Friday, December 12, 2014

Wall Street Writing Its Own Laws on Risky Derivative Trading

In just four years, Wall Street got away with weakening a part of the Dodd-Frank financial reform law, which became law in 2010 to protect the financial system from the excesses that led to the financial crisis in 2008. Wall Street bankers and their lobbyists accomplished their feat by luring members of Congress into a formidable conflict of interest, which I submit could have been obviated.

Just after a provision that lets banks trade in financial derivatives using deposits in FDIC-insured subsidiaries passed in the U.S. House of Representatives on December 11, 2014, Rep. Peter Welch of Vermont remarked, “This is exquisitely reckless—a special provision for Wall Street in exchange for money from Wall Street.”[1] Essentially, the big banks paid for the legislation. When the same language passed the U.S. House the year before, the New York Times reported that just weeks before, “Wall Street groups . . . [had] held fund-raisers for lawmakers who co-sponsored the bills. At one dinner . . . , corporate executives and lobbyists paid up to $2,500 to dine in a private room of a Greek restaurant just blocks from the Capitol with Representative Sean Patrick Maloney, Democrat of New York, a co-sponsor of the bill championed by Citigroup.”[2] Given the appearance of the conflict of interest facing lawmakers such as Maloney, it is telling that Citibank’s lawyers wrote 70 lines of the 85 line section of the bills that passed the House in 2013 and again in 2014. Such blatancy alone suggests that the practice of vested industry interests writing their own regulations is widespread in Congress.

The relevant section in the 2014 legislation. Relying on the bank's language involves a conflict of interest. (Image Source: Mother Jones)

As sordid as the practice must surely look to a public desiring to be protected from the risky derivative and swap trading that triggered the financial crisis in September 2008, Wall Street bankers and their paid lobbyists had no trouble looking past the ethical problem. “We will provide input if we see a bill and it is something we have interest in,” said Kenneth E. Bentsen Jr., a former lawmaker turned Wall Street lobbyist, who now serves as president of the Securities Industry and Financial Markets Association, or Sifma.[3] Bentsen was not about to hold back just because his involvement would create a conflict of interest for legislators. I suspect that he believed that his input would result in a stronger financial system, which is in the public interest; this belief could easily blind him to the problematic nature of his contribution to the conflict of interest facing members of Congress.

In 2013, Citigroup executives said the change they advocated was good for the financial system, not just the bank. Industry executives said that the changes, which were drafted in consultation with other major industry banks, would make the financial system more secure, as the derivatives trading that takes place inside the bank is subject to much greater scrutiny. That the closer examination is due to the heightened importance of banks in an economy—and thus risky trades are especially risky to the public good as well as the banks themselves—seems to have eluded the bankers. In fact, they were strangely comfortable with going back to the risky behavior leading up to the financial crisis in 2008. Marcus Stanley, a director at the nonprofit group, Americans for Financial Reform, said, “The bill restores the public subsidy to exotic Wall Street activities.”[4] That the view from Wall Street is partial, given the natural effect that self-interest has on perception, suggests that the rationale of being in the public interest justifies contributing to a conflict of interest facing lawmakers is flawed. I suspect that a poll on Wall Street would find little concern for putting lawmakers in such a bind, especially if the general public tends to accept institutional conflicts of interest as only mildly harmful.

On the Congressional side of the equation, we find lawmakers who recognize the conflict and accept it as a given rather than as something to be obviated. “I won’t dispute for one second the problems of a system that demands immense amount of fund-raisers by its legislators,” said Representative Jim Himes, who supported the 2013 industry-backed bill and lead the party’s fund-raising effort in the House at the time. A member of the Financial Services Committee and a former banker at Goldman Sachs, he was one of the top recipients of Wall Street donations. “It’s appalling, it’s disgusting, it’s wasteful and it opens the possibility of conflicts of interest and corruption. It’s unfortunately the world we live in.”[5] This rationalization is very common among people who allow themselves to exploit conflicts of interest. So it is worthwhile to unpack the excuse.

If Himes meant that everybody in Congress takes money from particular vested interests and allows them to essentially write their own laws, then the old adage applies—just because everyone is jumping off a bridge doesn’t mean you should do it. Alternatively, if Himes meant that the lawmakers must agree to take the money in exchange for allowing the regulated to write their own laws, then the question is whether such suspect funds are really necessary for an incumbent to be reelected. If so, public policy aimed at reducing political advertising costs may be the way to unwind the conflict of interest. Television stations could be required to allot substantial time for free political ads, for example, as part of the obligations that go with being licensed to use the public airwaves. Public financing of such ads could also be used. In short, institutional or structural conflicts of interest can be taken apart. The issue may come down to why we tend to overlook or accept them as only mildly harmful rather than inherently unethical and ruinous to the public good.



[1] Sabrina Siddiqui, Elise Foley, and Michael McAuliff, “Government Stays Open as Congress Advances Poison-Pill Spending Bill,” The Huffington Post, December 11, 2014.
[2] Eric Lipton and Ben Protess, “Banks’ Lobbyists Help in Drafting Financial Bills,” The New York Times, May 23, 2014.
[3] Ibid.
[4] Ibid.
[5] Ibid.