A Matter of Trust: Slowing Wall Street's Revolving Door

Businessman with suitcase using revolving door
Businessman with suitcase using revolving door

The revolving door between Wall Street and Washington once again threatens our nation's financial health.

Slowly and feebly the nation is recovering from the financial meltdown that crashed our economy in 2008. The financial collapse dearly hurt millions of middle-class, working and retired Americans, at its low point costing 8.8 million jobs, $2.5 trillion in retirement savings and 3 million homes. It tore apart countless lives.

But Wall Street did not suffer as badly. In fact many of the bankers responsible for the collapse got very rich. Top executives at Bear Stearns and Lehman Brothers profited about $1.4 billion and $1 billion, respectively, in cash bonuses and equity sales from 2000 through 2008, despite the collapse of their firms. Individual bankers usually did not take a loss themselves when their risky deals tanked. Shareholders covered their losses.

And when the federal government stepped in to bail out the largest nine banks with a $175 billion cash infusion, the banks paid their top executives $32.6 billion in bonuses in 2008. When the banks prospered, their executives flourished with private profits. When the banks failed, their executives flourished with taxpayer dollars. A win-win situation for Wall Street.

How did our nation fall into the financial crisis in the first place, and how did Wall Street avoid paying the price?

Although many of the specifics of the story may be complicated, the big picture is not all that difficult to understand. The financial crisis came primarily from a revolving-door dance between two groups: Wall Street itself, and the government regulators overseeing Wall Street. Over the last decade, these two groups have increasingly become the same people. Wall Street executives taking jobs as government regulators, and government regulators flowing into lucrative jobs on Wall Street. The same people, with increasingly the same interest: loosen government regulations, ease back on oversight, for the purpose of allowing bankers and investors to maximize profits.

A study by the Federal Reserve Bank of New York revealed a dramatic rise of financial executives moving into positions of government regulators ("regulatory capture") and regulators moving back into private sector employment in the financial services sector ("revolving door"). The result of spinning both ways through the financial services revolving door is reflected in the declining tenure of financial regulators, with 88 percent of regulators on the job for three or more years in 1988, down to 64 percent today.

This cozy relationship between the industry and the regulators fostered complacency and risk-taking. Years before the meltdown, bankers were reaping exorbitant profits from irresponsible mortgage lending and even concealed the high risks at stake. The regulators looked the other way or often simply lowered the standards. Pension funds, mutual funds and investors fell in love with these high-risk and highly-profitable investments.

Then it all crashed.

Congress responded to the public outcry and passed sweeping financial reforms in the Dodd-Frank legislation, vastly toughening the standards against risk-taking by financial institutions. But getting the regulators to implement these tough standards has been a whole different story. The Securities and Exchange Commission is years behind its rulemaking agenda, and many of the rules it has produced have been sharply criticized as inadequate by the authors of the law.

Enforcement of the rules has also languished. Carmen Segarra, a bank examiner with the Fed, uncovered numerous problems at Goldman Sachs, but was ordered by her supervisor to change her report. When she refused, she was fired - and her supervisor moved on to lucrative employment on Wall Street.

Good financial reform legislation was passed, but the revolving door between Wall Street and Washington spins unabated. Congress fixed the law but failed to address the problem of the regulators.

David Beim, a Columbia University professor, conducted a study of what's wrong with the Fed in 2009. He found a whole range of problems: deference to the banks, unwillingness to take enforcement actions, regulatory capture. Beim testified before Congress again in 2014 and said straight out: "The current law is not effective in accomplishing what it set out to accomplish." He observed that the revolving door culture in financial services regulatory agencies has not changed. "To reduce regulatory capture and stiffen the backbones of individual regulators, this easy revolving door must be stopped."

Legislation to do precisely that has been crafted. The "Financial Services Conflict of Interest Act" by Sen. Tammy Baldwin (D-WI) and Rep. Elijah Cummings (D-MD) focuses on fixing the regulatory process, so that Dodd-Frank may actually be implemented. The legislation would end banks giving bonuses to employees who become regulators; require regulators to recuse themselves from official actions that benefit former employers or clients; ban former regulators from influencing governmental decisions for two years after leaving public service; and prohibit bank examiners and their supervisors from taking jobs with banks they had overseen.

To gain confidence in the security of the financial services industry, we need to gain trust in the integrity of financial services regulators.