Global banking regulators recently decided to toughen the rules on banks, requiring them to hold more capital against their assets, to prevent another financial panic like the one that mushroomed in 2008. The new requirements will cut into profitability, since banks will have less money to lend and less leeway to gamble. Yet instead of falling in value, financial stocks rose after the announcement. The new rules, it turned out, made investors feel more comfortable about banks, not less.
Now comes another perceived threat to the financial industry: Elizabeth Warren, the consumer-friendly firebrand President Obama has tapped to lead the new Consumer Financial Protection Bureau. The Harvard professor has been a long-time Wall Street critic, ringing alarms about sky-high credit-card rates, hidden fees and other objectionable lending practices for years. Several of her proposals have been included in recent banking reforms. As chair of the Congressional Oversight Panel monitoring the Obama administration's economic aid, she's also castigated the government's handling of homeowner relief, the TARP bailouts, the AIG rescue, small-business lending and other federal programs. Critics label her a liberal crusader, even though she's made enemies among Republicans and Democrats alike.
In her new job, Warren will help regulate credit cards, mortgages, bank fees and a wide range of financial products that consumers use every day. On Wall Street, there's fear and loathing about yet another overzealous reformer out to eviscerate the banks. But it's much more likely that a tough banking critic like Warren could help restore trust in banks and revitalize their business—something they're clearly unable to do for themselves.
Wall Street executives tend to view financial reform as needless meddling by dim-witted outsiders who don't understand finance. If the system weren't broken, then financial executives would be right that there's no point fixing it. But the system is so flawed that Wall Street as we know it would have collapsed if the feds hadn't rushed in to rescue it in 2008.
Thanks to that largesse, the banks are back on their feet. But the taxpayers who bailed out the banks have never been more leery of institutions once considered foundations of the community. In surveys by Gallup, only 23 percent of Americans express confidence in banks. Right before the recession it was 41 percent. As recently as 2005 it was above 50 percent. It's hard to think of any other industry whose public esteem has fallen so sharply.
It might seem like American consumers are captive to banks, so it doesn't really matter whether we despise them or not. But that's looking like a flawed assumption. Credit-card lending, a big source of profits for banks, is down significantly. More consumers are using debit cards or simply relying on cash. One factor in the new phenomenon of "strategic defaults"—people who stop making their mortgage payments, even though they can afford to keep them up—is animosity toward lenders that got taxpayer bailouts but are ruthlessly inflexible toward their own customers.
"Banks in general have a well-deserved bad reputation," says Duke University professor Dan Ariely, author of the bestsellers Predictably Irrational and The Upside of Irrationality. "But none of them are taking steps to increase our trust. If some of them would make a move and give us more reason to trust them, we as consumers would flock to those banks." Plus, banking reforms would never have been possible if not for a groundswell of public outrage that trumped one of the most effective lobbying groups in Washington.
Flustered bankers now view Elizabeth Warren as yet another sheriff riding into town with her six-shooter. But as with other reform efforts, the fears are almost certainly overblown. Even if Warren were to go after banks with the vigor of a vigilante, she can't work alone. The new bureau she'll run must report to another new creation called the Financial Stability Oversight Council, which will be able to rein Warren in if she strays too far from mainstream regulation. Since Warren is a divisive figure who has already courted enemies and made her views well-known in the media, she'll enjoy little of the deference Congress sometimes shows to new appointees. "This political pressure may make it harder for her to act, especially if the Republicans win either the House or Senate this fall," says analysts Jaret Seiberg of Washington Research Group, a political consultancy.
When Warren does act, she'll have far more credibility than someone considered a friend of the banking industry. That will help build more trust in the system over time. The financial industry went through a similar trial when the Federal Reserve announced its plan to conduct "stress tests" of the nation's 19 biggest banks in the first half of 2009. Wall Street's first reaction was skepticism and dismay, with widespread kvetching about government overreach. But the stress tests turned out to be a turning point in the whole financial crisis. Analysts credited the Fed for tests that seemed sufficiently tough but not overbearing. Most banks passed, and those that didn't quickly met the capital targets outlined by the Fed. The exercise helped ease fears about an insolvent banking sector, and it's probably no coincidence that right after the Fed went public with the test results, stocks went on a huge, 13-month rally.
[Find out if you are a "zombie consumer."]
The CFPB won't have nearly the power of the Fed, and Warren herself would probably be surprised if she ever did anything that triggered a rally in bank stocks. But Wall Street could do worse than having a new regulator determined to keep them honest. They've already proven that.