In the leadup to the financial crisis of 2008, few investment banks played as intimate a role as Goldman Sachs. The firm was an eager participant in the business of packaging bundles of subprime mortgages in convoluted financial instruments like collateralized debt obligations or credit-default swaps, which eventually turned toxic and helped crash the economy. Nor were Goldman's bankers oblivious to the risks. In one famous email, a trader referred to tranches of loans as "crap pools."
Goldman would eventually pay fines totalling billions of dollars to settle charges brought by federal banking and housing regulators. But that didn't change the payout Goldman Sachs CEO Lloyd Blankfein earned in 2007, at the heady peak of the crisis: a record $68 million. According to Bloomberg, Blankfein became a billionaire earlier this month.
And Blankfein wasn't alone. In 2007, as Wall Street’s largest firms began imploding from the risky derivatives they had been gorging on for years, big bank executives raked in $39 billion in bonuses. That same year, shareholders of those firms lost some $80 billion in value.
Public pique over executive pay was crucial to Barney Frank, co-sponsor of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which turns 5 years old Tuesday. “I do think it’s important to respond to the public anger,” Frank said in 2009. “The business community needs, to some extent, to be saved from itself.”
But of all the new regulations enshrined in Dodd-Frank, executive pay rules are now some of the last to be enacted. Ten of the 14 policies related to C-suite compensation remain unimplemented, including rules that mandate companies to publish ratios of their CEO pay that of ordinary employees’.
The notion that ballooning CEO compensation abetted the risky behavior that cost the economy roughly $14 trillion was a central selling point of the Dodd-Frank Act. Now, rules around CEO pay remain one of the most notable shortcomings of the law's legacy.
But these measures aren't the only provisions to languish. Five years after the passage of the most comprehensive set of financial reforms since the 1930s, regulators and Wall Street remain pitched in an unrelenting battle. More than a third of the bill’s rules have yet to go into effect, snarled by bureaucratic delays and nonstop lobbying.
The wider effects of the law are hard to measure. Most experts agree that the immediate causes of the crisis have been effectively addressed: Banks cannot load up on risky, opaque assets as before. Certain provisions, like those requiring banks to hold sufficient buffer capital relative to their risks, have deeply impacted how risk is spread in the financial sector.
But other rules, like executive pay reforms, have made little splash. And industry observers remain wary of a massive derivatives market that remains difficult to tame.
“Considering the number of things that had to go wrong before the crisis and how wrong they had to go, Dodd-Frank has had an impact,” says Marcus Stanley of the advocacy group Americans for Financial Reform. But the work isn’t finished. “It hasn’t brought really deep systemic change to the financial sector.”
Two Cheers For Dodd-Frank
Advocates of tough bank regulation have met the anniversary with qualified praise. “Dodd-Frank made real progress,” said Sen. Elizabeth Warren, D-Mass., at an appearance last week. “But there is a lot more work to be done to complete the unfinished business of financial reform.”
Warren, who guided the creation of the Consumer Financial Protection Bureau under the bill, didn’t allow herself to declare total victory. “Two cheers for Dodd-Frank,” she said. ”Two long, loud cheers.”
The banking industry, meanwhile, has sounded one sustained grumble since July 21, 2010.
“Banks are under assault,” said, JPMorgan Chase & Co CEO Jamie Dimon in January. “In the old days, you dealt with one regulator when you had an issue, maybe two, and now it’s five or six. You all should ask the question about how American that is.”
Despite big banks’ protestations, the balance of power has shifted little since the crisis. As a share of overall banking assets, the size of the top five banks has actually grown by roughly a quarter since 2008, partly the result of crisis-era mergers and firesales. Though behemoths like Bank of America and Citigroup have shaved off billions of dollars in assets, their dominance is unimpaired.
Their sway can be felt in the lobbying effort that spends some $2.5 million a day pushing back against Dodd-Frank, according to Americans for Financial Reform estimates.
Dodd-Frank called for 390 new rules in financial markets, ranging from CEO pay disclosure to mandates that banks write living wills in the event of their collapse. The regulatory effort to draft those rules has given Wall Street hundreds of opportunities to blunt Dodd-Frank’s impact.
So far, regulatory agencies have finalized 247, or 63 percent, of the rules mandated by Dodd-Frank. “In every single one of these rules there’s significant money at stake,” Stanley says.
Bonuses and Derivatives
Two areas where regulators have taken the longest time implementing Dodd-Frank’s rules -- derivatives and executive compensation -- also drew critical scrutiny in the aftermath of the financial crisis. Inflated executive bonuses, Dodd-Frank’s authors argued, pushed CEOs to overlook long-term risks in pursuit of short-term profit. Derivatives tied to an unsustainable housing market provided one of these profit vehicles.
Ten of the 14 executive pay reforms today remain unimplemented. Of the 87 rules relating to derivatives, 53 have been finalized, according to a report by the law firm Davis Polk & Wardwell.
Still, Washington has come a long way in derivatives regulation.
When Luke Zubrod entered the Rayburn House Office Building in the summer of 2009, he expected lawmakers to have only a foggy notion of how derivatives worked. But he was still surprised when a member of the House Financial Services Committee, then chaired by Barney Frank, D-Mass., blurted, “What is a derivative? I wouldn’t know one if it hit me in the face.”
The financial tools, once derided by Warren Buffett as “financial weapons of mass destruction,” had just helped ignite the worst financial crisis in generations. Zubrod, as a director at Chatham Financial, had been invited to share his expertise as an adviser to non-financial companies in the purchase of derivatives.
“It was bracing to walk in there knowing in a matter of months these guys would soon be taking up the pen,” Zubrod recalls. “And doing so on a base of very little knowledge.”
Lawmakers have since become better educated, Zubrod says.
When used by ordinary non-financial businesses, derivatives allow parties to hedge risks in volatile markets like currency prices. The most common type, interest-rate swaps, are used by a wide swath of industry to mitigate future price swings. American banks hold roughly $200 trillion in derivatives on their books.
In the run-up to the financial crisis, the largely unregulated field exploded as speculators seized on the bespoke financial products. Suddenly a vast array of complicated and esoteric instruments were piling up on banks’ balance sheets, with little appreciation of the risks they carried. Between 2003 and 2008, investment banks like Goldman Sachs increased their exposure to derivatives threefold.
Lehman Brothers, whose 2008 failure touched off the financial crisis, became the poster child of the risk of derivatives. In its last annual report, the bank said it had $738 billion in derivatives on its books. Much of this total was mortgage-backed securities, which tanked disastrously as the housing market collapsed.
Dodd-Frank has brought about “extraordinary and fundamental changes,” says Zubrod, who has remained involved in discussions around derivatives industry reforms. Clearinghouses now stand between buyer and seller in most trades, ensuring that each party puts up collateral in case of calamity. Other entities known as swap execution facilities have made common derivatives trades more standardized and transparent.
Private industry has keenly felt these changes. “The stack of paper to execute a derivatives trade since before Dodd-Frank has about doubled,” Zubrod says.
But others remain skeptical that reforms have tamed the risks lurking in the derivatives field. “They started with a framework where they allowed all the existing complexities in the derivative world,” Stanley says. Rules have yet to be finalized regarding the margins participants must post to make a trade. And the bolstered role of clearinghouses has created another category of systemically important institution.
Sheila Bair, former head of the Federal Deposit Insurance Corporation, has criticized Dodd-Frank for taking too hands-off an approach to derivatives. “This market is amazingly complex and potentially destabilizing,” she said in a 2013 interview. “Yet Congress keeps showering special benefits on this industry.”
Those benefits were on display last winter, when congress slipped two rules easing regulation on derivatives into largely unrelated legislation. A measure passed in December received special scrutiny after it was revealed that Citigroup lobbyists had penned the bill’s exact language.
That update rolled back a Dodd-Frank measure that banned big banks from using federally insured capital to deal in certain specialized derivatives. The rule wasn’t central to Dodd-Frank. But its repeal was seen as a new front in the war over financial reform -- a war that is unlikely to end anytime soon.