Warren Plows Forward with Financial-Sector Regulatory Aims

WASHINGTON – Three years after the nation’s most comprehensive financial regulation overhaul, regulators have announced that they are near the end of completing a series of new rules, but some lawmakers think this is not enough to stop excessive risk-taking on Wall Street.

Officials from the Federal Deposit Insurance Corporation (FDIC), Treasury Department, and the Federal Reserve were called before the Senate Banking Committee to update the status of the 2010 regulatory overhaul.

Agency officials testified they were ready to wrap up the bulk of the rules under the Dodd-Frank Act by the end of the year. The legislation requires agencies to design hundreds of new rules forbidding risky lending and investment practices that caused the 2008 economic crisis.

By the end of the year, regulators should complete implementation of a risk-based capital surcharge for systemically important banks, a liquidity rule and the Volcker rule to ban proprietary trading by banks, Fed Governor Daniel Tarullo said.

The Fed, FDIC and the Office of the Comptroller of the Currency completed work this week on bank capital rules and proposed a tougher leverage requirement for eight of the largest lenders – those with more than $700 billion of assets – to hold equity capital to 6 percent of total assets.

Requiring banks to set aside money could ensure that they remain solvent in times of financial distress and eliminates the tough choice of funding a bailout or risking the collapse of a major bank.

At the same hearing, Sen. Elizabeth Warren (D-Mass.) admonished financial regulators for not taking firms to trial and instead seeking settlements with many of the violators. Warren criticized financial regulators for allowing firms to get accustomed to paying penalties for violations without admitting guilt. The Massachusetts Democrat argued that without the threat of trial, violators have more leverage to negotiate lower fines.

“How much you can settle with them for, that is, how much they will really pay as a result of having broken the law, depends in part on how they evaluate your willingness to push them to trial,” Warren said.

Warren also urged officials to reveal more information about the nature of violations and the corresponding $9.3 billion settlements. She said the Fed had been unwilling to turn over information about the abuses committed by individual banks.

“If you had real confidence in your settlements and that if people could see the details of those settlements, what the banks did wrong and how you determined how much money would go to individual people, then the public could evaluate for itself whether or not you're really out there fighting on their behalf. And so far, you have not been willing to do that,” Warren said.

Tarullo admitted the Fed could do a better job communicating with the public about its enforcement actions against big banks. Warren asked the Fed governor whether the central bank planned to follow the Securities and Exchange Commission’s (SEC) lead in requiring admission of guilt.

SEC Chairman Mary Jo White announced a few weeks ago that her agency would begin pressing for an admission of wrongdoing from defendants when settling civil charges.

“The question I'm asking about is really how much leverage you have. And what SEC Chairman White has said is that she's going to step it up. She's going to be tougher, and she thinks that's going to give her better leverage,” Warren said.

Tarullo described the “supervisory mechanisms” in place as an effective tool to prevent violations and penalize violators in the financial sector.

“I appreciate that you have another tool that you sometimes use quietly and out of public sight,” Warren responded. “The question I am asking is whether or not you’re going to require something more public.”

Sen. Sherrod Brown (D-Ohio) noted that banks could game the capital rules by using internal models to flatter their balance sheets. Regulators have historically allowed banks to weight assets according to their risk. This, in turn, determines their capital needs.

Tarullo said that liquidity and capital requirements under the Basel III regulatory standards make it more difficult for banks to game risk weighting. He also pointed out that the Fed has been conducting stress tests for firms over $50 billion.

“I think those three things together provide a quite solid base, each of which compensates for the potential shortcomings of the other,” Tarullo said.

Tarullo said the Fed is working to modify a bank-based capital model to cover insurance companies under Dodd-Frank.

“We’re not in a position to take account of that different business model in setting requirements,” Tarullo told the banking committee members. “I can assure you that we’re working as much as we can on tailoring risk weighting for unique insurance products. But we are a little bit confined here.”

Insurance-related holding companies were left out of capital rules approved by U.S. financial regulators this week. Tarullo said the regulators excluded them from the rule while they continue exploring the best approach.

Last Thursday, Warren and a small bipartisan group of senators introduced legislation that would break up Wall Street’s megabanks by separating traditional banking activities from riskier financial services.

“For half a century after the Great Depression, Glass-Steagall kept this country safe by separating the risky activities of investment banks from the basic checking and service and savings accounts that consumers rely on every day,” Warren said at the hearing. “Wall Street's high-risk betting nearly destroyed the economy. But since then, we've made real progress with Dodd-Frank's implementation. But despite this progress, the four largest banks are now 30 percent larger than they were just five years ago and they have continued to engage in dangerous high- risk practices.”

Warren and her colleagues hope the legislation can compel the financial sector to return to “the basics and try to keep the gamblers out of banks.”

The bill, called the 21st Century Glass-Steagall Act, shows the frustration of some lawmakers that banks have only continued to grow since the 2007 financial crisis. The other sponsors are Sens. John McCain (R-Ariz.), Maria Cantwell (D-Wash.), and Angus King (I-Maine).

“Since core provisions of the Glass-Steagall Act were repealed in 1999, shattering the wall dividing commercial banks and investment banks, a culture of dangerous greed and excessive risk-taking has taken root in the banking world,” McCain said in a statement. The Arizona senator voted in 1999 for the Gramm-Leach-Bliley Act, which repealed Glass-Steagall.

The bill would reestablish elements of the 1933 Glass-Steagall Act, which separated traditional banks that offer checking and savings accounts insured by the FDIC from financial companies that engage in investment banking, insurance, and other investment vehicles and was overturned in 1999.