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Gambling With Main Street

Bludgeoned by the financial crash of 2008, ten years later, Americans still understand the importance of strong Wall Street rules. Yet, the U.S. Senate is expected to soon vote on a major bill –S. 2155–that disturbingly rolls back financial protections put in place to protect against another collapse. Most troubling, 11 Democrats and Independent Sen. Angus King (Maine) endorse the measure, elevating chances this will become law.

After unifying to defend the Affordable Care Act and contest the corporate tax cuts (which benefits banks more than most industries), it’s dispiriting that Democrats are joining with Trump’s goals to effectively “do a number on Dodd-Frank,” referring to the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act.

These Democrats claim they’re cosponsoring S. 2155’s rollback of financial protections in an attempt to help community banks. Many Washington lawmakers view America’s community bankers through rose colored glasses.  Small banks know their customers. They redirect local savings into community businesses and home mortgages. And they didn’t cause the crash of 2008. From this perspective, members of Congress reflexively support bills that excuse this class from reporting and compliance rules that apply to their larger brethren.

But a careful look at one measure billed as “relief for community banks” shows it could lead to the kind of catastrophe suffered in the 1980s. That’s when thousands of Savings & Loans (S&Ls) institutions failed through bad real estate deals, precipitating the last taxpayer bailout before the 2008 crash.

The measure at issue excuses banks with less than $10 billion in assets from the Volcker Rule. Not that banks with $10 billion in assets are actually “small,” but they are community banks. Of the nation’s 6,000 banks, only 124 have more than $10 billion in assets, so we are talking about the vast majority of the nation’s banks being exempted from a critical safeguard for our economy.

Passed as part of Dodd-Frank, the Volcker Rule restricts proprietary trading with customer deposits. Proprietary trading is a prim term for gambling. Banks should deploy deposits to loans, such as for a factory or home mortgages, not engage in risky trading. This was an essential financial protection because leading to the 2008 crash, too many banks made short-term bets. And, when those bets went bad, many firms failed, from Bear Stearns and Lehman Brothers, to the mega-banks such Citigroup. The Volcker Rule was designed to effectively end those sorts of risky trades.

Proving compliance with the Volcker Rule means record-keeping. Banks of all sizes complain about it, as does most everyone when it comes to paperwork.  If cutting down reporting requirements was actually the goal, a solution for smaller banks could have been a rebuttable presumption that they’re not gambling with cheap FDIC deposits . But, the measure in the Senate bill doesn’t simply eliminate the record-keeping; instead, the provision in S. 2155 sanctions a return to tax-payer backed  gambling..). The only restriction is that the bank must limit gambling book to 5 percent of total assets. (Assets minus liabilities equals capital.)

A bank with $10 billion in assets, then, could operate a $500 million trading operation. A customer’s savings wouldn’t be recycled into funds to help the local community like a loan to a new factory, or a home mortgage, but instead bet on bitcoin or an exotic derivative. And if this $500 million betting pool evaporates in bets gone wrong, that can wipe out the bank. That’s because many banks operate with capital that’s only about 5 percent of assets.

Here’s where the comparison with the S&L Crisis comes in. A savings-and-loan, or “thrift,” is similar to a standard bank but limited in where it can loan money. Congress relaxed their lending rules in the 1980s, allowing the thrifts to invest directly into projects, notably real estate. This attracted a new population into this once sleepy business: real estate speculators. After the rules were relaxed, speculators no longer needed to supplicate themselves to appropriately skeptical loan officers; they could now buy a thrift and use the deposits to invest in their own schemes. Whereas a loan officer wants to see documentation that a real estate project such as an office building enjoys market demand, development speculators could ignore that because they owned the S&L. Real estate development grew with little regard to need. Cities became populated with “see-through” office towers, so named because they lacked tenants and one could see through from one side of the building to the other. Many lost billions of dollars. Taxpayers were ultimately forced to bail out this industry of small thrifts to the tune of $130 billion. Many thrift executives cooked their accounts to stall regulators, and prosecutors sent nearly 1,000 to prison. Public Citizen published Who Robbed America in 1990 documenting this catastrophe.

Unfortunately, it appears that history is poised to repeat itself. Banks with less than $10 billion in assets may not be gambling now with depositor money, but once this measure becomes law, speculators could easily enter the business by purchasing an existing bank, and redirect assets to a trading desk.

Even now, not all community bankers are virtuous. Walk through the monthly enforcement actions report by the Federal Deposit Insurance Corp and find a muck of misconduct, from lying to customers, to lying to regulators, to self-dealing and more.

Advertise that community banks can gamble with deposits made cheap and abundant by a taxpayer guarantee through the Federal Deposit Insurance Corp, and rogues are sure to swarm to this sector.

As with the law deregulating S&Ls in the 1980s to allow speculation, this Senate bill springs from bank lobbyists. Sen. Elizabeth Warren (D-Mass), a staunch opponent, dubs it the “Bank Lobbyists Act.” Examine the donors of the bill sponsors and the banking sector figures prominently, often as the number one source for campaign contributions.

Sen. John McCain (R-AZ) fell into the S&L trap. He accepted prodigious contributions from a developer named Charles Keating who bought Lincoln Savings and Loan Association as a vehicle to fund his real estate projects. When regulators began to question Keating’s operations, Keating turned to McCain and four other senators to block any sanctions. The episode became public and a major stain on McCain and his colleagues’ record.

McCain learned an important lesson, calling it the “worst mistake of my life.” Since then, he’s advocated for strong Wall Street rules. Today, he supports rules that go beyond the 2010 Wall Street Reform Act. Specifically, he supports restoration of the Glass-Steagall Act that completely separates commercial banking, which is loan-making, from investment banking, which entails speculation.

This measure should be addressed by the Senate, not the Wall Street deregulation bill that is now headed for the Senate floor. Restoring Glass Steagall is the centerpiece of bills promoted by the Take on Wall Street campaign. Others include reinstating a fee on financial speculation, elimination of favored tax rates for investment funds known as carried interest, and eliminating the corporate tax deduction for overpaid Wall Street bankers.

Americans support these measures. The conservative Cato Institute issued a poll showing bipartisan support for strong regulation:

  • 77 percent believe bankers would harm consumers if they thought they could make a lot of money doing so and get away with it.
  • 64 percent think Wall Street bankers “get paid huge amounts of money” for “essentially tricking people.”
  • Nearly half (49 percent) of Americans worry that corruption in the industry is “widespread” rather than limited to a few institutions.

Lawmakers who stand for Main Street, not Wall Street must heed to their constituents, not what’s on the bankers’ wish list. Public citizens should contact their senators and tell them to oppose S. 2155 and instead work to strengthen financial protections by supporting policies like reinstating Glass-Steagall to stop risky bank gambling once and for all

The full list of co-sponsors is here. Democrats sponsoring this misguided bill currently are:

  • Jon Tester, Montana;
  • Mark Warner and Tim Kaine, Virginia;
  • Heidi Heitkamp, North Dakota;
  • Joe Donnelly, Indiana;
  • Gary Peters, Michigan;
  • Tom Carper, Christopher Coons, Delaware;
  • Claire McCaskill, Missouri;
  • Angus King, Maine;
  • Michael Bennet, Colorado;
  • Joe Manchin, West Virginia;