Self-styled liberal wonks and opinion writers decided to turn their guns on Bernie Sanders this week, deriding him as myopic, unrealistic and even wrong on the merits of his arguments on behalf of single-payer healthcare and systemic financial reform. But at least on financial reform, they weren’t actually attacking Bernie. They were attacking Elizabeth Warren.
It’s Warren, not Sanders, who represents the leftward pole in the intra-Democratic debate over how deeply to reform the financial sector. Warren, not Sanders, manifests part of her vision in the bill she wrote — the 21st Century Glass-Steagall Act, named for the two Depression-era lawmakers who initially separated commercial and investment banking. When Hillary Clinton and her supporters in the media dismiss Glass-Steagall as unnecessary and dangerous, they dismiss a consensus in most developed nations about the need to break interconnections in finance. The radicals in this debate, in other words, are those protecting the deregulatory status quo.
Here’s one such radical: Paul Krugman, who derided the restoration of Glass-Steagall as “nowhere near solving the real problems.” As many commentators do, Krugman takes a detour into identifying whether the investment/commercial bank firewall caused the 2008 crisis, an irrelevant parlour game, unless you think the next financial crash will occur in precisely the same way. He is wedded to the idea that the rise of shadow banking — non-bank institutions performing bank-like activities outside the regulatory perimeter — represents the real threat.
This runs counter to the Financial Crisis Inquiry Commission’s report and a host of financial experts, all of whom list banks’ “too big to fail” status as a central factor. But beyond that, it’s clear to me that Krugman has never read the bill, Elizabeth Warren’s 21st Century Glass-Steagall Act, which he’s criticizing.
Here’s a one-page fact sheet, and the relatively longer 30-page bill text. The 21st Century Glass-Steagall Act restricts banks to a core set of activities: taking deposits, extending credit to individuals and businesses, processing payments, buying and selling “coin and bullion,” and investing in securities for customers — and only for customers, “in no case for its own account.”
Banks fitting this description get access to cheap Federal Reserve loans, deposit insurance from the FDIC and other government perks. Banks trying to do anything else — stock underwriting, bond issuance, market-making, investment advisory services, management consulting, hedge fund or private equity activity, investments in “structured or synthetic products” like asset-backed securities or derivatives, repurchase agreements, interest-rate or currency swaps, or even affiliating with or creating a subsidiary of firms engaged in any of this — will be cited with violations of the law and prosecuted (bank executives must sign a form attesting to this under penalty of perjury). Members of bank boards couldn’t even serve on the boards of non-bank financial firms.
These are often the activities of shadow banking. And Warren’s goal is to restrict shadow banks from government subsidies. We shouldn’t cross-subsidize risk-taking with public money. We shouldn’t want ordinary Americans’ deposits entangled with, and indeed funding, what amounts to high-stakes casino gambling. We shouldn’t want the largest banks to be able to dabble across the financial sector, outmuscling their competitors with giant balance sheets filled with precarious asset positions. And we shouldn’t want that subsequent growth to create political problems, imbuing financial institutions with massive power and influence.
Those are not controversial ideas. In the United Kingdom, the Vickers report reached the same conclusion, recommending the “ring-fencing” of retail banking deposits, separating taxpayers from the risks of investment banking. In Europe, the Liikanen report agreed, stating, “Separation of these activities into separate legal entities within a group is the most direct way of tackling banks’ complexity and interconnectedness.” Both the U.K. and Europe are implementing these reforms now.
So is the United States, through the Volcker rule, which kicks proprietary trading — making trades on the firm’s own account — out of deposit-taking banks. Warren’s bill simply goes further. It even closes loopholes in the Volcker rule, like allowing banks to invest small amounts in hedge funds. Clinton knows this; her financial reform plan includes that loophole closure.
Cutting off banks from participating in or funding shadow banking makes it more difficult for shadow banks to acquire capital. You can do this and extend the regulatory umbrella to cover shadow banks — as Dodd-Frank does to an extent. To that point, Clinton’s allegedly “more comprehensive” assault on shadow banking mostly comprises provisions already being implemented by regulators. Warren’s target is different — not just monitoring shadow banking but cutting off its oxygen.
Warren’s bill includes a potentially fatal blow to shadow banking: It reverses provisions from the 2005 bankruptcy law that allow institutions involved in short-term repurchase transactions (known as “repo lending” in the financial world) to get paid back prior to any bankruptcy. This effective guarantee creates major incentives to lend short-term funds to shadow banks. Eliminating it will choke off capital even more.
Krugman argues, “pushing the big banks out of shadow banking… could make the problem worse by causing the risky stuff to ‘migrate elsewhere, often to places where there is less regulatory infrastructure.’”
This is precisely the opposite of what Krugman said in 2014, when he fought against the eventual repeal of Dodd-Frank’s “swaps push-out” provision, which separated derivatives trading desks into separately capitalized subsidiaries. Lobbyists at the Financial Services Forum argued explicitly that pushing out swaps would place them into less-regulated corners; Krugman disagreed. He said the government should “stop banks from taking big risks with depositors’ money.” When did he change his mind? And does he now disagree with Hillary Clinton, whose plan calls for the restoration of the swaps push-out measure?
Elizabeth Warren has actually thought about this stuff. She’s not flailing about, trying on contradictory criticisms to make a political point. She believes that real Wall Street reform must target the financial system’s interconnected structure, the tight coupling of different institutions, which makes it too responsive to failure in any one area. There are lots of ways to get there: higher capital requirements, banning unproductive trading and, yes, segregating parts of the system to eliminate cross-subsidies.
Liberal reformers used to get this. In fact, Krugman and most of his backers pull from the work of Mike Konczal, who lately has led on the idea that Glass-Steagall restoration wouldn’t be a particularly effective goal. But back in 2010, when Dodd-Frank was being debated, Konczal co-wrote a chapter in a report for the Roosevelt Institute called “Creating a 21st Century Glass-Steagall.” He understood then that “the real problem of this crisis is in the overlap between investment banking and commercial banking.”
Konczal wanted mostly to extend regulatory strictures to shadow banks. But much of the thinking behind his solution in 2010 looks like Warren’s solution in 2016: preventing ordinary commercial banks from concentrating resources in the riskiest areas, and limiting shadow banks’ funding advantages. When you dig into Warren and Konczal’s seemingly disparate arguments, they come to a rough equilibrium: Let’s reduce risk by adding resiliency to the financial system. Everyone in the Democratic coalition concurs with this; the differences are a matter of degree.
But denying this consensus, and delegitimizing structural reform as silly and shortsighted, only does the work of banks and their lobbyists, who want to preserve the current system and cut off any avenues for a more far-reaching redesign.
Why in the world are people who call themselves liberals helping them do it? Those wondering why Warren hasn’t endorsed Hillary Clinton yet should consider whether it’s because Clinton and her minions are delivering a mortal wound to the cause of Warren’s life.