A Look at the Hill and Beyond

Financial company CEOs and their directors are no doubt watching the regulatory reform debate in Washington with the same morbid fascination that a coronary patient might listen to a team of surgeons argue how to perform his heart bypass procedure while he lies on the operating room table. He can only hope they don’t screw it up.

There may not be an organization anywhere in the country with a greater vested interest in the outcome of the reform debate that’s going on now in the U.S. Congress than the Financial Services Roundtable in Washington, whose members include the likes of JPMorgan Chase, Bank of America, Citigroup, Charles Schwab, General Electric, Allstate, and Fidelity Investments. Its current name and structure were adopted in 1999, but the Roundtable traces its roots back to the Association of Reserve City Bankers, formed in 1912. More than any other industry group in Washington, the Roundtable speaks for the giant financial services companies that are the hub of the U.S. economy.

These companies have good reason to be concerned because the reform winds are blowing strong and unpredictably in Washington at the moment. President Obama has made regulatory reform a priority and Treasury Secretary Tim Geithner outlined the administration’s proposals several months ago. Rep. Barney Frank, who chairs the House Financial Services Committee, has been working on a series of reform proposals of his own. And Sen. Chris Dodd, who chairs the Committee on Banking, Housing and Urban Affairs in the Senate, introduced a massive reform bill last November.

One likely feature of any reform law will be an extra layer of regulatory oversight for companies whose failure would pose a systemic risk to the economy-and a number of Roundtable members will most assuredly fall into that category. There has also been a strong push to create a new federal regulatory agency with the mission of protecting individual consumers against the kinds of abuses that occurred during the subprime mortgage lending spree a few years ago, and virtually all Roundtable members have large consumer businesses that would come directly under this new agency’s thumb.

Watching all of this with great interest is Steve Bartlett, a savvy Washington lobbyist who has served as president and CEO of the Roundtable since 1999. A native Texan with the requisite fondness for cowboy boots, Bartlett spent eight years in the House of Representatives-where he served on the House Banking Committee-and then put in another four years as the mayor of Dallas. The Roundtable supports the broad concept of reform, and Bartlett says frankly that Congress is “obligated” to fix the current regulatory system after the financial panic that gripped the global capital markets in the fall of 2008. When the markets experienced a frightening systemic breakdown, it was a clear sign that a regulatory system that can trace its roots back to the 19th century was in need of a major overhaul. But Roundtable members still fret-just like that patient lying on the operating room table-about exactly what Congress might do. Many Americans are angry at the financial services industry for its perceived role in the crisis, and Congress has been known to react to public anger the way a bullet responds to an itchy trigger finger.

There is a strong chance that Congress will author the most sweeping restructuring of the nation’s financial regulatory architecture since the Glass-Steagall Act of 1933, and Bartlett says it will most likely end up being “omnibus” legislation, which means it would address the entire regulatory structure rather than just discrete portions of it. When he outlined the possible ramifications of such a sweeping approach to his CEOs during a conference call, “one of them let out a little whistle and said, ‘Oh my god!’” Bartlett says. OMG, indeed. Lets all hope that Congress acts with rational thinking. In a recent interview with Bank Director Associate Publisher Jack Milligan, Bartlett sat down to discuss the regulatory reform effort in Washington and what he thinks will happen next.

In your estimation, what’s the likelihood that Congress will pass a new financial regulatory reform law in 2010?

I think it is almost certain. Let me explain the “almost” part because it’s not a complete certainty. The issues are very complicated and the various proposals have a lot of moving pieces, and there’s a heavy partisanship in this town that I suppose conceivably could derail it. But I don’t believe it will be derailed, and the reason why is that we nearly had a financial meltdown and when you have a problem the size of what occurred from 2008 through 2009, Congress really is obligated out of a sense of duty to take action to reform and correct the system as best it can. I don’t believe that either Congress or the Obama Administration will shirk from that duty, so I think it’s almost a certainty that something will happen.

Are you concerned that Congress, on a wave of populist anger, might overreact and come up with a new regulatory regime that suffocates the industry?

I am concerned. I’m of two minds on this. Some kind of regulatory reform is called for. The current system is showing its age, so we do need reform. But I am more than just a little concerned that Congress could create worse problems through trying to fix it. There’s a whole array of mistakes Congress could make. Congress could impose a cap on the size of our financial institutions, and while there is room for small institutions, they can’t finance our $50 trillion economy, much less the rest of the world. A cap on size will dramatically and negatively affect the ability of the American economy to grow jobs and to create a high standard of living. A second mistake would be to create a regulated utility instead of a competitive marketplace. If we try to regulate pricing and wages and terms and conditions, then we’ll end up in a short period of time with no creativity, with no innovation, and with an inability to respond to individual customer needs. That would stifle our nation’s economic growth. A third mistake would be to price our institutions out of the market through excess capital requirements. We believe there should be some additional capital in the system, but more capital in and of itself does not solve the problem. And too much capital adds to the cost of the credit. And a fourth problem could simply be an overreaction driven by anger that forces even more companies into unregulated markets. I haven’t listed all the mistakes that Congress could make, but those are four big ones.

Why do you oppose a cap on the size of institutions?

This is a particularly dangerous demagogic trend that has reared its ugly head in recent weeks. That would be a disaster for the economy because remember, it’s the large institutions that help finance the economy. Let’s say that banks were sized so that their legal lending limit was $10 million. You don’t have enough banks in this country to finance Wal-Mart much less the rest of the economy at $10 million per bank. You can’t finance either corporate America or the American consumer with only small institutions.

Given the size of the largest financial institutions in the United States, including some that are members of the Financial Services Roundtable, hasn’t the issue of “too big to fail” become a reality?

That question has two parts. Let’s look at Wells Fargo, U.S. Bancorp, BB&T, JPMorgan Chase, PNC, Northern Trust, and Bank of New York Mellon-those institutions are strong, well capitalized, well managed, and are financing the American economy and doing so in a way that is astounding in the face of all that’s been thrown at them in the last 18 months. The other institutions that didn’t do so well and made fundamental mistakes basically went away. A preponderance of large financial institutions in this country have carried this economy in an extraordinarily positive way. Our association believes there should not be a too-big-to-fail policy. The companies that fail should be allowed to fail-and in fact that’s what happened. Countrywide is no longer with us. Wachovia failed. Bear Sterns failed. Those companies were all acquired, but the reality is they did fail-and they should have failed because their business models created such huge losses that they lost all of their capital. So our group does not believe in too big to fail.

The other side of the too-big-to-fail issue is what do you do if one institution shuts down suddenly and has so much counterparty risk through derivative transactions that it causes the failure of a thousand other companies? That’s the one time when government should intervene to protect the economy. Let’s permit a company like Wachovia to fail, but let’s protect the economy while we’re doing it. Too big to fail does not mean that institutions shouldn’t fail. They should still fail, but you don’t take down another 1,000 companies because of it.

The government propped up American International Group because of the counterparty risk that you just cited since the company was a major derivatives dealer. Was that the right policy?

Well, in hindsight it appears it wasn’t. I’m not critical of the government because we don’t have a lot of experience dealing with companies that had that much counterparty risk. The first time was the Lehman Brothers failure. In the case of Lehman, the Treasury Department decided to just let it fail to see what would happen. The result was a run on the money markets and the risk of other financial institution failures around the country. So when AIG got into trouble, Treasury, in essence, said, “We don’t want another Lehman so let’s go in and keep it alive while we sell off its assets.” Turned out that wasn’t a good idea either. I think history will tell us that AIG was a mistake, and in the short term, we learned that allowing Lehman to fail was a mistake too. So what regulatory reform has to do is find a middle ground where you can prevent one major failure from resulting in a thousand of other failures and yet not prop up the first failed company over a long period of time.

There are a variety of regulatory reform ideas floating around out there including a proposal from the Obama Administration and a major bill introduced by Sen. Chris Dodd, who chairs the Senate’s Committee on Banking, Housing and Urban Affairs. And Rep. Barney Frank, who chairs the Financial Services Committee in the House, has been working on reform legislation as well. What do you like, and what do you dislike, in these various proposals?

As you talk to me today we’re right in the middle of making sausage and it’s not very pretty. You know the old saying: Making laws is like making sausage. You should never watch it while it’s being done, just wait and eat the product. There’s a lot coming from all three camps that we like and there’s a lot that we don’t like. We like the idea of systemic regulation, where you create a system to provide that extra level of prudential supervision over companies that are systemically important to the economy. We like the idea of providing the Treasury Department with explicit authority to act in the case of a major crisis. Remember, Treasury and the Federal Reserve took extraordinary action during the global financial crisis in late 2008 and early 2009, and many could argue that their authority was very limited, as in the case of AIG where they didn’t have the authority to appoint a receiver for the company. So we like the ideas of systemic regulation and clear resolution authority for when you do have failures. And frankly, we like the additional consumer protection features that we have seen, although we don’t like having those consumer protections separated from safety and soundness supervision. [That separation means] you can’t protect the consumers when you have two different sets of regulators, one focused on the consumer and one focused on safety and soundness. Neither will be satisfactory.

So you’re not in favor of the proposed Consumer Financial Protection Agency that Dodd, Frank, and the Obama administration have all been pushing?

Not through a new independent agency, although I am in favor of the additional protection and giving enforcement authority to the prudential agencies. We also like the fact that Sen. Dodd’s bill seems to be globally harmonized, meaning it places a high degree of emphasis on working with the G20 because we’ve found that if you have a collapse in the U.K. or in Iceland, it’s going to affect the rest of the world. So we like that. And we like the fact that Dodd’s bill took some preliminary steps toward a national system of insurance regulation, although we don’t think it goes far enough. So in some ways the proposals are too bold, and in some ways they’re not bold enough. But it’s a start and we’re in there pitching every day to try to make them better and make them work.

Who do you think the major players in the reform effort in Washington are going to be?

The top tier clearly will be Treasury Secretary Tim Geithner, Barney Frank, Chris Dodd, and Richard Shelby (the ranking Republican on the Senate banking committee). Those four will be there at the beginning of the day, at the end of the day, and for everything in between. There won’t be any legislative or regulatory fix that’s going to happen without those four being involved. Other people who will have major impact on any legislation and will have a lot to say about it include Mark Warner (D-Va), Bob Corker (R-Tenn), and Judd Gregg (R-NH) in the Senate; Melissa Bean (D-Ill) in the House; Federal Reserve Chairman Ben Bernanke; Larry Summers (who heads up President Obama’s National Economic Council); and Shelia Bair (chairman of the Federal Deposit Insurance Corp.) The first four I mentioned are the super, super gods and the second group still are powerful gods.

Tim Geithner has received a lot of criticism this year for a variety of things, including his role in some of the controversial bailouts during the financial crisis. Does he still have the power to be an influential player in this reform process?

He does have his critics. I think he has handled himself well. He did stub his toe a couple of times when he first started at Treasury. It wasn’t so much anything he did but rather the way he presented himself. I think he’s in good shape. He has to remember there’s only one vote that counts in this election and that’s Barack Obama’s.

Ben Bernanke has also come in for some sharp criticism in Washington, including some Republicans in Congress who seem to be angry about the Fed’s role in bailing out companies like AIG and General Motors. Federal Reserve chairmen traditionally have had a lot of sway in Congress because of the prestige of the institution. Does Bernanke still have influence there?

The Fed is still the most powerful financial agency in Washington. It’s the most powerful today and it will be the most powerful a year from now. I think that the Fed is appropriately limiting its commentary on specific policy proposals because it is not a political animal and it’s the role of Congress to determine the nation’s regulatory framework. The Fed’s role is to regulate those areas that it has the authority to regulate, set monetary policy, and, as we learned last year, avoid financial catastrophe through systemic intervention. When you have a systemic catastrophe and the Fed is called to intervene, of course there’s going to be second-guessing and criticism. But you know, the Fed acted appropriately during the financial crisis and it continues to enjoy widespread support in the financial community as well as in Congress. As for the Republicans who are angry about the Fed’s and Treasury’s intervention in the economy, I’m a Republican too, but in this case, those fellows are wrong. We were facing the abyss. Our economy was standing on the edge of a bottomless pit. I could do a lot of Monday morning quarterbacking about the Fed, but I’m glad the Fed acted and saved us from a total meltdown of an economy that would have continued to get worse, and I think history will show that.

One of the interesting features in Sen. Dodd’s reform legislation would be the creation of a new agency to oversee systemic risk regulation, taking that job away from the Federal Reserve. What do you think about that idea?

We think that the Fed should be in charge of systemic regulation. The Fed has a world view. It has a view of the whole economy. Any other regulator can only look at a piece of the economy. We do think the Fed’s authority should be balanced with a council of other financial regulators along the lines of what’s now called the President’s Working Group, to offer its advice and counsel. But at the end of the day the Fed should be the center of systemic regulation. Part of that is out of respect for the Fed. But the other half of that is, who else would you put in charge? The average tenure of a Treasury secretary is three years. It’s a political appointment, and sometimes you get good secretaries and sometimes you get really terrible secretaries. It’s just kind of luck of the draw. The number of people at Treasury that could engage in systemic regulation is maybe 25. The Fed has 14 offices around the country and thousands of employees. The Office of the Comptroller of the Currency is a great agency but its entire jurisdiction is nationally chartered banks. The FDIC is a great agency but its entire jurisdiction is to administer the deposit insurance fund. So either it’s the Fed or you create a brand new agency to duplicate the Fed. Creating a new agency to duplicate the Fed adds no value when you already have the Fed.

The TARP program has also come in for a lot of criticism around the country, including in Congress. In your opinion was it a success or a failure?

It was a success and is a success. I’m chagrined by the historical revisions I’m hearing of late. Hell, I wasn’t enthusiastic about allocating $700 billion of federal money to try to stop the demise of the global economy, but as contrasted with allowing it to collapse, it was a pretty good investment. The program will turn out to be self-funding, meaning that the government will get its money back. Those companies that have already repaid their TARP funds have repaid them with 10% return on their original allocation. TARP also recapitalized a banking industry that was on the verge of collapse. Had we not done that, all consumer and commercial lending would have stopped. Now some of the TARP money was used for some non-TARP activities like AIG and GM, and I think the verdict on those companies is still out. But in terms of recapitalizing the banking industry, it was a huge success.