Reality Check: Who's Afraid of Reforming Wall Street?

Well, pretty much everybody in Washington, except Elizabeth Warren

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Illustration by Matt Dorfman for TIME

"Three years after a horrific financial crisis caused by massive fraud, not a single financial executive has gone to jail," said Charles Ferguson, accepting a well-deserved Oscar for Inside Job, his documentary about the great Wall Street heist. "And that's wrong." Of course it is — but that shouldn't be a surprise. To put bad guys in jail, you need police and prosecutors. The financial police we have, agencies like the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC), have been laughably inept in the era of financial deregulation. The SEC wasn't even able to spot the broad-daylight highway robbery committed by Bernard Madoff. And so, in 2010, the Obama Administration nudged through Congress the Dodd-Frank financial-reform bill, which was designed to put real cops, with real regulatory heft, on the financial beat. And now, in 2011, the Republican House seems intent on quietly gutting the bill under the sordid camouflage of budget cutting. "They're defunding the police after we had the biggest bout of looting in history," an Administration official told me. "That's just crazy."

Let's review the outrage: the heart of the financial collapse was a fraudulent effort to sell home mortgages to people who couldn't afford them. Some of these mortgages were truly mind-boggling — no money down (but a hefty interest rate hidden in the thicket of contractual codicils), no documentation (like proof of job and salary). The mortgages were then thrown together into giant, opaque bond packages and sold again as solid investments. (The ratings agencies, Moody's and Standard & Poor's, were essentially unindicted co-conspirators in the scam.) And those packages were then sliced up, resold and transformed into exotic derivatives, which were bet on by bond traders and investors.

Confused? Well, that was the point. According to Michael Lewis, whose book The Big Short is a riveting encyclopedia of the disaster, even the SEC was confused by the actual contents of the most far-fetched packages, called collateralized debt obligations (CDOs). Wall Street spewed terms like collateralized debt obligation in order to mislead: a more accurate abbreviation might have been RCLs —repackaged crappy loans. When the crappy loans couldn't be repaid, the housing market, Wall Street and the American economy imploded. The Wall Street traders pocketed hundreds of millions in profits; the American taxpayer, and homeowner, picked up the losses.

The Dodd-Frank law was an imperfect remedy. It didn't restructure the big banks, which are still too big to fail. It didn't tax or outlaw the casino-game derivatives. But it did boost the power of the SEC and CFTC to regulate derivatives trading, and it set up a new agency, the Consumer Financial Protection Bureau (CFPB), to protect consumers from the shyster army peddling tricky mortgages, usurious credit-card rates and unscrupulous payday-check-cashing shops. The agencies need larger payrolls to perform those functions, and the Republican House has now stripped much of that money from the federal budget. "It's a back-alley maneuver," says Representative Barney Frank, whose name is on the law. "Unlike health care or environmental regulation, the Republicans didn't try a frontal assault. They hid behind the budget, which means that they're embarrassed by this. They don't want people to know that they're letting Wall Street off the hook."

But what about the Democratic-majority Senate? Can't it restore the funds for the financial police? Maybe, maybe not. Wall Street has some reliable Senate Democratic defenders, like New York's Charles Schumer. And there are a whole lot of higher-visibility — and more easily comprehensible — battles for Senate Democrats to fight. "I expect the President will take a stand soon," says Illinois Senator Dick Durbin, who chairs the Appropriations subcommittee that funds the regulatory agencies. "He'll probably emphasize the three areas he mentioned in the State of the Union speech: education, research and development, and infrastructure." And Wall Street regulation? "Well, I hope he does," Durbin says. "But you run into the problem of message overload. Will the public understand the importance of the issues at stake?"

And then there's the question of Elizabeth Warren, the Harvard law professor who invented the idea of the Consumer Financial Protection Bureau and should be its first director. The Administration seems undecided on whether to appoint her, fearing a Senate confirmation battle that could last for months. "The banks are scared to death of her," one Senator told me. "She speaks in clear, simple sentences. That terrifies them."

Which means this is a fight worth having — and a way to dramatize the complicated issues at the heart of regulatory reform. The President should appoint Warren. The Senate should be forced to vote on her, so the public will know who really wants to clean up Wall Street and who doesn't.