Barney Frank is erupting, as only Barney Frank can. "How dare you!" he says. "How dare you accuse me of lying!" I am up on Capitol Hill to talk about his efforts to fix Wall Street, and Frank is growing agitated as I ask about the influence of the banking lobby on the House Financial Services Committee, which he chairs. Frank is determined to quash any notion that he's been weak on financial reform. I inquire about his decision the day before to postpone a vote on a reform bill. His public statement had said only that some Democrats on his committee weren't ready to decide on the legislation. Was there any other reason? "Are you trying to catch me in some lie?" Frank retorts. "You think I put that off for the big banks?"
Actually, I hadn't said anything about the big banks—and I certainly hadn't accused him of lying. But this is the chairman's method of dealing with critics: go on the attack. Frank, a Harvard Law School graduate, is considered by many of his peers to be the brainiest member of the House. And he can be fierce when challenged—especially over legislation that is likely to change the face of America's financial system. Now, gazing from behind thick glasses, his mouth set in its trademark grimace, Frank fires back. "The big banks have no influence," he says. "They couldn't stop the credit-card [reform] bill. They get the full blast of the [new] Consumer Financial Protection Agency." When I press him further about the vote and how tough he's going to be on Wall Street's cash cow, derivatives trading, he's had enough. "This interview is over," Frank says, as if banging down a gavel.
It isn't surprising that Barney Frank seems a bit…defensive. For most of his long and colorful career, the 15-term Massachusetts Democrat has been a hero to the left and a bane to entrenched conservative interests. Among his -proudest achievements: protecting Legal Services, which represents the poor, against attempts to dismantle the agency; repealing a ban on gay immigrants; and championing housing reform. But now he finds himself second-guessed by his liberal supporters over what he says is the biggest challenge of his career: reining in Wall Street. A package of bills finally approved by Frank's committee last week seeks to regulate the financial industry and keep firms from growing "too big to fail." A key part of that effort is to gain control over the vast market in "over the counter" derivatives by forcing trading onto open exchanges, where regulators can monitor it. Unregulated derivatives were behind much of the havoc that nearly brought down the financial system last year, including the subprime-mortgage-backed securities that put many firms underwater and the credit default swaps sold by AIG, the giant insurance company that sucked up about $180 billion in bailout money. The $592 trillion global market in these mostly unmonitored derivatives remains among the most profitable businesses for the biggest banks—Goldman Sachs, JPMorgan Chase, Citigroup, Bank of America, and Morgan Stanley—and Wall Street doesn't want Washington tampering with it.
Early versions of Frank's bill allowed many derivatives to continue trading off exchanges. That touched off criticism from reformers on the left, who said that Wall Street had created large loopholes. Frank was outraged when one of his prominent critics was quoted in The Boston Globe as saying that the congressman had adopted the view of business and "walked away from the concerns of the major unions, consumer groups, and environmental groups.'' The next day Frank's office called the critic, Maryland law professor and ex–federal regulator Michael Greenberger, to complain about the comment, according to at least two people privy to the conversations.
Frank dismissed Greenberger's criticisms as "uninformed." But shortly after the Globe article was published, Frank admitted in a letter to another of his occasional critics, Gary Gensler, chairman of the Commodity Futures Trading Commission, that "there may be a problem" with the draft derivatives bill. The bill, Frank wrote, "could be subject to manipulation" by "clever financial firms" seeking to evade a requirement that they trade derivatives on open exchanges. Frank has tried to fix the loopholes in the legislation, which goes to a full House vote as early as this week.
Not even critics accuse Barney Frank of being in the pocket of Wall Street. The real question is whether he and -others are being swayed by the legislative legerdemain that Wall Street lobbyists have long practiced. The story of how those loopholes got into the derivatives bill, even with Frank at the helm and the wind of public outrage at his back, shows just how powerful the Wall Street banking lobby remains—and how complex Wall Street's financial instruments have become. "I don't think he ever fully understood the legislation" in its early stages, says Greenberger. Many of the key lobbyists now are the same gang that helped get us into this mess before, and they're spending huge sums once again. In the first three quarters of 2009, financial-industry interests have spent $344 million on lobbying efforts, putting them on pace to break all records, according to the Center for Responsive Politics. That's just for lobbyists' and lawyers' salaries, junkets, and dinners, and doesn't include political donations and issue ads. Even more impressive is the lobbying strategy that money is buying. According to insiders and industry e-mails obtained by NEWSWEEK, the banks have sought to stay in the background and put their corporate customers—a who's who of American business, including Apple, Whirlpool, and John Deere—out in front of the campaign. "This is an orchestrated, well-funded effort by the banks to manipulate our legislation and leave no fingerprints," says a congressional staffer involved in drafting the legislation. The staffer, who would speak only on condition of anonymity, passed on to NEWSWEEK nine pages of proposed changes in the legislation intended to protect trading from open scrutiny—all of it on paper without a letterhead—that she says came from Goldman Sachs. Samuel Robinson, a spokesman for Goldman, says "it's not our document" but adds that Goldman has "an active and appropriate involvement in the process of government" and supports "sensible reform."
The financial industry has argued that curbs on derivatives don't hurt just Wall Street but also the corporations in Main Street America—the "end users" —that need them to hedge risks. Airlines, for example, use derivatives as protection against sudden gyrations in fuel costs by "swapping" interest-rate payments or currencies with other companies. No one doubts derivatives are useful for that. What upsets Wall Street critics is that the banks that sell these contracts to corporations prefer the derivatives to be privately negotiated off exchanges. The more custom-made and out of public sight a derivative is, the harder it is for investors—and regulators—to assess its fair value and real risk. This makes it easier for the banks to charge a large "spread" and earn big profits. "It's like the used-car market, except that it's even less transparent," says Adam White, a derivatives expert at White Knight Research in Atlanta. The banks deny critics' charges that they are keeping prices high; many end-user companies are willing to do the deals privately because they aren't required to post -capital to cover margins, as regulators would require.
Frank heatedly denies that he's been fooled, though he concedes he is still catching up on some of the details of the bills he is pushing through. "I've become responsible for dealing with a lot of things that are new to me. I didn't have a great deal of knowledge. I've been relying on a whole lot of people," Frank says. In allowing some exemptions from exchange trading, Frank says he is merely accommodating the corporate end users—not Wall Street—who want to continue doing these private trades in derivatives. "The Wall Street lobbyists are not end users. Is Boeing a Wall Street lobbyist? Is John Deere a Wall Street lobbyist?" he asks, citing two big companies that have supported the "end-user exemption." But critics like the CFTC's Gensler have said that the exemption intended for nonfinancial companies might let many other players avoid regulation, including hedge funds, private-equity funds, and other financial firms. Other critics, such as Barbara Roper of the Consumer Federation of America, say some of the corporations themselves are being used by the banks. (Backers of the "Coalition of Derivatives End Users"—including the Chamber of Commerce, Business Roundtable, and National Association of Manufacturers—say they're acting on their own.) Roper, Gensler, and others have also argued that the corporations sometimes don't realize they could get better prices for their derivatives deals through open bidding on exchanges, even though it might cost them more upfront.
Frank contends that many of his critics don't understand the "push-pull" of the legislative process—how difficult it is to muster a majority vote for tougher approaches to regulating super-complex practices. He points to other victories: the approval of the Consumer Financial Protection Agency, and an amendment that will require banks with assets of $50 billion and above to contribute to a rainy-day fund that would be used to break them up if they cause another crisis. "Do you think Wall Street was all for that? They were very upset about it," Frank says.
But even Frank concedes that financial reform is the hardest thing he's done in three decades in the House. "It's taken over my life," he says, "in a way that nothing ever has before." Perpetually disheveled and proud of it—NEATNESS ISN'T EVERYTHING, one of Frank's early campaign posters read—he has also had to adapt from being an outside agitator on Capitol Hill to someone at the center of power. "There is a difference when you become chairman. You have the responsibility to shift from being an advocate to one who has to deliver. As I said to Ralph Nader at one point, there is a certain charm in the purity of irrelevance. But the more relevant you get, the more real you have to get," he says. "So I started out with what I wanted to do and then tried to come as close to it as possible."
The Wall Street lobby isn't giving up. After Frank had toughened up his stance on derivatives, the lobby tried to redefine what certain kinds of exchanges do, according to a former lobbyist involved in the strategy who would divulge it only anonymously. Under the lobby's proposed changes, a new kind of exchange called an "alternative swap execution facility" would have required only that derivatives trades be documented after they were completed, says the lobbyist. But the trades wouldn't be open to bidding—or easily regulated. Told about that latest move, Frank at first said he hadn't focused on the language. Last week he directed his staff to rewrite the definition, but questions remain about whether the loophole is actually closed. His decision to briefly postpone a final vote on his bill, he adds, was merely to give members of the Congressional Black Caucus on his committee more time to consider their position.
Now the lobbyists are working the Senate side, where banking-committee chairman Chris Dodd is also facing pressure to exempt end users. Frank insists he will get the law right in the end, and he's soliciting more views from his traditional liberal base. "I have been begging the consumer groups: 'Please, please speak out,' but it turns out you can't get people to get activated until they're angry," Frank says. Frank, who abruptly ended his NEWSWEEK interview shortly after that remark, is clearly both angry and activated. But is he angry enough at Wall Street?