Hillary Clinton has a strategy for attacking Bernie Sanders where he’s strongest in his left-wing challenge to her presidential ambitions: She has found a way to argue that the populist Vermonter would be weak on the financial sector, while she would be strong.
It’s a tough sell to Democratic voters deeply skeptical of Wall Street, given Clinton’s own ties to megabanks and that the socialist Sanders has called for breaking up the big banks and re-imposing the Depression-Era Glass-Steagall separation between commercial banks and investment banks.
Yet Clinton has employed a strategy of redirection. It’s not just big banks such as Citigroup or JPMorgan Chase that threaten to cause crises and require taxpayer bailouts, Clinton has argued. So do “shadow banks,” the money-market mutual funds, hedge funds and large insurance companies that perform bank-like activities. While she has proposed new rules for overseeing those companies, Sanders has not, leaving taxpayers exposed to future bailouts, she argues.
The former secretary of state laid out the case most clearly in the second Democratic debate in Iowa.
“I looked very carefully at your proposal reinstating Glass-Steagall as a part of what very well could help, but it is nowhere near enough,” Clinton said in an exchange over whether she would be sufficiently tough on the banking industry. “My proposal is tougher, more effective and more comprehensive because I go after all of Wall Street, not just the big banks.”
Clinton noted that insurer AIG and investment bank Lehman Bros. were at the heart of the financial crisis in 2008. She argues that threats can come from companies that are not commercial banks.
In making that claim, Clinton is on the same page as some of the top regulators appointed by President Obama, including Federal Reserve Chairwoman Janet Yellen and Treasury Secretary Jack Lew. They have prioritized improving safety in shadow banking and have not called for Congress to break up the banks or re-impose Glass-Steagall.
Yet Sanders’ version of Glass-Steagall legislation, the 21st Century Glass-Steagall Act of 2015 co-sponsored by Democrat Sen. Elizabeth Warren and Republican Sen. John McCain, would go far beyond the original Glass-Steagall law. It would so dramatically reshape the financial system as to practically eliminate the phenomenon of shadow banking and to prevent new forms of it from cropping up in the future.
“It really casts the net much, much more widely than the original Glass-Steagall Act did,” said Robert Hockett, a Cornell law professor who has consulted for members of Congress on financial regulatory issues.
The 21st Century-Glass Steagall Act would draw major distinctions separating banks from other financial businesses, creating a wall around banks that take deposits and receive federal insurance for those deposits. It would place broad restrictions on banks engaging in securities activities, banning them not only from containing investment banks but also mutual funds and hedge funds. And it would prevent banks from selling insurance or trading in most kinds of derivatives.
The effect would be to draw a bright line between banks, which take deposits and serve customers and have a federal backstop, and all other financial institutions, such as investment funds that may speculate in markets, insurers that help individuals or businesses hedge against risks, or investment banks that underwrite securities and advise companies on deals.
Sanders’ Glass-Steagall would be the blunt approach to the underlying problem, which is that when regulations raise costs for banks, bank-like activities move into other firms. When those firms start engaging in risky lending, regulators then feel pressured to regulate them as well, as is happening today.
“Financial risks have migrated outside the regulatory perimeter to institutions and markets that appear less systemically important but also may be less transparent and potentially less resilient,” the Office of Financial Research, a part of the Treasury, warned in a recent report.
A classic example is the money market mutual fund industry. One such fund, the Reserve Primary Fund, actually precipitated the worst panic of 2008. When it appeared that the fund may not be able to repay its clients, the Federal Reserve stepped in with a bailout, fearing a system-wide run by borrowers.
Regulators believe that the possibility of a run within the $2.7 trillion money market mutual fund industry is one of the biggest threats within the shadow banking system.
The money market mutual fund industry is largely an artifact of a regulation that capped the rate that banks could pay on savings accounts. When soaring inflation in the late 1970s pushed interest rates above that cap, Yale economist Gary Gorton has argued, depositors looked for alternatives, and the money market mutual fund industry arose as a response. The funds offered higher interest rates than banks could provide, while allowing customers to withdraw their money on demand.
People with money market mutual funds perceive their accounts to be as safe as bank accounts, but in fact they didn’t have the deposit insurance or access to Fed emergency loans that banks do. As it turns out, however, the industry did receive a bailout from the Fed when it threatened the economy.
Clinton’s plan specifically mentions reviewing the rules for money market mutual funds, although it doesn’t spell out what rules could prevent them from experiencing runs.
Sanders’ plan, in contrast, would leave investors in all kinds of funds with no doubt that their money was not backed by the federal government.
Under the updated Glass-Steagall bill, “Shadow banking is only going to occur through the use of the money of the shadow bankers themselves, or sophisticated investors who actually want to be engaged in the investment activity that constitutes shadow banking,” Hockett said. “This would be basically very high-flier wealthy people who have lots of money to play with who have their own brokers on the phone every other day saying, ‘Buy, buy, sell’ … it will never involve the use of what Supreme Court Justice [Louis] Brandeis called ‘other people’s money.'”
Given the far-reaching nature of Sanders’ bill, Clinton’s charge that he isn’t addressing shadow banks “is confused,” said Phillip Swagel, an economics professor at the University of Maryland and former official in the George W. Bush Treasury.
Swagel said he doesn’t favor Sanders’ approach, but it would be successful in starving shadow banks, whereas Clinton’s plan would not. “The cynic might say her plan was actually written by guys who work on Wall Street to check the boxes, give the appearance of cracking down without actually cracking down,” he said.
Sanders has seen only limited success in prosecuting that case against Clinton, perhaps because the details are beyond the grasp of people at rallies or watching a debate. The exact workings of the Glass-Steagall bill, too, might be beyond the ability of lawmakers to talk about fluidly on the stump.
Instead, Sanders has chosen to focus on Clinton’s campaign contributions from banks throughout her career and his own call to simply break them apart.
“I will break up these banks, support community banks and credit unions,” he said in the debate. “That’s the future of banking in America.”
