By Bart Naylor
Following the second biggest bank collapse in U.S. history—Silicon Valley Bank— the Biden administration is closing in on a major Wall Street reform. This is HUGE. To understand, a quick look at history. The fall of 2008 was a momentous time. America changed which political party controlled the White House, Wall Street crashed the economy, the Bush administration shoveled a record amount of taxpayer dollars to bail out the mega-banks, and the first of what would be millions of individuals lost their savings, jobs, and houses. Barack Obama, a Harvard-trained lawyer and former community organizer in touch with working people, won the election with a mandate to bring “banksters” to account for the harm they caused Main Street Americans and ensure a similar financial crisis could never happen again.
Unfortunately, policymakers fell short when it came to accountability for the individuals most responsible. Bank regulators failed to replace any senior executives. Even when the U.S. Department of Justice (DOJ) brought criminal fraud cases against the mega-banks, prosecutors didn’t name a responsible individual, let alone try and convict one. It’s as if the crimes were immaculately conceived.
Public Citizen (my employer) applauded the focus on systemic problems but recognized the need to also hold bad actors to account. U.S. Attorney General Eric Holder even confessed that in the case of HSBC, the world’s biggest bank, which was found guilty of massive money laundering, Obama’s DOJ deemed some firms “too big to jail,” although he used other words.
The biggest bailout in 2008 went to insurance giant AIG, which had written bond insurance (credit default swaps) but was then unable to pay claims when those bonds (collateralized mortgage obligations) defaulted. U.S. Treasury Secretary Timothy Geithner did not seek accountability for the gang at AIG that wrote all those insurance contracts. Instead, officials approved a collective $165 million bonus pool for them.
To give credit where it is due, Obama’s team did shepherd a major banking reform legislation through Congress. The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act created the U.S. Consumer Financial Protection Bureau, the brainchild of then Harvard Law Professor Elizabeth Warren. U.S. Sens. Carl Levin (D-Mich.) and Jeff Merkley (D-Ore.) added an important provision to combat bank gambling, the eponymous (Paul) Volcker Rule, conceived by the former Federal Reserve chair in an op-ed.
Importantly for individual accountability, the law created a vehicle to rein in the types of bonuses that incentivized bankers to commit the frauds that led to the 2008 crash. It’s called Section 956. The statute itself is simple and elegant. It prohibits any compensation structure that could lead to “inappropriate” risk-taking.
But the rule implementing this provision must be done right. Real reform requires that a sizeable chunk of the banker’s bonuses be deferred into a collective fund that is withheld for years. If their bank fails or is found guilty of misconduct, then this collective fund is used to pay penalties and uninsured depositors.
This approach makes every banker a bonus-incentivized inside police officer. That’s better oversight than bank regulators, shareholders, bondholders, board directors, bond rating agencies, or any other mechanism. This is how many private firms work and how investment banks used to work. If the firm screws up, the money to recoup comes out of the bonus pool for everyone.
Federal Deposit Insurance Corporation (FDIC) board member Rohit Chopra, who currently directs the U.S. Consumer Financial Protection Bureau, highlighted this reform in a March 10 interview with The Washington Post.
Congress wrote a nine-month deadline into Section 956, emphasizing its urgent importance. But shockingly, the provision has never been implemented. The agencies in charge of writing the regulation in the Obama era floated two proposals, the last one in 2016, but never finalized either. President Donald Trump’s team didn’t even propose a rule – hardly a surprise.
Now there’s a new financial policy team. Biden administration regulators that would handle banker pay reform include several former aides to now U.S. Senator Elizabeth Warren (D-Mass.). Treasury Secretary Janet Yellen did not spin through the revolving door from Wall Street, as did her predecessors. Martin Gruenberg chairs the FDIC, where he’s worked for decades following service to financial reform and good government advocate U.S. Sen. Paul Sarbanes (D-Md.). Michael Barr is vice chair for supervision of the Federal Reserve, coming to this position not from a bank, but from the University of Michigan law school. Gary Gensler, who chairs the U.S. Securities and Exchange Commission, did work for Goldman Sachs but proved his Main Street bona fides as a vigorous enforcer when he chaired the U.S. Commodity Futures Trading Commission.
These regulators and a few others are now working to finalize the years-overdue banker pay reform rule. The collapse of Silicon Valley Bank (SVB) has, once again, illustrated the consequences of misplaced bonus pay and the urgent need for such a rule.
Personnel is policy. We have the right people for the job right now. It’s important to make sure the regulators responsible for this critical reform appreciate the gravity their job in the wake of SVB’s collapse. Main Street is cheering them on to do right.
Naylor is the financial policy advocate for Public Citizen.