If we ever solve the problems of fixing the broken financial markets that promote Wall Street’s casino capitalism at the expense of productive investments built around relationship banking, the solutions will surely come in many different forms from a diverse set of people. So, it’s not entirely surprising that one solution could yet take the form of a 55-year-old Kazakh immigrant turned scholarly superstar whom President Biden has nominated to be the Comptroller of the Currency.
The candidate is Professor Saule Omarova, chosen by Biden to run the Office of the Comptroller of the Currency (OCC), the primary federal overseer of the nation’s largest banks – including Bank of America, Wells Fargo, Citigroup, JPMorgan Chase – whose branches are found from sea to shining sea. Prof. Omarova is that rarity in American financial regulation. She is a reformer who gleaned her insights in the belly of the beast, first at the white-shoe Wall Street law firm, Davis Polk & Wardell, and later in the Treasury Department of George W. Bush. A distinguished career in academia followed, and she is now a professor at Cornell. Given her nomination to the position, it is worth considering her academic research and what insights she would bring to the role if confirmed.
Prof. Omarova staked out her sterling academic reputation with an incisive critique about the way Wall Street has neglected lending for productive purposes and opted instead for the wheeler-dealer activities – derivatives and commodity trading. A healthy financial sector is supposed to be a conduit for capital to the “real economy,” but the development of sophisticated instruments grew the financial sector to a size where investment in exotic securities and secondary markets with a tangential link to productive non-financial enterprises became more profitable. Highlighting this disconnect is one thread that connects Prof. Omarova’s work over the last decade. That perspective incorporates a profound respect for the traditional bank charter and the role local banks play in extending credit to the real, non-financial economy that makes things and provides useful services. Her work is in harmony with the growing body of evidence that a bloated financial sector hampers sustainable growth.
Prof. Omarova’s most celebrated piece of scholarship involved the painstaking assembly of a series of under-the-public-radar decisions by the OCC, the very agency Biden would have her run, that allowed banks to begin dealing in derivatives (“weapons of financial mass destruction,” to quote Warren Buffett) that played a crucial role in amplifying the financial cataclysm of 2008. Titled “The Quiet Metamorphosis,” the article exposed how an industry-friendly regulator pushed the limits of the Lincoln-era National Banking Act enabling megabanks to stray from the role of channeling credit to the real economy. She wrote:
OCC’s highly expansive interpretation of the [National Banking Act] in the context of bank derivatives activities served to undermine the integrity and efficacy of the U.S. system of bank regulation. Through the seemingly routine and often nontransparent administrative actions, the OCC effectively enabled large U.S. commercial banks to transform themselves from the traditionally conservative deposit-taking and lending institutions, whose safety and soundness were guarded through statutory and regulatory restrictions on potentially risky activities, into a new breed of … wholesale dealers in pure financial risk.
The whittling away of regulations on larger institutions, which pose a larger risk to the systemic health of the financial sector and have historically benefited from being “too big to fail” in the eyes of the federal government, doesn’t just add to the wealth and income inequality driven by the financial sector. It also implicitly disadvantages smaller institutions that do not create such a risk by having large competitors that don’t pay the costs associated with their scale and the consequences of their failure.
There’s a better way. Community banks in the United States – the ones with less than $10 billion in assets and especially the ones with less than $1 billion – are the institutions that remain truer to the vision of a financial sector intertwined with productive activity. My own research on community banks demonstrates that while they have their flaws, they are intrinsic to promoting investment in productive capacity. There are about 5,000 of them, and their numbers have halved since bank deregulation began in earnest in the early 1980s. (The OCC regulates banks with a federal charter; though that includes many community banks, the giants it oversees tend to influence its work the most.)
Community banks are the ones that build personal relationships with local businesses, lend money in situations where Wall Street’s credit models and algorithms do not – and stay out of the megabank-run casino. But to thrive, they are going to need – absent massive structural change in banking – regulators like Prof. Omarova with the experience and insight to know the history and benefits of laws on the books necessary to prevent highly-leveraged large financial institutions from playing fast and loose–practices which are far rarer, if not nonexistent, among smaller institutions.
Prof. Omarova’s research on the commodities activities of large banks, titled “The Merchants of Wall Street,” involved an analysis of the Bank Holding Company Act of 1956 (BHCA). As originally enacted, this statute brought significant benefits to community banks by installing guardrails around bank holding companies that were growing quickly along with their systemic importance. Prof. Omarova demonstrates how both amendments to and interpretations provided by pliable regulators undermined the fundamental U.S. principles that separate banking from nonbank activities and turned things like raw materials and agricultural commodities into objects of financial speculation divorced from their role as commodities in the market. She warned:
When the same banking organizations that control access to money and credit also control access to such universal production inputs as raw materials and energy, they are in a position to exercise disproportionate control over the entire economic—and, by extension, political system. In this context, it is important to remind ourselves of Justice Brandeis’s famous warnings against the threat to American democracy posed by financial institutions accumulating direct control over the country’s industrial enterprises.
Prof. Omarova’s research also uncovered an important lack of transparency in the OCC’s decision-making process, which she described as “very nontransparent and individualized.” This observation should be significant for anyone who supports free markets. An opaque and individualized process is a recipe for reduced competition; there’s no level playing field when competitors are playing by different rules and when the rulebook is obscure. When I dealt with federal and state bank regulators as a bank general counsel, what I prized in a regulator was one who was well informed and consistently fair. I wanted a regulator who knew the law inside and out, understood the industry, and applied the law in a way that was transparent and consistent. That is what community banks need if they are going to thrive.
The Federal Deposit Insurance Corporation (FDIC) 2020 Community Banking Study confirmed that community banks continue to provide essential sources of lending in their local communities, particularly loans to small businesses, commercial real estate loans, and agricultural loans. The almost 5,000 community banks make up, by far, most of the banks in the U.S. Yet, community banks command only 15 percent of total banking assets. And, while community banks are declining in number, large banks’ assets continue to soar.
Prof. Omarova’s work vividly demonstrates the ways in which law and policy makers fertilized the growth of large banks, steered them into speculative activities, devalued relationship lending, and undermined the environment for community banks. For those who reject cronyism and believe that a thriving and competitive banking market best supports local economies and productive investment, experts like Prof. Omarova have some answers.
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