Janet Yellen’s Secret Weapon Against Wall Street Deregulation

AP Photo/Cliff Owen, File

Federal Reserve Board Chair Janet Yellen oversees an open meeting in Washington. 

There will be few moments over the next four years where the opportunity exists to dramatically improve financial regulation. But one of these moments just presented itself, and it must not be squandered.

The Federal Reserve announced Wednesday that Scott Alvarez, general counsel for the central bank, will retire after 36 years of service. Nicknamed the “eighth governor” of the Fed, Alvarez has since 2004 held the general counsel slot, a critical regulatory and legal policy position. He represents one of the last links to the reign of former chairman Alan Greenspan. And he shares Greenspan’s antipathy to regulation, a toxic attitude that literally helped usher in the 2008 financial crisis.

At the Fed, the nation’s most important banking regulator, Alvarez participated in virtually every deregulatory maneuver of the past 35 years. He was there when the Fed refused to regulate derivatives in the late 1990s. He helped draft and implement the law that formally eliminated the Glass-Steagall separation of commercial and investment banking. Before that, he was involved in chipping away at the Glass-Steagall firewall through loopholes and allowances for commercial banks that bought up investment-side entities.

He was general counsel when the Fed failed to use its consumer protection authority to tame the runaway mortgage market during the housing bubble. He was the legal architect behind the Fed’s opaque emergency lending operations, which did far more to bail out Wall Street than Congress’s TARP law. He was responsible for implementing the Dodd-Frank financial reform at the Fed, and did so with a characteristically light touch. He signed off on a sweetheart settlement with the banks over their criminal mortgage practices that the Fed’s governors didn’t even get to see. And when interviewed by the Financial Crisis Inquiry Commission, he denied that the central bank’s policies played any role in the meltdown, blaming investors and politicians and overlapping authorities.

Alvarez and his Fed defenders have always said that his loyalty is to the institution, not Wall Street. But in his case, it’s hard to know where one begins and the other ends. In 2014, he gave a speech to the American Bar Association (ABA) in which he said that the culture of Wall Street “is not something we feel we can regulate,” contradicting the main point person for banking supervision at the Fed, Daniel Tarullo. In the same speech, Alvarez also endorsed repealing two Dodd-Frank rules: the Volcker rule that restricts risky bank trading (which Alvarez attempted to sabotage during its authoring, according to The New York Times), and the measure pushing out swaps trading to separately capitalized entities.

When a high-ranking official such as Alvarez prompts lawyers and lobbyists about what rules he doesn’t support, it’s akin to drawing them a treasure map. Sure enough, within weeks of his ABA speech, both of the changes he had outlined took effect. Congress passed a rider repealing the swaps push-out rule in a must-pass budget bill. And the Fed delayed implementing a key element of the Volcker rule for two years, letting banks keep investments like collateralized loan obligations (CLOs) on their books. Alvarez was publicly singled out for promoting the Volcker rule delay; previously, he reportedly encouraged lawmakers to bash the provision. Delaying the rules gives bank lobbyists just the space they needed to get them rescinded.

This type of roadblock at the staff level is far more important than most people recognize. For over a decade, Alvarez’s team of 55 lawyers had to sign off on every rulemaking, supervisory action, and legal guidance issued by the Fed. Senior leadership needed to run everything they wanted to do in the regulatory arena by him. While governors come and go, Alvarez controlled what senior leadership saw, and he simply had a larger staff and more resources to win the bureaucratic knife fights. In the wrong hands, the Fed’s permanent regulatory staff can act as a mole for industry, able to defy the will of senior leadership, implement deregulatory policies, and signal Congress to act.

In 2015, Senator Elizabeth Warren called out Alvarez in congressional hearings, saying he was “picking and choosing” what to enforce. Presidential candidates suggested changes in the Fed structure to reduce the general counsel’s power. But Alvarez’s departure completely changes the game, creating an opening to use that position in the public interest rather than the interests of Wall Street.

Janet Yellen’s background is in macroeconomic policy rather than regulatory supervision; this is true of most members of the Federal Reserve Board. Though she has professed a commitment to regulating the financial system, Yellen backed up Alvarez when he served as general counsel; after all, he was the expert. But she now has the authority to name his replacement, and if she wants to do her part to prevent the flood of deregulation the Trump administration is likely to unleash on the financial system, hiring someone who disagrees with Alvarez’ clear worldview is paramount.

President Trump plays no role in naming the general counsel of the Federal Reserve. As chair, Yellen controls the search for his successor, at least until her term expires next January. And the general counsel serves at the pleasure of current and future Fed chairs. Sometimes all it takes is a general counsel opening up the possibilities of what can be done instead of closing them off to bring about a sea change in agency culture.

There’s a precedent for this. When Thomas Curry became head of the Office of the Comptroller of the Currency, the national banking regulator, he fired general counsel Julie Williams, who had been using her behind-the-scenes power to protect the industry’s biggest players. As a result, the agency improved significantly. That opportunity now exists once again for the Fed, and since it has more authority to crack down on the big banks than anybody else, choosing the right person for general counsel is critical.

In general, federal regulatory agencies are so cloistered that obscure staffers can overpower the process without public knowledge. That’s certainly true of the Fed, where transparency goes to die. Gatekeepers like Scott Alvarez worked to the advantage of the financial industry for too long, wedded to an obsolete, Greenspan-like worldview. Yellen needs to reverse this, and progressives should demand that she does. 

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