A New Era: the Passion of Janet Yellen

Reprinted from National Journal

Every Federal Reserve Board chairman comes into office with a secret agenda, a hidden passion. It's the sort of thing you don't hear about at the confirmation hearings, and yet it is often this grand passion—suddenly given voice in the world's bulliest economic pulpit—that shapes the nation's future in unexpected ways. Alan Greenspan, the erstwhile "maestro" of the Fed, wanted to turn finance into the kind of laissez-faire market that his mentor Ayn Rand, the uber-libertarian author, had always envisioned. The result was the across-the-board deregulation of banking. When Ben Bernanke took over Greenspan's job, he appeared to be just another conservative economist in the mold of his predecessor (who had endorsed him). But his great passion was using his life's work as a scholar of the Great Depression to stop another one. Only people who really knew Bernanke were aware of how the balding, mild-mannered man with the slightly quavery voice was committed, body and soul, to ensuring that the 2010s did not turn out like the 1930s. Thus, the startling spectacle of a Republican-appointed activist chief exploding the Fed's balance sheet by trillions of dollars to keep the economy going.

What is Janet Yellen's secret passion? By the accounts of her friends and colleagues, the 67-year-old Yale-trained economist, who was sworn in Monday,  doesn't have many secrets. She's served nearly 10 years in the Federal Reserve system, first as a governor, then as head of the San Francisco Fed, and now as vice chairwoman. Before that she ran the Council of Economic Advisers under Bill Clinton. "If you were dreaming up a training school for Fed chairmen, it would be her life story," jokes Princeton economist Alan Blinder, her former colleague at the Fed. "I don't think anybody in the Fed's history has come in with such a full résumé of Federal Reserve experience." As a result, she's probably as open a book as any nominee for chief in history. Yellen is considered a nonideologue who will relentlessly follow the facts, whether they lead her toward solutions on the left or the right. "She is truly a scientist, in that she is an observer," says Jim Adams, a University of Michigan economist who has known Yellen since the 1970s. In her actions on the Federal Reserve Board and in her agonizingly deliberate, Brooklyn-accented testimony before Congress, Yellen has resolutely toed the traditionalist middle line on the Fed's "twin" mandates to manage inflation and unemployment. And with her ready smile, pixie haircut, and diminutive size (5 feet), she doesn't look like much of a bomb-thrower.

But that is the public Janet Yellen. Disciplined, determined, and brilliant, Yellen is also the product of an old progressive tradition of activist, pro-government economics. Above all, according to colleagues, she takes the nation's worst problems, especially unemployment, as a deeply personal challenge. Yellen represents a strain of interventionist thinking that has not found expression at such a high level in Washington in decades—at least since Ronald Reagan and his Milton Friedman-inspired attempt to shrink the size of government. That philosophy still dictates the agenda; even the last two Democratic presidents, Clinton and Barack Obama, have advanced (or bowed to) get-government-out-of-the-way policies, and the GOP's no-new-tax religion prevents any concessions for a broader budget deal.

Yellen, unlike Greenspan or a pre-2008 Bernanke, is probably the last person you'd hear repeating one of Reagan's favorite jokes: "The nine scariest words in the English language are: 'I'm from the government, and I'm here to help.' " According to more than a half-dozen longtime friends and colleagues, she has two grand passions that will require government to help in a very big way: reducing chronically high unemployment—which is the focus of her life's work and is probably the single biggest economic problem in America today—and reining in Wall Street's excesses. Yellen already appears to be settling the Fed's eternal debate about the relative threats of unemployment and inflation; she declared bluntly in her testimony that joblessness is the issue of the moment. Based on her past positions, she is also likely to try to alter the discussion in Washington on issues ranging from the size and power of the big banks to the need for a higher minimum wage and extended jobless benefits. And at a time when Obama has declared that income inequality is "the defining challenge of our time," and polls show that a majority of Americans no longer believe their country offers equal opportunity to all, Yellen brings a raft of well-thought-out—and decidedly activist—views to these issues.

She has devoted much of her career to showing why markets fail so often and therefore government intervention is needed, says Nobel Prize-winning economist Joseph Stig­litz, her former teacher at Yale and a longtime friend. Far more than previous Fed chiefs, Yellen also embraces the young field of behavioral economics, which posits that people often don't act rationally the way economic models say they should. Yellen knows that the Fed's traditional powers are limited now because the economy may be caught in a "liquidity trap," with interest rates already so low that additional injections of cash by the central bank will do little or nothing to stimulate the economy. But she is constantly on the hunt for novel interventionist solutions; "out of the box" is one of her favorite phrases. "She knows that labor markets don't work perfectly; capital markets don't work perfectly," Stig­litz says. He adds that Yellen understands that monetary policy is itself the best proof of this thesis—because it wouldn't be needed at all if markets always worked correctly.

Those who have known Yellen the longest also hail her empathy. They say she feels the pain of the jobless on a gut level and has even scolded her fellow economists for treating the unemployment rate as a mere number rather than a tragic encapsulation of the misery of millions. "How deeply you care about the unemployed comes in part from your viscera rather than your intellect. And with Janet Yellen, it's very strong," Blinder says. "She spent a good part of her career studying why unemployment stays high. I can remember a conversation between the two of us at the Fed in the '90s—I was vice chairman and she was a governor. One day, we tried holding back [the Federal Open Market Committee, the Fed's chief decision-making body] from going overboard on raising interest rates. She said, 'Maybe we saved 500,000 people their jobs.' "

Now she gets her chance to save more. Alongside inequality, chronic unemployment is America's most pressing economic problem. The bleak backdrop to the latest positive news, the reduction in the unemployment rate to 7 percent, is that devastating numbers of people have simply dropped out of the workforce in despair. And yet Washington policymakers remain ideologically paralyzed over what to do about it. By a number of accounts, no one feels this more intensely than Yellen, who understands not just the human cost to individual lives and families but also the damage that a demoralized workforce can do to the economy as a whole. One of her most important papers, written with her husband, Nobel Prize winner George Akerlof, showed that workers who feel underpaid will be less productive. "She does see long-term unemployment, massive unemployment, as not only an economic problem or in terms of wasted resources but also as a human being," says John Williams, president of the San Francisco Fed, who was Yellen's research chief when she ran it. "It is very destructive to families.… This is passionate with her. Among economists, you don't often see that human side. With her, it's not just an abstraction, and if you try to treat it too much as an abstraction, she'll react."

Williams says he was "mildly chewed out" by Yellen for approaching the mortgage crisis too academically—too much like an economist. "We need to be working our hardest, thinking our best.… This country's in a crisis. We're on the precipice, and we need to really focus," he recalls her saying. Yellen, he adds, is not going to be the type of Fed chief "sitting there wringing her hands and saying monetary policy can't solve all the world's problems."

Already she is describing the central bank's job in ways that have stunned some traditional Fed watchers—and made them uneasy. Yellen's very first statement after Obama nominated her in October suggested she intends to extend Bernanke's revolutionary expansion of the Fed's role, not ratchet it back. "While we have made progress, we have further to go," she said, adding that the Fed's job was not just to keep the dollar sound but "to serve all the American people ... [and] ensure that everyone has the ability to work hard and build a better life."

The statement, which indicated that Yellen is focused on boosting employment, "knocked me over. It was a political statement which fits perfectly with her [academic] upbringing," says David Jones, a veteran Fed analyst and the author of the forthcoming book Understanding Central Banking: The New Era of Activism. He points out the risks. "Her biggest challenge now is to reverse the Fed's highly accommodative policy," but that runs right up against her activist approach to unemployment and income inequality. As a result, Jones is worried that Yellen will make a muddle of the job. "The trouble is, you don't know whethershe can rise to the level of that pay grade, which is the second-most-powerful person in the country," he says. "She also said that the greatest quality of the Fed is its ability to debate issues. I said to myself, debating issues is as far removed from the Fed's greatest quality as I can think of. It's the policy the Fed makes that counts."

YELLEN'S AGENDA

The daughter of a Brooklyn physician and a homemaker, Yellen grew up fairly well-off in the halcyon '50s. But she vividly remembers listening around the kitchen table as her father told tales of the Depression and her mother read about markets and economics from the business section of the newspaper. A math geek and the valedictorian of her high school class, Yellen adored the idea that people could actually figure out how a whole economy works and maybe even rescue it, as John Maynard Keynes proposed. She was drawn to Yale because her mentor, the famous liberal economist James Tobin, a Keynes acolyte, talked in passionate terms about preventing the terrible joblessness of the Depression, and the financial recklessness that led to it, from ever happening again.

Today, Yellen sees the economy as a great ailing beast, and she wants to massage it back to life.

So even though it's well out of the Fed's purview, Yellen has for years done academic work supporting a higher minimum wage and dealing with income inequality. Previous Fed chairmen have tended to shrink in horror from such legislative issues, but as far back as 2006, while president of the San Francisco Fed, she warned that rising inequality could "undermine American democracy" and that dramatic improvements in education were "imperative," along with a strengthening of the social safety net. It would be surprising if she did not try to convince Congress of the same in speeches and her semiannual testimony.

And then there is the rest of the globe. Stiglitz says that in such a powerful position—the most powerful economic post in the world, and the second-most-powerful job in Washington—Yellen could profoundly change the debate around the world. Despite growing concern about inequality, central bankers in many countries (especially at the European Central Bank) tend to support "wage flexibility," which is a fancy term for permitting economic policies that drive wages down and thus create more inequality to attract businesses, says Stiglitz, who consults for many of those nations. Yellen, as the world's most influential central banker, is likely to try to alter that conventional wisdom and other reflexively neoliberal (read: Reaganite) views.

Today, Yellen sees the economy as a great ailing beast, and she wants to massage it back to life. She knows that America is in danger of becoming like Japan, with chronically slow growth that leaves real interest rates low for a long time and tends to render the Fed chairman's traditional array of monetary tools ineffective. Even so, "there is a lot of intangible influence that a Fed chairman brings to the table," says Jared Bernstein, Vice President Joe Biden's former chief economist. "When it comes to just the basic problem of structurally deficient demand and persistent output gaps [the difference between what the economy could be producing and what it is], and of long-term unemployment, she seems to really get not only how important it is to attack those problems for the benefit of people who are hurt by them, but also for the macroeconomy. She recognizes that the longer the cyclical problems go on, the more they morph into structural problems"—in other words, the more they become a permanent condition.

Other supporters say it is the sheer breadth of Yellen's economic thinking that is most impressive—and useful. "I do think she does represent something of a new breed of policymakers in Washington," says John E. Kwoka, an economist at Northeastern who graduated with Yellen from Brown in 1967 and has followed her rise to the top with frank admiration. "She has wider knowledge of modern economics than certainly Alan Greenspan but probably Ben Bernanke, too.… And she's not part of the Washington-New York axis, which for some time has been controlling Fed and Treasury policy. That's why I think she's the perfect match for the issues of the day."

Yellen will also be inheriting a job that has never been as important as it is right now. "Bernanke has established monetary policy as the most powerful weapon the government can use in dealing with a crisis," overturning the post-Great Depression Keynesian focus on fiscal spending, Jones says. The question now is whether Yellen will try to out-Bernanke even Bernanke. Whatever Yellen's ambitions for shifting the debate in Washington—on minimum wage and income inequality, or on more fiscal stimulus or job programs—at the beginning of her term, she will be saddled with one big, decisive question: when to begin to "taper" or unwind Bernanke's latest aggressive intervention in the market, his "quantitative easing" program of buying $85 billion a month in bonds to keep interest rates down. As a Fed veteran, she may also be leery of jumping too quickly into the fiscal debate, fearing a backlash from a Congress that keeps threatening to rein in the Fed's traditional powers. Blinder and others say they expect Yellen to be cautious at first, in part because a bloc of dollar hawks such as Sen. Marco Rubio, R-Fla., have come out against her nomination, saying she and Bernanke have laid the groundwork for massive inflation. Jeffrey Frankel of the Harvard Kennedy School, who served under Yellen on Clinton's Council of Economic Advisers, says he thinks she might surprise everyone at first by tightening monetary policy sooner rather than later, "partly maybe to establish her reputation and make it clear that she's not just a soft-money person."

Senators who listened to her confirmation testimony also see a lot of continuity with Bernanke, with whom Yellen has worked smoothly as vice chairwoman for the past three years. "Not to sit down at a spreadsheet and compare the two, but I think they're pretty similar in their philosophies," says Sen. Jon Tester, D-Mont. "I mean, they could vary in other things that I'm not aware of, but I think that she's going to be a pretty steady hand at the Fed, because that's what Bernanke has been." Bernanke himself is said to be delighted with the choice, in large part because she will deliver the smoothest possible transition. As Mark Gertler of New York University, Bernanke's longtime coauthor and intimate friend, puts it, "She was his biggest advocate at the board, no question about it.… I remember meeting with her very early in the crisis, and her remarking on how well he was doing. She wants it to look seamless. No question about that. I think he probably feels good about leaving now."

Like Bernanke, of course, Yellen's biggest problem will be Washington's political dysfunction, especially the inability of Congress and the president to agree on a long-term budget, on how progressive the tax code should be, or on any additional fiscal stimulus. "What the Fed has had to do is to compensate for the absence of fiscal policy. That's not a healthy situation," Gertler says. "If it were not for the craziness going on in Congress, the Fed would probably be unwinding [its quantitative-easing policies] right now. It's going to be tough—different from what Bernanke had to deal with. He was fighting a lightning strike, with the crisis. This is more like a steady consistent battle she's going to have to fight." But while she isn't likely to come out swinging against the congressional intransigents, many of her friends and associates say it would be in character for her to use her powers of persuasion to quietly sway the larger debate. For her entire career, they say, she has been fearless about standing up for the economic views she believes are right. Michigan's Adams tells of getting to know her when he was a Ph.D. student at Harvard and Yellen was an untenured assistant professor there. Adams had just been rebuffed by his thesis adviser, an emeritus chairman of the economics department. When Adams told Yellen that his adviser had instructed him to rethink his economic argument, she replied calmly, "Hmm, it seems to me we could do something." Together, Yellen and Adams collaborated on an article advancing the same ideas; it became one of the most heavily cited in the field. "Janet was right. My thesis mentor was wrong. And what came out of it was much more than I had seen myself. Janet saw how to make it into something much better." Just as important, she was taking on a powerful tenured professor who could have easily voted her out of a job at a faculty meeting. "That takes some courage," Adams says. It's the kind of courage she will need to take on—in testimony, speeches, and meetings with legislators and regulators—an entire free-market Zeitgeist, the Reaganomic views that still dominate Washington. 

WALL STREET, WATCH OUT

Yellen is also said to be pushing for a far more aggressive approach to Wall Street—which is ironic, considering that Wall Street has cheered her nomination. Officials inside the Fed and out who have spoken to her say one big change in the offing is that Yellen plans to take charge of the financial-regulatory agenda herself, while Bernanke largely left the task to one of his governors, Daniel Tarullo. (Despite a shared perspective—that banking needs to be more heavily regulated with tough capital and liquidity ratios and restrictions on risky trading and lending—Yellen and Tarullo have battled over turf. (See "High Noon for Dan Tarullo,") Says one economist who knows her well: "The feeling I think she has is that Dan was given license [by Bernanke] and he treaded too lightly. He was not as forceful as he needed to be. She feels that the chairman has much more impact."

The biggest problem Yellen will face in her term is that she has a steep hill to climb to bring government back into the discussion in an enlightened way—especially on the heels of the troubled rollout of Obamacare.

Her view is that financial markets have and will continue to fail disastrously unless they are further constrained, sources close to her say. Already it appears that Yellen is prepared to tussle with Treasury Secretary Jacob Lew, who despite showing more enthusiasm for bank regulation than his predecessor, Timothy Geithner, suggested recently that the too-big-to-fail problem has been largely solved. In her own public remarks, Yellen echoes Tarullo's push for higher capital standards for "systemically important" banks, to prevent them from over-leveraging and running out of cash. And she also repeats his concerns about restricting the use of wholesale short-term funding markets, which seized up in the 2008 crisis and doomed Lehman Brothers. Tarullo has been more aggressive than Lew and the Obama administration in proposing what he's called a "set of complementary policy measures" to go beyond the Dodd-Frank law. Among them: limiting the expansion of big banks by restricting the funding they get from sources other than traditional federally insured deposits.

Yellen, in a major speech in Shanghai last June, went beyond what Bernanke has said by explicitly endorsing some of Tarullo's efforts. "I'm not convinced that the existing [systemically important financial institutions] regulatory work plan, which moves in the right direction, goes far enough," she said. She also spoke of doing much more, as Tarullo has, to constrain the "shadow banking" sector that caused so much trouble in 2008, including broker-dealers and money-market funds. Yellen said "a major source of unaddressed risk" were the hundreds of billions of dollars of short-term securities financing used by these firms, adding, "Regulatory reform mostly passed over these transactions."

More than that, as economist Kwoka suggests, Yellen is a rara avis in Washington these days—someone who has spent her life and career utterly detached from Wall Street. "Janet represents a return to the desanctification of finance," says an economist who knows her views well but would speak about them only on condition of anonymity. "I think that's a huge sociological change. She's not captured by Wall Street the way so many have been.… I think Janet will be more active. When it comes to financial innovation, it used to be, 'You can do it unless we say no.' Now I think the policy will be, 'You can't do it unless we authorize it.' " Because the Fed has the power to regulate and write rules for the giant bank holding companies, it has enormous discretion in this area and does not need to wait for Congress to act.

Still, even on Wall Street, it's hard to find people who will say negative things about Yellen, who was recently judged by The Wall Street Journal to be the most accurate forecaster on the Federal Reserve Board. It's easier, in fact, to track down the negative assessments that Yellen occasionally makes of herself. While she did not always act on regulation when needed—claiming that as head of the San Francisco Fed she had to wait on Washington's guidance—the record shows she appeared to be somewhat ahead of Bernanke in appreciating the dangers of the securitization-led housing bubble. At the Fed's June 2007 meeting, she warned that the failing housing sector was the "600-pound gorilla in the room." That was only a month after Bernanke, in congressional testimony, said he saw only a "limited impact" from subprime mortgages on "the broader housing market." Yet Yellen also offered up a personal mea culpa after the financial collapse, telling the Financial Crisis Inquiry Commission in 2010 she "did not see and did not appreciate what the risks were with securitization, the credit-ratings agencies, the shadow banking system, the [structured investment vehicles]—I didn't see any of that coming until it happened."

A few economists wonder whether Yellen may end up being more middle-of-the-road than her academic record indicates. As a resolute free-trade advocate, she's probably far more centrist than, say, Jared Bernstein, and she's not nearly as interventionist as Joseph Stiglitz, who during the 1990s fought a losing battle against opening up capital flows around the world. Yellen is probably even less liberal than her husband, who shared a Nobel Prize with Stiglitz, and her late teacher, James Tobin, the Nobel Prize winner from Yale who argued that financial markets are more inherently prone to failure than ordinary markets in goods and services. In a 2010 interview, Akerlof said he "was always apoplectic" about the kind of rapid deregulation advocated by Harvard economist Lawrence Summers, who almost certainly would have been nominated in Yellen's place had he not backed out. As Clinton's CEA chairwoman, by contrast, Yellen did not demur from some deregulatory moves such as Glass-Steagall repeal in 1999.

Nonetheless, by her own account, Yellen represents the government-activist "Yale School" of economics, which believes that there are "clear answers to key questions dividing macroeconomists, along with policy prescriptions," as she put it in a 1999 speech at Yale. "Will capitalist economies operate at full employment in the absence of routine intervention? Certainly not. Are deviations from full employment a social problem? Obviously." She is, more than previous Fed chiefs, an old-style "hydraulic Keynesian" who believes she can act as a control engineer over the economy, printing money to drive down unemployment. The two previous chairmen going back to the late 1980s have tended toward the Chicago libertarian side of economics, exalting the wisdom of markets.

The biggest problem Yellen will face in her term is that she has a steep hill to climb to bring government back into the discussion in an enlightened way—especially on the heels of the troubled rollout of Obamacare. And if America is entering "secular stagnation" where monetary policy is no longer very effective because interest rates are already so low, then her influence may be far more limited than, say, Greenspan's was in the heyday of "irrational exuberance." But, eventually, Gertler says, "she's going to carve her own niche," perhaps by expanding the Fed's mandate to target higher GDP growth and further restraining Wall Street.

The past several Fed chiefs have all seemed oddly suited to their moments. The cigar-chomping Paul Volcker was just the man to tame runaway inflation in the '70s and '80s. Greenspan, despite his errors on deregulation, was the right Fed chairman to handle the era of irrational exuberance and sudden productivity growth in the 1990s (one of his lesser-sung triumphs, in fact, was to hold off raising rates at a time when many economists, including Yellen, were urging him to worry about inflation—and he probably saved millions of jobs that way). "Helicopter Ben" Bernanke, of course, was just the savior we needed to prevent another Great Depression. 

In the end, all of these Fed chairmen profoundly changed the course of the U.S. economy (and Volcker, though in retirement, is still doing so with the just-approved "Volcker Rule" that will bar banks from the riskiest trading). There is every reason to think Janet Yellen will have just as much impact, in her own special way.

Catherine Hollander contributed to this article.

Watch Out Wall Street: The One-Two Punch of Yellen and Fischer

Reprinted from National Journal

Stanley Fischer was an adjunct member of the now-infamous "Committee to Save the World" in the late 1990s that consisted of Robert Rubin, then-Fed Chairman Alan Greenspan, and Rubin's deputy, Larry Summers. And like several other close associates of Rubin, Fischer followed the former Treasury secretary to Citigroup for a spell.

The difference is, Fischer, who was nominated Friday to be Janet Yellen's No. 2 at the Federal Reserve, was appalled by what he saw on the inside of the giant bank while working as its vice chairman. Citigroup, he thought, was just too big and too unmanageable—trying to do too many unrelated things, like selling insurance to bank customers. Fischer has told associates that he quickly decided that the idea of a "financial supermarket" didn't work, and that investment and commercial-banking cultures did not mesh well.  

Although he's renowned as a economic centrist—and a legendary teacher at MIT whose students included Ben Bernanke and Mario Draghi, Europe's central bank chief—as well as someone who will likely be more hawk than dove on inflation, Fischer is also something of a closet reformer when it comes to Wall Street. Recently some progressives like Sen. Elizabeth Warren, D-Mass., have raised questions about Fischer. "I want to [like him as vice chair]—I want to be hopeful that Fischer's going to work in the right direction," she told Bloomberg News. "I am not sure."  

In fact, despite his history as an associate of the Rubin-Greenspan-Summers troika responsible for disastrous deregulation in the 1990s, Fischer has come out for greater banking reform than the others have over the last several years.

At the Jackson Hole meeting of central bankers in August 2009, Fischer began to endorse the stronger views of former Federal Reserve Chairman Paul Volcker, who was pushing for what later became known as the Volcker Rule, which bars federally insured banks from the riskiest trading. He also publicly questioned the inclination of then-Treasury Secretary Tim Geithner and Summers, President Obama's chief economic advisor, to allow the big banks that had precipitated the financial crisis to remain intact. "We seem to be taking it for granted that we should go back to the structure of the financial system as it was on the eve of the crisis," said Fischer, who was then the governor of the Bank of Israel. (As former Federal Deposit Insurance Corp. Chairwoman Sheila Bair later wrote in a memoir, "I couldn't think of one Dodd-Frank reform that [Geithner] strongly supported. Resolution authority, derivatives reform, the Volcker and Collins amendments—he had worked to weaken or oppose them all.")

Most recently, Fischer delivered a zinger to Summers, his friend and former student, at a forum at the International Monetary Fund last November, which was held to honor the 70-year-old Fischer. After Summers remarked casually that "there were very few financial crises in the 35 years after the Second World War" because people were still being "careful, in a way, in the aftermath of the Depression," Fischer demurred. He said, "Larry, I wonder whether the 35 years after World War II had something to do with the fact that financial liberalization hadn't yet happened, and that that had something to do with the stability of the financial system." As Fischer well knew, it was under Summers and Rubin, in the 1990s, that financial liberalization seriously took off—first with the repeal of the Glass-Steagall Act separtating investment and commercial banking in 1999, and then with Summers' sponsorship of the Commodity Futures Modernization Act, which created a global laissez-faire market in tens of trillions of dollars' worth of unmonitored over-the-counter derivatives trades, among other moves.

As an economist, Fischer is indeed renowned as as centrist, or someone who can "bridge the spectrum between 'saltwater' [Keynesian] and 'freshwater' [free market]," as Harvard economist Ken Rogoff puts it. But he also appears to be fully on board with the aggressive pro-reform views of Yellen, who in speeches and interviews has already indicated that she plans to rein in systemic risk in the banking system even more than has been accomplished under the Dodd-Frank law.

Fischer, who served as chief deputy at the IMF in the late 1990s and was instrumental in restabilizing the global financial system after the peso and Asian crises of that era, also brings a lot of practical crisis-fighting experience to Yellen's new team. 

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.

It's Home to Mama for Timmy G

Reprinted from National Journal

No one should begrudge Timothy Geithner his new job. It was inevitable that a man who had been spiritually captured by Wall Street would someday join it in the flesh. In truth the former Treasury secretary held out far longer than the band of Rubinites he sprang from. And by joining a respectable private-equity firm, Warburg Pincus—rather than one of the banks he bailed out—at least Geithner is avoiding the path to reputational ruin followed by his mentor, Robert Rubin, who while he was in Washington freed up Citigroup to become an economy-destroying monster and then went to Wall Street to join it, standing by in befuddlement while the bank nearly imploded.

Geithner has a family to feed after all; he has every right to cash in with the vast industry he saved and protected. It seems a bit overripe for Dennis Kelleher, head of the Better Markets advocacy group, to suggest that Geithner's "spin through the revolving door" will "further erode public confidence in government," when such confidence is all but undetectable today.

But neither should Geithner get a full pass, as CNBC's Ben White seems all too eager to give him in a Web piece today.

CNBC, of course, tends to cover Wall Street in somewhat the way Pravda once covered the Soviet Union, with a lot of boosterism and without asking too many fundamental questions. But White, who also writes for Politico, is a respectable financial reporter and should know better. White argues that the criticism of Geithner "neglects to mention" that the former Treasury chief  "inherited the Wall Street bailout" and "fails to ask the fundamental question of what, exactly, the administration was supposed to do with the banking sector, let it fail and turn a crushing recession into a lasting depression?"

This is an egregious misrepresentation of history. No knowledgeable observer doubts that the Obama administration inherited the crisis (though Geithner, as head of the New York Fed, did not), and that the new president was faced with a stark choice of bailing out the banking sector in the nerve-wracking months of early 2009 or sending the economy into a Depression.

But by the time Congress began debating serious reform in late 2009, the banks were much healthier. The panic had passed. Yet even then Geithner refused to tamper with their structure and balance sheets—to the point where even senior Fed officials like Governor Dan Tarullo today think that Dodd-Frank doesn't have enough restraints on the banks. Geithner's fellow Cabinet member, Attorney General Eric Holder, has publicly questioned whether the banks are not only too big to fail, but also too big to prosecute.  As Harvard University's Kenneth Rogoff, a former adviser to John McCain, said of Geithner in a 2011interview with me, echoing the views of many financial experts: "He was too generous to the financial system. He followed a set of policies aimed at preserving the status quo."

White also credits Geithner with the best of the Dodd-Frank financial-reform law, saying, "It's a big stretch to suggest Geithner stood in the way of stronger reform in order to win a place for himself on Wall Street."

A truer history of that law would record that Geithner resisted many of its toughest provisions, including the "Volcker Rule," which he avoideduntil the president insisted on it. As former Federal Deposit Insurance Corp. chief Sheila Bair wrote in her frank memoir this year about her major battles with Geithner, Bull by the Horns: "I couldn't think of one Dodd-Frank reform that Tim strongly supported. Resolution authority, derivatives reform, the Volcker and Collins amendments—he had worked to weaken or oppose them all."

Geithner, in truth, often seemed in denial of the deeper systemic dangers on Wall Street that he, as a member of Rubin's team back in the 1990s, had helped to create. Their signature policy, the 1999 repeal of Glass-Steagall, ensured there would longer be any strong firewalls and capital buffers between Wall Street institutions and their affiliates, and between banks and nonbanks and insurance companies. A year later, in 2000, then-Treasury Secretary Lawrence Summers and Geithner pushed for the Commodity Futures Modernization Act, which created a global laissez-faire market worth trillions in unmonitored trades. With the repeal of Glass-Steagall, systemic failure was largely forgotten while at the same time, with the passage of the CFMA, huge new systemic risks were being created.

Yet Geithner, throughout his tenure, did not acknowledge these mistakes and resisted more fundamental reforms like the Volcker Rule, which harked back to the spirit of Glass-Steagall by seeking to bar federally insured banks from the riskiest trading.

Personally, I don't believe that Geithner took the positions he did "in order to win a place for himself on Wall Street." He's not that kind of fellow. I think he did it because he believed in Wall Street. Welcome home, Tim

You Gotta Love Elizabeth Warren, But .... for President???

Reprinted from National Journal

Gutsy, smart, and hyper-articulate, Elizabeth Warren is quickly becoming the voice of progressivism in Washington. Along with departing regulator Gary Gensler, Warren probably did more than anyone in Washington to bulk up Dodd-Frank from its rather flimsy beginnings and turn it into a financial-reform law with some weight. She also speaks out eloquently for the beleaguered middle class and on the deeper problem of income inequality.

But the idea that somehow this growing reputation translates into a competitive bid for the 2016 presidential nomination—The New Republic recently suggested on its cover that Warren represents the "soul" of the Democratic Party more than Hillary Clinton—is pretty over the top.

Here's why. As impressive and quotable as she is as a senator—"I'm really concerned 'too big to fail' has become 'too big for trial,' " Warren memorably declared at her very first Banking Committee hearing—she is basically a one-issue political figure. And that doesn't get you into the White House in this era. (OK, fine, Barack Obama first came to national attention by declaring Iraq a "dumb" war, but more on that later.) Warren's punditocratic boosters, like Jonathan Chait of New York magazine, have tried to compensate for her one-issueness by suggesting that the issue that Warren became famous for is still, as Chait put it, "the most potent, untapped issue in American politics." 

And what might Chait be talking about? Get ready: financial reform. That's right. An issue almost no one talks about anymore and far fewer people understand. I ought to know because I've spent tens of thousands of words trying to get people to talk about it since I published a 2010 book called Capital Offense: How Washington's Wise Men Turned America's Future Over to Wall Street. I fully agree that Obama failed miserably to exploit a potential populist issue that, once upon a time, might have made him the second coming of FDR. "Surveys show that both Left and Right, liberals and conservatives, were united in wanting to see fundamental change to Wall Street and big finance," I wrote in 2011. "Yet rather than seizing the chance at the kind of leadership that might have unified a good part of the country, Obama threw himself into an issue that divided Left and Right as never before, and which was not directly related to the historic crisis at hand—health care."

But that moment has long passed. Warren has consistently been a powerful, positive voice on financial reform, and it got her the party nomination in Massachusetts. But that's Massachusetts. A Harvard Law professor who became an expert in mortgage fraud and bankruptcy and later conceived of one of Dodd-Frank's most significant reforms, the Consumer Financial Protection Bureau, she's never done much of anything else in public life, other than chair the TARP oversight committee. And her "issue" has faded in popular imagination. Remember the Occupy Wall Street movement? You're forgiven if you don't. It petered out without a trace (while the tea-party movement doesn't seem to go away, demonstrating that you can have a successful movement these days; OWS just wasn't it).

And with each passing year the causal connection between Wall Street's unprosecuted perpetrators and the terrible recession and national PTSD they set in motion has grown more distant, draining the issue of its populist potential. In 2012 when Mitt Romney promised, and then failed, to propose an alternative to Dodd-Frank, almost no one cared. Polls consistently show that while the U.S. public is still mainly concerned about the economy (although the numbers have been steadily falling), Wall Street is way down the list, behind health care, immigration, education, guns, and a host of social issues. By the time the 2016 race rolls around, nearly eight years will have passed since the financial crisis.  

But that's not even the main point. Chait finds it "odd" that financial reform hasn't become a bigger issue despite surveys showing that large numbers of people are still angry about Wall Street (when they're asked about it: big difference). Here's why: It's booorrring. And incredibly esoteric. Yes, the banks are huger than ever and over-the-counter derivatives are being traded again in the hundreds of trillions—one reason why Gensler, the outgoing head of the Commodity Futures Trading Commission, may be one of the great unsung heroes in Washington thanks to his lonely fight to regulate derivatives internationally. But only a handful of people in the entire world truly understand derivatives regulation. "Bash the Bankers" works as a slogan, but when you get down to what really must be done about them you would have to talk about capital and liquidity ratios on the stump.

"Too big to fail?" Again, it's a vital issue. But it comes down to the scintillating debate over whether "resolution authority" will really work to liquidate (rather than bail out) a bank in trouble, or whether, as progressive Federal Reserve Gov. Dan Tarullo has argued, "a set of complementary policy measures" is needed to go with Dodd-Frank that would limit banks' sources of short-term funding.

Never heard of Dan Tarullo? That's my point.

OK, though, let's say for the sake of argument that the issue does play. Recall that Hillary entirely sat out the Dodd-Frank debate, and with good reason: She was secretary of State. She can basically write her own platform, make it as progressive as she wants, without worrying much about baggage. If Warren gets the big cheers at AFL-CIO rallies, Hillary can move left in a way she could never do on Iraq, where Obama easily outflanked her on an issue that had become truly toxic by the time 2008 rolled around and her vote for the Iraq War resolution looked very unpresidential. I mean, if even Larry Summers, the Great Deregulator, can reinvent himself as a champion of the middle class, Hillary Clinton can make a better case. Remember, she was pushing Hillarycare on the national agenda back when Warren was still teaching in obscurity in Cambridge, Mass. Other potential Democratic big names, like Governors Andrew Cuomo and Martin O'Malley, are also pretty credentialed up.  

And now let's get to the heart of the question: What is the soul of the Democratic Party? Is it really that leftward and progressive, or is that simply an agenda that old warriors like John Lewis talk about with nostalgia? The last two Democratic presidents both had populist inclinations but went straight to the center in order to win two terms. For both Bill Clinton and Barack Obama, that apparently also meant going easy on Wall Street. And Bill Clinton, at least, later publicly expressed regret for permitting the Alan Greenspanization of his views on financial reform. No doubt his wife has taken that particular lesson on board.

Being on Wall Street Means Never Having to Say You're Sorry

Picture credit: http://pogoblog.typepad.com


Over the weekend JPMorgan Chase, the world's largest bank, reportedly agreed to fork over $13 billion in what will be the world's largest corporate settlement. Although the penalty, in proportion to JPMorgan's multi-trillion-dollar balance sheet, will merely dampen its annual earnings, some commentators said they felt bad for CEO Jamie Dimon. Calling the not-yet-announced agreement a "shakedown," the Wall Street Journal opined: "Federal law enforcers are confiscating roughly half of a company's annual earnings for no other reason than because they can and because they want to appease their left-wing populist allies." The Washington Post, lamenting the "persecution" of Morgan, quibbled that the Justice Department should not be so "backward-looking" as to slap the bank "for allegedly misleading investors about the quality of [subprime] securities it marketed before the crash." After all, the editors said, "roughly 70 percent of the securities at issue were concocted not by JPMorgan but by two institutions, Bear Stearns and Washington Mutual, that it acquired in 2008" under government pressure.


Poor Jamie. We do feel his pain. But all this empathy misses the point. What the historic deal demonstrates, beyond any reasonable doubt, is that the biggest banks are so big today that almost no wrongdoing can threaten their existence. They have become, in effect, something close to sovereign powers. Yes, if you're a bigger power, like the United States, you can extract "tribute" from them occasionally, as the Romans used to do to vassal states. But you don't liquidate sovereign powers or put their officials in jail.


Consider the odd spectacle of Dimon reaching out like a potentate to Eric Holder, asking for a personal meeting in which the two of them could hash out the penalty in private. The head of a bank and the attorney general of the United States held, in other words, a kind of personal "summit" meeting. Such a pact would only have been possible if the government of the United States is itself afraid of disturbing the operations of the bank—and in fact Holder admitted just that back in March when he warned that the biggest banks have grown not only too big to fail, but too big to prosecute. (In testimony before the Senate Judiciary Committee, Holder delivered an implicit rebuke to his former Cabinet colleague, Treasury Secretary Timothy Geithner, who permitted Wall Street to resurrect itself in what is largely its former image.)


As MIT financial expert Simon Johnson, the former chief economist of the International Monetary Fund, observed, "If Dimon's bank didn't have $4 trillion in assets (measured using international accounting standards), but rather a much more moderate $250 billion or $500 billion, do you think he would have the same access?"


Dimon is apparently taking this deal as a large-scale cost of doing business, and he's still fighting Justice's demand that his bank admit some culpability or wrongdoing. Which is the same pattern we saw in previous cases with Goldman Sachs and others: in one case, against Citigroup in 2011, U.S. District Judge Jed Rakoff rebuked the Securities and Exchange Commission and refused to approve a $285 million settlement with the bank because the SEC failed to gain any admission of wrongdoing or liability. To his credit, Holder is reportedly still pursuing a criminal case against JPMorgan involving allegedly fraudulent mortgages in California; in previous instances, banks have successfully bargained for the dropping of criminal charges in exchange for substantial settlements.


But for those who are tut-tutting that poor JPMorgan is giving up some half its profits, consider these figures from Andrew Haldane, head of the Bank of England's financial-stability department. He wrote that the financial crisis of 2008-09 produced an output loss equivalent to between $60 trillion and $200 trillion for the world economy. Assuming that a financial crisis occurs every 20 years, the systemic levy needed to recoup these crisis costs would be in excess of $1.5 trillion per year, Haldane says. What that means is that overall, our unrestrained financial sector does not add any net benefit to the economy -- its repeated crises cost us far more than Wall Street brings to overall economic growth.


JPMorgan, in effect, is giving up what amounts to a medium-sized penalty fee so that it can perpetuate Wall Street's pattern of occasionally blowing up and costing the rest of society its pursuit of happiness. And despite crying now that 70 percent of the bad mortgages were accumulated by Bear Stearns and Washington Mutual—which the government pressed on Dimon in the heat of the crisis—in fact he made out very well. "He got a 'Jamie-deal' on both Bear (the U.S. government guaranteed $30 billion of mortgage assets) and WAMU (the FDIC put WAMU in bankruptcy and let JPMorgan buy it for peanuts)," says Jeff Connaughton, author of the book "The Payoff: Why Wall Street Always Wins." "So in some ways the fine is a belated increase in fair purchase price."


Dimon has often behaved like the latter-day potentate he is. In the years since the crash, no one has worked harder than Dimon to resurrect the debunked idea that Wall Street can regulate itself. He has publicly disparaged Paul Volcker, the legendary inflation-fighting Fed chief and namesake of President Obama's still-unimplemented "Volcker Rule," which prevents federally insured banks from acting like risky hedge funds. Volcker has taken to telling audiences in recent years that the big, complex trades earning billions for firms like JPMorgan Chase add little growth to the real economy, just as Haldane's paper concludes. And despite the evidence that not a single Wall Street CEO really understood the trades that would doom his firm in the months leading up to September 2008, JPMorgan and the other global banks have still sought to keep derivatives and swaps trading in the dark and out of regulatory control as much as possible, so as to keep their vast profit machine (which relied on a lack of transparency) going.


The latest deal? Just the cost of doing business.

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