What the New Sheriffs of Wall Street Can Do

This article appears in the November/December 2021 issue of The American Prospect magazine. Subscribe here.

The most stylish play running right now on Broadway follows the three Bavarian immigrants who founded Lehman Brothers bank.

“When we were in business, people gave us money and we gave something in exchange. Now that we’re a bank, people give us money just the same, but we give nothing in exchange,” frets the middle brother, Mayer Lehman, in The Lehman Trilogy.

The brothers got their start selling cotton fabric—“denim, that robust fustian work cloth”—from behind the counter of a modest shop in Alabama. They grew quickly, layering credit between their storefront and the commodities they traded.

“We’re middlemen,” one brother exclaims when asked to describe his line of work. Dutiful groans from the audience of New York intelligentsia and investors who fill the theater each week. (Jeff Bezos, Amazon’s former CEO, reportedly attended the play on a date.) The actors do not bother staging the climactic scene of September 2008. Why bother? Everybody knows how it ends.

More from Lee Harris

In The Lehman Trilogy, banking is the slippery domain of speculation; capitalism dwells in the real economy of guns and butter. It takes a Victorian, nose-holding view of finance. More than a decade after the financial crisis, it seems positively quaint. Progressives now describe the investment function as a public good rather than a presumptive evil, available to be put toward common ends like renewable energy and full employment.

Banks also look tamer today. Too-big-to-fail lenders weathered the coronavirus crisis, partly due to requirements in the Dodd-Frank Act passed after 2008. New buffers requiring conventional banks to hold more capital have made them more resilient.

The crisis response has not interrupted the 50-year growth of finance, however. The volume and complexity of financial intermediation has continued to swell, often beyond the scope of bank regulation. A growing share of financial activity now occurs in private markets and non-bank institutions.

Biden’s regulators could be missing fundamental ways in which the ground has shifted since 2008.

If we are said to live in an “hourglass economy” of high and low incomes, investments, too, have polarized between cheap index-tracking ETFs and high-fee alternatives such as hedge funds. New asset classes are flooded with institutional capital, from public infrastructure to farmland. Private equity conglomerate Blackstone built a market in single-family rental housing and is coming back for more. Observing these trends, one scholar has announced a “shift in the predominant function of finance from banking to asset management.” None of this leaves conventional banks struggling, as they arrange new tie-ups with the teenaged “fintech” industry. At the other end, tech giants are pushing deeper into financial services.

Into this protean environment, President Joe Biden has deployed a force of unusually bold financial regulators who are said to represent a break with industry-friendly regulation. The test of their success will be how they react to a set of challenges in financial markets that do not mirror the problems of the post-crash period.

The roster is impressive. Gary Gensler, who earned his reputation as a tough cop cracking down on derivatives in the Obama administration, now leads the Securities and Exchange Commission. He has assembled an all-star team of finreg advocates: policy director Heather Slavkin Corzo, who previously directed investment at the AFL-CIO; consumer advocate Barbara Roper, now a senior adviser; University of Colorado Law School expert Erik Gerding, who will head legal and regulatory policy at the Division of Corporation Finance; and general counsel Dan Berkovitz, who served that role for Gensler at the Commodity Futures Trading Commission and later became a commissioner there.

Former Federal Trade Commissioner and Elizabeth Warren protégé Rohit Chopra is running the Consumer Financial Protection Bureau, and has also brought heavy hitters like student debtor advocate Seth Frotman and financial stability expert Gregg Gelzinis with him. At the Office of the Comptroller of the Currency, Cornell professor Saule Omarova has been nominated. As a skeptic of crypto and bank entry into physical commodity businesses, she would upend the status quo in a historically captured agency.

Other agencies are stacked with progressives, too. Left think tanks like the Roosevelt Institute happily grumble that their top staff have been looted. Ex-Warren staffers are heavily represented.

Agency heads are suddenly invoking market power and concentration, rather than fiddling at the margins of technical rulemaking. Corporates have taken note. One Bloomberg article previewing Gensler’s aims blared, “The Everything Crackdown Is Coming.” Firms attempting to upend retail banking are bracing at Chopra’s arrival. Banks are so alarmed by the prospect of Omarova that they’ve taken to depicting her as a Marxist.

Gensler’s overall goal is to lower the level of finance as a share of total economic output. That is not a universally shared objective. Trump appointee Jelena McWilliams will run the Federal Deposit Insurance Corporation (FDIC) until 2023. At press time, a decision on Fed chair Jerome Powell’s reappointment had not been made, but Lael Brainard, who is talked of as the progressive alternative, could bring as much continuity as rupture to the institutionally conservative central bank. And for all the progressive energy at top agencies, new appointments have also pulled heavily from the ranks of the Fed, including Treasury Secretary Janet Yellen.

Early returns on the new finreg mandate have been mixed. Keenly awaited reports on two emerging risks to markets—crypto and climate change—have been disappointing. More critically, Biden’s regulators could be missing fundamental ways in which the ground has shifted since 2008. While prudential oversight is still needed to keep the system safe from bank overreach, capital has spread out into unregulated territory, becoming both more concentrated and more capillary.

The past year’s unprecedented Fed interventions have papered over areas of fragility, but Biden’s promise of shared growth will require a macroeconomic environment that tamps down on risk, restores markets, and directs public investment.

Fintech: What’s Old Is New Again

As the pandemic bore down on cities in April and May of 2020, about 25 percent of Black-owned businesses seeking government Paycheck Protection Program (PPP) loans turned to online lenders rather than big banks, which have long failed to reach minorities. When sole proprietors, which include higher numbers of Hispanic and Black business owners, were made eligible for bigger PPP awards, many chose to go through fintech lenders like Kabbage, Square, and PayPal Working Capital. (Areas with a higher concentration of community banks also saw greater uptake of PPP.) Even before coronavirus, online platforms like Cross River Bank had grown more popular by digitally replicating traditional community banking activities.

Most fintech apps use conventional, mid-sized banking operations to hold and move around cash. Still, even as a wave of recent scholarship has underscored the bias encoded in algorithms, these upstarts have exposed gaps in the offerings of major banks. If the digital economy, which relies on reams of data and credit scores rather than direct evaluation, is punitive and exclusionary, it is a reminder that the personal discretion of bankers also was not without flaws.

On the consumer protection side, bank-like lenders that reach consumers through their phones are resurfacing old scams like point-of-sale credit products and buy now, pay later installment plans, and repackaging them as democratizing finance. For example, Chime, a mobile banking service app, markets itself as “fee-free.” But it disguises charges and relies on a voluntary “tipping” model, while often making it difficult not to tip.

Fintech has undercut some systemic abuses by incumbent lenders. But important protections that apply to credit card companies and depository institutions haven’t been extended to tech lenders.

At key regulatory agencies, fintech is in the crosshairs. Donald Trump’s OCC advanced the idea of handing fintech firms special purpose bank charters, which could preempt state regulations. But last month, two fintechs, Oportun and Monzo, abruptly canceled their applications for bank charters, and a proposed industrial loan company (ILC) charter for Japanese fintech Rakuten has been stuck all year, suggesting that the Biden administration will look unkindly on giving fintechs the ability to bank and lend on their own.

At the CFPB, Chopra is attempting a delicate pincer movement: crack down on the abuses of fintech insurgents, while also attacking older problems that have plagued conventional banking. In his first weeks on the job, Chopra announced a probe into the payment systems of tech giants, requesting information on how firms including Google, Amazon, and Paypal manage user data and financial information.

“In China, we can already see the long-term implications of these forces. Alipay and WeChat Pay are deeply embedded into the lives of the Chinese public,” Chopra said in a notice on the inquiry. “In such a market, consumers have little choice but to use these apps and little market power to shape how their data is used.”

Another early target of Chopra’s CFPB is JPay, a firm that has monopolized email and digital services in prisons across the country. Rather than an exotic tech-enabled credit instrument, JPay is an old-fashioned price-gouger, which has bought up a controlling stake in prison communications and driven up rates for writing emails to loved ones.

At just 39, Chopra has come of age politically in a period marked by the onslaught of abusive tech firms. Giving a report to the Senate Banking Committee in October, Chopra testified that it is a top priority for the bureau to “restore relationship banking in an era of big data.”

Watchdog groups acknowledge the weirdness of the moment. “It’s ironic that we have been beating up on big banks for years,” said Lauren Saunders, associate director at the National Consumer Law Center, “but today they may be the relative good guys, in the face of tech giants that are pushing into financial services with little oversight.”

Crypto: Token Regulation

Gensler and others are scrambling to build a regulatory regime for cryptocurrency. The SEC chair has compared crypto to “wildcat banking” of the 19th century, questioning its long-term viability and warning of dangers to investors. Acting OCC chief Michael Hsu has called crypto and its companion, decentralized finance (DeFi), “fool’s gold” that would inflate the kind of risk seen before the 2008 financial crisis.

Two recent CFTC enforcement actions against crypto firms have netted $140 million, and CFTC chair Rostin Behnam has called this the “tip of the iceberg.” But a highly anticipated report, the first interagency effort to deal with emerging digital currency threats, could be a gift to the banking sector.

Sheila Bair, who chaired the FDIC under two presidents, told the Prospect she is reminded of a jurisdictional battle in the 1990s. That decade saw the mushrooming of derivatives traded directly between banks, off public exchanges and out of sight of regulators. An effort to regulate them sparked a standoff between bank regulators at the Fed, the OCC, and the Treasury, and the market regulators at the CFTC and SEC, led by CFTC head Brooksley Born.

Bank regulators won, arguing that big players like JPMorgan Chase were known entities, subject to bank regulation. Taking a pragmatic tone, Larry Summers argued that the horse was out of the barn: Derivatives were in such widespread use that their sudden regulation could incite a panic. That decision is now infamous, since derivatives levered up the risk of mortgage-backed securities, which touched off the financial crisis.

Bair sees another battle brewing between bank and market regulators. This time, it concerns stablecoins, a type of cryptocurrency that pegs its value to that of another currency, typically the dollar.

Like a money market mutual fund, the key pledge of a stablecoin is that the issuer will buy it back at par, on demand. To make good on this promise, observers have pointed out, stablecoins need high-quality collateral backing the entire account. Enforcing this regulation has made money markets more secure and less profitable. Stablecoins are trying to resist the same requirements.

Regulators who agree that stablecoins are risky are torn over whether to treat them as bank deposits, under the purview of the Fed and FDIC, or allow them to exist as a medium of exchange outside banks. Outside observers have differing views on how to best regulate the product. But the new stablecoin report, published by a President’s Working Group comprised of the heads of key agencies, has left almost no one happy.

“That report is a big win for Wall Street,” Bair said. “The bank regulators went to the President’s Working Group, because it is dominated by the Treasury and the Fed, and came up with this bank-centric model that requires all this activity to be jammed into a bank. That will either kill the business, or, like with derivatives, they will let all the business be in the banks, and then it will blow up in the banks.” Bair serves on multiple boards, including Paxos, issuer of the stablecoin PAX.

The report recommends that Congress pass legislation allowing only banks to issue stablecoins. This has been a trend from the regulators, with the SEC and CFTC asking for additional congressional authority on crypto. To punt the issue back to a gridlocked Congress, said Dennis Kelleher of Better Markets, is an “abdication of duty.”

The only group apparently pleased with the report is the banking sector. In early November, Vikram Pandit, the former CEO of Citigroup, told the Singapore Fintech Festival that within the next three years, he expects every major bank to consider getting into crypto trading.

The SIFI Conundrum

There is not a single systemically significant non-bank in the United States today, according to the Financial Stability Oversight Council (FSOC).

That’s the body led by the Treasury Department and created by the Dodd-Frank Act to convene the crazy quilt of regulatory agencies that independently monitor banks, markets, and other financial institutions. Beyond getting everyone in one room to focus on systemic risk, FSOC has two main authorities: a research arm that can direct investigations, and the ability to designate key financial institutions and activities as “systemically important.” But it has not lately used that authority.

That wasn’t always the case. After it was created, FSOC designated a handful of non-bank actors, including GE Capital and insurer MetLife, as systemically important financial institutions (SIFI). MetLife successfully fought back on its designation, helped along by a George W. Bush–appointed activist judge, and Trump’s FSOC subsequently stripped away the power to single out institutions, issuing guidelines for an activities-based approach.

Biden’s FSOC could revise its internal procedures for designation, reviving discretionary oversight and the regulation of institutions with outsized power, whose failure could have ripple effects for the financial system. But it has not done so, keeping with the activities regulation of the Trump era.

Arguments by MetLife, which says the SIFI designation is a blunt instrument not suited to the nature of its business, have gained credibility at the Treasury. As Treasury secretary, Yellen chairs FSOC. She has not exhibited the same regulatory aggressiveness as some of her counterparts in the administration, and critics bristle at the timidity.

“Whether or not you have an opinion on the bluntness of your instrument, that’s the one Congress gave you, and you’re supposed to use it,” said Kelleher, of Better Markets. “No regulator ever thinks they have an ideal set of tools.”

Kate Judge, a law professor at Columbia who served on a Task Force on Financial Stability that issued a report on systemic risk, argued that FSOC’s tools are plenty flexible. While non-banks should not be subject to the same prudential regulation as banks, Judge said, FSOC could help plan more rigorous regulation for the most leveraged hedge funds and the biggest asset managers.

“The Amazon of Wall Street,” as one financial analyst has dubbed the asset manager BlackRock, is at the top of the pile.

Taming BlackRock

During the pandemic, the Federal Reserve Bank of New York contracted BlackRock to administer an array of emergency securities purchase programs. (The firm played a similar role in 2008, helping to price and sell troubled assets in the wake of that crash.) This put BlackRock in the position of buying its own exchange-traded funds on the government’s behalf.

Defending the choice to hire BlackRock, Powell explained at a hearing that they had little choice. “It was done very quickly, due to the urgency and the need for their expertise,” he said. Indeed, the Fed would be hard-pressed to find another manager with the same scope and reach.

BlackRock also sits directly in the administration: National Economic Council Director Brian Deese, Deputy Treasury Secretary Wally Adeyemo, and the chief economic adviser to the vice president, Mike Pyle, are all veterans. “It’s a bit like Goldman ten or fifteen years ago, when everybody figured out the revolving door,” Mark Blyth, a political economist at Brown, has said. “Goldman has fallen out of favor. Now it’s these big asset managers.”

BlackRock is not only a sprawling market-maker, but also has extraordinary visibility into markets through Aladdin, its portfolio and risk platform. “Aladdin is like oxygen. Without it we wouldn’t be able to function,” said Anthony Malloy, CEO of New York Life Investors, one of many firms that pay steep fees to use the platform. Other customers include rivals like Vanguard and State Street, tech giants like Apple and Microsoft, and top insurers. As of 2020, just a third of Aladdin’s 240 clients had $21.6 trillion sitting on the platform, according to a Financial Times analysis.

BlackRock and other asset managers have lobbied hard against any suggestion that they should be regulated as a SIFI. More recently, they have fought an effort in the Build Back Better Act, led by Sen. Ron Wyden (D-OR), to tax ETFs.

Some regulators have an appetite to go further. Graham Steele, the assistant Treasury secretary for financial markets, authored an influential report about the big asset managers’ oligopoly, with a particular focus on BlackRock and its Aladdin system.

But analysts who share Steele’s worries about BlackRock’s influence are split over how to respond.

“One route is breaking people up, and relying on competition. The other is accepting that this entity has become critical and is almost like a utility within the financial system, and putting tighter controls on what they do,” said Marcus Stanley, the former policy director at Americans for Financial Reform.

Pursued on its own, either path has drawbacks. Dan Awrey, a law professor at Cornell, thinks BlackRock should be identified as a SIFI because it is a giant liquidity pool. Awrey said he is unconvinced by “the neo-Brandeisian logic of ‘If something is systemically important, it’s either infrastructure, or I have to break it up.’”

BlackRock may be uniquely suited to antitrust action, however, since it enjoys not only scale but unrivaled vision into markets—and rivals. The fact that it was indispensable to the Fed in the pandemic meltdown may be proof enough that Aladdin is a kind of public utility. And others caution against what they see as a new enthusiasm for labeling key market players as too big to fail.

“I’m not so wild about institutional designations,” said Bair. “Certainly, if you’re going to do a significant designation, you’d want to designate BlackRock. But with all the BlackRock people in this administration, I’m not sure that’s ever going to happen.”

The Climate Switch

“Climate risk is investment risk,” Larry Fink has been widely praised for telling investors. The statement has the same tautological ring as Hillary Clinton’s “women’s rights are human rights,” another remark celebrated as brave and masterfully critical of the Chinese. Fink basically just means that climate perils create attractive, investment-grade risk.

It pairs well with the most recent re-christening of the climate crisis, once known as global warming. Whereas “crisis” implies considerable balance-sheet risk, a major downer, business leaders now stress that we are on the threshold of a financially intriguing, multi-decade “energy transition.”

Reframing the climate crisis as a business opportunity is a good idea. But, giddy with the discovery that politically distasteful climate change can be spun as a chance for economic growth, policymakers are neglecting to do more than nod at systemic risk.

A new FSOC report on climate, which was expected to fire a starting gun for regulation, does not include a single timeline or specific recommendation for action by a financial regulatory agency. The report registers alarm about climate change as an “emerging threat” to financial stability, including credit and market risks. But it is studiously nonprescriptive.

Rather than inducing private actors into green lending, a vanguard of policymakers want the government to lead the way.

It omits any mention of a climate component for capital risk weighting, among the most direct tools that could convey environmental hazards to markets. Currently, capital rules do not capture risk of exposure to asset classes that could be impacted by a severe climate event.

Bold talk on fintech represents a substantive break with the previous administration. By contrast, the rhetorical shift on climate was already under way during the Trump administration. From the Trump CFTC to the Defense Department, agencies have increasingly acknowledged climate as a threat multiplier.

Regulation aside, whether this administration takes climate risk seriously will be measured not only by how safely it fences off environmental liabilities, but by creating a macroeconomic environment conducive to climate investment.

Evergreen Action, an environmental group, has floated the idea that the next Fed chair might rely on the Community Reinvestment Act to spur green financing. Lael Brainard has championed the idea of modernizing it, and was a holdout vote during the Trump administration’s attempt to gut the law, which is meant to encourage lending to areas banks have neglected to reach. Now, the Trump-appointed chair of the FDIC functionally has the same veto vote as Brainard, making an overhaul less likely.

But rather than inducing private actors into green lending, a vanguard of policymakers want the government to lead the way.

Lender of Last Resort

Last year, the Federal Reserve went far beyond its 2008 crisis playbook, purchasing corporate bonds and offering new emergency facilities. In one popular telling, central-bank authorities had learned the lesson of the financial crisis: This time, the Fed would bail out not only Wall Street, but Main Street.

That story is wildly inflated. The Fed did set up a “Main Street Lending Program” for midsize firms, and announced loans for cities through a new Municipal Liquidity Facility (MLF). But those programs were designed to lend on unfavorable terms, and barely used. (Low pickup rates were actually touted as proof of success. While there is a logic to the penalty rate, it is selectively applied; the Fed happily lent on friendlier terms to corporate clients.)

Biden has not yet announced his Fed chair pick. But some of his top officials urge a new monetary policy that would benefit ordinary Americans. Bharat Ramamurti, a Warren veteran who is now deputy director of the National Economic Council, chaired an oversight commission for pandemic emergency lending, where he criticized the prohibitive terms of the MLF and supported proposals for a permanent version designed to actually compete with private lenders. The NEC’s second-in-command is also fond of pointing out that North Dakota—the only state in the country with a public bank—was most effective at distributing PPP money.

The possibility of permanent lending facilities has raised worries about the Fed being pulled into politics. Following pressure from the Trump administration, the central bank extended its Main Street program to bigger firms, in a move that made wildcat oil and gas companies eligible. The Fed and Treasury have denied the suggestion that they did so at the urging of energy lobbyists. But as a result of the expansion, fossil fuel companies received more than 10 percent of Main Street loans, compared to just 1 percent for renewables.

Instead, corporate bond purchasing could be tilted toward green companies. Several central banks, including the European Central Bank and Bank of Japan, already routinely buy corporate bonds. Given that they are already engaged in picking winners and losers, some central-bank analysts have begun to study how quantitative easing (QE) might be limited to green companies.

Some QE supporters think the Fed should just say the quiet part loud. “The Fed should be explicit about support for public borrowing,” the economists J.W. Mason and Mike Konczal wrote in a 2017 report that argued for the Fed purchasing the debt of cities.

Others think the central bank is the wrong entity to invest directly in businesses and other economic activity. The Fed has effectively seized the role of a national investment authority, according to Lev Menand, an academic fellow and lecturer at Columbia Law School. That is a political task, he argues, which Congress should confront explicitly and assign either to the Fed or to an independent entity. Omarova, the OCC nominee, has been a leading proponent in these pages for such an authority.

Given that we are living in a liquidity supernova for the foreseeable future, some argue for making use of the high foreign demand for U.S. government-backed debt with an investment agency that does not need to seek funding through the appropriations process. Benefits that accrue to the rich can, in theory, be taxed away.

The Fed’s extended reliance on expansionary monetary policy, which makes asset owners richer, has triggered some unease on the left. Loose monetary policy can also cause asset bubbles. Some attribute the emergence of crypto and other digital assets with few real-world uses to the glut of liquidity. Wherever you stand on easy money, you’d better hope that your financial plumbing can handle the pressure.

“In an environment where you want to allow the economy to run hot for a period of time,” Judge said, “it is all the more important that we have a robust financial regulatory scheme, and understand the interconnections and common exposures in the financial system that could trigger dysfunction.”

Biden’s new cohort could well rise to the occasion. At the moment, however, more liquidity is churning through opaque financial channels, a prospect that seems unlikely to change even under Lael Brainard, the relatively progressive alternative to Powell.

Expansionary monetary policy can trickle down to real growth. And it is surely a preferable alternative to austerity. But a tax-the-rich regime offsetting the resultant inequality is not around the corner. Neither is clean-energy investment at the needed scale. In that environment, a renewed call to politicize economic growth, rather than endlessly buoying up asset prices, seems appropriate.

Perhaps there is something to be said for Mayer Lehman’s childlike, even metaphysical, distinction between makers and takers, speculative and productive investment. Biden ran on a simple pledge: “It’s time to reward work, not wealth, in America.”