Talking With an Ex-FDIC Chair; Crypto Firms Hit D.C.; SEC's Own Investor Group Criticizes AI Rule
Capitol Account: Free Weekly Version
Financial regulation news sputtered back to life this week. The Supreme Court heard more than two hours of arguments on the SEC’s in-house judicial system — and the conservative majority of justices didn’t seem very sympathetic. On Capitol Hill, CFPB Director Rohit Chopra got his turn in the barrel during two days of hearings. We also headed to the Blockchain Association’s annual policy summit on D.C.’s Southwest waterfront. The crypto crowd was feeling bullish (as usual), even as some lawmakers cautioned that legislation to provide clarity on the oversight of digital assets isn’t likely to pass any time soon. And at the SEC, more criticism was heaped on the controversial plan to regulate how brokers use artificial intelligence. Interestingly, this time the complaints came from the agency’s own investor advisory committee. For our Friday interview, we spoke to a former FDIC chair who has a lot of thoughts on bank policy, Wall Street lobbyists and addressing the toxic workplace issues at the regulator.
Thank you for subscribing to out free edition, a digest of articles we published throughout the week. The daily newsletter had many more. Click the button below to upgrade to our paid product.
Friday Q and A: It’s been a rough few weeks for the FDIC as allegations about its toxic, boys-club workplace culture rocketed across Washington. Several investigations are now under way, assuring that the scandal will continue to reverberate – especially on Capitol Hill. Though Democrats are mostly reserving judgment for now, a handful of Republican lawmakers have already called for the resignation of Chairman Martin Gruenberg.
The firestorm also threatens to slow the Biden administration’s aggressive regulatory agenda for the banking industry, which took on greater significance after the collapse of several regional lenders earlier this year. Gruenberg, the longest serving FDIC chief, has been a strong advocate for tightening up the rules. Wall Street, which has gone to the mat against the new proposal to hike bank capital requirements, would especially like to see him sidelined – or ousted.
To get a deeper understanding of everything that is going on, we talked last week with former FDIC Chair Sheila Bair. During her time leading the agency, from 2006 to 2011, Bair was a key player in the federal government’s response to the financial crisis. Her calls for ending too-big-to-fail policies and setting stricter regulations earned her an almost folk-hero status (including a spot on the cover of Time as one of the “new sheriffs of Wall Street”). But Bair’s stances also put her at odds at times with fellow Republicans and the powerful bank lobby – not to mention some of her regulatory colleagues.
Today, Bair spends a lot of time outside the Beltway, but she hasn’t left the world of policy behind. She keeps a busy speaking schedule and advises financial firms like Banco Santander and Wealthfront. Bair also works with the Systemic Risk Council, a group she helped found.
Bair’s labor of love, however, is writing. And not just op-eds. Her series of picture books, called “Money Tales,” is aimed at teaching kids good financial habits. The two latest editions came out this fall. Read on to get her thoughts on the Basel endgame capital proposal, out-of-control bank lobbyists and how to fix the problems at the FDIC. What follows is our (lightly edited and condensed) conversation.
Capitol Account: Looking back, which post-crisis reforms have worked best?
Sheila Bair: The system is better capitalized. That's good. There's better preparation for handling failed banks. The tools are there — whether regulators are going to use them is another thing. But the thing that's most dramatically improved is capital and liquidity. That's through a combination of the Dodd-Frank reforms and regulatory efforts to strengthen the capital and liquidity rules, which were far too weak leading up to the crisis.
CA: But don’t you think bank capital should be even higher?
SB: I've always said we need more capital. I argued in my book, a 10 percent leverage ratio would be great. At 12 percent we could call it a day. We're not anywhere close to that. But I think it's also important to understand that on credit risk, these Basel III endgame rules don’t even increase capital. It would stay the same. Actually, it goes down a little bit.
CA: Is there anything that sticks out to you that wasn’t fixed in Dodd-Frank?
SB: The big, gaping hole is the non-bank sector. The assets in the private funds – venture capital, hedge funds, private equity – exceed what's in the regulated banking sector. They have become a bigger part of credit intermediation than the regulated banking system. So that is a problem.
CA: What do you fear could go wrong?
SB: The beast is being fed by the regulated banks. They'll have counterparty exposures, credit lines – they support that non-bank sector. And frankly, I think there's a lot of capital arbitrage going on because the banks have tougher capital standards than the non-banks…Basically, the banks still have exposure to them. So, you have a situation where they’re more levered than the banks. They're far less transparent. We don't really know what's going on there.
CA: What about the Basel proposal? Banks have blasted it.
SB: The industry criticism is nonsense – I think [Sen.] Mark Warner called it ‘Chicken Little.’ It's all this stuff they bring up every time regulators try to toughen capital requirements. It's going to hurt lending, it’s going to raise the cost of credit to Main Street…It's all the usual arguments, which are just wrong. It doesn't make them less competitive globally. Every time we raise capital requirements, their capital costs go down because investors just view them as safer. Whether they want to admit it, they have a stronger competitive position because we gold-plated our capital rules versus Europe. All the research shows that through the cycle, a better capitalized bank will do a better job of lending than a highly leveraged bank.
CA: A new trend since you left government has been the financial industry’s greater appetite to sue regulators. What do you make of this?
SB: It's getting a lot more combative. I think it is troubling…If regulators just end up being so gun shy, because they're going to have bad press spread about them or people try to hold them personally liable in court, that's not a good thing. Just being routinely overturned whenever you try to write a rule and stand up to the industry – that's going to make them gun shy too. Bless Gary Gensler. He's standing up to it. He's been subject to challenges. The CFPB, as you know, their funding mechanism is being subject to challenge. They’re standing up and fighting the good fight. But I think the more courts are receptive to this, the more you're going to see it happening.
CA: Who’s to blame for the more adversarial relationship?
SB: These lobbyists, some of them are just out of control. I wish the CEOs would pay more attention to what some of their lobbyists do. I just think they need some grown-up supervision…People in Washington who are doing this stuff, I don't think the CEOs know about it. Maybe they're pretending they don't. But I really think some of it, they don't. And it would be nice if you had a Jamie Dimon or other leading CEO say, ‘Okay, we feel strongly about this, but our lobbying is going to be based on issues and nothing else.’ That would be a nice tone for some leading CEO like him to set.
CA: It sounds like you wouldn’t be shocked if the bank lobby was behind some of the recent negative reports about the FDIC.
SB: No, it would not surprise me. I'm sad to say that, but it's bare knuckles. They like to say, ‘Oh no, we're just advocating good policy.’ But I think behind the scenes, there's some stuff that goes on that is really not professional.
CA: Are you skeptical of some of the allegations reported by the Wall Street Journal?
SB: I've dealt with the Journal over the years. I think that they have integrity, and I hope they try to be balanced. But both things can be true – that there are some serious problems with sexual harassment with the FDIC but also that the industry has worked overtime to try to feed this to reporters and spread it around to weaken the FDIC and distract it. Or even to force the current chair out, so then you'd have a gridlocked FDIC and you couldn't move forward with some of these capital rules.
CA: Did these kinds of problems exist under your watch?
SB: A hard no. I don't think there was anything in that article that suggested there was a toxic culture at the FDIC during my tenure. If there had been, I would've known about it. Our [inspector general] would've known about it. We would have been all over it.
CA: How can the FDIC turn things around?
SB: Leadership needs to be personally involved. You need to get down in the nitty gritty. You need to talk to your people, you need to bring them in. You need to hear what they're saying. You need to knock heads…Some of the activity that I was hearing, if true, that I was reading about in the Wall Street Journal, people should have been fired…You can't hide from these issues. You can't kick the can down the road. You can't think somebody else is going to deal with it. The chairman has to be personally involved in this to turn it around. Whatever the future leadership of the FDIC, I hope that the chair understands that that's what has to happen.
Thanks for reading. Follow us on X @CapitolAccount and on LinkedIn by clicking here. We’re always looking for stories, so if you have any suggestions on what we should cover (or comments about Capitol Account), shoot us a note. Jesse can be reached at: jwestbrook@capitolaccountdc.com, Rob at: rschmidt@capitolaccountdc.com and Jessica at: jholzer@capitolaccountdc.com. If somebody forwarded this to you and you’d like to subscribe, hit the button below. Please email for our special rates for government employees and academics, and group discounts for businesses: subscriptions@capitolaccountdc.com
The View from the Crypto Universe: Most realists see crypto policy as stuck in an endless rut, but there is always plenty of hope in the industry that Congress will miraculously come together and pass comprehensive legislation laying out the regulatory rules of the road. That was certainly the vibe at the Blockchain Association’s annual policy summit in Washington, where attendees were buzzing about both a market structure and a stablecoin bill perhaps getting approved sometime early next year.
The speculation wasn’t even tamped down by the political reality laid out by some of the lawmakers – most champions of digital assets – who spoke at the conference. The message: In an era of divided government, a long slog may be the much more likely outcome.
“I wish I could end on an optimistic note,” New York Democratic Rep. Ritchie Torres told the crowd at the InterContinental hotel on D.C.’s trendy Southwest waterfront. “The bills will likely pass the House, but there are real barriers to passage in the Senate – that’s my honest political assessment.”
Republican Sen. Cynthia Lummis was a bit more bullish, but she did allow that there was one big roadblock: the Senate Banking Committee, led by Chairman Sherrod Brown, a noted crypto skeptic. “Banking has been a tough nut to crack,” Lummis said. “It is a committee that advances very little legislation.”
The senator added that one positive sign is that the Treasury Department – once a “closed door” – is now engaging in a more constructive way. She added that Deputy Secretary Wally Adeyemo is the most informed and has been taking the lead in interactions with lawmakers.
A number of the crypto entrepreneurs and evangelists at the gathering pointed out that there is good reason for touting crypto’s resilience. Token prices are up and the FTX scandal (which broke shortly before the trade group’s policy conference last year) is slipping from the public’s consciousness while Sam Bankman-Fried sits behind bars. And the recent guilty pleas by Binance and its now-former CEO Changpeng Zhao were heralded as a winnowing of bad actors (the exchange is not a Blockchain Association member).
Alluding to some of the past turmoil, Blockchain Association CEO Kristin Smith compared token firms’ Washington efforts to building a plane “while flying it in a Category 5 hurricane with a couple of very unruly passengers.” But, she added: “We built the plane, and now we have all the pieces in place that our industry needs in order to effectively engage in the policy making process…Our destination is within grasp.”
The specter of Gary Gensler, of course, hovered over the policy summit – and the mention of his name often provoked a good amount of applause. Torres, as usual, was the most pointed of the critics. However, his description of the SEC chair as “the regulatory equivalent of George Santos” may have gone a bit too far – judging by the smattering of nervous laughter. “He went from a crypto cheerleader at MIT to a crypto critic,” Torres explained.
The SEC chief’s treatment was notably different from the warm reception for Republican Commissioner Hester Peirce. She was interviewed by Joshua Rivera of Blockchain Capital who at one point begged her to stay in her seat as long as possible. “I am amazed that you have spent so much time in what feels like kind of banging your head against the wall for crypto,” he said. “Please don’t leave us.”
“I will not lie, it is frustrating for me too, to not see positive movement on this,” Peirce responded…(Thursday)
Another Day, Another Critic of AI Rule: The SEC’s attempt to regulate how financial advisers use predictive data analytics has sparked fierce resistance in the industry. Now, the agency’s own investor advisory committee is joining the chorus of complaints, arguing that the plan could drive up costs for retail traders and even cause firms to curtail access to basic technology like retirement planning tools.
“We fear that these overbroad proposals, if adopted, will harm investors, limit investor choice, and result in investors losing access to some benefits of the securities markets,” the group stressed in a set of draft recommendations issued last week.
Echoing numerous brokers, investment advisers and asset managers that have already weighed in against the effort, the panel especially took issue with the breadth of the requirements. It urged the SEC to narrow the rule “rather than using language which could be construed as covering virtually every technology used by broker-dealers and advisers.” Instead, the regulator should “target the unique risks posed by predictive data analytics and artificial intelligence that interact directly with investors.”
While the assessment is yet another sign of worry about SEC Chair Gary Gensler’s aggressive approach on the issue, the group’s full report isn't likely to be fully embraced by the industry opponents. The committee also called for the agency to take strong steps to “improve the oversight” of digital engagement practices, taking particular aim at online brokers.
“Features such as alerts and top investment lists, especially when coupled with frequent push notifications, can prompt irrational investor behaviors by creating a false sense of urgency or a fear of missing out,” the panel noted, saying some of these online prompts and nudges should be construed as recommendations. Brokers would then need to ensure they were following SEC rules that ensure clients’ interests come first…(Monday)
There is a lot more where this came from. You really should subscribe…