Sheila Bair: Janet Yellen Botched Glass-Steagall, But Should Still Be Fed Chair

UNITED STATES - SEPTEMBER 09:  Sheila Bair, chairman of the Federal Deposit Insurance Corp., listens to a speaker during a bo
UNITED STATES - SEPTEMBER 09: Sheila Bair, chairman of the Federal Deposit Insurance Corp., listens to a speaker during a board meeting in Washington, D.C., U.S., on Wednesday, Sept. 9, 2009. The FDIC proposed a six-month, emergency-only extension to its debt guarantee program as regulators move to wean companies from federal aid approved at the height of last year's credit crisis. (Photo by Andrew Harrer/Bloomberg via Getty Images)

WASHINGTON -- Federal Reserve Vice Chair Janet Yellen's support for repealing the landmark Glass-Steagall banking law shouldn't disqualify her from the central bank's top post, according to Sheila Bair, former chair of the Federal Deposit Insurance Corp.

Bair was an outspoken critic of the financial status quo during her tenure at the FDIC from 2006 to 2011 -- a rarity among bank regulators -- and has remained a strong proponent of Wall Street reform since leaving office. In an interview with HuffPost, she said Yellen's support for deregulating Wall Street during Bill Clinton's presidency is common among potential candidates to replace retiring Fed Chairman Ben Bernanke.

"I saw your piece about how [Yellen] supported repealing Glass-Steagall," Bair said. "That really didn't surprise me. Everybody at the Fed did. But I think she's the best of the people out there."

Like Bair, Yellen warned about the developing housing bubble during the George W. Bush presidency, and criticized predatory lending in the market for subprime real estate mortgages. Most other financial policymakers either downplayed such problems or ignored them. In speeches throughout 2008, when Yellen served as president of the San Francisco Federal Reserve Bank, she called for restructuring the financial system, saying turmoil in financial markets had revealed fundamental problems in the banking industry.

But as an economic adviser to Clinton, Yellen supported doing away with Glass-Steagall's separation between traditional bank lending and risky securities trading. She also signaled an openness to allowing banks to team up with commercial and industrial firms.

Bair said she doesn't downplay the significance of the Glass-Steagall repeal, widely cited as a major cause of the 2008 bank crash and subsequent bailout. Former Obama economic adviser Larry Summers withdrew from consideration for Fed chairman, in part over concerns about his support for deregulation in the 1990s, including the repeal of Glass-Steagall and the push to exempt trading in opaque financial derivatives from regulatory oversight.

"There were two problems," Bair said. "One was the Citigroup problem. It created institutions that were too complex to manage. People at Citigroup just didn't know how to handle that behemoth. And some of those problems were in proprietary trading, but some of them weren't. It just created and reinforced companies that were beyond the capacity of any management team to control."

Bair emphasized that among the 2008 bailout recipients, Morgan Stanley had the most visible problems with proprietary trading. By 2008, every major financial firm had both commercial banking and securities trading operations. But Morgan Stanley was devoted to its securities business, making the effective government subsidy for proprietary trading relatively low. Today, Morgan Stanley is a formal bank holding company with access to cheap Federal Reserve loans, now as close to zero percent as the central bank can manage. The firm can plow this money into any enterprise it sees fit, including risky speculative trades for its own book. Bair said the Volcker Rule -- which would allow commercial lenders to trade securities on behalf of clients, but ban them from doing so for their own accounts -- is critical given the post-crisis financial landscape.

"The Volcker Rule would have helped [before the crisis], but it's especially important now because all these investment banks are now bank holding companies," Bair said. "We don't want them speculating with their government-supported money. What Volcker says to me is that if you're a safety-net institution, it's fine to make money. You're a for-profit firm. But you have to do it by providing credit that's directly useful to the economy."

In 2012, JPMorgan was burned by its proprietary London Whale trades, losing more than $6 billion. The company categorized the trades as a hedge against other risks, but that explanation is not generally accepted by financial experts, and Bair rejects it. While Congress required regulators to write a Volcker Rule in 2010, the version proposed by federal regulators includes hundreds of pages of loopholes and exemptions, and has not yet been implemented. JPMorgan has negotiated settlements with U.S. and international regulators over other legal infractions related to the London Whale trades, however, and individual traders face domestic criminal charges.

"A lot of that stuff goes on," Bair said. "We saw it with London Whale. They call it hedging, they call it market making, but it's really something else ... Volcker would give regulators examination and enforcement tools to enforce that culture change."

Bank lobbyists have aggressively lobbied regulators against implementing a straightforward Volcker Rule banning proprietary trading, arguing that would punish harmless trades made on behalf of clients -- so-called market making activities -- or efforts to hedge against risk. Under Bair's blueprint, megabanks would have to move all of their securities operations outside of subsidiaries that offer customers taxpayer-guaranteed deposits.

"I will grant the industry this," Bair said. "I think it's hard to distinguish market making from proprietary trading. There will be clear cases, but there will be a gray area, so we should at least force all market making out of the bank. Don't let it be financed by deposits. Wall off that funding, get it out of the depository institution."

Bair said she doesn't buy the bank lobby's hedging argument. "It's easy to see whether something is a hedge or not. I think regulators can easily distinguish that."

Bair also objected to Yellen's enthusiasm for the Fed purchasing Treasury bonds and mortgage bonds to further depress interest rates, arguing that the policy mostly fuels asset bubbles. But Bair emphasized that many top contenders for the central bank simply are not interested in using the Fed to lower unemployment.

"I don't agree with her monetary policy, but she really does care about unemployment, and that's not a given," Bair said. "So I respect her motivations, even if the policy we disagree on."



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