financial markets... dramatic failures of corporate governance and risk management at many systemically important financial institutions were a key cause of this crisis... a combination of excessive borrowing, risky investments and lack of transparency put the financial system on a collision course with crisis... government was ill-prepared for the crisis, and its inconsistent response added to the uncertainty and panic in financial markets... there was a systematic breakdown in accountability and ethics... [and that] collapsing mortgage-lending standards and the mortgage securitization pipeline lit and spread the flame of contagion and crisis.

If that was not enough, the Senate's own Permanent Subcommittee on Investigations -- headed by the Democrat Carl Levin and the Republican Tom Coburn -- was sufficiently disturbed by what it discovered about the practices of the major financial players it examined, and so irritated by the lack of cooperation and transparency it received from key witnesses subpoenaed to appear before it, that its critical findings were initially referred to the Justice Department, on the assumption that in addition to folly in the run-up to the 2008 financial crisis, there might also have been criminality.

If that was the entire story, then we could surely have expected several things to follow: (1) a return to safer and more legitimate banking practices, (2) the prosecution of wrongdoing, (3) the moderation of bank bonuses, and (4) full bank cooperation with the creation of stronger regulations.

Actually, none of that has happened.

We have not returned to safer and more legitimate banking practices. On the contrary, in the years since the financial crisis we have seen major banks mishandle huge numbers of home foreclosures -- the so-called robo-signing scandal. We have seen federal regulators fail to pick up that fraud with sufficient speed and diligence. We have seen major delinquent financial institutions -- AIG for one -- return to the buying of problematic mortgage-backed securities of the kind that initially triggered the crisis. We have seen the continued growth of the shadow banking system, and we have just witnessed one of the big five U.S. banks -- JPMorgan Chase -- speculating again and losing heavily (to the tune of $2-$3 billion-and-counting), in ways that in 2007 and 2008 had brought the global economy to a halt.

Instead of using the original bailout as the route to direct federal control of banking practices, the Obama Administration has allowed the largest financial institutions to work themselves back to profitability and to return the TARP money that had initially saved them. The result has been the worst kind of capitalism: what Joseph Stiglitz called "ersatz capitalism, the privatizing of gains and the socializing of losses." Even today, remarkably, JPMorgan Chase (and other large U.S. financial institutions) are still allowed to park the bulk of their derivatives holdings in their commercial bank sections, so gaining FDIC (that is, taxpayer guaranteed) insurance against loss.

There has been little or no prosecution of wrongdoing. Or at least, as yet, no major figure has gone to jail. Foreign courts have jailed the odd banker, even -- in the case of Iceland -- convicting the odd former prime minister; just as, two decades ago, U.S. courts sent more than 800 bankers and thrift executives to jail for abuses related to the Savings and Loans crisis. But not this time. This time, the New York Times reports that according to the S.E.C's website, the miniscule "total of 46 top executives have been sued and [just] 25 individuals have been penalized, either by being barred from the industry or from acting as a corporate director or officer."

Many major individuals -- but shockingly not always minor ones -- have been allowed to settle out of court, avoiding jail altogether: including such key players in the 2008 financial drama as Angelo Mozilo of Countrywide Financial and Joseph Cassano of AIG. And under the legal fiction of "deferred prosecutions," major financial institutions have been allowed to "settle for pennies on the dollar, with no admission of wrongdoing" ever where wrongdoing was rife. (Wells Fargo, for example, was fined just $85 million by the Federal Reserve in 2011 for financial irregularities during the subprime bubble. )

The Nation Magazine rightly said of these nominal fines, paid by banks in return for promises of future good behavior: it is "not law: it is a toll gate for criminal activity." The biggest recent toll gate was actually the one erected by the Obama administration: the one that allowed the big five banks to settle their account with foreclosed home owners for a modest $26 billion. At least now we have an (admittedly seriously under-resourced) Residential Mortgage-Backed Securities Group, led by federal officials and New York Attorney-General Eric Schneiderman -- an investigatory task force which is due to announce its first tranche of prosecutions in the fall. But thus far at least, the major banks have escaped serious penalty for their widespread wrongdoing during the foreclosure crisis; and, as the FCIC chairman Phil Angelides put it, "executives who ran companies that made, packaged and sold trillions of dollars in toxic mortgages and mortgage-backed securities remain largely unscathed."

Bank bonuses are back with us with a vengeance. In the immediate wake of the 2008 credit crisis, there was a lull in excessive payments to bankers bailed out by taxpayer dollars: but not for long. As John Cassidy said, "on Wall Street, the Great Recession didn't last very long. Having sustained losses of $42.6 billion in 2008, the securities industry generated $55 billion in profits in 2009, smashing the previous record, and it paid out $20.3 billion in bonuses." Indeed the phenomenon is now international. According to the Financial Times, "The world's big international banks are paying out much more in staff costs relative to profits since the financial crisis while slashing the proportion of income paid out in dividends: staff costs now accounting for 81 percent of the total payout, as against 58 percent before the 2008 crisis."

It is true that more of that payout is now in deferred compensation: actual cash bonuses fell 14 percent on Wall Street in 2011. But even so, that diminution is less than the overall fall in industry earnings, and still allows for some staggeringly large personal payouts. The most dramatic of these in 2011 was that to Jamie Dimon. JPMorgan Chase paid him over $23 million: a base salary up from $1 million to $1.5 million, and $17 million in stock options with a $4.5 million cash bonus. Yet in spite of the chief investment division of the bank then losing billions of dollars on an investment model reportedly cleared by Dimon himself, the result of risky practices known about at the very top of the bank, JPMorgan Chase has not yet asked for any of its money back. Nor has Dimon felt any need to return any, let alone to do anything so honorable as to resign. We are clearly back once more to a financial world in which "bankers and traders are short on humility and long on arrogance." That was the world that took us, before 2008, on the road to ruin.

• Instead of full bank cooperation with a strengthening of regulations and oversight, and a rapid return to the separation of commercial and investment banking as advocated by the Volcker rule, we have now endured three years of steady pushback by leading financial institutions and their CEOs against any major change in the regulatory frameworks within which they are obliged to operate. The Washington Post reports that "the financial industry has spent millions of dollars on lobbying to try to shape the new regulations, according to public records;" so helping to explain why, as late as May 2012, the Davis Polk monthly monitoring of the Dodd-Frank rule-making requirements found that of the 221 rule-making deadlines that had passed, 148 (67 percent) had been missed.

The Wall Street pushback began when the Dodd-Frank reforms were working their way through Congress. It continued as the detailed codes required by the new legislation were being designed and implemented; and the pushback continues even today, with leading bankers regularly claiming that more bank regulation can only slow down vital business investment. There is a rich irony in that claim: since business investment has remained low since 2008 precisely because of a generalized recession (and slow economic recovery) triggered by inadequately regulated banking practices. And the irony doesn't stop there, since we now know that among the very exceptions that JPMorgan Chase lawyers and lobbyists worked hardest to win, when pushing back against the new regulations required by Dodd-Frank, " target="_hplink">were ones "that would allow banks to make big bets in their portfolios, including some of the types of trading that led to the $2 billion loss now rocking the bank." With so little new regulation accomplished, and with many of the new regulations being watered down in prolonged consultation processes, it is little wonder that the Fed's point man on tighter bank regulation, Daniel Tarullo, could go public last month with his "very real concern... that the momentum generated during the crisis will wane or be redirected to other issues before reforms have been completed."

What does all this tell us? It tells us that in a very real sense, the important dimensions of effective bank reform have not so much stalled as simply not happened at all. The case for breaking up the biggest of the banks remains a powerful one, and yet the biggest banks -- the ones that took the bulk of the bailout money in 2008 -- are actually larger now than they were then. The case for the separation of commercial from investment banking remains equally powerful, and yet we have so far seen no such separation reestablished: the detail of the forthcoming Volcker rule remains under discussion, perpetually challenged, and likely when implemented to be woefully inadequate. The institutional causes of the 2008 financial meltdown are now widely recognized, yet they remain firmly in place, threatening us with even more damaging meltdowns to come.

None of this should necessarily surprise us, because the Obama Administration's record on bank reform remains -- to put it as politely as possible -- frustratingly uneven: occasionally hot on rhetoric but invariably cold on delivery. Paul Krugman writes, "Ever since the current economic crisis began, it has seemed that five words sum up the central principle of United States financial policy: go easy on the bankers." It is not immediately obvious why. In part, it would appear to be a matter of personalities and policies: the "revolving door" between Wall Street and the White House that leaves a Tim Geithner or a Larry Summers well placed to marginalize an Elizabeth Warren or a Paul Volcker. It may partly be a simple matter of campaign contributions and personal friendships; It may derive from caution associated with the sheer complexity of the financial processes now requiring tight oversight, and the necessary closeness of the working relationship between the regulators and the regulated. But one thing, at least, is clear. We remain firmly embedded in a financial business culture in which senior executives happily take responsibility for corporate success -- and reward themselves generously in the process -- while declining to take similar responsibility for corporate failure. No bonuses returned, no falling on their swords by this generation of corporate leaders -- that much, at least, has not changed.

No doubt the historians will eventually tell us quite why and how the speed with which the big banks were bailed out in 2008-9 was not matched later by any similar speed in the creation of a more effective regulatory regime; but by then, of course, it will be way too late. In Beckett's Waiting for Godot, the two main characters, Vladimir and Estragon, are driven to such a level of frustration by their waiting for someone who never comes, that in the end they consider suicide. We shouldn't do that -- but they did have a point. What does a banker have to do around here to be held responsible for his/her actions? When will this Administration get off the fence, and unambiguously support -- in private as well as in public -- those federal regulators pushing for effective controls over banking excess? If only for the sake of our sanity, it would be good to know.

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