Epstein: Regulations announced by President Obama don’t prevent “too big to fail” banks

Story Transcript

PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I’m Paul Jay in Washington. On Thursday, President Obama came out swinging against Wall Street and the big banks—or did he? Anyway, let’s first of all see what he had to say.

PRES. BARACK OBAMA: For while the financial system is far stronger today than it was one year ago, it’s still operating under the same rules that led to its near collapse. These are rules that allowed firms to act contrary to the interests of customers, to conceal their exposure to debt through complex financial deals, to benefit from taxpayer-insured deposits while making speculative investments, and to take on risks so vast that they pose threats to the entire system. It’s for these reasons that I’m proposing a simple and commonsense reform, which we’re calling the “Volcker Rule” after this tall guy behind me. Banks will no longer be allowed to own, invest, or sponsor hedge funds, private equity funds, or proprietary trading operations for their own profit, unrelated to serving their customers. If financial firms want to trade for profit, that’s something they’re free to do. Indeed, doing so responsibly is a good thing for the markets and the economy. But these firms should not be allowed to run these hedge funds and private equity funds while running a bank backed by the American people.

JAY: Now joining us to try to unravel what President Obama actually means by what he said is Gerald Epstein. He’s codirector of the Political Economy Research Institute, known as PERI. He’s also one of the organizers of SAFER, a committee of economists that’s promoting economic reform in Washington. Thanks for joining us, Gerald.


JAY: So, first of all, did President Obama announce something that will actually take on and stop too-big-to-fail?

EPSTEIN: No. What he announced was something that is going to get the ball rolling again in a process that’s been completely stopped now in the Senate, and that will once again put on the agenda the possibility of doing something to stop the banks from crashing the system again.

JAY: Okay. So let’s try to figure out whether this is more than election positioning. Let me tell you what I understand of what he did, and then tell me if this is correct and whether you think this is enough. So we had a situation where, prior to the crash, more or less prior to the fall of ’08, investment houses didn’t have access to the Federal Reserve discount window, which means they couldn’t get this practically-zero-interest-rate cash out of the Fed. But they were virtually unregulated, and they had all the financial products, which are essential financial—complicated shenanigans. They now become commercial banks through becoming bank holding companies, in theory subject to the kind of regulation Obama talked about on Thursday, except all something like Goldman has to do is give up, go back to where they were before they became a bank holding company, and we’re back where we were. So what did this actually accomplish, what he’s talking about?

EPSTEIN: Well, there are several things. First of all, Goldman, if this policy gets put into law, Goldman would not be able to start accepting a lot of insured deposits and then use those insured deposits to do this kind of proprietary trading.

JAY: Which they couldn’t do before the crash anyway.

EPSTEIN: That’s right. But now that they’re bank holding companies, in principle they could do that; they could start creating a big retail banking business, where they could take insured deposits. But they would not be able to do this, and they would not be able to use the discount window. But I think basically you are right that Goldman doesn’t need the discount window, really. They’re able to raise all kinds of money on short-term markets, repurchase agreements, and other kinds of short-term borrowing, and use that money, which they’re able to borrow at very low interest rates because the Federal Reserve policy is to keep interest rates close to zero. They can borrow that on the open market, engage in proprietary trading of a very risky nature, gambling, essentially, make a lot of money, which then goes to huge bonuses for their rainmakers, as my colleague Jim Crotty calls them, and take on very risky bets that could crash the system.

JAY: It’s back more or less from the Goldman and companies like Goldman. To some extent it’s back where we were before the crash, except for one very important factor: they’re even bigger now than they were then, because a lot of their competition’s gone down, and Goldman’s gotten even bigger during this process.

EPSTEIN: That’s right. They’re bigger now and still they have access to even cheaper credit than they did then, because interest rates are so low. So, yes, this does not really do anything to the Goldmans of the world, and if anything, as you suggested, they might even be in a slightly better position. What it does do, though, is limit what Citibank, Bank of America, the real commercial banks are able to do, at least in theory, depending on how this is really implemented.

JAY: So this is particularly an issue now where some of these banks now—like, Bank of America owns Merrill Lynch, where they picked up—some of the investment houses came under the bank roofs.

EPSTEIN: That’s right.

JAY: So maybe this could force them to give that up or separate it. Is that possible?

EPSTEIN: Well, again, depending on how it’s implemented, yes, that’s possible, because those arms of these bank holding companies would not then be able to engage in these trades for their own accounts that generates profits for their shareholders or bonuses and income for their executives. They would have to sell off those kinds of activities or move them someplace else that is outside the purview of this rule. So it may well effect what Bank of America, Wells Fargo, Citibank can do.

JAY: So is that good, then? So, in theory, some of these commercial banks would be less vulnerable or not?

EPSTEIN: Well, I think it could be useful in the sense that these big banks, which are at the core of the financial payment system, which should be at the core of the financial monetary system, as Paul Volcker, I think, has correctly said, may be a little bit less risky than they would have otherwise. But let’s not have any illusions: this will not solve the problem. But it is a step in the right direction with respect to those kinds of financial institutions.

JAY: And in terms of the PR value of this, so much seems to be connected to the Massachusetts election.

EPSTEIN: That’s right.

JAY: Now, we know these things didn’t just get figured out in the last week. The administration’s been working on these regulations for couple of months. But the substance of what’s being said seems more like election positioning than a real reining in of Wall Street.

EPSTEIN: Absolutely. I think that’s correct. But if you put this on top of the other announcement, the bank tax, and you look at this lineup that was on TV when Obama spoke yesterday, and look at who was not there—Larry Summers—and look where [Timothy] Geithner was—over on the side—and you look where Paul Volcker was—right there—.

JAY: All carefully worked out ahead of time.

EPSTEIN: Yeah, absolutely.

JAY: They’re sending some kind of message, yeah.

EPSTEIN: In the middle. They’re sending a message, and it may reflect something a little deeper that’s going on that has some potential. It may be that finally Obama has seen that following the path of defending Wall Street, protecting Wall Street, going back to square one before the crisis, just trying to hit the reset button, this policy has failed politically. They can no longer just listen to Summers; they can no longer just listen to Geithner. So it may signal a more serious shift in the underlying politics of financial reform. And it may not. So we really have to see.

JAY: Well, one of the things, I think, that would be a litmus test of—if—whether they’re serious about this is the government owns AIG, the biggest insurance company, which insures these banking products and which, I think it was—was it $18 million of insurance was paid to Goldman?


JAY: Now, if that’s the case, then can’t they use AIG as an enormous leverage on Wall Street to say, you know, when you have dangerous financial products, go ahead; we’re not going to insure them, and no one’s going to back you on this, and you can’t hedge your investments using our insurance fund. Is there any suggestion they’re doing that? And not only that, AIG could also say, “We’re not going to rely on these rating agencies. We’re going to do our own assessment. And if we think what you’re selling is crap, we won’t insure it.” Is there any suggestion they’re heading there?

EPSTEIN: Absolutely not, and I think you’re completely correct that if there’s going to be real reform, there are a number of things that have to happen. One of them is to use these institutions that we the taxpayers own—notably AIG, but there are others, the government-supported institutions like Fannie Mae, Freddie Mac—to start playing a significant role, positive role, socially oriented role in the financial markets. The government has refused to use the ownership stakes that they have in these institutions to actually change, in a serious way, what they do. So, yes, they could go to AIG and do exactly what you said: “We’re not going to write these collateralized—these CDSs, these debt swaps, credit default swaps anymore. We’re not going to insure these risky bets anymore.” And they could use AIG to start underwriting insurance for small businesses, for homeowners. They could use the AIG much more positively there as well. But they have refused to do that because they want to protect the prerogatives—until now they’ve wanted to protect the prerogatives of Wall Street.

JAY: Okay. In the next segment of our interview, I’m going to ask you, if you’d been standing behind President Obama in that lineup [inaudible] the picture, what would you have had him say about what should be done. So please join us for the next segment of our interview with Gerald Epstein.

Gerald Epstein

Gerald Epstein is co-director of the Political Economy Research Institute and Professor of Economics at UMass Amherst.