GW Law School Public Law and Legal Theory Paper No. 2013‐117 GW Legal Studies Research Paper No. 2013‐117 Turning a Blind Eye: Why Washington Keeps Giving In to Wall Street Arthur E. Wilmarth, Jr. 2013 81 U. CIN. L. REV. 1283-1446 This paper can be downloaded free of charge from the Social Science Research Network: http://ssrn.com/abstract=2327872 TURNING A BLIND EYE: WHY WASHINGTON KEEPS GIVING IN TO WALL STREET Arthur E. Wilmarth, Jr.* As the Dodd–Frank Act approaches its third anniversary in mid-2013, federal regulators have missed deadlines for more than 60% of the required implementing rules. The financial industry has undermined Dodd–Frank by lobbying regulators to delay or weaken rules, by suing to overturn completed rules, and by pushing for legislation to freeze agency budgets and repeal Dodd–Frank’s key mandates. The financial industry did not succeed in its efforts to prevent President Obama’s re- election in 2012. Even so, the Obama Administration has continued to court Wall Street’s leaders and has not given a high priority to implementing Dodd–Frank. At first glance, Wall Street’s ability to block Dodd–Frank’s implementation seems surprising. After all, public outrage over Wall Street’s role in the global financial crisis impelled Congress to pass Dodd–Frank in 2010 despite the financial industry’s intense opposition. Moreover, scandals at systemically important financial institutions (SIFIs) have continued to tarnish Wall Street’s reputation since Dodd– Frank’s enactment. However, as the general public’s focus on the financial crisis has waned—due in large part to massive governmental support that saved Wall Street—the momentum for meaningful financial reform has faded. Wall Street’s political and regulatory victories since 2010 shed new light on the financial industry’s remarkable success in gaining broader powers and more lenient regulation during the 1990s and 2000s. Four principal factors account for Wall Street’s continued dominance in the corridors of Washington. First, the financial industry has spent massive sums on lobbying and campaign contributions, and its political * Professor of Law and Executive Director of the Center for Law, Economics & Finance, George Washington University Law School. I wish to thank GW Law School and Dean Gregory Maggs for a summer research grant that supported my work on this article. I am indebted to Sarah Trumble (GW Law Class of 2012), Eric Klein (GW Law Class of 2015), and Germaine Leahy (Head of Reference for the Jacob Burns Law Library) for their superb research assistance. I am also grateful to Anat Admati, Lawrence Baxter, Bill Black, Cheryl Block, Bill Bratton, Peter Conti-Brown, Jim Cox, Michael Greenberger, Robert Hockett, Robert Jenkins, Simon Johnson, Dennis Kelleher, Adam Levitin, Pat McCoy, Saule Omarova, Frank Partnoy, Heidi Schooner, Lynn Stout, and participants in conferences at the University of Cincinnati College of Law and GW Law School for helpful comments and conversations. Unless otherwise indicated, this article includes developments through June 15, 2013. 1283 1284 UNIVERSITY OF CINCINNATI LAW REVIEW [VOL. 81 influence has expanded along with the growing significance of the financial sector in the U.S. economy. Second, financial regulators have aggressively competed within and across national boundaries to attract the allegiance of large financial institutions. Wall Street has skillfully exploited the resulting opportunities for regulatory arbitrage Third, Wall Street’s political clout discourages regulators from imposing restraints on the financial industry. Politicians and regulators encounter significant “pushback” whenever they oppose Wall Street’s agenda, and they also lose opportunities for lucrative “revolving door” employment from the industry and its service providers. Fourth, the financial industry has achieved “cognitive capture” through the “revolving door” and other close connections between Wall Street and Washington. A widely-shared “conventional wisdom” persists in Washington—notwithstanding abundant evidence to the contrary—that (i) giant SIFIs are safer than smaller, more specialized institutions, (ii) SIFIs are essential to meet the demands of large multinational corporations in a globalized economy, and (iii) requiring U.S. SIFIs to comply with stronger rules will impair their ability to compete with foreign financial conglomerates and reduce the availability of credit to U.S. firms and consumers. Despite Wall Street’s continued mastery over Washington, two recent events could lead to a renewed public focus on the need for stronger restraints on SIFIs. In March 2013, Attorney General Eric Holder admitted that global SIFIs are “too big to jail,” and a Senate subcommittee issued a stunning report on pervasive managerial failures and regulatory shortcomings surrounding JPMorgan Chase’s “London Whale” trading scandal. In response to those events, Senators Sherrod Brown and David Vitter introduced a bill that would require SIFIs to satisfy much higher capital requirements and would also limit their access to federal safety net subsidies. The Brown-Vitter bill could prove to be a milestone because it demonstrates Dodd–Frank’s inadequacy and also focuses the “too big to fail” debate on issues where Wall Street is most vulnerable, including dangerously low levels of capital at the largest banks and extensive public subsidies exploited by those banks. “Turn a blind eye”: “To knowingly refuse to acknowledge something which you know to be real”;1 “to refuse to see: be oblivious”2 1. Turn a Blind Eye, PHRASE FINDER, http://www.phrases.org.uk/meanings/turn-a-blind- eye.html (last visited Oct. 29, 2012). Admiral Horatio Nelson reportedly inspired this saying at the Battle of Copenhagen in 1801, when he ignored a superior’s signal to disengage from the enemy fleet. 2013] TURNING A BLIND EYE 1285 “I remind people, we do have the best capital markets in the world.” (Jamie Dimon, chairman of JPMorgan Chase, June 19, 2012)3 “[T]he size of some of these [financial] institutions becomes so large that it does become difficult for us to prosecute them when we are hit with indications that if you do prosecute, . it will have a negative impact on the national economy, perhaps even the world economy.” (Attorney General Eric Holder, March 6, 2013)4 “[D]on’t you see? Too big to fail isn’t a problem with the system. It is the system . The bigger [global corporations] get, the bigger financial institutions will have to get.” (Robert Rubin, former Treasury Secretary and former senior executive at Goldman Sachs and Citigroup)5 I. Introduction ..................................................................................... 1288 II. The Financial Industry’s Campaign to Block Dodd–Frank’s Implementation ........................................................................ 1296 A. The Industry’s Lobbying Efforts to Impede Dodd–Frank’s Reforms .............................................................................. 1296 1. Enhanced Regulatory Requirements for SIFIs ........ 1297 Instead, he put his spyglass to his blind eye and said, “I have only one eye, I have a right to be blind sometimes . I really do not see the signal.” JAMES STANIER CLARKE & JOHN M’ARTHUR, 2 THE LIFE OF ADMIRAL LORD NELSON, K.B. FROM HIS LORDSHIP’S MANUSCRIPTS 270 (1809). 2. MERRIAM WEBSTER’S COLLEGIATE DICTIONARY 1349 (11th Ed. 2004). Kathleen Engel and Patricia McCoy have previously used this phrase to characterize the manner in which Wall Street investment banks “securitize[d] subprime home loans without determining if loan pools contain[ed] predatory loans” and thereby “actively facilitated abusive lending.” Kathleen C. Engel & Patricia A. McCoy, Turning a Blind Eye: Wall Street Finance of Predatory Lending, 75 FORDHAM L. REV. 2039, 2040 (2007). 3. William D. Cohan, Wall Street Forgets its Job Is to Create Jobs, BLOOMBERG (June 24, 2012 6:05 PM), http://www.bloomberg.com/news/2012-06-24/wall-street-forgets-its-job-is-to-create- jobs.html (quoting testimony by Mr. Dimon during a hearing on the “London Whale” trading scandal before the House Financial Services Committee on June 19, 2012); see also infra Part IV(C)(2) (describing that scandal and Mr. Dimon’s role in it). 4. Transcript: Attorney General Eric Holder on ‘Too Big to Jail’, AM. BANKER (Mar. 7, 2013) (quoting testimony by Mr. Holder before the Senate Judiciary Committee on Mar. 6, 2013) (available on Lexis). 5. DAVID ROTHKOPF, POWER, INC.: THE EPIC RIVALRY BETWEEN BIG BUSINESS AND GOVERNMENT—AND THE RECKONING THAT LIES AHEAD 266 (2012) (quoting from undated recent interview with Mr. Rubin). Mr. Rubin served as co-chairman of Goldman Sachs before serving as Treasury Secretary during the Clinton Administration, and he then served as senior counselor, chairman of the executive committee, and a director of Citigroup from 1999 to 2009. During his tenure at Citigroup, Rubin encouraged the bank to engage in high-risk securitization and trading activities. Those activities inflicted massive losses on Citigroup and led to the bank’s near-failure and bailout by the U.S. government in 2008. CHARLES GASPARINO, THE SELLOUT: HOW THREE DECADES OF WALL STREET GREED AND GOVERNMENT MISMANGEMENT DESTROYED THE GLOBAL FINANCIAL SYSTEM 145-47, 190-91, 304-08, 317-20, 482-83 (2009); Eric Dash & Louise Story, Rubin Leaving Citigroup; Smith Barney for Sale, N.Y. TIMES, Jan. 10, 2009, at B1; Ken Brown & David Enrich, Rubin Under Fire, Defends His Role at Citi, WALL ST. J., Nov. 29, 2008, at A1; Eric Dash & Julie Creswell, Citigroup Pays for a Rush to Risk, N.Y. TIMES, Nov. 23, 2008, at A1. 1286 UNIVERSITY OF CINCINNATI LAW REVIEW [VOL. 81 2. Regulations Implementing the Volcker Rule and Title VII of Dodd–Frank ....................................... 1302 B. The Industry’s Litigation Strategy to Block Financial Reforms .............................................................................. 1308 1. The Industry’s Reliance on “Cost–Benefit Analysis” in Challenging Financial Reforms........ 1308 2. Any Analysis of the Costs and Benefits of Dodd– Frank’s Reforms Must Consider the Huge Costs of the Financial Crisis and the Comparable Benefits of Avoiding Future Crises ...................... 1312 C.