Gerald Epstein is codirector of the Political Economy Research Institute (PERI) and Professor of Economics. He received his Ph.D. in economics from Princeton University. He has published widely on a variety of progressive economic policy issues, especially in the areas of central banking and international finance, and is the editor or co-editor of six volumes.
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Paul Jay, Senior Editor, TRNN: Welcome to The Real News Network. I’m Paul Jay in Washington.
If you listen to President Obama, his State of the Union speeches or other times, he talks about financial reform and financial regulation. If you pay attention to mainstream media, if you listen to most mainstream politicians, you would probably come to the conclusion that Dodd–Frank, the financial reform bill that was passed by Congress and signed by President Obama, has kind of got it covered—we have financial reform, don’t worry about it. Well, perhaps that’s not the case.
Now joining us to deconstruct the real state of financial reform in the United States is Gerry Epstein. Gerry is codirector of the Political Economy Research Institute (PERI). He’s a professor of economics at the University of Massachusetts Amherst. He’s published widely on a variety of economic policy issues, and he’s recently written a blog called “Bankers’ Assault on Financial Reform”. Gerry now joins us from the PERI institute in Amherst. Thanks for joining us again, Gerry.
Gerald Epstein, Peri Codirector, UMass Amhers Professor: Thank you, Paul.
Jay:So perhaps we’re not so safe as we thought. Give us your kind of overall take what’s happening, and then we’ll kind of dig into some of the issues.
Epstein: We’re not safe at all. Dodd–Frank has not been implemented. The way it was written, it left the field open for hundreds of rules that had to be made by various regulatory agencies, which basically allowed the bankers to come in and spend millions of dollars lobbying to gut the rules and to do in the regulatory stages what they couldn’t do in the congressional stage a couple of years ago. So the bankers have spent hundreds of millions of dollars—the latest estimates were well over $100 million last year—trying to gut Dodd–Frank, and they have a multi-front strategy that so far has been very successful.
Jay:And this was part of the criticism I know I think you had mentioned, and other interviews we did at the time on The Real News, was that some of what Dodd–Frank was should have been more law (like you cannot do this) versus regulations (we’ll figure out what you can do or can’t do), ’cause once it’s in the realm of the regulatory environment rather than straightforward law, then the regulatory agencies are subject to, number one, all this lobbying, and two, partly to a large extent what the Republicans are pushing is just simply underfunding these agencies, so even if there is a regulation they can’t do anything about it.
Epstein: That’s right. And as I said, there’s this multi-front strategy. One is to underfund the agencies that have to make and enforce all these rules—the Commodity Futures Trading Commission (CFTC), the Securities and Exchange Commission (SEC). The Republican-led Congress are trying to underfund these. They’re also bringing lawsuits against these agencies when they make rules that the banking lobbyists don’t like. They’re putting forward weekly bills in Congress in the House of Representatives to gut these rules even further. So this process is completely being taken over.
Jay:Well, let’s dig into some of this. One of the issues that was most talked about was something called the Volcker issue, which was supposed to limit and contain proprietary trading. So, first of all, tell us why that matters, and then where are we at with this Volcker rule.
Epstein: Well, proprietary trading rule, the Volcker rule, is important because these large banks like JPMorgan, Goldman Sachs, Merrill Lynch, and others took on billions of dollars of debt, and they used that debt to create dangerous products like collateralized debt obligations, credit default swaps, and so forth, sold these to unsuspecting customers, and then, when the crisis hit, they had to bring these products back on their own balance sheets, and this pushed all of these banks into virtual insolvency, and the government had to come and bail them out. So the Volcker rule was designed to prevent these banks from taking on so much risk, so then the taxpayer wouldn’t be on the hook again.
And the rule was written in such a way that it had a strict, bright line against proprietary trading. But even when it was written, many loopholes were put into it, for example, an exception for market-making by these banks and hedging by these banks. Those were problematic enough. But in the writing of the rules, the banks have come in and broadened those exemptions, so that now they can drive barrels of money through them. And the rules have gotten so complex now that the Federal Reserve just came out and said, well, it’s so complex, we’re going to need another couple of years before it’s really going to be implemented. And the bankers, like Jamie Dimon and others, are coming out and saying, oh my gosh, this rule is so complex now, let’s just gut the whole thing. So in fact this was part of their strategy.
Jay:Didn’t Volcker himself said he thought this could have been written on one piece of paper?
Epstein: Yeah, Volcker himself thought, look, let’s just have a really bright line against proprietary trading, let’s have the heads of the banks sign a piece of paper saying that they’re not going to engage in proprietary trading, hold the heads of the banks accountable. So he thought it could have been done much more simply. However, even Volcker says, look, even though it’s more complex now, it still would be a lot better than the way we were before.
Jay:But it’s been put off two years, and two years from now they can make the same argument. And I guess they’re also trying to put it off hopefully for them to have a Republican administration, which means they’ll even have even more success than they’ve already had. So the delay helps in many ways for them.
Epstein: That’s right. It’s a waiting game for them, and they’re banking on more Republican support. The odd thing, of course, is the Republicans are running on an anti-bank, populist kind of platform, but they’re doing nothing but supporting the big banks. And even a number of Democrats are going along.
Jay:Well, I was just about to say it’s not like the Democrats, you know, pushed—what Volcker himself actually wanted was a straightforward law, a simple law on this issue. The Democrats in charge of this process, you know, collaborated with the Republicans in making this process so complicated and so open to lobbying. So it’s not like they didn’t have a chance to do more than they did.
Epstein: There were some strong Democrats pushing for better laws, and sometimes they prevailed, but that’s right, there were a large number of Democrats who were reluctant to have—.
Jay:Yeah, there were individual senators and congresspeople that were fighting for something more.
Epstein: And now we’re seeing the same kind of thing happening in Congress itself, in the House of Representatives, where weekly the Republicans-dominated House puts up these bills to broaden these exemptions even more, and some of them are even sailing through the House with broad Democratic support.
Jay:So let’s talk about another part of the major issue that was supposed to be regulated. People said it was critical that it was. And that’s the issue of over-the-counter and unregulated derivatives. And am I correct? The size of this derivatives market, what they call dark markets, I think, is something like $600 trillion? Like, it’s—what is it?—three times bigger than the global economy, and it’s essentially unregulated.
Epstein: That’s right. It’s massive. It was essentially unregulated. One of the major achievements of the Dodd–Frank Act was to bring at least a large part of this under scrutiny and under regulation. And now a lot of the emphasis of the financial lobby, and not just the financial lobby but the commodities traders, the oil speculators, a lot of what they’re trying to do is prevent this market from having any regulation at all. And so there was a recent ruling by the Commodity Futures Trading Commission that raised the bar so that so many of these firms that engage in this kind of derivatives trading will escape regulation. The original bar was firms that have fewer trades than 100 million a year would not have to be regulated, but everybody above that had to be regulated, and that would have captured about 70 percent of the firms. They recently raised the bar to 8 billion average trades in a year, and so more than 80 percent of the firms will escape any regulation at all, and even the largest firms probably will be able to escape by separating their trades into different subsidiaries offshore and in other locales, and so that at this point, if this goes through and continues, this attempt to regulate this unregulated market—.
Jay:How did that get through the future trading commission? How did it get through there? That’s controlled by, supposedly, three Democrats.
Epstein: Well, there are several Republicans there, and not all the Democrats are on board. Part of it is the massive campaign contributions. The financial lobby has spent hundreds of—as I said, hundreds of millions of dollars. But, also, the Commodity Futures Trading Commission and the SEC, they’re intimidated now, because if they go against these lobbies, then the lobbies bring lawsuits and try to bollocks up the process that way. So there’s a great degree of intimidation going on of the regulators now.
Jay:I mean, that’s crazy. You raise it to $8 billion, it’s totally escapable.
Epstein: That’s right. And a lot of this, as I suggested, is for the commodities trading firms. It’s not just what we think of as the banks and the derivatives-trading financial institutions.
Jay:Okay. So there’s another issue, which is a bill passed the house, HR 3336, I think it’s called, the Small Business Credit Availability Act. What’s the significance of that?
Epstein: Well, first of all, it has nothing to do with small business. And part of the annoying thing about this is they always name these bills so that if people vote against it, they can go out and campaign against them, saying, oh, you’re against small business. But once again, this was to take this basic $8 billion exemption that I talked about and extend it even further, so that firms that are engaging in these kinds of derivatives trades and so forth will be able to escape scrutiny. So this is whittling away even more, so that 15 percent that might’ve gotten caught in the regulatory net before are now going to be able to find it easier to escape.
And this kind of bill, it took a massive lobbying effort on the part of Americans for Financial Reform, Better Markets, and other groups to just get, you know, 70 or, you know, to just get 100 Democrats to vote against it. It still passed the House because the Republicans voted party-line. But it’s a big effort just to even get a subset of the Democrats to vote against these things.
Jay:Yeah, I think it’s an important point that to the extent that there is some movement, regulatory movement, a lot of it is the result of a lot of grassroots organizing. I interviewed Bart Chilton, who’s a member of the Commodity Futures Trading Commission, and he said he was seeing a hundred industry lobbyists, if not more, to one reform lobbyist. But still there was a presence there of reform lobbyists, which I think is important. People are fighting on this. But when something does get passed, even if it’s weak, like the position limits that were passed, now the industry’s going to court to fight the—even fight the idea that there can can be limitations on position limits. What’s going on with the court cases now?
Epstein: There are a lot of court cases, as I said, and they’re using these rules that say there has to be a cost-benefit analysis done to show that imposing regulations do not impose greater costs than the benefits that are gotten from them. So the presumption is that deregulation or unregulated markets is best, and so, in order to regulate these markets, there has to be a hurdle gone over to show that the benefits outweigh the costs. Well, this is completely putting mud into the regulatory works. I mean, it’s completely backwards. We know from experience that the deregulated markets have caused this enormous recession/depression that we’re in. So the Congress, in choosing these rules, has already made the decision and the analysis that the benefits outweigh these costs. So this is just a tool being used to try to prevent this kind of regulation.
Jay:Well, it sounds like it’s a delaying tactic. I mean, if Congress can’t decide what’s in benefit of the society and they do the cost-benefit judgment and then they vote on something, I mean, how can you undo that in court? It doesn’t make any sense, other than to delay the whole thing.
Epstein: That’s right. And it’s very costly to try to do these kinds of analyses. So you have to hire lots of, quote-unquote, “experts”, and it’s hard to find experts that will do reasonable jobs on these things. So it really is a way of just trying to gut this regulation.
Jay:Alright. So the argument the banks would made—if I had a banker here, he would probably say, if I can try to put words in their mouths, okay, maybe all of what you’re saying, there’s some truth to it, but the bottom line here is if the banks don’t have liquidity, they fall. So all of these measures are going to limit bank liquidity, and that’s more dangerous to the whole system than anything else that’s going on, so you’d better get out of our way; otherwise, these measures are going to cause the problem.
Epstein: That’s right. Cost-benefit analysis is one set of boring economics terms that they’re using in the banker’s defense. And this notion of liquidity is another one of these arcane terms. One of the really powerful ways in which the banks have been operating is that they have gotten their customers to support them in gutting this regulation, and they’ve gotten the customers to say, well, look, we need liquidity in order to sell our bonds, in order to do our investments, and if you impose the Volcker rule or you impose these other kinds of regulations, that’s going to inhibit the ability of banks to provide liquidity to these markets, and our cost of borrowing and our cost of investment is going to go up. And you have economists, some very well-known economists, like Darrell Duffie at Stanford University, who write these papers, are trying to show that, you know, you impose the Volcker rule, that’s going to make liquidity dry up and it’s going to harm the economy.
The really silly part about all of this is they use data from the financial crisis itself when the banking system crashed. And yes, liquidity did dry up, and yes, that did have negative effects, but the reason the banking system crashed in the first place is because these banks were engaging in all kinds of proprietary trading, using all kinds of liquidity inappropriately. And it’s precisely that kind of trading and that kind of inappropriate liquidity that rules like the Volcker rule are meant to prevent and to prevent these crises from continuing to happen.
Jay:I mean, they’re sitting on—what is it?—$1.5 trillion dollars right now, and they’re worried about liquidity?
Epstein: That’s right. The fact that the banks are sitting on almost $2 trillion of excess reserves and the corporations are sitting on another $1 trillion or so—there’s plenty of liquidity in the market. And in the next bubble, if we don’t impose these rules like the Volcker rule, the liquidity’s going to go into all kinds of risky and toxic products that will crash the system again.
Jay:Well, as you said in your opening of your blog, the bankers are fighting this. They for now seem to be winning. And to quote you, then they’re going wee-wee-wee all the way home.
Epstein: That’s right. And, as you suggested, there are a lot of valiant and smart and hard-working activists from the Americans for Financial Reform and Better Markets and the AFL-CIO and others, SAFER, a group here centered at PERI. But we need more help, we need more support, we need more economists and others to fight against these things.
Jay:Alright. Thanks for joining us, Gerry.
Epstein: Thank you.
Jay:And thank you for joining us on The Real News Network.