Class of ’66 | “I’ve said this on the Senate floor many times: The two things that make America great are democracy and free capital markets,” Senator Ted Kaufman WG’66 was saying. “Our free markets are the envy of the world, and have been for 200 years.”
Statements like that make Kaufman—the junior Democratic U.S. Senator from Delaware who was appointed to fill Joe Biden’s seat when the latter got a new job in the White House—sound every bit the Wharton MBA graduate that he is. If you didn’t know better, you might reasonably conclude that he’s a wildly pro-Wall Street free-marketeer.
Thing is, he wants to make sure those markets stay the envy of the world, and don’t get downgraded because of another massive, self-inflicted meltdown. In that respect, he appears to be that rare bird: a politician who not only understands the pitfalls facing the financial markets but has been fighting passionately—albeit with mixed results—to head them off. Though he may be best known for co-authoring the Brown-Kaufman amendment, which would have capped the size and leverage of the nation’s largest banks (it was defeated by a 61-33 vote in the Senate in early May, having received no support from the White House), he has been deeply involved in the financial-reform bill sponsored by Connecticut Senator Christopher Dodd. His series of speeches on the Senate floor were considered by some critics to be the toughest and most perceptive on a variety of financial subjects.
After he warned about the dangers of high-frequency trading in letters to SEC Chair Mary Schapiro and in Senate speeches, that high-tech practice caused the Dow to plummet nearly 1,000 points in a few minutes on May 6.
A few days later, Kaufman and Michigan Senator Carl Levin introduced a package of amendments to the financial-reform bill that would have addressed a broad variety of problems, ranging from mortgage standards to credit-rating agencies. Kaufman also co-sponsored an amendment by Levin and Oregon Senator Jeff Merkley to limit high-risk proprietary trading and conflicts of interest by financial institutions.
“Senator Ted Kaufman is a strident critic of our current financial system and a tough voice for greatly strengthening the Dodd bill,” wrote Simon Johnson, the Kurtz Professor of Entrepreneurship at MIT’s Sloan School of Management, former chief economist of the International Monetary Fund, and co-author of 13 Bankers: The Wall Street Takeover and The Next Financial Meltdown. Partly because of “great efforts” by Kaufman and others, added Johnson in his Baseline Scenario blog, the national consensus to reform the banking industry was “beginning to shift significantly.” (Whether those efforts and that consensus will be enough to overcome the monetary muscle of the banking lobby is another matter.)
We spoke with Kaufman this past May, when he was on campus to deliver the Commencement address to the School of Engineering and Applied Science. (He has an engineering degree himself, albeit from Duke.) A few days before, the Huffington Post ran an item that not only praised him to the skies but urged readers to “draft him to run for reelection.” That’s not going to happen. Kaufman may only be in his second year as a senator, but he’s also 71 years old, and he took the job under the condition that he finish out the two years leading up to this fall’s special election—and no more. There is, he notes, something to be said for lame-duckery: you don’t have to waste valuable time fundraising or groveling for votes.
Besides, it’s not as though he’s some starry-eyed newbie. Having served as Biden’s chief of staff from 1976 to 1995 (and having spent the next four years as co-chair of the Duke Law School Center for the Study of Congress), Kaufman could pretty much hit the ground running when he took over the vice president’s seats on the judiciary and foreign-relations committees.
In fact, the only Wall Street-related item on his original agenda was to have the judiciary committee “go after the guys who committed fraud and brought the country down and put so many people out of work,” he says. (Kaufman, along with Democratic Senator Patrick Leahy and Republican Senator Chuck Grassley, co-authored the Fraud Enforcement and Recovery Act, which was signed into law in May 2009.) “And I was really angry about that—that they could get away with it. But I never once thought about getting involved in the financial-reform part of it.”
Fast-forward to this past March, when Kaufman gave a speech on the Senate floor describing how, over the past 30 years, the financial industry had managed to remove the regulatory protections and standards enacted in the wake of the 1929 stock-market crash and Depression. It culminated in the repeal of the Banking Act of 1933, better known as the Glass-Steagall Act, which had kept commercial and investment banking separate. (Glass-Steagall’s 1999 replacement, the Gramm-Leach-Bliley Act, allowed commercial banks, investment banks, securities firms, and insurance companies to consolidate.)
That deregulation “made our financial system more vulnerable to collapse,” Kaufman told the Senate. “A shadow banking industry grew to larger proportions than even the banking industry itself, virtually unshackled by any regulation. By lifting basic restraints on financial markets and institutions, and more importantly, failing to put in place new rules as complex innovations arose and became widespread, this deregulatory philosophy unleashed the forces that would cause our financial crisis.”
Back when he was at Wharton, Glass-Steagall “was an article of faith,” says Kaufman now. “The commercial-banking business was set up as a way that people could take the money in their mattress and put it in the bank and not worry about the run on the bank because we did FDIC, and we insured it. The possible meltdown, the possible failure, goes way up when you start adding investment banks” to commercial banking.
In Kaufman’s view, the list of culprits responsible for those regulatory changes is long and bipartisan.
“There’s a whole group of very, very smart people,” he says. “And they just fell for this self-regulation thing, the idea that somehow the government was the problem.” He likens their attitude to that of football fans getting annoyed by the referees “blowing their whistles and slowing the game down”—and concluding that they should get rid of the refs.
“You can imagine what the second pileup would be like,” he says. “I would not want to be in that second pileup with no referees.”
Another unhappy change came in 2007, when the SEC “made a bunch of dumb decisions,” including one that did away with the 1938 “uptick rule,” which prohibited the short-selling of securities except on an uptick (a transaction at a price above that of the preceding transaction). Eliminating that rule meant that “when you sell short, you really don’t have to have the underlying stock—what we call ‘naked short-selling,’” he explains. “Now, when I was at Wharton, that [rule] was just an article of faith. I mean, predatory bears are always there. You can’t eliminate them. What you’re going to have to do is deal with them. And the way we did that was the uptick rule, and we made sure that you had to actually own the stock, borrow the stock, before you sold it.”
Point No. 3 of the Things That Have Changed for the Worse since his Wharton days is that “people just don’t recognize conflict of interest anymore,” he says. “I mean, if you raise conflict of interest to somebody, it’s like, ‘What, do you think I’m a crook?’ I’m not saying anybody’s a crook. But it’s human nature. I mean, if I am selling you securities at the same time I am selling somebody else the same securities short, that is a conflict of interest, and it clearly isn’t in the interest of anybody except Goldman Sachs for that to go on.”
When Kaufman went to New York on fact-finding missions, he found a lot of people who wanted to talk to him about illegal and unethical financial conduct—as long as they didn’t have to be identified by name.
“After the second trip, I told everybody, ‘I should have brought those things from the inner city that say No Snitch,’” he says. “Because people tell you, ‘Let me tell you what’s going on—oh, don’t quote me.’ I kept saying to them, ‘You guys are going to kill the goose that laid the golden egg. If we have another meltdown, you’re out of business.’
“We have to maintain the credibility of the markets,” he adds. “We lost a lot of ground with this last thing. Other countries are developing markets. People are delisting from our markets and listing on other exchanges. I do not want to leave my grandchildren [in a position where] American markets are the second, third, fourth, or fifth best in the world.”
Lest anyone get the impression that Kaufman has no sympathy at all for the banking industry, it should be noted that on May 19, he voted against an amendment that would have closed a loophole that essentially prevents states from capping credit-card interest rates. (By allowing credit-card companies to headquarter in states like Delaware that don’t cap interest rates, the current law allows them to export high rates to other, more consumer-friendly states.) Saying that the bill would have created a “patchwork of interest rates and laws around the country,” he added: “That being said, I do represent Delaware and in Delaware the credit-card business is a major, major part of our industry.”
At the time of that mid-May interview, Kaufman was still hopeful that the financial-reform bill (the Restoring American Financial Stability Act) then being debated would be a good one. Three days later, after the Senate passed a watered-down version, he released a statement saying that he was “disappointed the Senate did not pass a stronger bill.” While he applauded Dodd and his colleagues for having “crafted a bill that includes many provisions that I support” (such as creating a Consumer Finance Protection Bureau and “urgently needed reforms of the over-the-counter derivatives markets”), he criticized the bill for relying on “regulatory discretion to decide limits on the size, leverage, and activities of dangerously concentrated financial institutions.”
“Nobody gets what they want,” he told the Gazette. “If I were writing the bill it’d be different. But I’m not, and I shouldn’t be writing a bill all by myself. And my basic approach to this is, if they don’t do it this year, they’ll do it next year or the year after. My only concern is that something really bad happens in the interim.”