Frank: A Life in Politics from the Great Society to Same-Sex Marriage (45 page)

In my concededly inadequate defense, I was motivated only partially by my own indignation. As committee chairman, I bore considerable responsibility for the difficult political position of members who had voted for a TARP bill, which included funds for AIG. Even more important, I knew I would be asking them to cast further difficult votes. Those votes would be punitive enough to anger the financial firms whose support many coveted. But they would not be sufficiently punitive to suit the mood of an electorate which, at that point, reminded me of the villagers in a Frankenstein movie who march on the laboratory with pitchforks and torches. In demanding names, I sought to reassure committee members and their constituents that I shared their fury.

Fortunately, wiser heads prevailed, especially on the committee staff. I was never better served by having aides who’d known me long enough and well enough to tell me how badly mistaken I had been. Realizing my error, I wrote to federal and state law enforcement officials telling them that I would drop my demand for names unless I could be reassured that it would not endanger anyone. As I expected—and hoped—I got no such reassurances and used this to justify withdrawing my threat of a subpoena. It was an admittedly transparent ruse, and it did not save much face, but it did give me a way to save my butt.

Chris Dodd fared less well, in a classic reaffirmation that no good deed goes unpunished. With great foresight and political judgment, he had successfully added a provision to the Economic Recovery Act capping the bonuses that could be paid out by TARP recipients. His provision also authorized the Treasury to claw back bonuses that were already paid. When the Treasury Department correctly commented that this last piece would be unconstitutional and could lead to litigation that would jeopardize the entire idea, he agreed to make the restrictions prospective only.

When the AIG bonuses became public, Dodd was blamed for enabling them. In fact, his amendment was an important safeguard against future abuses. Without it, there would have been no antibonus language at all. But in the irrationally angry atmosphere that prevailed, the accusation stuck and became a political problem as his reelection approached. (A word here about political semantics. Most people know the Recovery Act as the “stimulus bill.” When we were considering it, our leadership consulted some public opinion research and deemed “Recovery” a more appealing title than “Stimulus.” I found this counterintuitive, since everyone I know prefers being stimulated to recovering, but this was not in my committee’s jurisdiction, so no one asked me.)

Feeling even more heat from fellow Democrats than I was, Pelosi acted promptly. She had the Ways and Means Committee put a bill on the floor levying a retroactive 90 percent tax on any high-level bonuses given out by TARP recipients—singling out AIG alone would have added a clearly unconstitutional bill of attainder to an already constitutionally dubious proposal. The proposed taxation of non-AIG employees made it easy for most Republicans to vote against the bill, but it did give Democrats a chance to show our constituents that our hearts (if not our minds) were in the right place. I didn’t like the idea, but I knew that my voting no would attract a great deal of attention, seriously undermine the credibility of the effort, and diminish the political capital with my Democratic colleagues that I would need to get a financial reform bill adopted. A combination of the bill’s overreach and an abatement in public fury allowed the Senate leadership to ignore the tax proposal with little outcry.

But abatement is not disappearance. AIG’s serial irresponsibility—running up enormous debts that it could not pay, then giving bonuses to the people responsible—inflicted serious political damage on our system immediately, and in the long run. I have not checked public opinion polls before and after March 2009, but I would be surprised if public confidence in government did not drop at that time. Even though most people do not recall the specifics of this fiasco today, the deep resentment it triggered remains embedded in their minds. I am convinced it is one of the reasons that TARP, which staved off total economic collapse and did not end up costing taxpayers, remains so reviled. Indeed, it is the most wildly unpopular highly successful major program in America’s history.

Compounding the problem from my standpoint, the onus of public anger fell disproportionately and unfairly on the Democrats. Everything but the announcement of the bonuses happened while Bush was in power, and it was the Bush administration that resisted our effort to put stronger compensation restrictions in the original bill. But we were in power when the public learned of AIG’s payments, and Chris Dodd was blamed for not preventing them, even though he’d tried the hardest to do just that. Additionally, and frustratingly, I came to realize that for much of the public, we are in power even when we aren’t. The fact that we are the progovernment party merges in some voters’ minds with the notion that we are the government—all of the time.

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Once the AIG firestorm subsided, I was at last able to turn to comprehensive financial reform. The events of 2008 had made the need for a new system abundantly clear. It is true that the flood of imprudently granted mortgages was a major reason for the crisis, but our problems went far beyond that. The failure of Bear Stearns and the messy ad hoc response to it demonstrated that we needed rules to keep large banks and investment firms from incurring obligations they couldn’t meet. If such firms failed nonetheless, we would also need a legal framework to keep that failure from destabilizing the entire system.

As I understood it, the financial industry’s dramatically changed business model required equally far-reaching revisions in the way that industry was regulated. This recognition brought out my inner amateur economic historian. What we were experiencing, I concluded, was a third iteration of the need to reinvent regulation to fit a transformed private sector. In 1850, there were no large economic enterprises in the United States; our economy was essentially regional. By 1890, large nationwide businesses had been formed—steel, coal, oil, and railroad corporations became immensely powerful, and often colluded with each other. New regulation followed, first with the Sherman Antitrust Act of 1890, then after a lag during the conservative administrations of Grover Cleveland and William McKinley, in greater volume under Theodore Roosevelt, William Howard Taft, and Woodrow Wilson. By the end of that period, we had the Federal Trade Commission, the Interstate Commerce Commission, a national food and drug law, the Clayton Antitrust Act, the Federal Reserve System, and more. A new set of rules was created to govern the new national economy.

One set of innovations usually calls forth another. With large enterprises now dominating the economy, the stock market took on a new, greatly enhanced role. But there were no new rules for new forms of financing. Thus the New Deal set about establishing institutions to contain finance capitalism within reasonable bounds. Federal Deposit Insurance, administered by the new Federal Deposit Insurance Commission, the Securities and Exchange Commission, the Commodity Futures Trading Commission, and the Investment Company Act governing mutual funds were Franklin Delano Roosevelt’s response.

This set of rules worked very well for fifty years. Then came the great changes that I described earlier: securitization, shadow banking, derivatives, the proliferation of financial engineering. This time, the ideology of deregulation had taken so strong a grip on our politics that the appropriate updated regulations were delayed for more than twenty-five years. Our great mistake was not deregulation but nonregulation. We waited too long to put new rules in place. In some cases, we even took pains to prevent new rules from being established. The Commodity Futures Modernization Act of 2000 exempted many derivatives from scrutiny.

My view of how to create a new regulatory framework had one central theme. The transformative innovations that began in the 1980s had weakened the linkage between risk and responsibility. Our job was to reestablish it. With very few exceptions, it was neither our intention, nor the effect of the legislation, to forbid the private sector from conducting transactions that had become part of the financial system. We did not want to inhibit institutions from making investments, placing bets, or engaging in speculation. We did want to ensure that when they carried out these activities they would remain responsible for at least a part of any losses and have the financial resources to meet that responsibility.

As we embarked on our effort, the Obama administration drew up an initial draft, reflecting the broad consensus that existed among those of us who had worked together since the financial crisis exploded. Given the concentration of expertise in the executive branch, and the existence of that consensus, we were happy to take it as a starting point. Dodd’s Banking Committee and the Financial Services Committee I chaired would each mark it up, make changes, and proceed from there.

There were several major components of the bill. First, in tandem with the actions of international regulators who worked through the Basel Accords, it would raise capital requirements for banks and nonbanks alike. This additional capital would serve as a cushion against losses resulting from misjudgments or adverse economic conditions.

Second, and most important in my mind, we could require entities that packaged loans made by others and sold them as securities to retain some of the risk. They would keep “skin in the game.” If the original loans defaulted, they would pay a price. This measure, we hoped, would correct the practices most directly responsible for the crisis.

Third, we would attempt to limit those “financial weapons of mass destruction” known as derivatives. We directed the regulators, particularly the Commodity Futures Trading Commission, to promulgate rules that would transform the $400 trillion derivatives market from one dominated by opaque individual deals between parties with prices known only to the participants into a much more open and transparent system.

The loud objections to our proposal reminded me that for many businesspeople in America, competition is a great spectator sport. They like to watch others engage in it, but they can readily produce reasons why it would be harmful in their own lines of work. When I met with two insurance company representatives, the younger of the two complained that if we made his company publish the price they planned to charge for a given deal, some other company could offer their counterparty a lower price. His older colleague quickly intervened to assure me that this explicitly anticompetitive argument was not their basis for opposing the rule. Further discussion made it clear that he objected to voicing the argument so openly, not its substance.

The reform bill also contained a Consumer Financial Protection Bureau—an idea that had been supported most prominently by Elizabeth Warren. The CFPB would take all the consumer protection functions away from all the various financial regulatory agencies and consolidate them into one independent bureau whose sole function would be to protect consumers in financial transactions. It would be lodged in the Federal Reserve for organizational purposes but granted complete independence from any Fed interference with its policies, its personnel, or its funding. Senator Dodd was the one who decided on this arrangement, and Elizabeth Warren and I agreed that it fully protected the CFPB’s mission.

I am especially proud of one other provision—one I freely acknowledge had no connection to the crisis. It gratified me immensely when Bono, the U2 singer who has done so much to combat poverty, disease, and deprivation in the poorer parts of the world, publicly thanked me for including the section known as “publish what you pay.” This part of the law requires any American company that is engaged in resource extraction in any country to make public all the money it has paid to any source, official or unofficial, in the country where the extraction takes place. The scandal of corrupt rulers profiting handsomely from such activities while their people get no benefit seemed to me an entirely legitimate subject for our attention.

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Adopting a new framework for the operation of financial markets was one of the major tasks we faced in 2009. But what if the worst happened, and even under the new rules a major firm was in peril? Our other task was to find a better way of coping with financial institutions that could no longer operate. Federal officials should not have to choose between letting a major institution go bankrupt or propping it up—both terrible options. Bankruptcy meant letting the insolvent firm’s unpaid debts course through the economy, leaving further financial damage in their wake. But bailouts also had serious defects. They created moral hazard, effectively protecting the institution’s leaders and business partners from the consequences of its irresponsibility. The other problem with this approach was that it required using public—that is, taxpayer—money to protect the economy from reckless private sector behavior. This was rightly a very unpopular thing to do. Neither the abrupt, unbuffered bankruptcy of Lehman nor the $160 billion taxpayer lifeline to AIG was an acceptable precedent for the future.

And so the bill provided a third way, which was called the Orderly Liquidation Authority. Under its terms, if an institution’s imminent failure threatens to destabilize the entire financial system, the institution is put into receivership, under the direction of the FDIC. The officers and directors are dismissed, and any funds available to the entity are used to reduce its indebtedness. If the institution’s debts remain dangerous, the receiver can advance funds—the minimum required to prevent a crisis. The secretary of the treasury is then mandated to recover those funds by assessing a special tax on financial institutions with $50 billion or more in assets.

To be explicit, we were not offering anyone a bailout. In a case like this, the institution fails. Unlike AIG, it is no longer a functioning private entity: Its officers are dismissed, its board is dissolved, and the shareholders’ equity is wiped out. Unlike Lehman, however, the government could pay off some of the firm’s debts to prevent its failure from precipitating a chain reaction of other failures. Other large financial institutions would then foot the bill for paying off those debts. The rationale for this was clear. These institutions benefit from the increased assurances of a stable system and should bear the cost of sustaining it.