Taking on Wall Street

Remarks by Attorney General Richard Cordray

May 2010

Thank you very much.  You are not likely to be the most formidable audience I face this week, as I also have spoken to my twins’ fifth-grade class.  The topic was the constitutional rights of children.  And, as you can imagine, they had strong views that were forcefully expressed!

When I think about my own children, my mind inevitably wanders to the future of this country, and the world we are leaving to the generations that will follow us.  The economic collapse of 2008, combined with rising income inequality, stagnating wages and ballooning debt, have threatened our growth, challenged our shared economic security, and left us all wondering whether the next generation will experience the same opportunities that prior generations created for us.

It is this issue, economic security, that I want to discuss with you today.  Helping to restore it is the defining challenge of our time.

The United States was established in our Constitution as a land of political liberty with a framework for a great common market.  The rule of law and our free market economy have created not only the wealthiest nation in the history of the world, but our shared prosperity has proved to be the strong foundation for an enduring democracy that has helped millions upon millions of people pursue happiness in their own way by leading stable and secure lives.

But, at certain times in our history, powerful forces have distorted the marketplace by tipping the economic and political system in their favor at the expense of a fair and just society that maintains broad opportunity for all.  Their actions threaten the vibrancy of the free market itself and the ability of all Americans to ensure their own economic security.  At those times, Americans have responded by restoring a more sustainable balance between what is right for those at the highest rungs of the economic ladder and what is right for society as a whole.

We saw this balance upset during the Gilded Age, after the Civil War, when monopolies threatened the integrity of the competitive free market.  As Justice Brandeis noted, the interwoven web of corporate trusts that came to strangle the economy harmed us all by substituting the pull of privileged relationships for the push of individual merit.

Ohio, anticipating the progressive era, was at the forefront of fighting against monopolies.  David K. Watson, who served as the Ohio Attorney General in the 1890s, confronted the Standard Oil Trust and battled it in the courts.  The Ohio Supreme Court declared the trust illegal, paving the way for the federal government to break it up decisively in 1911.

Ohio, and the United States, took action against the trusts because we decided that the free market could no longer bear the burden of domination by a few, powerful interests.  Instead, open competition is the true hallmark of our political and economic system.

In the 1920s, another powerful interest – Wall Street bankers – became so mighty and so reckless that their failures resulted in the economic calamity of the Great Depression.  The heedless leverage in corporate finance was unlike anything ever seen before or since – at least until this past decade.  After the crash, the resulting stringent reforms created the Securities and Exchange Commission and other federal regulatory bodies that imposed reasonable oversight to curb the wild excesses of the Roaring Twenties.  These changes led to what economists have dubbed the era of “boring banking” – where the banking industry, constrained by regulations, became far more conservative in its lending practices.  Household debt, which had exploded in the pre-Depression era, decreased significantly.  Again, the people of the United States and their public officials restored order after a period of corporate excess.  During and after the postwar boom, the financial sector – and America – hummed along.  The economy grew, and the financial industry made anywhere from 7 to 18 percent of total business profits.  In other words, the financial sector was just one industry in American life alongside others, but without dominating those other productive industries.

All that began to change in the 1980s, when our political and financial culture on Wall Street began to recoil against its perceived limitations.  Banking regulations were lifted, new and exotic instruments were created (such as Michael Milken’s original conception of so-called “junk bonds”) and financial profits began to soar.  Financial industry profits as a share of total annual U.S. business profits eventually came to exceed 40 percent at times during the past decade.  After a long period of balance, we again entered a period in which the American economy was dominated by the increasingly reckless things that some people did with “other people’s money.”

The few really big banks – now a handful of trillion-dollar institutions – were booming, and the financial industry reinvested a substantial amount of its profits in Washington to further expand its clout.  As the regulatory barriers between distinct financial pursuits – deposit banking, investment banking and insurance, in particular – were dismantled, the balance tipped further away from the era of “boring banking” toward the pervasive “financialization” of the American economy.

As the Associated Press recently reported, the financial sector has made $2.3 billion in direct contributions to candidates for federal office in the past two decades.  In the past decade, the financial sector has spent billions on lobbying the federal government – more than any other industry over that same period.

Emboldened and enabled by indulgent lawmakers and by regulators who hardly enforced those laws that remained on the books, the new financial mandarins devised ever more complicated ways to place their financial bets and to generate fees by packaging increasingly incomprehensible financial products, like naked credit default swaps, collateralized debt obligations, and complex derivatives.  Wall Street became a glorified casino, and there wasn’t even a gaming commission to certify the new slot machines.  Warren Buffet dubbed many of these derivatives as “financial weapons of mass destruction” that were not understood even by those who bought and sold them or by the experts who rated almost all of them as “AAA.”

These paper products were based on an explosion of household debt, which itself became a commodity.  This burgeoning household debt was often based on sloppy underwriting and interest rates that were packaged fraudulently to seem very different from what they actually were.

The greatest service that a healthy financial market can render to society is to provide investment and capital for growing industries.  This allows capital to flow to more productive uses while limiting the risks caused by market failures, of which there must be some in any vibrant system of capitalism.  Investment leads to productive results by helping companies create things of value and by incentivizing innovation.

But Wall Street, increasingly, was not raising capital to build industries, but investing in debt that allowed people to take on too much risk by making financial bets that had no larger economic purpose.

Wall Street took debt – be it consumer debt or mortgages – and sliced and diced it into indecipherable products, generating fees at every stage in the process.  Far from being instruments that delivered much needed capital to new and growing businesses, many of these new products were simply bets against other products – all justified in the name of spreading and diversifying financial risk, but often only pretending to do so by using off-balance-sheet vehicles and phony accounting.

This house of cards could remain standing only for as long as indebted Americans had access to cheap money and their houses were continually increasing in value, allowing them to borrow more and create more debt.  Over a single decade running up to 2004, household savings plunged from four percent of the nation’s GDP to negative four percent of GDP.

The bursting of the housing bubble brought an end to this mirage of leverage, decreasing the price of houses and causing the collapse of the credit markets that had held up consumer spending.  The bills came due.

Perhaps this could have been avoided if some independent third party had been able to discern that the new financial products relied on a mountain of unsustainable debt.  But the federal government chose not to actively regulate this conduct.  In the 1970s, the SEC gave official designations to the three major rating agencies – Standard and Poor’s, Fitch, and Moody’s – to rate bonds held by brokers.  As market watchers have noted, the government simply outsourced its regulatory function.

Compounding the regulatory gap – this was, you will recall, the same SEC that could never manage to identify or pursue Bernie Madoff for his multi-billion-dollar frauds – was that the rating agencies competed for business by catering to the Wall Street firms whose products they were rating.  As New York Times columnist David Segal has summed up the problem:  “For years, banks and other issuers have paid rating agencies to appraise securities – a bit like a restaurant paying a critic to review its food, and only if the verdict is highly favorable.”

The rating agencies thus blithely gave many mortgage-backed securities their highest ratings.  To put this gross irresponsibility into perspective, consider that in January 2008 only twelve companies in the world were rated AAA, but some 64,000 structured finance instruments, such as subprime mortgage investments, were rated AAA.  Ironically, it was Goldman Sachs CEO Lloyd Blankfein who pointed out this fact, calling it the “dilution of the coveted AAA rating.”

When the housing market collapsed, the rating agencies changed their tune.  According to a U.S. Senate investigative subcommittee, of all the subprime residential mortgage-backed securities issued in 2006 and 2007 and originally rated AAA, 92 percent of them have now been downgraded to junk status.

When the housing bubble burst, only Uncle Sam, facing a second Great Depression, could bail out the Wall Street wizards that he had helped enable and embolden.  Even then, while millions of Americans lost their jobs or their homes in the wreckage, those at the top of the pyramid on Wall Street did not share their pain.  And our government was plunged deeply into debt in an effort to save the financial system.

The titans of finance have always been concerned above all with making money for themselves and their shareholders.  That’s just market capitalism at work.  But we fool ourselves if we allow Wall Street to claim, as Goldman Sachs’ CEO Blankfein did last November, that it is doing “God’s work.”  Unless their financing practices serve to advance the more productive sectors of the American economy, they are simply operating as a casino on the grandest terms and they are imperiling the marketplace for all the rest of our citizens who are simply seeking a fair chance to find gainful work and reasonable economic opportunity.

Wall Street banks deserve exactly what every other industry deserves – a fair chance to compete in a fair market, and reasonable objective scrutiny to ensure that they are not exploiting that market.  Nothing more, nothing less.  Washington would be wise to remember that.

And I also strongly believe that my office must do all we can to confront this challenge.  As Attorney General, I represent Ohio’s five public pension systems.  Among those are the Public Employees Retirement System; the State Teachers Retirement System; the School Employees Retirement System for non-teaching school employees; the Police and Fire Pension Fund; and the Highway Patrol Pension Fund.

A sound pension to see a person through their retirement years – the keeping of promises made to the participants over many years or even a lifetime of steady work – is the very essence of economic security.

Ohio’s pension funds are some of the largest institutional investors in the world, with over $150 billion in assets.  They therefore are in a good position to try to unearth misconduct that causes them to lose money, as Congress recognized in shaping the federal securities laws.

As their lawyer, I fight for their members – the firefighters, police officers, teachers, public servants – and for the many others who were hurt by the wrongdoing that came with Wall Street’s binge.

During my tenure, we have managed eight major lawsuits against some of the biggest players on Wall Street in the financial crisis: AIG, Bank of America, Fannie Mae, Freddie Mac, Merrill Lynch, Marsh, and the national credit rating agencies that I have previously mentioned.

Through these lawsuits, we have already recovered more than $2 billion – and some of the largest cases are not yet resolved.  Since the cases are typically filed as class actions, we are truly representing not only our public pension systems, but all investors and retirees who have been harmed by misconduct on Wall Street.  That includes every one of you who now will have to work longer and harder before you can ever retire.

No privileged few are entitled to play by any different set of rules than the rest of us.  All are bound to comply with the law, and if they violate the law and harm others as a result, then they must be held responsible to pay compensation for the harm they have done.

Just as we enforce laws against physical crimes, so must we aggressively confront corporate malfeasance.  In your neighborhood, if someone breaks into your home and steals your valuables, we work to catch that person, recover your property, and hold them accountable.

On Wall Street, if someone commits fraud that devastates a person’s 401k, should not the responsible parties also be held accountable?  Congress and the Supreme Court have said so, and I believe it is my duty to do everything in my power to protect the investments of Ohioans and to make Wall Street pay for its wrongdoing.

And in a larger sense, Ohio and the other states play a vital role in policing the marketplace.  Indeed, during the troubled times of the past decade, the state attorneys general were practically the only cops on the beat who took seriously their responsibility to protect average American households who cannot afford their own lawyers.  These people rely on us to stand up for their rights and fight for fairness in the marketplace, by enforcing the laws evenhandedly and effectively.

For this reason, during the current Washington debate on Wall Street reform, we have fought tenaciously against legions of lobbyists who are seeking to preempt state authority in order to remove attorneys general from our traditional role.  We are heartened that the effort to sideline state authorities in the financial reform bill seems mostly to have failed, at least so far.

No matter what happens in Washington, I pledge to the people of Ohio that I will use my office to stand up for them against the forces that wrecked our economy and caused so much pain for so many.  I know that we alone cannot clean up the mess on Wall Street and level the economic playing field.  But Ohio can play its part to help push the country in a different direction.  Just as my predecessor David Watson, a century ago, began busting the trusts to restrain monopoly power, so too we will continue our efforts to hold accountable those who undermine the fundamental economic security that Americans deserve.

Thank you.