Barack Obama was “incredulous” at what he was hearing, said one of his top economic advisers. The president had spent his first year in office overseeing the biggest government bailout of the financial industry in American history. Together with Federal Reserve chairman Ben Bernanke, he had kept Wall Street afloat on a trillion-dollar tide of taxpayer money. But the banks were barely lending, and the economy was still mired in high unemployment. And now, in December 2009, the holiday news had started to filter out of the canyons of lower Manhattan: Wall Street’s year-end bonuses would actually be larger in 2009 than they had been in 2007, the year prior to the catastrophe. “Wait, let me get this straight,” Obama said at a White House meeting that December. “These guys are reserving record bonuses because they’re profitable, and they’re profitable only because we rescued them.” It was as if nothing had changed. Even after a Depression-size crash, the banks were not altering their behavior. The president was being perceived, more and more, as a man on the wrong side of an incendiary issue.
And so, prodded forward by Vice President Joe Biden—the product of a working-class upbringing in Scranton, Pa.—the president began to consider getting tougher on Wall Street. “We kept revisiting it,” said the economic adviser (who recounted details of the meetings only on condition of anonymity). One big proposal the White House hadn’t adopted was Paul Volcker’s idea of barring commercial banks from indulging in heavy risk taking and “proprietary” trading. In Volcker’s view, America’s major banks, which enjoy federal guarantees on their deposits, had to stop putting taxpayer money at risk by acting like hedge funds. This had become a grand passion for Volcker, a living legend renowned for crushing inflation 30 years before as Fed chairman. He had long been skeptical of financial deregulation. Beyond the ATM, Volcker asked, what new banking products had really added to economic growth? Exhibit one for this argument was derivatives, trillions of dollars in “side bets” placed by Wall Street traders. “I wish somebody would give me some shred of neutral evidence about the relationship between financial innovation recently and the growth of the economy,” he barked at one conference.
Yet for most of that first year, Obama and his economic team had largely ignored Volcker, a sometime adviser. Treasury Secretary Tim Geithner and chief economic adviser Larry Summers still questioned whether Volcker’s proposals were feasible. Now Obama was pressing them—very gingerly—to reconsider. “I’m not convinced Volcker’s not right about this,” Obama said at one meeting in the Roosevelt Room. Biden, a longtime fan of Volcker’s, bluntly piped up: “I’m quite convinced Volcker is right about this!”
Obama’s cautious, late embrace of Volcker was all too typical. He had arrived in office perceived by some as the second coming of Franklin Delano Roosevelt. Yet Obama hadn’t acted much like FDR in the ensuing months. Instead he had faithfully channeled Summers and Geithner and their conservative approach to stimulus and reform. Early on, Obama’s two key economic officials had argued down Christina Romer, the new chairwoman of the Council of Economic Advisers, when she suggested a massive $1.2 trillion stimulus to make up for the collapse of private demand. They opted for slightly less than $800 billion. “We believe that this is a properly sized approach to move the economy forward,” said Summers, who didn’t want to expand the federal deficit or worry the bond market. With the recession still darkening their outlook, Summers and Geithner also didn’t want to tamper too much with what they still saw as the economy’s engine room: Wall Street. Partly on their advice, the president “explicitly decided not to break up all big financial institutions,” said another top economic adviser, Austan Goolsbee.
After his first year, Obama felt he had done well overall on the economy. Helped by Fed chairman Bernanke, his administration had brought the financial system back from the abyss—from another Great Depression, in effect—by shoring up the banks with hundreds of billions in new bailouts. The administration also pushed for a broad array of reforms. The giant bill Obama signed early in the summer of 2010 brought trillions of dollars in “dark” trading in over-the-counter derivatives into the open. It created new, tough watchdogs for credit-card and mortgage companies, as well as banks. It gave the government new powers to liquidate failing financial firms rather than bail them out.
The president proudly called the new law “the toughest financial reform since the one we created in the aftermath of the Great Depression.” What Obama left unsaid was that his administration had argued against many of the toughest amendments in the bill. And Wall Street, in the end, didn’t complain about it all that much. The biggest firms knew that much of what their powerful lobbyists had failed to block or water down in the bill could be taken care of later on. They’d still be able to influence the vast set of rules on capital, leverage, and other financial issues that would be written by regulators. Led by Summers and Geithner, Obama’s economic team resisted almost every structural change to Wall Street—in particular, Volcker’s plan (initially) and Arkansas Sen. Blanche Lincoln’s idea to bar banks from swaps trading. The administration’s program for getting underwater mortgage holders out of trouble was also criticized as too modest. Obama’s team accepted “too many givens,” says a former senior career Fed official who asked to remain anonymous so as not to offend his former colleagues. Obama’s effort “certainly wasn’t like FDR’s because reform wasn’t driven by the White House,” says Michael Greenberger, a former senior regulator who did much to shape derivatives legislation behind the scenes. “If anything, during most of the journey the White House was a problem and Treasury was a problem.”
Obama’s aides claimed they were only making necessary compromises, placating the Republicans and centrist Democrats they needed to pass the law. And they did stand firm on creating a strong Consumer Financial Protection Bureau. But by midsummer of 2010 the Volcker rule that Obama finally backed was so full of exemptions—allowing banks to invest substantially in hedge and equity funds—that even Volcker expressed dismay. The fundamental structure of Wall Street had hardly changed. On the contrary, the new law effectively anointed the existing banking elite, possibly making them even more powerful. The major firms got to keep the biggest part of their derivatives business in interest-rate and foreign-exchange swaps. (JPMorgan, Goldman Sachs, Citigroup, Bank of America, and Morgan Stanley control more than 95 percent, or about $200 trillion worth, of that market.)
The same banks may end up controlling or at least dominating the clearinghouses they are being pressed to trade on as well. New capital charges, meanwhile, have created barriers to entry for new firms. This consolidation of the elites has in turn kept alive the “too big to fail” problem. “It makes it way tougher now to kiss somebody off when they get in trouble,” says the former Fed official. Eugene Ludwig, a former comptroller of the currency, believes the new law’s impact will be “profound” in changing the way banks do business. But he worries about a “skewing of the playing field” in favor of the big banks, putting community banks at a disadvantage.
The Obama administration also did little to use its bully pulpit to reorient pay packages at the big financial houses, where bonuses still often run in the tens of millions of dollars. Critics make the case that changing this pay structure would do more than punish those who helped spur the meltdown. It might also encourage some of America’s greatest minds to stay away from financial engineering, which contributes little of substance to the economy, and instead consider real engineering. Nor has the Justice Department launched prosecutions as it did after the S&L crisis, or during the insider-trading scandals of the ’80s, when Michael Milken and Ivan Boesky were led off in handcuffs. (One problem this time around, lawyers say, is that virtually everyone was complicit in the subprime-mortgage scam.)
Most significantly, Barack Obama, in contrast to FDR in the depths of the Depression, has failed as yet to restore confidence in the economy. A recent Associated Press poll showed him at his lowest point ever on that issue, with just 41 percent of Americans approving of his performance. It was little surprise last week when Republican House leader John Boehner, sensing blood in the water—and a possible speakership in his future—attacked the president’s economic team and called for the resignations of Geithner and Summers. (Both budget chief Peter Orszag and Romer had already announced over the summer they were leaving.)
Obama can hardly take all the blame for the surprising persistence of high unemployment and slow growth. Among the new headwinds beating the economy down in recent months was Europe’s currency crisis, for example. But the leadership question can’t be ignored. Financial and economic reform just never seemed to be a subject that kindled Obama’s passions, his critics say. (The White House strenuously disagrees: “Financial reform has been a top priority to the president since day one,” administration spokeswoman Jennifer Psaki told me.) For much of his first 18 months in office, Obama always seemed to be finding some new thing to focus on. He spoke about financial reform, but he often seemed to address it on the fly, as he was tackling other priorities, like health care. To be fair, Obama was also juggling two wars. Yet all in all, he seemed perfectly willing to leave things to his trusted lieutenants, Geithner and Summers, puzzling some Democratic allies on the Hill. “Doesn’t the president realize he’s got a big flank exposed here?” said one Democratic staffer pushing for tougher restrictions on Wall Street early in the summer of 2010.
There was so much passion and ambition in Obama’s words about fixing the economy, and so much dispassion and caution in his policy choices. Early in the Democratic primaries, in January 2008, Obama had stunned many of his supporters by praising Reagan as a transformational president—a contrast to the eight years of Bill Clinton, Obama added cuttingly. Reagan, Obama said, “put us on a fundamentally different path because the country was ready for it.” Yet at what would seem to be a similar historical inflection point—what should have been the end of Reaganism, or deregulatory fervor—President Obama seemed unprepared to address the deeper ills of the financial system and the economy. Several officials who have worked with the Obama team said the president’s heart was in health care above all else. “He didn’t run for president to fix derivatives,” says Greenberger. “And when he brought in Summers and Geithner, he just thought he was getting the best of the best”—good financial mechanics, in other words, who would “get the car out of the ditch,” to use one of Obama’s favorite metaphors.
But the administration had a much bigger job than that. The worst economic downturn since the Great Depression hadn’t occurred just because of a simple crash. An entire era had overreached—the markets-are-always-good, government-is-always-bad zeitgeist that defined the post–Cold War period. The very idea of government regulation and oversight had become heresy during this epoch. Washington policymakers came to ignore the key differences between financial and other markets, differences that economists had known about for hundreds of years. Financial markets were always more imperfect than markets for goods and other services, more prone to manias and panics and susceptible to the pitfalls of imperfect information unequally shared by investors. Yet that critical distinction was lost in the whirlwind of deregulatory passion that followed the collapse of the Soviet Union and other command economies. Finance, completely unleashed, had come to dominate the real economy rather than serve its traditional role as a supplier of capital to goods and services. Venture capital transmogrified into speculative fever. Innovative ways of financing new business ideas evolved into vastly complex derivatives deals, like subprime-mortgage-backed securities, that were often little more than scams.
All of these challenges required a fundamental rethinking of the U.S. and global economy. Yet those who were most aligned with the “progressive” side of the Wall Street reform issue remained, for the most part, on the outside of the administration looking in. Among them were Brooksley Born, the former chairwoman of the Commodity Futures Trading Commission, and Nobel-winning economist Joseph Stiglitz. Summers and Geithner, by contrast, had been acolytes of Bob Rubin, the former Clinton Treasury secretary who, along with then–Fed chairman Alan Greenspan, had presided over many of the key deregulatory changes in the ’90s. And they convinced Obama that the financial system they themselves had done so much to nurture was, on the whole, fine. As long as there were greater capital reserves, leverage limits, and more regulatory oversight, Wall Street could remain intact. (Summers would continue to maintain, well after the crisis, that he had never been a full-blown advocate of deregulation; Geithner did not respond to a request to comment for this article, but previously told me that he was no creature of Wall Street and was simply doing as much as he could to constrain it.)
Obama was clearly not pushing very hard to be FDR or even his trust-busting relative Teddy Roosevelt. Now it looks like grim growth and unemployment numbers could extend all the way into 2012. Distracting himself with health care and other issues, Obama may have politically maneuvered himself out of the only major remedy that could bring unemployment down and growth up enough to assure his re-election: another giant fiscal stimulus. Today, after engendering Tea Party and centrist Democratic resistance to more government spending by pushing his health-care plan, the question is whether he has the political capital he may well need, in the end, to save his presidency. And after a two-year fight over financial reform, one other question still lingers: has Wall Street come out the big winner yet again?
Adapted from Capital Offense, by Michael Hirsh, a new book on the 30-year history behind the financial crash and ongoing economic crisis.