Last week, Massachusetts senator Elizabeth Warren threatened to derail the omnibus continuing resolution (“cromnibus”) that funds most of the government through the end of the fiscal year. She objected to the elimination of an obscure rule in the Dodd-Frank financial reform law known as “push-out.” Under Dodd-Frank, federally backed financial institutions must spin their “swap trades” off to uninsured subsidiaries; after cromnibus, they will no longer have to do this.
Conservatives were caught off guard by this last-minute opposition from Warren. Unfortunately, though, she and the left wing of the Democratic party had a point. While the push-out provision hardly spelled doom and gloom for the country, as they warned, congressional Republicans went about repealing it the wrong way.
To be clear, the 2010 Dodd-Frank financial reform law is a bad piece of legislation, built on two flawed premises. First, by enshrining in law the principle of too big to fail, it doubles down on the mistaken policies of the 1990s and 2000s that paved the way for the financial crisis. Businesses, whatever their size, should bear the consequences of the risks they take. They should not be able to count on Uncle Sam to bail them out. That generates moral hazard. It also creates unfair competitive advantages, as the largest and most politically connected firms enjoy lower borrowing costs.
Second, Dodd-Frank wrongly assumes that an additional regulatory regime is what is needed to keep Wall Street in line. The old regime actually provided all the tools necessary to regulate the big financial firms; the regulators simply chose not to use them. One reason was “regulatory capture,” a phenomenon as old as the Interstate Commerce Commission (ICC), the first U.S. government regulatory body, created in 1887. In fact, the experience of the ICC, especially its manipulation by the railroad barons, proves that more regulation can be worse than useless. If the regulated industry captures its regulator, then it actually enjoys the best of both worlds: the appearance of oversight and the reality of unfettered discretion.
The financial mess of the last decade had a lot to do with regulatory capture. For instance, the Office of Thrift Supervision, which oversaw outlets like Washington Mutual, and the Office of Federal Housing Enterprise Oversight, which regulated Fannie Mae and Freddie Mac, were clearly captured by their industries. In both instances, the mechanisms for capture were actually written into the originating laws, which predated the crisis by decades. So the problem was not so much laissez-faire economics run amok as bad regulations that facilitated interest group power run amok.
As for the push-out provision itself, it was not widely adored when the law was passed. As Tim Carney of the Washington Examiner notes, former Arkansas senator Blanche Lincoln insisted on its inclusion in Dodd-Frank as a way to beef up her anti-Wall Street bona fides in advance of her reelection bid, which eventually failed. Financial institutions have been agitating for repeal of the provision ever since, and not just the biggest banks. As Carney reports, a coalition that included even the Bank of Oklahoma wanted the provision undone. They had a point, too. Leading up to the financial collapse in 2008, the vast array of elaborate credit default swaps ultimately made matters worse because they did not mitigate risk as the firms thought they would. But that does not mean that swaps have no value. Employed properly, they can indeed provide a useful hedge.
Elizabeth Warren, moreover, has been an inconstant opponent of corporate giveaways. When conservative House Republicans tried to eliminate the Export-Import Bank this summer, she refused to join the cause. That says a lot about her intentions. Ex-Im actually does what she claims push-out does: use taxpayer money to underwrite private bets, mostly by Boeing.
So Warren is only a sometime opponent of corporate cronyism. She is defending a fundamentally flawed regime, and in championing push-outs has taken up a cause of questionable importance. Regardless, House Republicans were wrong on this issue.
Even if these swaps, in and of themselves, are not problematic investment instruments, they are a problem in the context of Dodd-Frank. Specifically, they create additional complexity in the financial markets, which historically has facilitated capture. In highly technical situations, the transaction costs of acquiring information are often so great for regulators that they must rely on the regulated industry to supply it. The same goes for Congress. Members are tasked with legislating in a seemingly infinite number of policy domains. The information required to make sound decisions can be prohibitively difficult to acquire—unless interest groups supply it. By injecting more complexity into the financial markets, Congress has given an informational edge to the private interests that specialize in such trades.
The problem is not the swaps themselves, but the regime of Dodd-Frank. It harks back to the naïveté of Teddy Roosevelt and the Progressive campaign of 1912: the view that some private firms are systemically important and that the government must partner with them. All of this is anathema to conservatives, and history has shown time and again that such assumptions lead straight to regulatory capture. Conservatives are right to oppose this alliance of big government and big business, but until an alternative regime is put in place, they should not make regulatory capture easier.
Moreover, the process by which Congress undid push-out was objectionable. The repeal was an ad hoc provision actually written by Citigroup, then placed in an interminably long, inscrutably complicated appropriations bill that did not allow for reasoned, informed debate. This was done only after the Senate refused to take up a bill dealing exclusively with this matter. In other words, the House’s advocates of this provision decided to force the issue—compelling the Senate either to accept the push-out repeal or reject the entire cromnibus and shut the government down. An overwhelming majority of the country disapproves of how Congress handles its responsibilities, and this sort of factional gamesmanship is a big reason why.
If the House Republicans are really interested in financial reform, they should not do it piecemeal, mysteriously, and at the urging of pressure groups. Instead, the process should be comprehensive, open, and rigorously public-spirited. And they should not give away such an important bargaining chip for nothing in return. The main goal for conservatives is the end of too big to fail, which will strip a valuable subsidy from megafirms like Citigroup. By making the current regime more tolerable for the big banks, House Republicans are only inducing them to fight harder to keep their federal guarantees.
For better or worse, the Republican party is now the dominant force in the House of Representatives, having won 8 of the last 10 elections. But this is actually a two-way street: The party’s reputation, and for that matter the conservative movement’s reputation, is now inextricably linked to the performance of the House of Representatives. How can the Republican party and the conservative movement credibly claim to be responsible stewards of the public trust when their most powerful agents legislate in such a shabby fashion?
And the politics of this are terrible. For 30 years, Democrats have had their cake and eaten it, too. Since the labor unions began to fall apart in the 1970s, Democrats have had to curry favor with business interests to fill their campaign coffers; yet for most of this period they have been able to maintain the absurd pretense that they stand for the people against the powerful. By allowing this provision to go through, congressional Republicans have given Democratic corporate stand-ins an easy opportunity to pose, once again, as the defenders of Main Street against Wall Street. In this case, they’ve allowed Warren—a potential presidential candidate who approves of Boeing’s massive federal subsidy—to fulminate against federal subsidies to big banks.
Unfortunately, the opportunity to rectify this error has passed. Let us hope that, moving forward, the Republicans in Congress will do a better job of resisting interest group pressure, particularly when it originates from the corner of Wall and Broad. Until a Republican president is elected, it falls to them to demonstrate that conservatives can govern in the public interest. In this recent instance, congressional Republicans failed their own side.
Jay Cost is a staff writer at The Weekly Standard and the author of A Republic No More: Big Government and the Rise of American Political Corruption, due out in February from Encounter Books.
