The Real Story Behind The Volcker Rule, this Era's Glass-Steagall Act

Reprinted from National Journal

As 2009 rolled on and the panic receded, Paul Volcker felt there was something very wrong with the Obama administration's plans for reforming Wall Street. But no one was listening to him. The gruff-voiced, cigar-chomping former Fed chairman may have been nominally a member of the Obama team—chairman of the president's new Economic Recovery Advisory Board—as well as a living legend of finance, the conquerer of runaway inflation in the '70s. But the then-82-year-old Volcker found that his rep wasn't getting him anywhere with the president's inner circle, especially Obama's bank-friendly Treasury secretary, Tim Geithner, and chief economic advisor Larry Summers, both of whom had little time for him. 

In an interview in late 2009, Volcker said he felt somewhat used early on by Obama (whom he had publicly backed for president)--merely trotted out for the cameras during the presidential campaign, but then sidelined when the real decisions were being made. "When the economy began going sour, then they decided I could be some kind of symbol of responsibility and prudence of their economic policy," he said with a wry smile.

What bothered Volcker was very simple: After hundreds of billions of dollars in taxpayer bailouts, he was appalled that the biggest banks--which Obama allowed to remain intact even though they had caused the worst financial crisis since the Great Depression--were being permitted to resume their pre-crisis habits of behaving like hedge funds, trading recklessly with taxpayer-guaranteed money. Volcker wanted a rule that would bar commercial banks from indulging in "proprietary" trading (in other words, gambling with clients' money for the firm's own gain), thus cordoning off federally guaranteed bank deposits and Federal Reserve lending from the heaviest risk-taking on the Street. It was the closest thing he could get to a return of Glass-Steagall, the 1933 law that forced big banks like J.P. Morgan to spin off their riskier investment banking sides into new firms (in that case, Morgan Stanley) after the Crash that led to the Depression. Commercial banks that lie at the heart of the economy and are able to draw cheap money from the Fed discount window "shouldn't be doing risky capital market stuff," Volcker told me. "I don't want them to be Goldman Sachs, running a zillion proprietary operations." But the president "obviously decided not to accept" his recommendations, Volcker said then.

Volcker had been skeptical of financial deregulation going back to February of 1987, shortly before the end of his tenure of Fed chairman. The big Wall Street banks were even then chipping away at Glass-Steagall. At a hearing room in Washington, in one of his last acts as chairman, Volcker listened skeptically as Thomas Theobald, the vice chairman of Citicorp, argued that “the world has changed a hell of a lot” since the ‘30s. Theobald declared that there were three new "outside checks" on corporate misconduct since then: "a very effective" Securities and Exchange Commission, knowledgeable investors, and "very sophisticated" rating agencies. Volcker stared gruffly at Theobald and the other two bankers who came to plead their case. They made it sound so "innocuous," so "sensible," that "we don't have to worry a bit," Volcker said sarcastically, according to The Wall Street Journal. "But I guess I worry a little bit." Volcker said that without Glass-Steagall, lenders might begin recklessly lowering loan standards in order to win more contracts for public offerings of their borrowers’ stock. He said that banks might start marketing bad loans to an unsuspecting public.

No one listened. In that particular episode, Volcker was outvoted 3-2 by his Board, which included two Reagan free-market appointees, on new rules that allowed Citicorp, J.P. Morgan and Bankers Trust to move into some underwriting. It was the beginning of the process by which Glass-Steagall became effectively moot by the time it was formally repealed in 1999.

A generation later, Volcker’s premonition came dramatically true in the subprime crisis and crash of 2008. But Volcker's prescience carried almost no weight with Geithner and Summers, who in the 1990s were themselves part of the broad deregulatory moves that Volcker had feared, especially the repeal of Glass-Steagall and the adoption of the Commodity Futures Modernization Act of 2000, which Summers had enthusiastically endorsed and which created, effectively, a totally laissez-faire market in over-the-counter derivatives, allowing trillions of dollars worth of trades to go unmonitored by any government. 

And now Geithner and Summers also shot down Volcker's proposal to bar proprietary trading. Channeling the argument of Wall Street, they contended it was simply not feasible: How was anybody supposed to know when a trade was "proprietary" as opposed to a legitimate hedging or "market-making" transaction for clients. Just couldn't work, they said. And so Volcker began traveling all over the country to deliver a series of speeches pushing for even more fundamental reform of the financial system--parting ways with both the Obama administration and most of the Congress.

By late 2009 and early 2010--especially after the stunning special Senate election result in Massachusetts gave the once-Democratic seat to a Republican, Scott Brown--Obama began to think that his administration looked vulnerable on the issue. According to a senior administration official involved in economic policy-making, the president came to believe that Geithner and Summers hadn't gone far enough with financial reform. They had, in fact, resisted almost every structural change to Wall Street, not only Volcker's plan but also Arkansas Sen. Blanche Lincoln's idea to bar banks from swaps trading. And Wall Street didn't seem to be changing on its own: In December 2009, the president was outraged to hear that year-end bonuses would actually be larger in 2009 than they had been in 2007, the year prior to the catastrophe. "Wait, let me get this straight," Obama said at a White House meeting. "These guys are reserving record bonuses because they're profitable, and they're profitable only because we rescued them." And so at a meeting late that year in the Roosevelt Room, Obama said: "I'm not convinced Volcker's not right about this." Vice President Joe Biden, a longtime fan of Volcker's, bluntly piped up: "I'm quite convinced Volcker is right about this!"

Obama formally proposed the rule at a White House news conference on Jan. 21, 2010 with Volcker in rare attendance, announcing: "We're calling it the Volcker Rule after the tall guy behind me." Senators Jeff Merkley, D-Ore., and Carl Levin, D-Mich, later formally introduced the rule into the Dodd-Frank law. But even then Geithner dragged his feet on implementation, and for the next two and a half years Wall Street lawyers loaded the proposal down with loopholes and exemptions.

The Volcker Rule was, in fact, in grave danger of being loopholed to death right up until its adoption this week. And in the end it was largely one regulator, more than any other, stood firm against those efforts and managed to avert the worst of the watering down: Gary Gensler, the outgoing chairman of the Commodity Futures Trading Commission. As diminutive in stature as Volcker is towering, Gensler was the Jeff to Volcker's Mutt, an essential part of a de facto team.

Like Volcker, the 56-year-old Gensler was also something of a relic from an earlier era, not necessarily the person you would expect to be taking on Wall Street in the second decade of the 21st century. Serving under Treasury Secretary Robert Rubin in the '90s, Gensler had helped to open the way to massive deregulation of the banks, ultimately leading to the subprime mortgage crisis. As a result, progressive senators such as Bernie Sanders, I-Vt., and Maria Cantwell, D-Wash., even put on a hold on his CFTC nomination at first. But in testimony and later on in interviews, Gensler became one of the very few former Clinton or Bush administration officials to admit his errors of judgment in freeing up finance in the '90s. And as CFTC chief, he sought to make right what had gone so terribly wrong.

It was Gensler, using the unmatched expertise he had developed in the previous three years cracking down on over-the-counter derivatives trading--which is the main source of the banks' proprietary profits--who mainly led the charge to toughen the Volcker Rule and extend it worldwide, especially when it became clear that banks could evade it by shifting trading to their overseas operations, by several accounts. Along with Securities and Exchange Commissioner Kara Stein, he was also the key player behind a critical provision that places the burden of proof on the banks to justify that activities they are engaged in are not proprietary trading, forcing them to provide a regular analysis correlating such trades to appropriate hedges or other approved activities. Giving additional teeth to the rule, Gensler and the other regulators also forced the banks to restrict their hedging to specific identifiable investments and ban so-called portfolio hedging--which had allowed the banks to engage in complicated trades putatively to hedge against general risks across a broad portfolio of investments. Gensler held up as a cautionary tale the notorious "London Whale" episode, when even a blue-chip bank like JPMorgan was found to be making derivative bets that cost $6.2 billion in losses and masking them as a portfolio hedge. Gensler "went to the mat on that issue," says Michael Greenberger, a University of Maryland regulatory expert and a sometime advisor to the CFTC.

By taking the baton from Volcker, and pushing almost alone to regulate trillions in derivatives trades overseas, Gensler initially earned himself enemies in the Treasury Department and White House, especially when European and Asian governments began complaining about his efforts to extend his purview to U.S. banks' overseas activities. Helped by in the end by Treasury Secretary Jacob Lew, who proved much more eager to endorse his efforts than Geithner had been, Gensler won over less enthusiastic regulators. In a recent speech that could almost have been written by Gensler, Lew praised the rule as "true to President Obama's vision" and echoed Gensler in saying that it was intended to prohibit "risky trading bets like the 'London Whale' that are masked as risk-mitigating hedges."

Now, with little fanfare, Gensler is on his way out at the CFTC--perhaps the most unsung hero of the entire post-financial crisis period--and the effectiveness of the Volcker Rule remains to be seen, especially since regulators have put off implementation until 2015. The banks will no doubt sue to change it further. But even some skeptics of Dodd-Frank think it could be the biggest breakthrough yet against the concentrated power of Wall Street banks. It "will not end all gambling activities on Wall Street, but should limit them and reduce the risk to Main Street," Dennis Kelleher, the head of the advocacy group Better Markets, said in a statement. Thanks largely to the odd couple of Paul Volcker and Gary Gensler, the rule may yet prove to be the single most effective solution to the too-big-to-fail problem.

Last of the Immortals

Reprinted from National Journal

The great ones, it often seems, hand off the mantle of greatness to each other. Nelson Mandela, in his 1994 autobiography, Long Walk to Freedom, described how Franklin Roosevelt and Winston Churchill in 1941 helped change his life and those of his fellow black students in the infant African National Congress with the Atlantic Charter, which committed the West to human dignity and universal rights, setting the stage for the entire postwar world. "Some in the West saw the charter as empty promises," Mandela wrote, "but not those of us in Africa. Inspired by the Atlantic Charter and the fight of the Allies against tyranny and oppression, the ANC created its own charter." Called "African Claims," it set out the aspirations that would make Mandela a revered world figure a half-century later.

Then a young Barack Obama sought to take the mantle from Mandela. In his own autobiography, Dreams from My Father—in a story he again repeated on his visit to Africa last June—Obama described how the anti-apartheid movement that Mandela led effectively began his own rise to charismatic leadership. As a freshman at Occidental College in Los Angeles in the early 1980s, Obama made his first attempt at public speaking at a divestment-from-South-Africa rally (where "Free Mandela!" was often a rallying cry). He wrote that few of the Frisbee-playing students were listening when he began in a low voice, saying, "There's a struggle going on." Then he raised his deep baritone, and suddenly, for the first time, the Obama Effect made itself known. "The Frisbee players stopped.... The crowd was quiet now, watching me. Somebody started to clap. 'Go on with it, Barack,' somebody shouted.... I knew I had them, that the connection had been made." Thus, inspired by Mandela's struggle, was launched a voice that would ignite a meteoric political rise and later inspire huge crowds in places like Berlin and Cairo.

With the announcement of Mandela's death Thursday at age 95, who will the mantle go to now? In his remarks, the president of South Africa, Jacob Zuma, called Mandela South Africa's "greatest son." But Mandela was far, far more than that, as Obama indicated when he flew to South Africa last June, just after Mandela fell mortally ill, and pre-eulogized his personal hero as a "hero for the world." Is there anyone else left on the planet who could be described that way? Who's the next Mandela? Is one even possible?

Certainly Obama himself doesn't qualify (yet). Indeed, it doesn't seem far-fetched to call Mandela the last of the great ones, the truly inspirational historical leaders on the scale of a Gandhi or Churchill or FDR who lived noble (if not entirely untainted, though Mandela comes close) lives and, more importantly, who genuinely changed the world for the better. Look around the world, and you see no one else of that stature. Even the once-sainted Aung San Suu Kyi, Asia's answer to Mandela who suffered as a house prisoner of the Burmese junta for 20 years while her husband died and her children grew up without her, has looked somewhat compromised since she was freed and began her tentative dance with the dictators. Recently Suu Kyi has temporized, in a most un-Mandela-like way, over the Burmese military's brutal oppression of the Kachin and Rohingya communities in Burma, and that "has tarnished her image abroad while raising concerns about the future of Burma's tentative political reform," Ellen Bork wrote in an article titled "Burma's Fallen Idol" in Foreign Policy.

As for the other major leaders on the scene, from the United Kingdom to Europe to China to Russia to most of the rest of Africa, there is precious little to admire, and plenty to lament.

Why is that? Don't we still have great causes, or has the entire globalized system grown too gray and compromised? Perhaps somehow, starting with places like South Africa, just enough justice and freedom has been achieved in the last few decades to make everyone just a little too satisfied and a little too willing to hedge and fudge. The anti-apartheid movement of the '80s was in some ways the last really coherent global social-justice campaign. We've seen two successive social movements erupt in the last two decades over the still-devastating inequalities in the global economy—the anti-globalization protests of the '90s and then Occupy Wall Street—and yet no inspirational figure has emerged from them and both movements petered out with a whimper (though old Ralph Nader's still around, making some fairly valid points about the excesses of free-trade agreements). Timemagazine's annual list of the world's "100 Most Influential People" is continually deflating, stocked with pop artists, tycoons, marginal politicians and ... Sheryl Sandberg.

It's not like we haven't seen some new mini-heroes spring up, and Aung San Suu Kyi's story is far from finished, just as Obama's isn't. Aaron Swartz, the Internet activist who tragically killed himself when faced with prosecution in January, has inspired a movement around a bill that would rein in prosecutors. Malala Yousafzai, the teenaged education activist who was shot in the head by the Taliban, would seem to have a great future—if she survives future assaults. National Security Agency leaker Edward Snowden has found a following among a few libertarians and far-leftists, but few others. If the global economy has had any heroes over the last few years, it's probably central bankers like Ben Bernanke and Mario Draghi—but, never mind about that. No cause, and no leader, has inspired anything like the devotion and reverence that Mandela did.

Is it that Mandela was truly unique? In his autobiography, Mandela wrote that he was "no more virtuous or self-sacrificing than the next man" and never wanted the mantle of movement leader, but it was the struggle for basic freedom "that transformed a frightened young man into a bold one, that drove a law-abiding attorney to become a criminal, that turned a family-loving husband in to a man without a home, that forced a life-loving man to live like a monk." As usual, Mandela is being too humble. It wasn't just the way he conducted his struggle against the racist white regime in South Africa, in and out of prison (refusing, in case we've forgotten, any conditions at all for his release, including renouncing violence). It was also the way, after he was released from 26 years of imprisonment and became president, Mandela transmuted his personal suffering into a larger understanding, as only the great ones can do, and an embrace of his former enemies that was about as close as you get to Christ-like in the modern world.

"He's a personal hero, but I don't think I'm unique in that regard," Obama said in Dakar last June. "I think he's a hero for the world. And if and when he passes from this place, one thing I think we'll all know is that his legacy is one that will linger on throughout the ages."

Especially because there is no one to replace him.