As the financial system teetered on the brink of meltdown in the fall of 2008, former Federal Reserve Chairman Alan Greenspan — known for years as “the Oracle” — admitted he had been blindsided by the housing crash and breakdown in the credit markets.
“This crisis … has turned out to be much broader than anything I could have imagined,” a chastened Greenspan testified before a House committee, which had summoned him to determine why one of the nation’s key financial regulators had failed to see the dangers in the explosive growth in subprime lending.
Those stumbles by Greenspan, who had stepped down in 2006 after more than 18 years leading the central bank, and other Fed officials were a major reason Congress enacted the Dodd-Frank reform act. The 2010 law instituted new restrictions on the banking industry and financial markets — and took away some of the Fed’s discretion.
Now, less than a decade later, a Senate banking deregulation bill would restore some of the Fed’s regulatory flexibility — something critics warn is dangerous and would increase the risk of another crisis.
“Everyone should be justifiably scared about what’s happening,” said Phil Angelides, who chaired the federal commission that examined the causes of the financial crisis. “At the end of 10 years of relative stability in the financial system and with an economy that is growing, why would we put ourselves at risk again?”
Some Senate Democrats are dubious that regulators appointed by President Trump will be tough enough on large banks to prevent another crisis despite promises from new Fed Chairman Jerome H. Powell that he would remain vigilant.
Sen. Catherine Cortez Masto (D-Nev.) said she’s “not at all” comfortable deferring regulatory decisions to Fed officials after she saw the flood of foreclosures in Nevada caused by subprime lending when she was a state official from 2007 to 2015.
“The question I had when I was attorney general was: Where was the Fed from the very beginning prior to 2007” when the housing market crash began? she said. “They weren’t there. So now we’re going to trust them that they’re going to be there this time?”
The Senate legislation is focused on easing regulations on small and midsized banks. Many of the rules were put in place by the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The bipartisan deregulation bill, which is expected to get Senate approval this week, would reduce the number of larger financial institutions that are mandated to face more intense scrutiny from the Fed under Dodd-Frank.
The legislation would raise the threshold for so-called systemically important financial institutions, which face mandatory and rigorous annual "stress tests" and other heightened oversight, to $250 billion in assets from the current $50-billion level.
Critics of the bill said that level is higher than it needs to be to ease burdens on midsized banks without adding to the risk of a future crisis.
The new level would provide significant relief for about two dozen large firms, such as Charles Schwab Corp., BB&T Corp. and Suntrust Banks Inc. The Federal Reserve would retain the ability to apply heightened oversight to those firms, but such supervision no longer would be mandated.
Instead of requiring annual stress tests to determine a bank’s ability to withstand a severe economic downturn, for example, the bill would direct the Fed to conduct “periodic” tests for banks with more than $100 billion in assets but less than $250 billion.
“Who decides what periodically means — the former investment bankers Donald Trump has nominated to lead the Fed and to head up the Fed’s supervisory work?” said Sen. Elizabeth Warren (D-Mass.). “Does that make you feel safe?”
Powell was an investment banker early in his career and later was a partner at a private equity firm. And the new Fed vice chairman in charge of bank oversight, Randal Quarles, worked as an investment manager and at a private equity firm.
Another change in the law actually takes away some discretion from the Fed but not in a good way, bill opponents said. Instead of stating that the Fed “may” tailor its rules for the largest banks — those with more than $250 billion in assets — the law would be changed to say the Fed “shall” tailor its rules.
“That one word change will allow the big banks to sue the Fed if they don’t weaken the rules the way the banks want,” Warren said. “And that pressure on the Fed will lead to a systematic weakening of the rules for all the big banks.”
Powell was pressed at a Senate Banking Committee hearing on March 1 about whether lowering the threshold for tough regulation would hinder the Fed’s job.
“Is it accurate that this provision does not in any way restrict the Fed's supervisory, regulatory and enforcement authorities to ensure the safety and soundness of financial institutions?” asked committee Chairman Mike Crapo (R-Idaho), the bill’s lead author.
Powell responded, “Yes, sir.”
He later said Fed officials would “feel comfortable” about imposing tougher oversight on any bank with less than $250 billion in assets that they deemed needed it.
But Sarah Bloom Raskin, who served on the Fed board from 2010 to ’14 before becoming a top Treasury Department official in the Obama administration, called the Senate bill’s language giving the Fed the ability of regulators to maintain tough oversight “legislative fool’s gold.”
“My time serving as a Federal Reserve governor taught me that the Federal Reserve has never been inclined to act quickly and proactively when bank conditions begin to deteriorate but almost always waits until a crisis has peaked and the costs of remedy are already extremely high,” Raskin wrote last month in a letter to Sen. Sherrod Brown (D-Ohio).
Angelides, a former California state treasurer, said giving Fed regulators more flexibility made no sense given the findings of the Financial Crisis Inquiry Commission. Its 2011 report cited the Fed’s “pivotal failure to stem the flow of toxic mortgages” as a “prime example” of regulatory inaction that led to the crisis.
“As irresponsible lending, including predatory and fraudulent practices, became more prevalent, the Federal Reserve and other regulators and authorities heard warnings from many quarters,” the commission said. “Yet the Federal Reserve neglected its mission ‘to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers.’ ”
In 1994, Congress gave the Fed the power to enact rules to protect consumers from unscrupulous mortgage lending. But the Fed waited until 2008 to adopt rules to prohibit unfair, abusive or deceptive lending practices — long after the housing crash triggered the Great Recession.
The long delay in taking action was a major reason that Dodd-Frank created the Consumer Financial Protection Bureau and shifted the Fed’s authority over mortgages to the new agency.
Former Rep. Barney Frank (D-Mass.), who helped lead the effort to pass the 2010 bill that bears his name, said he attributed the Fed’s subprime failures to Greenspan’s strong deregulatory views.
“The best law in the world is not self-enforcing…. It depends on the regulators,” Frank said. “It’s very hard to guard against a regulator not using their powers.”
Frank said he’d be more worried about the Senate bill’s effect if Trump hadn’t selected the well-respected Powell to lead the Fed.
Although Frank believes Trump appointees will be less likely to use regulatory power in a precautionary way, he said Fed officials have learned from the 2008 crisis and predicted they would act quicker if they see problems developing.
Frank said he would not vote for the Senate bill, in part because he preferred the threshold for tough bank oversight only be increased to $125 billion. But he doesn’t think that what he called the bill’s modest changes would significantly reduce financial stability.
“I do not regard it as the unraveling of Dodd-Frank if it passes,” he said.