The highly divided Congress is providing futile ground for plutocracy, a country dominated and effectively ruled by a tiny wealthy elite. The bipartisan budget bill just passed significantly raises the contribution limits to political parties and weakens an important safety and soundness protection against recklessness in the financial industry.
The first harmful provision, the relaxation of campaign limits, is far easier to explain. A donor’s contribution to one of the political parties had been limited to $97,200. Under the bill, the donor can now contribute an incredible $777,600. This only increases the political influence of the rich and powerful, who will now be listened to even more intently when they call members of Congress and ask for a loosening of consumer protections and financial safeguards.
Phone calling brings us to the second harmful provision. Mr. Jamie Dimon, the head of JP Morgan Chase, reportedly called members of Congress urging them to relax an important safeguard in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.
Section 716 of the Dodd-Frank law requires banks that engage in complex and risky derivatives and swaps activities to place those activities in affiliates that do not have access to federal deposit insurance. This firewall ensures that U.S. taxpayers are not exposed to bailing out banks when derivatives and swaps result in large losses.
But Mr. Dimon and his big bank allies succeeded in getting this push-out of swaps and derivatives to be repealed. In other words, bank affiliates engaging in these activities can now be covered by federal deposit insurance. This is a profit maximizing strategy: the cost of raising funds for these risky and complex activities will be lowered since these activities are now covered by federal deposit insurance.
Simon Johnson, a MIT economist and big bank critic, says that the change would affect a small portion of derivatives and adds that, “I don’t want to make a mountain out of a molehill on this,” but added that “on a forward-looking basis this could become very big”.
The impact of this new rule depends on the riskiness of new swaps instruments invented by the financial industry. One type of swap that made large financial firms insolvent during the financial crisis was called the credit default swap. In particular, the giant financial firm, AIG, provided credit default swaps (CDS) to investors who purchased subprime mortgage-backed securities (as long as borrowers of subprime loans paid their loans on time, investors of mortgage-backed securities got paid). CDS was akin to insurance. In the event that borrowers of subprime loans defaulted en masse, AIG would reimburse the investors.
AIG made a horrendous bet, writing $79 billion of CDS protection. Because subprime loans were poorly underwritten, borrowers defaulted en masse. As the storm clouds were gathering and defaults were mounting, a senior AIG official maintained on an investor call, that “it is hard for us, without being flippant, to even imagine a scenario within any kind of realm or reason that would see us losing $1 in any of these transactions.”
Similarly one of bank regulatory agencies, the now defunct Office of Thrift Supervision (OTS), was just as clueless as some of AIG officials. Former OTS Director John Reich said the OTS was no match for AIG, could not understand AIG’s operations, and the OTS was like “a gnat on an elephant” when it came to controlling AIG.
The rest is history. AIG was so interconnected with the rest of the financial industry that the federal government bailed out AIG to the tune of $182 billion. The choice was a bailout or a depression worse than the Great Recession.
In order to prevent a repeat of the financial crisis, the Dodd-Frank law required new standards and safeguards to avoid the poor underwriting and tricks and traps of abusive subprime loans. In the short to medium term, it is unlikely that a predatory lending industry will use the banks to write CDS like AIG did since abusive loan terms and conditions are now outlawed. However, new tricks and traps can be invented by an industry ravenous for profits. And it is just too risky to place these risky activities in the reach of federal deposit insurance.
Leading the opposition to the budget bill, Senator Elizabeth Warren stated that “A vote for this bill is a vote for future taxpayer bailouts of Wall Street. When the next bailout comes, a lot of people will look back to this vote to see who was responsible.”
Reflecting on the relaxed contribution limits and the repeal of Section 716, Rep. Chris Van Hollen said, “Putting these two things in the same bill illustrates everything that is wrong with the political process right now: a giveaway to the special interests and then providing them with the ability to more easily finance the process.”
The plutocrats are now emboldened in the divisive atmosphere in Capital Hill. Wait until the 11th hour in difficult budget negotiation when there is no time for reflection and public hearings on complex, arcane, but important financial legal and regulatory issues. Then slip in a major change to financial and consumer protection laws. Today it was Section 716. Tomorrow it might be other parts of Dodd-Frank such as the Consumer Financial Protection Bureau.
The plutocrats are resurgent. To prevent them from laughing all the way to the bank while the common folk pay the bill, a re-energized grassroots holding the elected officials accountable is our only hope.
Josh Silver is the Development Manager at Manna, Inc. Prior to his time at Manna, Josh served as the vice president of research & policy at NCRC. Josh is an avid District sports fan and loves spending time with his daughter.