Congressman Barney Frank, former chairman of the powerful United States House Financial Services Committee at the height of the 2007–2011 global financial crisis, discusses the new order that is emerging in the banking and financial services world.
Here is the transcript of the video:
Emmanuel Daniel (ED): I am very excited to speak with Barney Frank, co-author of the Dodd-Frank legislation, the doyen of the Congress in the U.S., who has been in the thick of the reformation that has been taking place in the banking system in the U.S. with a lot of implications in the rest of the world.
Protecting the economy
ED: When you were putting the Dodd-Frank together, and even today when we think of what the banks have to do to keep the economy going, how much does international effects feature in your thinking?
BF: A great deal. First of all, it was clear that the world was interrelated. When the crisis hit in 2008, people said “Oh, this could be almost as bad as 1929-1930.” I think in many ways it could have been worse because in 1929-1930, there were separate things going on. By 2008, the whole world was in one grid. It was just one economy and we were aware of that. We were aware that what we did affected others and what others did also affected us.
When we were about to start regulating, we were aware that there are financial institutions, who could transfer their operations to other countries if they thought they were being tightly regulated in America.
During that period, I spent a good deal of time working with regulators and financial authorities from other countries, like Japan, the European Union, Britain, and Canada, who are closest to us. We were very aware that we were in an interconnected situation. One example that became controversial was when we insisted to regulate the activities of American banks in their foreign affiliates. What are happening to them there had a lot of impact on us.
ED: Right! But what happened in the end was the other way around. In a way, anyone with a dollar clearing business, which is practically the rest of the world, is now subjected to the American regulatory regime. So, unless you wanted to deal in another currency, the things that the Feds have been doing in the last two years – taking past foreign banks for information that they provide when they are clearing through the bank system – sounds like you have actually created a system where you now regulate the rest of the world.
BF: Well, we have one very particular rule that says that if there are regulations in other countries, which we believe meet the appropriate standard, then we defer to them. That is particularly with regards the derivative activities of banks. But beyond that, I think our view is that these are reasonable regulations and there is also an ongoing conversation.
As I have said, we talked very frequently with other regulators when we passed these laws. I know the American regulators themselves, in fact I’d say that in America, the Secretary of the Treasury, is now seen as almost as much of an international agent as the Secretary of State.
ED: Now, let’s go back to the architecture of the banking system where you played a pivotal role. Sixteen sections in a huge book, a lot of the proposed elements in the legislation have not been executed or are still in progress. Were they too ambitious? Should you have broken it up into sections like the “consumer protection” being legislated differently from banking?
BF: Two things. First, almost all of the important provisions are now set. I don’t think any harm came from the fact that they weren’t fully implemented because knowing that these rules were coming, banks weren’t going to rush in to do things which would subsequently have been ruled out. As to the size of the bill, we compared what we have done to what America did under Franklin Roosevelt, which was a similar situation where the financial system out-stripped the regulations and we had to catch up.
My response about the size is, if you look at what they had done in the Roosevelt era, it was almost the same size as what did. They did do them in separate bills and here’s the answer to that, it is a reasonable question. Originally, our proposal in the House was to adopt them as nine separate bills and that was how we worked on them. We had nine separate sets of hearings and committee meetings. A small technical point became a big one.
In the United States Senate, thanks to the filibuster, you need 60 out of 100 votes to pass something and we had 59 or 60 Democrats, then SenatorKennedy died. I said to Senator Dodd, Chairman of the Senate committee, “Look, we’re going to pass these nine bills.” He said, “Oh, please don’t do that. It’s hard enough to get 60 votes once. I can’t get 60 votes nine times.” So, we put them all together, but it did not make any difference in the end. The fact that they were all passed in one bill does not affect how they operate. Whether we passed them as nine separate bills or as one big bill, it would have had no difference.
One problem is that it has taken longer to implement than what we anticipated. Again, politics was involved. When we passed this bill, we had a Democratic majority in the House and the Senate. We did not anticipate that the Republican Party would take over the House in 2010. The Republicans are on the whole opposed to the bill, but it’s too popular for them to simply say we’re going to repeal it. So, what they were able to do was simply to withhold the funding that was needed particularly for the Security Exchange Commission and the Commodity Futures Trading Commission.
The major reason for the delay in the implementation, which was longer than what we thought, was that the Republicans took over the House, and they had significant control over the funding. The best example: the Commodity Futures Trading Commission got the major new jurisdiction over financial derivatives, which was the biggest innovation. That was the biggest gap in our regulation that there was nothing there.
That’s how AGI got in trouble with credit default swaps they couldn’t pay. The Commodity Futures Trading Commission, which has jurisdiction over financial derivatives with nominal, notional value in the hundreds of trillions, has a budget of $250 million. What happened was that the Republicans tried to slow it down. I think they thought they were doing the business community a favour by cutting off the funding, but many in the business community said, “No, because having these things drawn out and taking too long was not helpful.” But that’s the major reason why it took so long.
ED: So, what you are saying is that you constructed the architecture and then let the process breathe life into it and how it works out over the years depends on – ?
BF: Well, for one thing, you could not get more specific for two reasons. First of all, if you are providing rules to keep people from doing things that you think will be a problem, and if the rule is too specific, it can be easily evaded. If you say, “Don’t do A, B, C, D, and E,” they’ll say, “Oh, we just did A, C, D, and E. We didn’t do B. We can do it.” Secondly, you need to let things evolve.”
ED: So, you will be more British than what you realised?
BF: No, we were very aware of this. I talked very much with the British regulators throughout and we were aware of this.
ED: It’s funny because Dodd-Frank really reads like a rule book. If you read the principles of accounting, or the principles of governance, those read like principles rather than rules. How comprehensive were you setting out to be? Is Dodd-Frank breaking somewhat today, given the fact that non-banks are coming into the picture?
BF: We have given the regulators full power to deal with the non-banks. For the first time, we adopted some rules covering hedge funds. But for other institutions, like the Consumer Bureau, if you are lending money to consumers, you are covered. You can be called a bank or a lending company or Cirque de Soleil, and you are covered. What we understand is that the financial system is very interactive and you have to look at all the parts and cover all of them.
ED: Is there a return to Glass-Steagall in some way?
BF: No, Glass-Steagall became a symbol in America for people who do not like banks. First, no thoughtful person will believe that if Glass-Steagall would have stopped the crisis if it is still in effect. For example, I think the single, biggest problem of the crisis was the ability to securitise mortgage loans. Well, you could have securitised mortgage loans under Glass-Steagall but they never heard of securitisation. Sub-prime mortgages were not banned by Glass-Steagall.
Glass-Steagall said nothing about the whole question of derivatives. Let us go back to the first two institutions that caused the problem – Lehman Brothers and AGI. Glass-Steagall was irrelevant to them because they were not banks. So, what we said was that there may be institutions that are too complex and who are doing too much. We gave the regulators the power to do this, institution by institution rather than across the board, with one exception, and that was Paul Volcker’s rule. That was part of Glass-Steagall, but not the other parts and I don’t see that it is a problem if a commercial bank underwrites some IPOs, which was not the cause of the problem.
ED: You probably had three constituents in the back of your head when you were crafting it. You have the consumer, the taxpayer, who you do not want to be out of pocket because of banks, and the institutions themselves. Did you have multiple constituents?
BF: Yes, that is a very good conceptualization except that I would make this substitution. Instead of the institutions, the third category, and really the most important, was the economy. These institutions were the proxy for the economy. Yes, we wanted consumer protection, not overall related to the problem, although there were some interrelationship.
The extension of mortgage loans to people who should not have it was both a consumer abuse and a systemic danger. But yes, we were worried about the consumers. We were worried about protecting the taxpayer and we did that. By the way, one of the clearest things in this bill is that it is illegal now for the Secretary of the Treasury or the Federal Reserve to pay the debts of any institution that can’t make it on its own without putting first the institution out of business.
Secondly, and this is something that’s not noticed enough, any money that the Secretary of the Treasury advances to prevent a thing from spinning out of control, is mandated by law to recover it from other large financial institutions. So, the taxpayers are completely protected. The consumers get a great deal of protection under this new bureau. But the main purpose of this law was to protect the economy and the system. The basic point was that financial institutions could not be trusted to be left entirely on their own in deciding how much debt to incur and how to provide for it. That was a systemic concern. So, you’re right, it is focused on the institutions, but the institutions as the proxy for the economy.
Creating a workable model
ED: Having said that, if you look at the way in which the living wills are played right now, what do you think is the issue when it comes to a workable model?
BF: Well, first of all, I am very happy that you brought that up. There are three levels of protection for the system. First, we want to prevent large financial institutions from incurring more debt that they cannot pay off. That is s the problem and that was what I said to some of my Liberal friends who say, “Oh, isn’t the problem that the banks are too big?” No, the size of the institution is not the problem. The problem is the size of the indebtedness that they occur, which they cannot pay off.
This bill tries to severely restrict the ability of a financial institution to be indebted beyond its ability to repay. AGI had $170 billion that they couldn’t repay. That is the first set of rules. Then the second one is the living wills, which says that in case they get too indebted and we are going to step in, we want to have a plan. We don’t want to say, “Oh, look at this institution, what can we do about it?”
In fact, the two are related because one argument that many people make is that they are so complicated that nobody knows what’s happening. I think with a good deal of plausibility, this is one reason why institutions get indebted beyond their ability to repay. No single group of people have a span of control for the whole thing. So, the living will gives the regulators the ability to say “You are just too complicated, and we are going to have to break you up.’ That, by the way, is the part of the bill that Hillary Clinton has been focusing on.
ED: How would you describe the dynamics of the discourse between the chairmen of these banks and the regulators in not giving in to working out a model that makes sense?
BF: Well, I’d say two things. First of all, the first response from the regulators was, “Hey guys, we’re serious. You’re not taking this seriously. Don’t just go through this as some paper exercise unrelated to your reality.” Then there was a difference of opinion. You take JP Morgan Chase, run by Jamie Dimon, who is a very able and highly respected man. I think, there is a difference between some of the regulators and Mr. Dimon on how much he can handle. As good as he is, it is not a criticism of Jamie Dimon, they think it is a recognition of human limits. What you have is this view on the part of the institutions that ‘we can handle this,’ and the regulators saying, “No, we’re not sure you can. You better make sure and show us how.”
ED: In a way, it is a learning process, because a lot of these institutions’ leverage is actually outside jurisdiction. It’s global not –
BF: Well, they are subject to that. That is one of the fights we have. For example, one explicit thing we did was to say to the Security Exchange Commission and the Commodity Futures Trading Commission, “you are in-charge of the overseas derivative activities of American institutions.” There was an effort by some of the Republicans to cut that back when they took office in 2011. And that was ended by London Whale, the overseas affiliate of JP Morgan Chase, one of the best run institutions – what was important there was they were not only losing billions of dollars, but for some period of time, they could not tell how much they were losing.
ED: It was a problem. It was a learning curve for Jamie Dimon.
BF: What we said was, “No, we’re going to regulate that.” Unless again, and this goes back to your first question, the rule that was explicitly adopted stating that we will regulate you unless you’re in the jurisdiction of another country whom we believe is doing a good job. We’re not going to insist on doing it our way if they’re doing it in an appropriate way. But no activity of any American institution escapes that regulation.
ED: Dealing with institutions is one bit, but we’re also dealing with leaders who think they can hold it all together, right? And in the case of Jamie Dimon and the London Whale, he probably was on a learning curve himself. He was absorbing it. Do you think that to some extent – given the fact that you are both a legislator and a human being interacting with people like Jamie – you will give him more slack than you would give to others?
BF: No, not with the legislation. As far the regulators are concerned, yes, but he has to earn that with what he shows. That is, if he does this and says, “Look, here are the controls we have. Here’s what we will do. If this becomes a problem, here’s our response.” So, to the extent that any very talented, top official can show that that’s there is control. By the way, I want to go back in terms of what we’re talking about losing control.
One of the things that – this was new to me in 2008 –struck me the most was when Ben Bernanke told the leadership of Congress that he had to advance $85 billion to AGI to make good on their credit-default swaps. The next week, he was listing a total amount of $85 billion for AIG. We said, “Oh, no, you told us that last week.” His answer was, “Oh, no, this is another $85 billion.” AIG was not only $170 billion short of being able to pay off its obligations, it had no idea how much it owed. So, that’s when we said we had to step in.
Part of the idea of the living will is to say, frankly, we don’t think you’ve paid enough attention. And the living will is also a way to get them to pay attention. But finally, they said it is the second stage. If we reach the point where we are short of dissolving the institution, and we would like to cut it back, the living will is the way to do that.
ED: In hindsight, do you think that the U.S. Congress will have the appetite to save another AIG in the future?
BF: In fact, that’s a very good point. People have said the opposite. They said, “Oh, they are still going to bailout.” We were barely able to get the votes to do it the last time.
ED: Who were you conflicted with on that one? Because the fact that you had Hank Paulson, who was brave enough to come in and say, “Give me $85 billion,” at that point he was asking $700 billion…
BF: If you’re asking me personally, it’s an odd quirk of the American Congress. The committee on which I served – just to show how little we understood, as a country, the financial system, in the U.S. House of Representatives – one committee had jurisdiction over the securities industry and another over the banking industry. I was in the committee that dealt with banking. I never paid much attention to derivatives. I was concerned with housing for lower income people. I spent most of my time on that committee on international matters with the World Bank and the IMF.
We were surprised by it, but you’re right to mention the courage of Hank Paulson. Paulson became Bush’s Secretary of the Treasury in 2006, I became chairman of the committee in 2007, and we began a very close working relationship. In fact, there was a period in 2007 when I said he would ruin every weekend for me because on a Friday afternoon, after the markets closed, he would call me up to tell me about another crisis that was about to be happen. But no, we didn’t see that coming to that extent. They didn’t either, but again, that’s part of the living will. One of the things that struck me was how little they knew about their own situation.
ED: Here’s another dimension that is coming in the picture. The Fed is issuing as much debt as it had been doing, not just the Fed but every other central bank around the world, and the numbers seem to very interesting. For the moment, they seem to be profiting from the debt that they are issuing and the treasury is collecting all of that profit. You have a new dimension to global markets, the central bank, and governments being a market-maker in a way. What do legislators need to do to rein that in?
BF: It is very simple, better fiscal policy. What happened was that too many legislatures have said to the central banks, “We want you to make sure that employment stays up, but we are not going to do anything to help.” Now, it depends on your view, but I think it is very clear. Bernanke has said this, Yellen has said it, and others, I think even Draghi has said this, “We don’t want to be in-charge of stimulating employment. That is not our major function. But if you don’t, then we have to.”
ED: Central banks have two mandates: employment and economy, right?
BF: The American central bank has that unusually, but if you look at the ECB, they act as if that was their mandate. Draghi is clearly worried about employment as well. The Germans don’t like it, but everybody does. It is true that the American system is different there, but with the reasons why the central banks have stepped in, I’d be very supportive of what the Fed has done. Also, you made a very important point that we have made money from this since the beginning, but the problem is that the Congress has not done its job in fiscal policy and I think the legislatures have on the whole abdicated any responsibility for keeping employment up and put it all on the central bank.
Governance and fiscal responsibility
ED: Is the fiscal responsibility in the U.S. system coming back at any point in time?
BF: Yes, if Hillary Clinton wins the Presidency, which I believe she will. This is very much being decided. If Hillary Clinton wins, and I think it is very likely that you will see a Democratic Senate and an increased Democratic role in the House, you will see a massive program for doing roads and bridges and public transportation in America.
ED: Why are those programs not set in place while the quantitative easing was taking place?
BF: Because the Republicans controlled one bench of the Congress and they are philosophically opposed to it. I mean, that’s very straightforward. There are two issues here. One is, you believe in a kind of stimulative effect, a king of New Keynesian, and they do not. Many of the Republicans believe the smaller the government role, the better the economy will be. I think that’s contrary to the fact but that is their belief. The other is a philosophical kind of Libertarianism. It is bad for the government to do this and it is bad for the central government to do it.
ED: While the government was issuing all that debt into the market.
BF: Well they were opposed to it. Look, there were no politicians who were saying it’s a good thing for the Fed to do this and for Congress to do nothing. There were people who controlled the House of Representatives who didn’t want fiscal policy. They were all opposed to a stimulative monetary policy, but they couldn’t stop it.
ED: Can you see Trump being fiscally responsible?
BF: The man is incoherent. I have no idea. When he says that he doesn’t worry about the debt because America will not pay it in full, that is just extraordinary. He has confused the United States with one his casinos.
ED: He is speaking as to what actually exists in the market. If 75% of American debt is actually outside of the states, the U.S. dollar circulates more outside than inside the U.S. If a lot of that came back home to roost, then you have a problem. But you know that it is not. So, he’s speaking a truism.
BF: No, it is not. That’s not remotely the case. In fact, he was advocating that. Yes, and in fact, that’s very self-defeating. If he really got people to believe that there was a serious likelihood that we would not pay every dollar, in the first place, we’d have to pay them out more. The risk premium would suddenly go way up. The fact is, America borrows more cheaply than almost any other entity in the world. Why would you want to pump up our borrowing cost by threatening that we’re not going to pay people off?
ED: Having said that, the Bernie Sanders option is maybe more Communism?
BF: No, he is not a Communism fan. He is a Socialist, but it is a new form of Socialism. He’s not for nationalizing very much. It’s a kind of aspirational Socialism. I am supporting Hillary Clinton, but no, you would not see him – it is more like Tony Blair and New Labour, not even that far.
ED: What do you think is the ground asking for when you look at this phenomenon on the kind of support that Trump gets?
BF: There is nothing that people are asking for. They are angry and I do think, and this is something that we have to take into account, there is this anger, and it’s undeniable. Given the nature of the world, in terms of equality in the developed world as greatly exacerbated, what you’re getting is anger at the fact that the people’s income is not rising.
ED: Here is an indictment on Dodd-Frank, “From between 2000 and 2007, 159 new banks. In 2012, there were only ten applications for new banks, four approved, and one, which was a credit union being upgraded. Where do you think is this this pull-back from being interested in the banking business in itself coming from?
BF: I think what we had in 2000 to 2007 was that we made banking too easy, especially that you had a situation where, thanks to securitisation, the quantity of loans you made became more important than the quality of loans. You can get into the business of lending people money without regard to whether or not they were going to pay you back because you can package it into a security and get a rating from the most irresponsible of the entities there. The rating agencies are just sitting there making stuff up, giving AAA ratings to junk. So, I think, what happened was the banking system expanded too much because it was making loans that should not have been made.
ED: Going forward, in terms of how the world is evolving, the move towards becoming more conservative, and the anger that is being spread, what do you think politicians should do?
BF: First, I would say that it is not moving more conservative in America. I think it’s going to wind up with a Democratic victory and the anger of the population has both a left and a right aspect. You do have Bernie Sanders.
ED: In fact, I find it difficult to label it either left or right.
BF: Well, you have Syriza in Greece and Podemos in Spain. What we have to do is a better job of seeing that the increased wealth is distributed less unfairly and, I think, that’s the key. Trade is an example, and I have been skeptical. I have held this position since I first got to Congress and their vote against NAFTA.
Is trade good or bad? The answer is yes. Trade is good for the overall economy, but in developed countries, certainly in America, it has the effect of shifting from the lower income people to higher income people, from people who were doing basic manufacturing to people who were into the intellectual properties side. What we need to do is to put in public policies that take some of the increased wealth that you are getting from increased technology and the globalization process, and provide it to people who are not going to be doing as well, not just who are not doing as well, but how they were hurt by it.
ED: Can you conceptually accept that there will come a time when America will not be the greatest country in the world, not because it’s not trying hard enough, but because a lot of the mechanics are changing, such as automation and robots, for example?
BF: It doesn’t bother me in the slightest. When you say ‘greatest,’ you mean most powerful?
ED: Well, it is many things, isn’t it?
BF: It doesn’t bother. Yes, I welcome that. This notion that we must be the leader of the world – why? I think people in Norway and Denmark should be very happy. Look, America got into that sort out of necessity. My focus is on making things as good as it can be in America. If it turns out there is another country that surpasses us in GDP per capita, why would I be mad that them? Why would I be unhappy? At some point, China’s GDP will be greater than America’s. Of course, it should be!
ED: Not because of its own reductionism, but it is more on how the rest of the world looks at America for a number of things. We look up to America, where freedom is taken to its logical extreme and where a lot of the good things are coming out of that. A lot of people look to America for how capital is formed, deployed, and changed. A lot of people look to America for ways how ideas are created.
BF: I agree with you, but I want to judge those in the absolute, not in the comparative. Going back to your question if I am worried about how America’s relative standing in the world is deteriorating. Yes, it should, it is artificial. America became this colossus because we emerged from World War II as the…
ED: As the reluctant savior?
BF: Well, here’s what happened. Every developed economy in the world, even the semi-developed economies in the world, were devastated by World War II. America gained from World War II. Now, obviously we had a great loss of life.
From 1945 to 1970s, and until OPEC came up, America had an unrealistic dominance in the world. We could make anything and sell it anywhere. But it was never going to be, nor should it be, that our small percentage should be so dominant forever. But I don’t want to see a deterioration in the absolute.
The things you talked about, capitalism, our freedom, our intellectual property. I would like to add to that a fourth, which is doing a better job of distributing that in a less unequal way. But I want to continue those things as themselves good. Whether another country exceeds us in that regard, good luck to them. Why would I begrudge them what I want for my own country?
ED: How do you read China?
BF: Sadly, for years, there has been these hopes that the Internet or the economic development – because you mentioned freedom first, and I appreciate that you did. China, unfortunately, appears to be diminishing freedom, the notion that a capitalist economy, a market economy, the internet, that that’s going to lead to more freedom. No, Xi seems to me to be going in absolutely the opposite direction.
ED: But Xi is going in one direction but a lot of the innovations taking place in China, ironically, is a freedom of a different kind.
BF: Yes, it is economic freedom for Jack Ma and for Alibaba. But the argument for many on the conservative side, “Oh, the free market economics brings political freedom.” Unfortunately, it doesn’t. I wish it did. I read China as obviously doing better economically, although in fact I think China is a reminder that the market has a discipline that you should not ignore. China clearly tried to force the pace and I think this is causing them some problems.
But my great sadness is that Xi is going in the direction of basically saying we can make progress in economic freedom to a great extent, at the same time diminishing intellectual and political freedom and I’m sorry to see that.
ED: I asked you these questions in the context of you being a life-long career Congressman whose first job is to mobilize your own people. What do you worry about most of all when you think about the American population today?
BF: The fact that we have done too little to deal with increasing inequality, and that we allowed to monopolize the increased wealth by a small number. I have two reasons for deeply regretting that. One is that it’s just unfair. There are children who should not have struggled as much as they do. There are middle income people who shouldn’t have these concerns.
But the other is the political impact of that, which you’ve eluded. I think we’re in a vicious cycle in America. People have this expectation that government will see that they are treated more fairly and when they aren’t treated fairly, they blame the government, and when they blame the government, they vote for people who hate the government. The more they vote for people who hate the government, the less likely it is that government will make things fairer. The less likely it is that government makes things fairer, the more they vote for people who hate the government. That is a vicious cycle that we have to break.