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Vintage Statute

By Bartlett Naylor

As the Biden administration plows through the policy trash left by Trump’s four-year frat house party of corrupt cronies, they should be pleased to discover an untouched 2010 vintage statue probably  buried beneath a pile of empties.

It’s Section 956 from the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, approved in the wake of the 2008 financial crash. And it addresses the core reason for that crash—banker greed.

While banker greed didn’t cause the current pandemic, banker and general corporate greed have contributed to economic hardships borne especially by lower income Americans, especially during this induced coma for swaths of the employment sector such as restaurants and travel.  As Biden’s regulators  uncork Section 956, congressional lawmakers can use an ideal implementation as a model for pay reform more broadly.

Section 956 provides for basic banker pay reform. In its operational phrase, it directs “ the appropriate Federal regulators [to] jointly prescribe regulations or guidelines that prohibit any types of incentive-based payment arrangement . . . that . . . encourages inappropriate risks.”

“Inappropriate risk” is an elegant phrase under which ambitious reforms are possible. Bankers engaged in wholesale fraud based on the compensation packages leading to the 2008 crash. Wholesale fraud is certainly “inappropriate.” For this, 49 financial institutions have paid various government entities and private plaintiffs nearly $190 billion in fines and settlements, according to an one analysis. Whatever those compensation packages were that led to this fraud, they must be radically changed under a responsible implementation of Section 956. And it’s also notable who paid that $190 billion: it’ wasn’t the culpable bankers; it was their shareholders. A responsible Section 956 must ensure that bankers pay. One way to do this is through deferral of current compensation by senior bankers that would be sequestered in a fund. Should the bank be fined for misconduct, that fund would be used. This enlists all senior bankers to police one another, since one or a few wayward senior bankers jeopardizes the pay of the entire C-suite. Consider it a whistleblower bounty in reverse. The idea surfaced with then-New York Federal Reserve President William Dudley. Public Citizen promoted this concept in our appeals to regulators as they considered the rule five years ago.

Ideally, Congress can build on the principles of this statute for other areas, such as recipients of CARES Act funding. Pay packages shouldn’t encourage CARES Act profiteering. Certainly, penalties that arise from misuse of taxpayer funds should not, in effect, be paid by taxpayers. They should be paid by executives, collectively. Beyond this, Congress should apply pay reform to all corporations, so that pay does not motivate misconduct. Public Citizen surveyed the intersection of misconduct and exorbitant pay that may have rewarded this misconduct.  Pharma executives pocketed millions after raising drug prices. A coal mining executive doubled his pay after cutting corners that led to the fatal Upper Big Branch disaster. Boeing’s CEO got a $62 million bonus connected to “cost saving” with the development of the fatal 737 Max jet.

The ”appropriate” regulators who must implement the statue are many, including the Securities and Exchange Commission, the Federal Reserve, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency, and the Federal Housing Finance Agency.

Congress also set a deadline for prescribing regulations: May, 2011. It was one of the few deadlines for the 400 rules from the Wall Street Reform Act, attesting to Congress’ and widespread understanding that bankers caused the crash because they were incentivized to do so, and they made a fortune.

Why Obama’s regulators failed to meet this deadline is subject to debate. It’s worth dwelling on this failure since Biden’s regulators must not repeat this error of neglect.

Many openly blame the requirement that five regulatory agencies must “jointly” prescribe the regulation, as did then Fed Gov. Dan Tarullo. Part of this regulatory gridlock and/or willful inattention may reflect Wall Street lobbying. Few incentives motivate a banker to petition the government  as much as protecting his own bank account.  Wall Street’s 3000 lobbyists certainly know how to petition the government.

Some, such as then-Rep. Michael Capuano (D-Mass) specifically questioned whether then-SEC Chair Mary Jo White  was obstructing work on the rule. She claimed in 2015 that a new rule would be out in the “very near future.” [It is now nearing 2021.] Progressives were skeptical of White from the start of her term. We questioned White’s nomination to be SEC chair since she’d worked as a corporate defense lawyer for Debevoise & Plimpton. She represented many of the firms responsible for the 2008 crash. She deflected those concerns, claiming that the SEC position would be her last job, that she would not return to Debevoise, a claim buttressed by her ethics disclosure declaration that she elected a lump sum retirement payment.  Days after she left the SEC chair, however, she returned to Debevoise. The firm’s first sentence description of her reads: “Mary Jo White, who has previously served as the Chair of the United States Securities and Exchange Commission . . . is leader of the firm’s Strategic Crisis Response and Solutions Group.” A “strategic crisis” is when you’re in trouble with the SEC. Who better to shield a corporation from the SEC than a person who once ran the agency.

Jay Clayton who is finishing his term as Trump’s SEC chair didn’t even claim to be working on Section 956, despite Congress’ mandate. In fact, whereas Chair White at least placed the rule on the SEC’s official “to-do” list, which all agencies file with the Office of Management and Budget’s Office of Information and Regulatory Affairs, Clayton omitted it.

When Trump nominated Clayton, Public Citizen and other progressives opposed confirmation because of his background at Sullivan & Cromwell representing the same corporate miscreants as White.

The reason for Trump’s regulatory inaction on Section 956 were transparent, and we spur the Biden administration to do better. Again, five agencies must jointly propose the rule. Biden enjoys the power to name candidates who will control several agencies. He can name the Comptroller, a one-person office. He can name a majority of the five-person FDIC. One of the five seats is vacant; the Comptroller automatically occupies another seat; and the director of the Consumer Financial Protection Bureau occupies another. Biden will certainly replace Trump’s CFPB director, who has inverted the agency into an abuse-enabling corp. Long serving member and former chair Martin Gruenberg, a Democrat, continues his service at the FDIC. Chair Jelena McWilliams’ term extends well into the Biden administration. She can be outvoted, but she sets the agenda.

Chair Clayton announced he will leave the SEC at the end of 2020. With two sitting progressive Democrats now on the commission, Biden’s replacement chair will ensure majority control there. With Clayton’s announced departure, Biden can designate a sitting SEC commissioner as chair, even before Clayton’s replacement is named and confirmed by the Senate.

Dr. Mark Calabria serves as Trump’s Director of the FHFA. A libertarian former staffer to Sen. Richard Shelby (R-Ala.) when the latter chaired the Senate Banking Committee, and then division chief for the Cato Institute, Calabria actually worked with Public Citizen to promote reform of banker prosecutions.  His job at Cato prevented him from lobbying on specific legislation, such as the pay proposals advanced by Public Citizen. As FHFA director, he will be required to take a position on this pay rule. Ideally, his libertarian principles about accountability will prevail.

The seven-person Federal Reserve represents, however, a clear obstacle.  Chair Jay Powell and Vice Chair Richard Clarida, both Republicans, can serve in those positions until February and September 2022 respectively. Powell can remain as governor (even if he is not reappointed chair) through 2028. Republican Randy Quarles, who serves as the important vice chair for supervision, can remain as governor until 2032. Republican Miki Bowman can serve through 2034. Two seats remain vacant. Trump nominated Judy Shelton, and Christopher Waller. The latter is  an economist and research director at the St Louis Federal Reserve Bank, and a Republican. They await Senate confirmation.  Shelton’s adherence to the gold standard and other controversial views (she’s questioned why the Fed should even exist) has led to concern even among Republican senators. Three Republican senators announced they oppose her (As did more than 100 economists, including seven Nobel laureates, and 78 former Federal Reserve employees.)  Shelton failed a Senate vote Nov. 17, and it is unclear  whether Majority Leader Mitch McConnell (R-Kentucky) can salvage her. In a few weeks, McConnell will only enjoy a two-senator margin when Mark Kelly replaces Sen. Martha McSally (R-Arizona). Arizona provides that a replacement senator must be seated immediately after state certification, which is due Nov. 30.  Those three Republicans who oppose Shelton along with the Kelly’s seating mean McConnell will need to act quickly after the Thanksgiving break.

Depending on the fate of Shelton and Waller, Republicans would control four to six the seven seats at the Fed through part of 2022. They might control a majority for much longer.

Of course, the Republican brick wall at the Fed poses a problem for Biden financial policy beyond Section 956. The Federal Reserve establish rules for bank holding companies, including the amount of borrowing they can do relative to their net worth (assets less liabilities), known as “capital.” The 2008 financial crash proved bank capital woefully inadequate. Obama’s regulators increased capital from woeful to thread bare, while Trump’s regulators relaxed the capital standards again to woeful-plus. The Federal Reserve also oversees the Volcker Rule, a Dodd-Frank statute aimed at limiting speculation by banks with cheap, taxpayer-insured deposits. At the very least, trading results should be made public, a simple but important reform that regulators can implement.  Transparency can help ensure that banks aren’t evading the principle. Trump’s regulators, led by the Fed, have been eroding the already frail Volcker Rule  guardrails.

One possible workaround is through what’s known as assignment of “the pen.” In a multi-agency rule, one agency might take the lead, holding “the pen.” The agency with “the pen” incorporates comment from the other agencies. While the Fed could still block any joint agreement, the agency with the pen could report this, such as a congressional oversight hearings. While it was never clear that SEC Chair White blocked progress on Section 956, it was also clear that she didn’t want to claim responsibility. Ideally, a Fed chair would similarly want to appear as agreeable and not an impediment.

Another workaround is for one agency to publish its proposal. While the final rule must be jointly signed by all the agencies, publication of a proposal would give a template for congressional  overseers to press the Fed on what, precisely, they oppose.

Given the Republican control of the Fed, it will be critical to appoint Main Street-minded regulators to the other Wall Street regulators.

To that end, the Biden transition team is populated by an excellent cadre of enlightened banking experts. Leading the Biden transition team is Ted Kaufman, a one-time senator and long-time advisor to Sen. Biden. He chaired the Congressional Oversight Panel, succeeding then Harvard Prof. Elizabeth Warren, now Sen. Warren (D-Mass). Kaufman has also called for breaking up the big banks. The banking sector transition team, which will weigh in with recommendations on regulatory nominations, includes AFL-CIO policy director Damon Silvers, former Commodity Futures Trading Commission Chair Gary Gensler, Center for American Progress officer Andy Green, MIT professor and Wall Street critic Simon Johnson, postal banking advocate and California Law Prof. Mehrsa Baradaran, and affordable housing leader Buzz Roberts.   Importantly, this group is laudably diverse with proven understanding of racial injustice in the financial sector that demands reform. And it’s a stalwart group well aware that personnel is policy and unlikely to forward nominee suggestions from Sullivan & Cromwell or Debevoise & Plimpton.

The frat party is over. Time to hit the books and finally publish Section 956. It’s nine years late.