RegFi Episode 33: Gene Ludwig on Transforming Financial Regulation for Shared Economic Prosperity
32 min listen
RegFi co-hosts Jerry Buckley and Caroline Stapleton welcome Eugene Ludwig to discuss the decline in economic opportunities for middle- and low-income Americans. Gene, former Comptroller of the Currency and founder of Promontory Financial Group, shares insights from his book The Vanishing American Dream and the work of the Ludwig Institute for Shared Economic Prosperity to develop better statistical indicators for reporting economic conditions.
The conversation explores regulatory, technological, and policy solutions to improve economic prospects for working-class Americans, emphasizing the role of the private sector in creating living wage jobs and proposing financial regulation reforms to foster innovation and consumer empowerment while ensuring safety and soundness.
Links:
- Ludwig Institute for Shared Economic Prosperity
- The Vanishing American Dream: A Frank Look at the Economic Realities Facing Middle- and Lower-Income Americans
- Orrick Financial & Fintech Advisory
- RegFiPodcast.com
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Jerry Buckley: Hello, this is Jerry Buckley, and I am here with my RegFi co-host, Caroline Stapleton. Our guest today is Gene Ludwig. Gene has had a legendary career in financial services. He left private practice to serve for five years as Comptroller of the Currency, the chief banking regulator in the Clinton administration. And after his government service, he served as vice chairman of Bankers Trust, then the fifth-largest banking organization in the United States.
In 2001, Gene founded and served as CEO of Promontory Financial Group, the industry leader in regulatory compliance and risk management consulting for the financial services industry. Promontory was acquired by IBM in 2016. He also founded and served as chairman of Promontory Interfinancial Network, now called IntraFi Network, an early fintech company with a network of approximately 3,000 bank members.
Gene has always had a deep interest in public policy, particularly economic policy, which led to his founding of the Ludwig Institute for Shared Economic Prosperity, which is dedicated to improving the economic well-being of middle-and lower-income Americans. Its research includes new economic indicators for unemployment, earnings and cost of living. His book, The Vanishing American Dream, was published in September 2020.
Gene, it’s so good to have you with us. To start with, I think our listeners would be interested in hearing about the principal findings contained in your book, The Vanishing American Dream. Can you share those with our listeners?Gene Ludwig: Well, Jerry, first, it’s an honor to be on this podcast with you. And Caroline, you have been an enormous leader in the financial services industry as long as I’ve been practicing in it, and a real force for good in terms of making the industry, as well as the country a better place. So, I won’t throw the bouquet entirely, but ... Jerry: Well, thank you so much. Gene: But it’s certainly well-deserved and Caroline as well. The Vanishing American Dream, it seems to me, like anything you write, I guess you think is important. But I think the book is very, very important. It isn’t so much my words in that, though the second book we’re coming out with in this winter, The Mismeasurement of America is. And here’s the story. So, when I went back to my little town in York, Pennsylvania, what I noticed after many years was a declining Amish town, which had been for centuries, through two centuries, a leading industrial farm community and a lovely place when I grew up. When I walk past the Federal Reserve or I rode my bicycle past, and I now occasionally walk or take the car, the only thing I can say is changed, it’s not their tennis court or the beautiful green grass around the Federal Reserve. It’s the tent community that’s growing almost every day of homeless people. And there are people with babies and things. So, when you look just with your eyes, you say something’s wrong here.
And so, I put together a symposium at the Yale Law School that included businesspeople, bankers, academics, activists, local political leaders, a mayor and a couple governors. And that’s all reflected in the book. The book is a transcription of what went on at that symposium. What we asked were three questions. One, are things really as bad as I think they are? And if so, how bad? Two, what should we do about this in terms of national policy? And three, what do you do about it on the local level?
The first part of this, which I want to dwell on, is really the most shocking. Everybody, there wasn’t a single person, right / left—by the way, this was completely nonpartisan—didn’t think things were bad and getting worse for middle- and low-income Americans and had been doing so for quite some time. But nobody, while they had anecdotal evidence that was powerful, had actually data.
And indeed, if you look at the headline statistics and you look at them today, things look pretty rosy. Unemployment is low. Until very recently, inflation was low. GDP keeps growing. Wages, according to the wage data put out by the BLS for middle-income Americans, is better today than it was 20 years ago. But that’s completely contrary to what everybody said, what the anecdotal evidence indicated.
So, what we’ve done since the book, and I encourage people to take a look, is dig down into the data and find out, well, is the BLS right? Or are we really mismeasuring this country in terms of middle- and low-income Americans? And the latter, sadly, is true. The reality for middle- and low-income Americans is bad and getting worse. This has been a 40-year trend. It isn’t pointing fingers at the right, the left, or anything. It is a trend. And one thing that we will recommend in the new book, and I’m recommending right now, is we must change these headline statistics. What you measure in life is what you get. And you, Jerry, as a successful businessperson, I understand that and our listeners do entirely. And we have got to change the headline statistics to give us an accurate picture of what America looks like today.Jerry: Extremely important observation. And I’ve seen the numbers that you’ve produced already, and it’s really shocking. And it’s not surprising that the malaise that exists in much of society and the divisions are a result of that disparity between what people are saying the numbers are and what they in fact really are. So thank you, Gene. That’s a huge contribution.
You know, Gene, the premise of this RegFi podcast series is that financial regulation driven by technology will change more in the next 10 years than the last 50. We’ve discussed with other guests how technology is likely to impact the way financial services firms deliver services to their customers, and how financial regulators respond and use technology to enhance their own oversight of financial firms.
You know, Gene, if I were to rewrite the Dodd-Frank Act, I would be tempted to change the name from the Consumer Financial Protection Bureau to the Consumer Financial Empowerment Bureau, rather than focusing primarily on protecting borrowers from abusive and predatory credit practices, important though that is, maybe we should focus more on helping consumers find financial products and services that help them build net worth and achieve financial security. Availability of credit is important, an important element, but it is not sufficient in itself.
Gene, you have a unique perspective, and your focus on the need to improve the financial well-being of middle- and lower-income Americans raises this question. How can our financial services industry and the regulatory regime that facilitates it help to enhance the financial well-being of average Americans? And what role might technology play in that process?Gene: Well, Jerry, this is a really deeply important question. And it was very well-stated by you in terms of part of what our problem is. So, if you take where we have been going, which is things aren’t good and they’re getting worse for middle- and low-income Americans, what do you do to empower them? Great question. And the answer is only one thing. It’s very easy. We must be providing Americans with living-wage jobs, and that is a private sector responsibility and not a public sector. The public sector cannot do that. You can have all the good-hearted government programs in the world, and that is not where the living-wage jobs are going to come from. They are going to come from the private sector.
And my, sort of, take on this, which is one of the most important things, is one of the most arcane. And you’re alluding to this in your question. And that is that this is like Goliath chained. That is the private sector generally and particularly the financial services sector chained, in my view, by regulations just like these definitions, which were formed years and years and years ago, which have piled one on top of the other, on top of the other, on top of the other and are not constructed for a 21st century world.
And so accordingly, the talents and the innovation and the things that we see in the tech sector, which is so transforming America, we’re not seeing in the financial sector because we have a regulatory environment that is not fit for purpose any longer. We’ve got great people in the regulation. We must have regulation. I’m not a deregulator. But what we’ve got in terms of how we’re going about this is debilitating, not enhancing to where you’re going. It’s not preventing people from doing things. It’s empowering—you said it, I think, very well—people to basically better their lives and giving them more opportunity.
This is a critical part, I think, of the future. It is very hard to do. And, you know in fact, I’ve been envisioning what the third book would be in a third set of studies. And this is certainly a big part of that because I do not believe we can get out of this corner unless we have an increasingly vigorous private sector and importantly, financial sector that enhances that. And we’re not going to have that if we don’t change our regulatory environment.Jerry: You know, I couldn’t agree more. And this point has been made. You know, I was sadly present when these laws were written half a century ago. As I’ve said before, the mainframe computers at the Defense Department didn’t have the power of our handheld today. There is so much more we could do, and yet we have a regulatory scheme that is based on mid-20th century thinking or late-20th century thinking. So yes, you can imagine how AI could be used. You can imagine how high school students using gamification could learn about how to manage their finances and really enjoy learning about it and learning about what’s involved in the rest of life. So, it really, there is so much that we could do, but you have to begin with what you’re doing, which is calling it out and identifying the issue and then trying to find solutions. And I thank you for doing it. Gene: Well, you’re nice to say it, and Jerry, I’ll tell you how far we’ve come. When I first entered the office as Comptroller of the Currency in 1992, people were still talking about the historic method of doing examination, which was still done, I think, in part, which was called the “count the cash method.” You went into the safe and counted the cash! Which made a lot of sense when the Comptroller’s office got started in the 19th century. But today, we have money whizzing around, you know– Jerry: –the globe! Gene: …in the computer. It’s a different world. And regulation and supervision have got to enter the 21st century with vigor, and the “count the cash method” is clearly over. Jerry: Listen, so Caroline, let’s bring you into this conversation. I know you were at the OCC, but after Gene’s time, but I know you have some good questions here. Caroline Stapleton: Yeah. I mean, I think this conversation is so important and timely, Gene. We do a lot of work with innovative banks and fintech companies, and many of them are offering to, are seeking to offer fintech products to underserved populations in particular. And just to broaden the scope of banking and financial services generally. And like you said, part of what differentiates these companies is that they really prioritize innovation. And by definition, that means doing things that are new and different, which ... you know, I think can translate to regulators sometimes as untested and in their view, potentially risky.
So, curious for your thoughts on how regulators should be balancing the need to foster or at least permit innovation and greater inclusivity in financial services, but their mandate to ensure a safe and sound banking system. Because I think that those things can go together. I think regulators think they can, too. But striking that right balance, particularly, as you pointed out, in an environment with decades-old regulations governing many products and services, that can be a real challenge.Gene: Well, Caroline, it’s an excellent question and very, very thoughtful. Here’s how I would begin the inquiry. I would look not on what we can do when times are better. I’d actually look at what regulation does, which I believe is deleterious, when times are bad. What regulators tend to do, irrespective of the technology they use, but in a modern world, technology would help them do it right, is when things get bad, they get very tough, particularly on those entities that deal with low- and moderate-income Americans, and particularly the smaller ones.
I remember one OCC bank that came to me for help. I can even tell you which one it was. It was Neighborhood National Bank out of San Diego. And the OCC came in and they were criticizing a $1 million portfolio of loans to an immigrant community that was actually an asylum-seeking community because the files were not up to standards. Well, these people, these were $200 loans! They were $300 loans! I looked at the files. They weren’t perfect. But this was not the end of the world. And if the whole portfolio went down, it was not going to cause the bank a problem.
Rather than thinking how can we criticize it, by the way, something they would have never done at a large bank—they never even look at a million-dollar portfolio of anything—what they should be doing is working with the bank to figure out, “Okay, how do we give you the time and the assistance so you can get through this period as opposed to make this period more difficult for you and your borrowers?”
Too often, many of the, in particular, home mortgage loans for low- and moderate-income people that have been advanced by banks, which are so critical to wealth creation for low- and moderate-income people, are written down by the regulators during bad times when people have no jobs and things are difficult, only to be bought up by sophisticated market-making entities in large cities who then make a fortune on the underlying properties and leaving behind the low- and moderate-income person with nothing and a ruined life, let alone the financial institution.
So, if I were to start with the regulators, it is thinking through a new process for dealing particularly with entities that lend to low- and moderate-income people. During times that are difficult, if they’ve– if there’s stealing, if there’s cheating, that’s a different story, but that’s almost never the case. It is, “How do you help the institution and these people get through times that are not of their making, typically, so that they are the beneficiaries of the value creation, not the people who get taken advantage of by the big city slickers.”Caroline: And maybe it’s that partnership, you know, that needs to be fostered. Just hearing you talk about it sounds like what you’re envisioning is a desire to figure out how to solve the issue rather than, you know, to criticize and find things that aren’t perfect. And I think that there’s some folks who say that driven by this stricter regulation, that there are functions that historically have been performed by banks like these lending functions, lending to low- and moderate-income communities, you know, marginalized populations that that’s moving into more of a shadow banking system, you know, outside of the purview of visitorial supervision. And I guess, you know, my question for you is, if you were a prudential regulator today, what would you be trying to do to mitigate the risk of that flight into, you know, an unregulated space? Gene: Collaboration, not criticism. When I did the CRA rule, which is not perfect, but it did a lot of good, I brought bankers into my office. I had frequent meetings with them trying to work over the regulation and activists. And sometimes meetings with the activists and the bankers, to work over. So, it was a collaborative process, including with the other regulators, to come out with a rule. I think we have got to basically do much more by way of collaboration and challenge as opposed to confrontation. What is really aggravating, and it’s become far worse in the last few years, the unwillingness of some of the regulatory agencies to sit down and open the dialog. But rather, they want to be prescriptive and punish. Now, the best regulators are not that way today, and they weren’t then. But we have really got to foster an environment of collaboration, not confrontation. That’s certainly true with regard to low- and moderate-income issues, but it’s true across the board. Jerry: Yeah, that tendency toward “gotcha” and rewarding those who bring troubles to the leadership and say, look what you can get a headline out of here. It’s a temptation in the short run, but in the long run, it really hurts the country. Gene: Oh yeah. One of the worst examples of that, and it’s human nature. I’ve seen this again and again. So, Bank A is being examined and Bank A is looking fine. Or looking good enough. Or looking okay. And then all of a sudden, there’s a new EIC, new examiner in charge. And all of a sudden, the same things look bad! Or there’s a horizontal exam. And all of a sudden, they look terrible! Because it’s right and it’s human nature to say, aha, see, I’m the smart one. I found all these things that are to be criticized. That is not good practice, actually. It’s particularly disruptive where you have people trying to do the right things, and they’re even following with prescriptions that have been laid down by the regulators and then they get whacked for it. Bad, bad, bad. Bad practice. Jerry: Sadly, Gene, we’ve seen the same thing ourselves. It’s amazing. I’ve seen a CRA area designated and approved time after time, and then all of a sudden, “Wait a second, you have the wrong area. You should be much different,” by a new examiner! It really is frustrating, and there are many examples of it. But, you know, basically, we need a strong regulatory system. And it generally works, but it needs almost a different way of thinking. And I think that what you’re bringing to this, in terms of thinking about how can we enhance the ordinary American’s life by having a better and more effective financial system is really crucial. And that has to be part of the mindset of the regulator. Gene: Well, Jerry, thank you for that. But I think that really is it. What are the goals? What are we trying to achieve? If we’re dealing with institutions that focus on low- and moderate-income well-being, okay, how can we, through the examination process, ensuring safety and soundness, enhance that institution, enhance that experience? You know, collaborate to make it better, not how do we criticize them and make it worse!
The typical examiner, the federal government and leadership at these agencies are filled with terrific people, talented people, good-hearted people, but the system has gotten in the way and we’ve just got to change it. We have got to change the whole focus. It takes a certain amount of courage because there are people in government, you know some in Congress, that love the opportunity to get a headline and criticize.
I remember one of my early hearings, I have to laugh. I was having a very good, it was a public hearing, and Democrat and Republican, House and Senate. And once the … we were having a very collaborative time, good time. And once the press came in with the cameras rolling, one of the congresspeople who had been very helpful, all of a sudden, he jumped up, put his finger in my face and said, “You regulators have ruined America.” And he went on and on in this, and it made probably good headlines for the time. But it’s the natural sort of political to-ing and fro-ing. But of course, it can terrify a regulator. But that’s the natural process. It’s OK, you laugh at it.
But we’ve got to get people back in the room working together. Now, in that regard, one thing we need is, whether you call it an ombudsman’s process or an appeals process or a strategic review process, there must be some way—beyond a big court thing and where people get criticized because they’ve raised issues—to actually examine decisions in a dispassionate way to get the best answer. That is better for the supervisory system. We’re in a country where we value fairness, and it would, I think, be one of the key elements to improve our financial system and our financial regulatory system. And we don’t have it right now.Caroline: Yeah. I’m often surprised at how, you know, few institutions that, you know, are regulated by supervisors that have an ombuds process or an appeals process think that it would even be possible for there to be a fair decision, so they don’t pursue it. And then I’ve equally been surprised by state regulators in some cases not having that process. So, it’s like you’ve said, I think that institutions feel like there isn’t a way sometimes to have a discussion about, you know, a finding or an MRA that they disagree with, they feel wasn’t warranted. And it makes that relationship less collaborative and definitely, you know, changes how people talk to one another. And that’s really the key to making sure you understand what the issues are and how to fix problems that arise. Gene: Caroline, and that’s precisely right. In my day, when we appointed Sam Goldman ombudsman, I said, the only way you’re ever going to get fired at the OCC, to examiners, is if you ever criticize a bank or take any action against the bank for using the ombudsman. The second you do that, and I hear about it, you’re gone. Other than that, you know, and Sam had a thousand, over a thousand cases. Fifty percent of the rulings at least went in favor of the bank. Caroline: Wow. Gene: Sam was a well-respected examiner, he was a top-notch guy, and the supervisory staff was fine with the way this thing was going. Since then, it’s degraded in all the agencies. That’s terrible. Partly, the folks are scared to death that if they raise this, they’re going to get hammered on by the regulators. Should never be the case, and our leadership at these agencies should make that clear. And the second thing is we want something that’s informal enough that, you know, the head of the review agency calls them as he sees them. Caroline: I couldn't agree more. Jerry: Gene, that’s been my experience, too. The fear of, first of all, there has been a change since Sam’s time, and secondly, the fear of retribution holds people back. And it’s unfortunate, but it’s true.
I also wanted to raise, in our short remaining time, the question of sandboxes and experimentation. There’s been a to-ing and fro-ing on that issue, you know, headed in that direction and then not. But what you’re advocating, which is opening up more opportunity, requires some new thinking and therefore some risk-taking. But if it’s controlled, it actually serves the consumer better. But I think our regulatory agencies are very reluctant to allow experimentation for fear of criticism.Gene: Well, this is a terrific topic to get into, and I’m hopeful that we will not have to get into sandboxing, but we may. Sandboxing is a European technique, because Europeans, if we are conservative, or that’s the wrong word to use, if we are restrictive, you might say in terms of new technologies, Europe historically has been much worse. So, they felt they had to have this sandbox thing so everybody got together and you weren’t criticized for innovation.
Historically, America has been an open, encouraging of innovation. Unfortunately, things have degraded. There is more and more reluctance to see innovative solutions, particularly on the safety and soundness side, utilized by banking organizations. Bad, bad, bad, terrible. The attitude of the regulatory agencies should be encouraging institutions to innovate, particularly in the safety and soundness area. How can you say we’ve solved the problem when we had what we had in the spring of last year? We have got to be able to have new tools that can give people signals that something’s wrong, I need to deal with this problem differently.
And it’s very hard, particularly, in dealing with tail risk situations. By the way, one of the big mistakes we constantly make is focus on the center of the distribution curve in terms of dealing with risk as opposed to the tails. But to deal with the tails effectively, one needs new technologies and new thinking and new innovation. So, if we get to the point where we have to have sandboxes because it’s the only way we allow innovation, I think we’ve taken a huge step back.
Not that I’m against sandboxes, but I think the way the federal government should be leaning is in favor of innovation and change and advancement by our financial services sectors, particularly regulated entities like banks. They’re already regulated. People go in and look at them. Nothing’s hidden. Everything’s transparent. The regulators are there sometimes 24/7, but at least once a year at any sizable institution. And so, allowing them to innovate, encouraging them to innovate is really where we ought to be on our front foot, not on our back foot.Jerry: If we could only bring a Steve Jobs mentality to financial services, looking for new ways to provide service and being creative, wouldn’t it be great? Gene: Hear, hear. Caroline: I think it really speaks to Gene’s point earlier about thinking about collaboration, thinking about what the goals are so that you can have the right incentives to bring that mentality to the table. Without the right incentives, everyone will kind of move toward that “protecting from risk” mentality rather than balancing that with “what are the benefits” of innovation. Gene: Yeah. You know, Caroline, I have known almost no banker that I ever dealt with, certainly at the C-suite, that had an ill intention, not bankers, in terms of how they dealt with their public, their customers. After all, that’s their business. Caroline: Right. Gene: They make customers unhappy, and they don’t have a business. They want to serve their customers, particularly the American banking system. And so, taking advantage of that, of those juices, and allowing for collaboration and innovation and opportunity to change is so essential to the well-being of this country. If we’re ever going to get out of this low- and moderate-income tornado we’re in, the only way to do it is to push forward, not to restrain things. Jerry: Steve Jobs, I mentioned earlier, was creative and actually has transformed communication in America. And Gene, what you’re doing in terms of calling out this problem of middle-income and low-income America falling farther behind is really a clarion call. I hope it’s heard because it’s a very, very important message. And it goes beyond, obviously, it goes beyond financial services. It goes to the entire private sector in creating those meaningful and rewarding jobs, that maybe with the advance of technology that we are seeing now can be done. So again, thank you so much for joining us and for sharing your insights. It’s a pleasure to have had you with us. Gene: Thank you, Jerry. And thank you, Caroline. It’s great to be with you and an honor indeed. And, you know, look forward to all getting together soon and best to your listeners. Caroline: Thanks, Gene.