The title is a play on words of course, taken from John Donne's Meditation VII, which starts, "No 
man is an island entire of itself; every man is a piece of the continent, a part of the main" and end with "And therefore never send to know for whom the bell tolls; it tolls for thee.". The message being in a society we are all mutually interdependent. Sadly, this is a message which not only seems to have been lost on the Finance Industry but they would appear, judging from last quarter's earnings and their source in proprietary trading profits, to turned on its head. Ask not for whom the bell rings for it rings for me, but never thee. Having been monitoring and analyzing the business performance of the Industry for two years now we were, and are, nonetheless very surprised. Because the other side of that coin is that society requires that it's major organizations and institutions provide a service that creates value. And, especially, does no harm to society. When the opposite is true, and when it looks likely that the behaviors will continue, society has no choice but to act. Well this week is the anniversary of Lehman's fall and it behooves us to ask what lessons have we learned, what have we done to fix the systemic and systematic problems and what will we do. Washington has been focused on saving us from our own and the industry's follies but the President marked the occasion with a speech to Wall St. putting them on notice that the reckless behaviors of the past will no longer be tolerated; and inviting them to constructively contribute to creating new regulatory regimes. An invitation they've had for months and been fighting in every possible way. The week ended with the Fed's announcement that they will start setting compensation policy. Meanwhile Barney Frank on MSNBC provided pretty clear indications of where he sees things going and Pecora II is about to kick off. Now it's a siren rushing to the crime scene and the results could be very ugly.
Perverse Incentives, Bad Consequences
Let's review some stuff we've gone over before separately and put a new picture together, plus add in some stuff, from this week. Here we look at the overall performance of the Economy vs sector Profits, the Economy vs Markets and Wall St. vs Society. The UL chart we've talked about a lot so moving on the UR chart is updated and shows real SP500 vs real GDP cumulative growth from 1950 to now. The bottom triptych puts charts showing the growth of Debt with Wall St. relative compensation and Bonuses. Taken all together it almost seems to us that a complete story is being told, eh what? But what we have is de-regulation that led to a wave of financial engineering innovation that started by creating value but soon focused almost entirely on internal products, e.g. proprietary trading, that created a tsuanmi of debt leading to completely out-of-balance compensation for the Industry. Not least amusing is that this didn't metastasize until this decade. In other words despite all the tooth-gnashing about systemic problems and accumulated history it wasn't really until the last five years that we all got ebolasized! Anyway that's how we read.
Continued....
Give 'em More Rope
One of the interesting things, whatever else you might think, the political sausage-making the Administration went thru on Healthcare was carefully managed and got buyin from all the major stakeholders. The Administration took the same careful steps, signaling its intent in advance, contacting the players. trial-ballooning multiple aspects of its agendii and so forth. Unlike the Healthcare stakeholders the Finance Industry has been fighting tooth and toenail. Now that the rest of the agenda, like saving the economy, has made some progress they apparantly feel it's time to dig into finance. We dissected the major lines of business, which made money and which didn't and how, in a prior post (BaU vs. NN I: Finance Fumes, Realities and Pecora II). The bottom line is that the Industry think that not that they've been saved it's time to return to business as usual. In point of fact all the bad capital is still on the books, it could take a decade to repair, the business models in each line of business are broke, it's been government support and guarantees for Housing loans (80% of mortgages are FHA), "bank" funds and various Fed instruments (TALF, etc.) that have let things return to a semblance of reality, when we were all trembling on the edge of the cliff. Yet the Industry and investors are treating things as if it never happened. We use the Finance ETFs to gauge that where IYG is the Industry, IAI is Broker-Dealers, IAK is Insurance, and IAT is Regional Banks. Now either we're completely nuts, the euphorialistic relief rally that the world didn't end is generating enormous momentum or we're right and none of this is grounded in any of the realities we've just listed out. We know where we vote...how about you? We think the Industry is going to go thru a decade of poor performance that reverses at least the last decade of perversities, or more, and returns it to its roots and that's irrespective of what regulatory changes occur.
Get Ready for Adult Supervision
Any organization must provide, as we've said, a value to society. It doesn't exist for it's own sake but on sufferance. When you take that down organizations must: 1) create value-add (a profit for businesses), 2) creative a productive workplace environment and 3) contribute to the existence of a healty society. The grades for the Industry are so bad here, unparalleled since the last time they screwed up this bad, that we won't bother to give them. That'll be your pleasure.
Over and above those when you talk specifically about not creating social damages there are three further goals: 1) do no harm, 2) act proactively to develop solutions to external problems created by the industry that no one firm can handle alone and 3) contribute materially to addressing broader social problems where feasible; after all no enterprise can be healthy in an unhealthy society. It is a preeminent leadership responsibility for management to deal with these rather than ignore them; or worse try and actively oppose them while continuing to create problems.
In the early part of the 20thC Theodore Vail, the first CEO of ATT, acted to create a productive and constructive relationship with Federal and State regulatory authorities that kept ATT a profitable private company. The only such company in the developed or developing world. The rest of the world's telecom is run by their PTT Ministries. It should be done, it can done and it certainly shouldn't be done in reverse. Vail proved himself and ATT capable of adult self-supervision. Not only did the Finance Industry do just the opposite but it literally thumbed its nose at society in the last two quarters. The Piper is beginning to ask for his pay.
NO Plan? Don't Worry One Will Be Provided!
We'd ask, "where's the plan Wall St." but it's becoming clearer that one will have to be provided for them. Or so says much of the public, Washington and the rest of the Industry who was badly damaged by the malfeasant behavior of a too well rewarded few.
And in the meantime here's some background reading that collects the last two years of our aggregate analysis plus our set on governance and social responsibility. We suggest you might want to peruse it to review and refresh yourselves on some of these points.
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Lessons, Consequences & Changes
Sleep-At-Night-Money Lost in Lehman Lesson Missed With Bent's $63 Billion It was commercial paper and the $3.6 trillion money market industry that traded the notes that came close to sinking the global economy -- not a breakdown in credit-default swaps or bank-to-bank lending. The bankers were focused on saving themselves, and commercial paper, as invisible as the air they breathed, never came up at the meetings, according to one of the two dozen executives invited to the New York Fed by its president… Like ice-nine, the fictitious substance in Kurt Vonnegut Jr.’s 1963 novel “Cat’s Cradle,” a single seed of which could harden all the world’s water, commercial paper was the crystallizing force that froze credit markets, choking off the ability of companies and banks to borrow money and pay bills. That a 158-year-old investment bank with $613 billion in liabilities could go belly up made every institution seem vulnerable. Within hours, investors were yanking money out of funds that just the day before seemed impregnable.
Record Plunge in US Consumer Credit Signals Weakened Spending A record $21.6 billion drop in borrowing by Americans added to evidence that consumer spending will be slow to recover as banks and credit-card companies tighten lending standards and households pay down debt. Consumer credit fell by 10 percent at an annual rate in July to $2.5 trillion, according to a Federal Reserve report released yesterday in Washington. The drop was more than five times larger than economists forecast. Credit fell for a sixth month, the longest series of declines since 1991. Unemployment that’s projected to reach 10 percent by early next year and a decline in household wealth are casting doubt on the strength of the recovery from the worst economic slump since the 1930s. Federal Reserve policy makers, at their last meeting in August, expressed “uncertainty” about the projected pace of gains in spending by households. Non-revolving debt, including loans for automobiles and mobile homes, plunged by $15.4 billion in July. The Fed’s report doesn’t cover borrowing secured by real estate. Revolving debt, such as credit cards, fell by $6.1 billion. Most banks cited reduced risk tolerance and “a more uncertain economic outlook” as the main reasons for restricting credit to businesses, with 35.2 percent saying they “tightened somewhat,” the Fed said in its quarterly Senior Loan Officer survey.
Credit card satisfaction hits new low J.D. Power reports that overall customer satisfaction with credit card issuers hit a three-year low, clocking in at 703 (on a scale of 1000) in 2009. That was slightly lower than the already anemic 710 score from 2008, and is the lowest showing since the firm started looking at credit cards in 2007. On the sub-topic of fees and rates, the 2009 satisfaction score slumped from a solid D (640 in 2008) to a D-minus (603 in 2009) as the percentage of respondents who were hit with an interest rate increase nearly doubled over the past year, to close to 20%. Customers reporting complaints/problems also shot up; from 10% in 2008 to 18% this year. No surprise then, that J.D. Power says credit card issuers own the dubious distinction of having the lowest satisfaction score across the financial services industry, trailing investment services, insurance and banking.
'Zombie' bankers haunt Wall Street Robert Benmosche, the combative new chief executive of American International Group (AIG, news, msgs), hasn't wasted much time ruffling the new Washington-Wall Street establishment, but his most audacious move wasn't brushing off taxpayers -- it was thumbing his nose at common sense. How else can you describe Benmosche's decision to bring back Hank Greenberg, the founder, architect and builder of AIG? He's also the man who smeared the company in a nasty accounting scandal and who was ultimately responsible for the insurer being dragged into the industry's bid-rigging scheme of a few years ago.Benmosche is unrepentant in his decision to reach out to the shamed Greenberg. But the chutzpah of Wall Street scourges doesn't end there. Stephen Feinberg, whose hedge fund, Cerberus Capital Management, invested in such doomed companies as Chrysler and GMAC, is launching a new fund even as investors are scrambling to get out of his old funds. The kicker: Cerberus is asking for a three-year lockup, meaning that investors won't be able to withdraw their funds for that period. All of these characters share one thing in common. It's one thing that separates them from those who flame out on Wall Street never to return. No matter how much evidence of failure is gathered against them, the Blodgets, the Spitzers and the Meriwethers never really admit they were wrong. They walk around as if nothing happened. They ride the notoriety of their names to new or refurbished careers.
Exposure at Default: As Banks Shrink, So Does the Economy Looking at the banking industry, it is really remarkable that Fed Chairman Ben Bernanke has decided that the recession is over – but not surprising. After the past decade or more of credit fueled exuberance, no surprise that the maddening crowd wants to go back to the way it was. Many of the bankers and Buy Side investors with whom we speak feel that the worst of the economic crisis is behind us. And we do see increase activity in the secondary markets for loans and failed properties, an encouraging sign that may – emphasis may – push down the ultimate cost of cleaning up the mess in the banking industry. There are many other indicators that suggest consumers and business are rebounding from the summer of dread. But while we all do hope for better times ahead, the fact remains that the supply of credit available to the global economy continues to shrink with the balance sheets of banks around the world. Forbearance and flexibility are the order of the day for most lenders. The impact of this credit shrinkage on asset prices is decidedly negative, but in many cases, investments in residential and commercial real estate made over the past five years are so far under water that the owners are simply walking away. And when we say owners, we are not just talking about residential home owners, but some of the most respected institutional players in the worlds of Wall Street and commercial real estate as well.
Bottom line is that deflation is still the chief threat to the US economy, driven by a relentless contraction in bank and nonbank credit. Until we see a restoration of the market for nonbank finance and a sustained turn in the EAD of the large bank peer group, which accounts for almost 70% of the entire US industry balance sheet, we do not believe that any economic recovery will be meaningful in terms of jobs or asset prices. Indeed, we have to wonder whether the FDIC should even try to impose another assessment on the banking industry to fund failed bank resolutions when the effect of this action is to remove capital from the system and thereby accelerate the shrinkage of the collective balance sheet of US banks. Before Secretary Geithner and the G-20 talk further about raising bank capital levels, we first need to find a way – and fast – to stabilize the existing capital base of the banking industry. Failure to do so, in our view, could be catastrophic for the global economy and could also further radicalize the political situation in the US, where many Americans are starting to realize that the party is well and truly over. As
we said on CNBC on Monday, talking about raising bank capital at the present time is the functional equivalent of the imposition of the Smoot-Hawley Tariff Act of 1930. We desperately need a different approach.
Chart: Exposure at Default: C, JPM, BAC, WFC and large bank peers. Global Financial Market Crisis Hasn't Ended Yet, Fund Manager Survey Says Most fund managers say the financial crisis has not yet ended, with companies still burdened by large amounts of debt and credit markets still fragile, according to a survey by FTI Consulting Inc. Almost two-thirds of fund managers said the financial crisis is continuing, with U.K., U.S. and Australian investors the most pessimistic, the survey said. West Palm Beach, Florida- based FTI said 153 investors with $2.8 trillion of equity funds under management took part in the research. “Investors were still concerned that the amount of leverage in the system that caused the original problem has not been reduced,” said Jack Dunn, FTI’s chief executive officer. “There has been so much economic stimulus that markets cannot help but go up. The concern was what would happen when government money runs out.” Central banks in Europe, the U.K. and the U.S. lowered their benchmark interest rates to record lows and spent billions of dollars to stimulate lending and economic growth after the worst financial crisis since the 1930s. Joseph Stiglitz, the Nobel Price-winning economist, said yesterday problems in the banking industry are worse now than before the crisis, which began in 2007.
Wall Street’s new shape - rearranging towers of gold The aftershocks of September 2008 are still being felt, not least by the firms at the centre of it. Although chunks of Lehman were sold quickly to Barclays of Britain and Nomura of Japan, tens of billions of dollars of clients’ cash, much of it belonging to hedge funds, is still trapped in the world’s biggest bankruptcy. AIG is part way through a tortuous dismemberment. America’s financial-services industry has shed record numbers of jobs as firms have failed, been sold or retrenched (see chart 1). Life has become less gilded for those still at their desks: Wall Street bonuses fell by 44% last year (chart 2). This renewed focus on old-fashioned finance is spreading. Consulting firms say they have seen a surge of interest from banks keen to sharpen their service in everything from retail banking to prime brokerage (the financing of trading by hedge funds). Bob Gach, head of the capital-markets practice at Accenture, a consultancy, knows of several that have set aside $400m or more to improve their technology links with customers. “Relationships are back,” he says. Investment banks are also throwing more resources into merger and restructuring advice, neglected by some during the boom as “a mere pimple on the donkey’s arse”, as one veteran puts it, but now seen as a core source of revenue—with limited downside. Much of this comes in anticipation of new rules designed to curb bankers’ wilder instincts. With Congress fixated on health care, the fate of the Obama administration’s sweeping financial reforms remains unclear. Banks are in anxious limbo, awaiting the fine print on the treatment of securitised mortgages, credit-default swaps and more. But no one doubts that changes are coming. However, the days when finance accounted for 40% of corporate America’s profits are over. Mr Winters thinks investment banks’ average return on equity will settle at a hardly dazzling 10-12% (though the best firms will do much better than that). At leverage of 15 times equity—the reduced level at which investment banks now typically operate—large parts of the fixed-income business fail to cover their cost of capital, reckons Brad Hintz, an analyst with Alliance Bernstein. Rising interest rates will provide further drag—and probably ensure that credit grows more slowly than the economy for some years. “Everyone was running downhill for 15 years,” says Michael Poulos of Oliver Wyman, a consultancy. “Now we’ll see who the real athletes are.”
Government's Trial and Error Helped Stem Financial Panic It was only a year ago that the world economy was enveloped in a financial panic of such dimensions that, if one believes Federal Reserve Chairman Ben Bernanke, it threatened to produce a calamity as bad as the Great Depression. Today, the economy is far from vigorous. Unemployment remains high. Huge swaths of the financial system remain on government life-support. But the global recession appears over, and now forecasters are arguing over the pace and sustainability of recovery. Leaders of the world economy are breathing an audible sigh of relief, and talking about the "exit strategy."President Barack Obama goes to Wall Street Monday, the anniversary of Lehman Brothers' collapse, to deliver a cautious victory speech. He will discuss the administration's plans "to wind down government involvement in the financial sector," and will push for immediate action on regulatory changes needed to prevent future crises. With Wall Street executives, as well as government officials, in attendance, the president also will admonish "to avoid a return to the practices on Wall Street that led us to the financial crisis and to recognize their obligation to help produce a wider recovery on behalf of the American people." With a modicum of hindsight now available, do governments and central banks deserve credit for preventing catastrophe? The early verdict from most scholars, executives and government insiders is yes. On the question of which of dozens of extraordinary interventions -- rock-bottom interest rates, surging government spending, billions of taxpayer dollars injected into banks, sweeping government guarantees -- made the biggest difference, there's less agreement. Mr. Geithner's "stress tests" of the 19 largest financial firms got off to an inauspicious start on Feb. 10 when he unveiled them in a widely mocked speech. He announced without much detail that banks would be required to raise enough capital to cover likely losses projected in scenarios devised by the Fed and Treasury. For weeks, the stress tests contributed to uncertainty over the state of the banking industry, and to worries that the administration might use the stress tests either as a cover for nationalizing the banks or as a way to paper over banks' problems. But when they were completed in May, they seemed to clear the air and paved the way for banks to raise capital from private investors.
- No Easy Exit for U.S. As Housing's Savior The government's extraordinary interventions in the economy are the primary reason the housing market is functioning at all, economists say, which makes an exit unlikely any time soon.
Americans Have Been Taken Hostage The American people have been taken hostage to a broken system. It is a system that remains in place to this day. A system where bank lobbyists have been spending in record numbers to make sure it stays that way. A system that corrupts the most basic principles of competition and fair play, principles upon which this country was built. It is a system that so far has forced the taxpayer to provide the banks with the use of $14 trillion from the Federal Reserve, much of the $7 trillion outstanding at the US Treasury and $2.3 trillion at the FDIC. A system partially built by the very people who currently advise our President, run our Treasury Department and are charged with its reform. And most stunningly — it is a system that no one in our government has yet made any effort to fundamentally change. Like health care, this is a referendum on our government’s ability to function on behalf of the American people. Ask yourself how long you are willing to be held hostage? How long will you let our elected officials be the agents of those whose business it is to exploit our government and the American people at any cost? And more than anything else — why does the US Congress refuse to outlaw the most anti-competitive structure known to our economy, one summed up as TOO BIG TOO FAIL? It has become startlingly clear that we as a country, and I as a journalist, had made a grave error in affording those who built and ran those banks and insurance companies the honorable treatment of being called capitalists. When in fact the exact opposite was true, these people were more like vampires using the threat of Too Big Too Fail to hold us hostage and collect ongoing ransom from the US Government and the American taxpayer. This was no unlucky accident. The massive spike in unemployment, the utter destruction of retirement wealth, the collapse in the value of our homes, the worst recession since the Great Depression all resulted directly from these actions. Even with all that — the only changes that have been made, have been made to prop up and hide the massive flaws on behalf of those who perpetuated them. Still utterly nothing has been done to disclose the flaws in this system, improve it or rebuild it. Last fall was an awakening for me, as it was for many in our country. And yet, our Congress has yet to open its eyes, much less do anything about it. In fact conditions have never been better for the banks or worse for the rest of us. Why is this? Who does our Government work for? How much longer will we as Americans tolerate it? And what, if anything, can we do about it? As a country, we must demand that our politicians stop serving those whose business models are based on systemic theft and start serving those who seek to create value for others — the workers, innovators and investors who have made this country great.
The real lesson of Lehman's demise Did we act like cowards last winter, withdrawing to the safety of Treasury bills? Did we act like mercenaries, short-selling the weakened banks' securities for our own benefit? Did we just stand to the side in speechless awe, feeling helpless and dumbfounded? Or did we have a plan to act at a time of crisis with mindful sobriety, waiting for a moment of maximum pain to arise to buy securities at their greatest discounts of the past three generations and make fortunes for our families? One would hope that it was the last, but after talking to a dozen professionals this week and reflecting on my interviews with fund managers at the time, I haven't found anyone who feels that he or she did exactly the right thing after the Lehman collapse and the crisis that followed. And that just goes to show how important it is that we lay plans now for next time, whether that's three months, three years or 30 years from now. Of course, this is not exactly the first time in history that financial collapse has brought opportunity, yet each generation fails to learn the lessons of the past and needs to experience those lessons anew. Back in the Wall Street of the 1800s, an era that was a lot more like the present than you might think, depressions and panics occurred with regularity, and making a plan for them was discussed often.
Industry Relations: Private Greed vs Public Safety
Investment Advisor Frustration BNN talks to Lubo Li, senior director and financial services practice leader, JD Power & Associates.
Americans' Trust "Shattered" & CEOs Still in Denial, Elizabeth Warren Says Americans’ trust in the financial system has been “shattered” in the past 18 months, says Elizabeth Warren, the Harvard law professor who chairs the Congressional Oversight Panel. She says we’re on our way to restoring that trust, but only as the nation’s elites wake up to a new reality: “What we’re having to do is change an entire culture. Let’s be clear: The folks who’ve been running these multibillion-dollar institutions – they are accustomed only to talking to other people who run multibillion-dollar institutions. And the rest of you can stay far, far away. What has fundamentally changed is they’re now taking taxpayer dollars. And the taxpayers think that gives them a seat at the conversational table and the decision-making table. And it’s taking a while for those CEOs to figure out the game has changed. And I do believe the game has changed.” Warren acknowledges that some Wall Street CEOs keep acting as if the old rules apply. She is appalled at Wall Street’s continued practice of handing out oversized bonuses, as evinced by the latest revelations about AIG’s 2008 pool or recent increases in bonuses across the industry. The idea that firms need to pay up to retain top talent “carries zero” weight with the bailout monitor, who also disagrees with the criticism the Obama administration is overreaching in its dealings with Wall Street. The president, she says, is calling shots as a major shareholder, representing the taxpayer. “We’re going from a world in which folks at the top only talked to each other, and maybe their regulators on occasion,” Warren says. “It was a very quiet and very private conversation involving billions of dollars. Once you take taxpayer money.... it’s a three-way conversation.” In that light, Warren believes there will be more public “conversations” like the AIG hearing. She believes faith in the system may be restored by a modern version of the Pecora Commission, which investigated the banking industry after the 1929 crash, although she dodged our question as to whether she would want to lead it, as some have proposed.
Americans Aren't Here to Serve the Banks, They're Here to Serve Us Bailout monitor Elizabeth Warren says the U.S. government "shows strong improvement" from the early days of TARP, when $350 billion was "shoveled into financial institutions" with a "no strings attached" and an attitude of "take my money, please." The chair of the Congressional Oversight Panel was fairly complimentary of Treasury Secretary Tim Geithner, certainly in comparison to his predecessor in three key areas: transparency, accountability and clarity of purpose for various programs. But "we started in the basement", she says, in terms of both the government's handling of the bailouts and the public's confidence in how taxpayer money was being spent. The Harvard law professor gives the government an “incomplete” for its handling of the bailouts, up from an early failing grade. "It's better than it was but I'm still wanting more," Warren says, suggesting a fundamental issue remains unresolved: "Is this all about ‘we've got to fix problem at the top [and] boost high-end financial institutions' or about 117 million American households who really are in trouble?" No matter how much money is put into banks, no economic recovery is sustainable without "building from the bottom" and getting average Americans on sounder financial footing, says Warren, an expert in consumer bankruptcy and co-author of The Two-Income Trap. "American families are not here to serve the banks," she says. "The banks are here to serve the American people."
Big Banks Get Bailouts But Small Businesses Need Help Too, Elizabeth Warren Says Wall Street's celebration of (among other things) the thawing of the credit markets resumed with vigor Wednesday. But small businesses and consumers are facing obstacles in trying to find available credit, according to the Congressional Oversight Panel's latest report. Elizabeth Warren, who chairs the panel, joined Henry and me yesterday to discuss the report and the implications of its findings. Specifically, Warren is concerned the government's efforts to date, specifically the Term Asset-Backed Securities Loan Facility (TALF), is focused on the securitization of consumer loans, which doesn't do much for small businesses. "There's a fair question about whether dollars put into this [TALF] program are going to be felt for the small business who are struggling to get themselves enough lifeblood, enough money to keep going," Warren says. That's critical because, according to the panel's report, small businesses: Produce about half of the nation's private, nonfarm GDP. Employ more than half of all private-sector workers. Generated more than half of all new jobs over the past 10 years and nearly 79% of new jobs created in 2004-2005. "We still need to keep thinking about how to get enough credit to small businesses," Warren says. "We can't say ‘we got TALF, let's move on to next issue.'"
Wall Street’s Newest Product Is Tale of Denial Most people wonder how the financial crisis will end. For some, the story of how it began is just as important. Control of that tale will help determine how we respond to the past two years of market mayhem. At stake is the financial industry’s business model and billions of dollars in annual profits. No wonder Wall Street executives are spinning the causes of the crisis, downplaying their roles in inflating the housing and credit bubbles while presenting themselves as integral to any solution. This is part of an industry wide effort to return to some semblance of the pre-crisis status quo. The strategy will be tested this month when Congress holds hearings on aspects of Barack Obama’s proposed overhaul of the financial regulatory system. Another tactic is to pin blame on short sellers who try to profit from falling stock prices. Taken together, the message is clear: the credit crunch didn’t occur because the financial system was rotten. No, instead it was swamped by an epic storm worsened by investors looking to profit from misery. And if Wall Street says it’s not to blame, can anyone argue with that? Yes. That scenario flies in the face of what really happened: banks intentionally used too much borrowed money to make bad loans and investments in inflated assets while regulators turned a blind eye to runaway financial engineering and investors took it on trust that everything would be fine. Decay had indeed set in.
The Regulatory Wars: Pushback vs Backlash
How the Banks Plan to Limit Credit-Card Protections A popular president taking on a reviled industry should get what he wants, in principle, especially when he's working with a sympathetic Congress. But it's not so clear Barack Obama will be able to deliver on his promises of clamping down on credit card abuses, thanks to the banking industry's experienced Washington lobbyists and their plans to limit proposed restrictions on their business. Obama laid down his marker for reform last week, outlining general principles like simpler forms and more flexible rules for borrowers. And he pressured industry bigwigs at a White House meeting to agree to limit sudden interest rate hikes. But the real fight begins this week, and it's about to get ugly, as Democrats enter negotiations with banks and both sides test the resilience of each other's initial, aggressive postures. The banks have fired back, arguing that they'll get paid one way or another: they say Dodd's recipe is political posturing that will only produce higher initial rates for everyone and diminished credit for an ailing economy. "The American people can't manage their credit," says one industry heavyweight, "If you change the rules, guess what, we'll just start at a higher rate and you'll see a decrease in availability of credit and an increase in the cost to everyone else." But for all their bluster, and supporters, the banks understand that they are in political hot water, and that they will need to compromise — a little. In Congresswoman Carolyn Maloney, who represents much of Manhattan's armies of financial service workers and is head of the joint economic committee, they have found someone more to their liking. She has moved a bill that is less draconian than Dodd's, allowing rate boosts for existing and future balances in most cases. The bill does incorporate into law many regulatory changes the Administration has already pushed through, like partially applying payments to highest interest rate balances. The most likely outcome is a bill somewhere between Maloney's and Dodd's that prevents credit card companies from boosting rates on existing balances but allows them to jack them up for future purchases, eliminates a variety of unfair billing and payment gimmicks the card companies use to jack up fees, and gives the consumer more ways out if the card companies do try to squeeze them. And what if the banks ultimately deliver on their threats, simply jacking up initial interest rates on everyone thereafter and constraining credit? "Then you'll continue to see us changing the law and the regulations so that eventually they're out of options," says the Democratic leadership aide.
Showdown Seen Between Banks and Regulators As the Obama administration completes its examinations of the nation’s largest banks, industry executives are bracing for fights with the government over repayment of bailout money and forced sales of bad mortgages. President Obama emerged from a meeting with his senior economic advisers on Friday to say “what you’re starting to see is glimmers of hope across the economy.” But there were also signs of growing tensions between the White House and the nation’s banks over the next phase of the financial rescue. Some of the healthier banks want to pay back their bailout loans to avoid executive pay and other restrictions that come with the money. But the banks are balking at the hefty premium they agreed to pay when they took the money. Meanwhile, the Obama administration wants weaker banks to move more quickly to relieve their balance sheets of the toxic assets, the home loans and mortgage bonds that nobody wants to buy right now. But the banks are resisting because they would have to book big losses. Finally, there is increasing anxiety in the industry that the administration could use the stress tests of the 19 biggest banks, due to be completed in the next three weeks, to insist on management changes, just as it did with General Motors when officials forced the resignation of its chief executive after examining that company’s books. Senior officials, recognizing that the next few weeks could prove pivotal for both the industry and the bailout effort, are moving ahead with major plans.
Geithner Calls for `Very Substantial' Change in Wall Street Pay Practices Treasury Secretary Timothy Geithner called for major changes in compensation practices at financial companies and said the Obama administration’s plan to help realign pay with performance will be rolled out by mid-June. “I don’t think we can go back to the way it was,” Geithner said in an interview on Bloomberg Television’s “Political Capital with Al Hunt,” to be aired tonight and over the weekend. “We’re going to need to see very, very substantial change.” He said that Wall Street’s pay practices, which include big year-end bonuses, encouraged excessive risk-taking and helped precipitate the financial crisis. What’s needed is a set of broad standards that financial supervisors can use to make sure that doesn’t happen again, he said. The administration’s pay plan would be part of a proposed comprehensive overhaul of financial regulation aimed at both protecting consumers and reducing vulnerability to crises. Geithner has previously ruled out setting specific caps on pay and declined to alter existing compensation contracts. Geithner praised SEC Chairman Mary Schapiro and said he would support giving her agency more resources where needed. He declined to say whether he thought the SEC should lose oversight of mutual funds as part of the overhaul. He also said the administration is working with top lawmakers to craft a new regulator that would police risk across the financial system. He said no judgments have been made yet about who would fill that task, or what the roles of the Federal Reserve and Treasury will be. A “white paper” on the subject is due in several weeks, he said. The Treasury chief brushed off suggestions that he and Summers were at odds with the FDIC’s Bair and that the two didn’t consider her a team player. He called Bair “very creative” and said that he had worked very closely with her.
U.S. Financial System Needs a New Regulator, but Who? The worst financial crisis since the Great Depression is about to prompt the most far-reaching renovation of the rules and institutions that regulate finance since the 1930s. And the change won't wait for the economy to recover. The Obama administration is rushing to finish a proposal for reshaping financial regulation and wants Congress to act on it by the fall. The current crisis exposed two huge vulnerabilities. One is that a handful of financial institutions grew so large and so intertwined that the failure of just one put the entire world financial system at risk. There are two basic never-again solutions: either break them into smaller pieces or better regulate them to make them less prone to collapse. The political winds in Washington are blowing toward the latter. The other vulnerability, as Federal Reserve Chairman Ben Bernanke put it recently, is "that an approach to supervision that focuses narrowly on individual institutions can miss broader problems that are building up in the system." Both in and out of government, there's a strong consensus to name an overarching overseer of financial stability -- both to keep an eye on institutions so big that their collapse would hurt everyone and to prevent and treat financial infections spreading throughout the system, such as complicated instruments that imprudently rely on house prices rising forever. But who should be this financial stability regulator? The growing consensus, though not the universal one, is the Fed, despite congressional concerns that the Fed already has too much power. The reaction to the Great Depression gave us the Securities and Exchange Commission, created deposit insurance, divided commercial banking from investment banking, and shifted power inside the Fed to Washington. The response to the Great Panic of 2008 surely will bring similarly long-lasting changes. We just don't know yet what they will be.
U.S. Considers Financial Pay Rules Obama administration officials are contemplating a major overhaul of the compensation practices in the financial services industry, moving beyond banks to include more loosely regulated hedge funds and private equity firms. Federal policymakers have been discussing ways to ensure that pay is more closely linked to performance. Among the ideas under consideration are incorporating compensation as a “safety and soundness” concern on official bank examinations as well as expanding the existing regulatory powers of the Securities and Exchange Commission and Federal Reserve to obtain more information regarding compensation. The policymakers are also expected to publish formal guidelines regarding Wall Street pay. Any overhaul is likely to be tied to the Obama administration’s broader efforts to curb systemic risks to the economy. Administration officials have been contemplating broad-based pay reforms since early this year. But the effort was apparently put off after the furor over bonuses at the insurance giant American International Group in March. Financial policymakers had hoped for things to cool down, and have also been preoccupied with a number of other issues, including the highly-anticipated stress tests for the nation’s biggest banks. Just as the tests aimed to give the markets more clarity on the financial condition of the banks, the compensation guidelines may be designed to give the market more clarity over pay. Wall Street pay has long been a hot-button issue in Washington, but the public outrage over excessive compensation has erupted in recent weeks.
Even in Crisis, Banks Dig In for Fight Against Rules As the financial crisis entered one of its darkest phases in October, a handful of the nation’s largest banks began holding daily telephone sessions. Murmurs were already emanating from Washington about the need for a wide-ranging regulatory overhaul, and Wall Street executives girded for a fight. Atop the agenda during their calls: how to counter an expected attempt to rein in credit-default swaps and other derivatives — the sophisticated and profitable financial instruments that were intended to limit risk but instead had helped take the economy to the brink of disaster.The nine biggest participants in the derivatives market — including JPMorgan Chase, Goldman Sachs, Citigroup and Bank of America — created a lobbying organization, the CDS Dealers Consortium, on Nov. 13, a month after five of its members accepted federal bailout money. The looming fight over regulation is the beginning of a broader debate over the future of the financial industry. At the center of the argument: What is the right amount of regulation? The debate about where derivatives will trade speaks to core concerns about the products: transparency and disclosure. There are two distinct camps in this argument. One camp, which includes legislative leaders, is pushing for trading on an open exchange — much like stocks — where value and structure are visible and easily determined. Another camp, led by the banks, prefers that some of the products be traded in privately managed clearinghouses, with less disclosure.The Obama administration agrees that more regulation is needed. A proposal unveiled recently by Treasury Secretary Timothy F. Geithner won plaudits for trying to make derivatives trading less freewheeling and more accountable — a plan that hinges in part on using clearinghouses for the trades. Critics in both the financial world and Congress say relying on clearinghouses would be problematic.
Obama’s Plan to Reshape Financial Rules President Barack Obama’s plan to reshape financial regulation, which he is to introduce Wednesday, is the product of weeks of meetings among government officials, financial experts, lawmakers, industry executives and lobbyists, many of whom were invited to help the White House draft the proposal, The New York Times’s Stephen Labaton writes. Mr. Obama told reporters Tuesday that a “lack of oversight” allowed what he called “wild risk-taking.” He said it led to “very dangerous” conditions that imperiled the global economy. Executives from an array of industries caught up in the financial crisis came to Washington over the last several weeks to make their case for how the new regulatory landscape should look, The Times writes. They came from big banks and small ones, insurance companies and stock exchanges, hedge funds and mutual funds, and were joined by officials from consumer groups and big labor — often with conflicting views. Now, lobbyists who lost the initial skirmish inside the administration will head to Congress to try to influence the final product. The plan the president will formally announce on Wednesday would give the Federal Reserve greater supervisory authority over large financial institutions whose problems pose potential risks to the economic system. It would separately expand the reach of the Federal Deposit Insurance Corporation to seize and break up troubled financial institutions. And it would create a council of regulators, led by the Treasury secretary, to fill in regulatory gaps. In doing so, the plan seeks to give Washington the tools to police the shadow system of finance that has grown up outside the government’s purview, and to make it easier for regulators to head off problems at large, troubled institutions or take control of them if they fail. Although it would strikingly reorganize the regulatory architecture, the president’s plan results from many compromises with industry executives and lawmakers, and is not as bold as some had hoped.
Wash Wire: A Condensed Version of the Plan
Economic Team Set Out To Get at Root of Crisis The plan President Obama unveiled yesterday to overhaul the government's oversight of the financial system was not the wholesale remaking of Washington that the administration had initially envisioned. As the proposal came under intense pressure this spring, its chief architects held firm to a few reforms they deemed the most fundamental to averting another financial crisis while giving ground on nearly everything else. Time and again, lawmakers, regulators and industry lobbyists pressed their concerns behind closed doors at the White House and the Treasury Department, according to participants. Turf-conscious regulators opposed the idea to consolidate banking oversight agencies and took their appeal over the Treasury directly to the White House. Ultimately the administration spared all but one agency. A few key lawmakers argued against merging the two federal agencies that oversee the stock and commodity markets. That did not happen. Insurance companies fought over whether a national regulator should oversee them. The White House dropped the proposal. But on those elements that mattered most to the administration, particularly expanding the powers of the Federal Reserve, Obama's senior advisers were unyielding. "We made a decision to focus on doing what is necessary to prevent future crises," Summers said in an interview. "The test of whether this is going to be bold and far-reaching is going to be what happens in practice in the financial industry not what happens to organizational charts in Washington." Changes to Market Oversight(Graphic)
- Dems to push through banking overhaul quickly Treasury Secretary Timothy Geithner says it is clear that the government could have done more to prevent the economic downfall. In prepared testimony, Geithner says that gaps and weaknesses in the regulatory framework governing banks and other financial institutions "presented challenges" to the government's ability to monitor and address risky market bets. One problem, he says, is that no single regulator saw its job as protecting the economy and financial system as a whole.
Hedge Fund Leader Blasts Obama for "Bullying" and "Abuse of Power" Cliff Asness, whose firm manages some $20 billion of assets, has written an open letter blasting President Obama for his attack on the hedge fund industry in the wake of the Chrysler bankruptcy. As you'll recall, hedge funds, which hold approximately $1 billion in Chrysler bonds, refused the government's offer to take approximately thirty cents on the dollar. Obama accused hedge funds of holding out "for the prospect of an unjustified taxpayer-funded bailout." These comments have enraged many in the industry but few have spoken out publicly. Asness, whose firm doesn't hold Chrysler bonds, says the industry is genuinely afraid in the face of Obama's power. Stating that he himself is "fearful writing this," Asness still pulls no punches:
Industry Targets Plan to Create Financial Watchdog Business and trade-group lobbyists are beating a path to Capitol Hill this week for the first major battle over the Obama administration's efforts to overhaul the financial regulatory system. A coalition of business representatives, who are skeptical about a proposed Consumer Financial Protection Agency, has met repeatedly in recent weeks to hone their argument that a new regulator could cause more harm than good and to strategize about which members of Congress might be sympathetic to their cause. These opponents of a new agency have begun visiting members of the House Financial Services Committee, which plans to take up the proposal in the coming weeks, and are putting a top priority on centrist Democrats, according to people familiar with the meetings. "It's your basic shoe-leather lobbying," said Bill Himpler, executive vice president for government affairs of the American Financial Services Association, the trade group for the consumer credit industry. "This has become front burner -- the number-one issue of our association, at least for the foreseeable future." In addition to AFSA, the recent discussions have involved the American Bankers Association, National Auto Dealers Association, U.S. Chamber of Commerce, Mortgage Bankers Association and other lobbyists. They are also courting other organizations, such as those representing home builders, lobbyists said. Though the groups represent different industries with often divergent interests, they share concerns that the new agency proposed by the administration could intervene in business activities in overbearing and unproductive ways. This coalition has solicited pitches from several public relations firms, including Powell Tate and Direct Impact, to help make their case through advertising and grass-roots political outreach. There have been discussions about launching a television campaign similar to the "Harry and Louise" ads that helped torpedo President Clinton's health-care plan in the early 1990s, said two people familiar with the meetings.
Hey, Wall Street: Stop the whining Yes, the federal government does a lot of stupid things. And yes, it's easy to see why Wall Street firms are bailing out of the Troubled Asset Relief Program: to avoid having to deal with the government's ever-changing rules and with publicity-hungry congressmen. (Is there any other kind?) But that doesn't excuse the way that Wall Street is engaged in selective memory now that the government has shelled out trillions of taxpayer dollars to keep the Street alive. Wall Street, which I define as our major financial institutions, is complaining that the government is messing up the financial system through its attempts at reregulation, its new credit card rules, and its invention of things such as a pay czar. But before you accept the Street's version of events, recall that you didn't hear complaints about "socialism" when the government bailed out creditors of Bear Stearns and AIG and let Goldman Sachs and Morgan Stanley become bank companies so that they could borrow hugely -- and cheaply -- from the Fed. Let's also remember that Wall Street brought all this Washington attention on itself. When it was left alone, the Street unleashed a wild speculative bubble that almost destroyed the world's financial system when it burst. The Street abused vulnerable credit card customers with 30% interest rates and endless fees, and paid its big hitters obscene amounts of money. Now we're seeing the reaction to those excesses. You should also remember that the recession, which has so empowered the liberal Democrats whom Wall Street loathes, was touched off by the financial markets' meltdown. So the Street really has no one to blame but itself for its current problems. The meltdown was so bad that if the government hadn't bailed out the financial system, even prudently run outfits could well have gone under if the government had allowed more giant firms to fail. So these outfits too owe Uncle Sam. Bigtime. It's not hard to understand firms' motivation to escape from TARP, which gave them bailout money on attractive Bush administration terms but has now stuck them with expansive Obamoid regulations. Who needs this? The Street's biggest hope -- and my biggest fear -- is that Washington will focus on symbolism such as a pay czar while substantive things, such as regulating derivatives and setting capital requirements, are done out of public view. Wall Street wants to make its own rules again -- and could get away with it. What's more, now that many big banks have raised money from investors and are repaying their federal bailout loans, they're trying to buy back the stock-purchase warrants Treasury got as part of the deal. Those warrants -- the right to buy a fixed number of shares at a fixed price -- were taxpayers' big chance to make some serious money.
Regulatory Reform Backlash: Is the Beef Being Served Yet?
The Wait for Financial Reform We are barely emerging from the greatest financial crisis since the 1930s. From last September to March, it was downright frightening. Yet by the time Congress left town for its summer recess, financial reform appeared to be losing steam. Monday is Labor Day, the psychological end of summer. So, starting on Tuesday, it’s up to the administration and the Congressional leadership to breathe some life into what’s left of the reform concept. After all we’ve been through, and with so much anger still directed at financial miscreants, the political indifference toward financial reform is somewhere between maddening and tragic. Why is the pulse of reform so faint? I see five main reasons: IT’S YESTERDAY’S PROBLEM People have an amazing capacity to forget. Our financial system is now functioning much better than it was in March or last fall. So the Alfred E. Neuman Principle (“What, me worry?”) threatens to displace the Emanuel Principle. LOST IN THE CROWD The problem of short attention spans has a first cousin: the overcrowded legislative agenda, which has spread the resources and time of Congress and the administration thinly over a vast array of issues. THE MOTHER OF ALL LOBBIES Almost everything becomes lobbied to death in Washington. In the case of financial reform, the money at stake is mind-boggling, and one financial industry after another will go to the mat to fight any provision that might hurt it. But your exercise instructor had it right: no pain, no gain. If we don’t inflict a modicum of pain on financial players — not out of spite, but because the system needs change — we will accomplish little. BUREAUCRATIC INFIGHTING Industry lobbyists are not the only problem. Regulatory deck chairs need to be rearranged, and various government agencies are scrambling to maintain or expand their turfs. I’d attach greater importance to at least three major Treasury proposals that may wind up on the cutting-room floor: First, we need a systemic risk monitor or regulator. A monitor just watches risks develop and issues warnings, while a regulator is empowered to take action. In my last column, I explained the reasons for wanting a systemic risk regulator, and why the Fed should get the job. Second, we need a new mechanism to euthanize or rehabilitate giant financial institutions whose failure could threaten the whole system. Lehman was put into Chapter 11, with catastrophic effects. A.I.G. was turned into an appallingly expensive ward of the state. There must be no more situations like these. As both Mr. Geithner and Ben S. Bernanke, the Fed chairman, have observed, we need a better way out. Third, something serious must be done to tame — though not to destroy — the derivatives markets. Today, virtually all derivatives trading remains unregulated and nontransparent. Much of it also has too little capital and, at crucial times, too little collateral behind it. The Treasury’s draft legislation proposes to fix these problems by standardizing many derivatives and pushing trading into clearinghouses or organized exchanges, where more capital would be required and collateral would have to be posted often. And there is a great deal more in those 618 pages. So let’s get on with the job, remembering the Emanuel Principle. There will never be a better time “to do important things” for our financial system.
Banking's Third Way BNN speaks to Suzanne Labarge, former vice chair and chief risk officer, RBC and board member, Deutsche Bank, and Mauro F. Guillen, professor, The Wharton School, about banking's third way.
A Breakdown on Handling Big Failures As we approach the anniversary of some of the most cataclysmic failures in our economic history, we appear to be in perhaps no better position to manage the failure of an investment bank, a hedge fund or an insurance company than we were before. Absent any legislation that would prevent another 9/15 (as some people are calling it on Wall Street) from happening, our only options are to throw money at problem companies or arrange shotgun marriages to keep them from failing. That hardly seems like a long-term solution. Timothy F. Geithner, the current Treasury secretary, proposed legislation in March that would do exactly what his predecessor talked about — give the government the ability to take over a failing firm like Lehman Brothers to prevent its collapse from infecting others. Little has happened. But as the economy has seemingly recovered and President Obama has focused his attention on health care and other issues — all of which no doubt merit attention — perhaps the one piece of legislation that could prevent a repeat of what has arguably ruined the lives of millions of people has been left in limbo. As we approach a different anniversary, that of 9/11, there is still no new building in the place of the World Trade Center, eight years after so many lives were lost and businesses destroyed. Addressing the critical issue of resolution authority in less time could be essential to avoiding another financial crisis.
Warren on getting to the root of financial collapse: Professor Elizabeth Warren, chair of the Congressional Oversight panel on the bail out, had an in depth conversation with Dylan Ratigan on what she wants to hear from the president a year after the start of the financial collapse, and what Congress needs to do to fix the economy.
Has the economy recovered? : Arianna Huffington joins a Morning Meeting panel to discuss whether financial reform has been evident on Wall Street one year after Lehman Brothers filed for bankruptcy triggering a domino effect which sent the economy into a tailspin.
Wall Street's Mania for Short-Term Results Hurts Economy It's been a year since the onset of a financial crisis that wiped out $15 trillion of wealth from the balance sheet of American households, and more than two years since serious cracks in the financial system became apparent. Yet while the system has been stabilized and the worst of the crisis has passed, little has been done to keep another meltdown from happening. Even the modest regulatory reform effort launched with much fanfare back in the spring is now bogged down by bureaucratic infighting and special interest lobbying. And back on Wall Street, the wise guys are up to their old tricks, suckering investors into a stock and commodity rally, posting huge profits on their trading desks and passing out Ferrari-sized bonuses. The Wall Street Journal reports they've even cranked up the old structured-finance machine, buying up claims to life insurance proceeds and packaging them into securities. All of which makes it particularly disappointing that so little attention was paid this week to a report by a panel convened by the Aspen Institute on the "short-termism" that has now become hard-wired into the culture of Wall Street and corporate America. This wasn't just any blue-ribbon committee. Its members include billionaire investors Lester Crown and Warren Buffett; mutual fund pioneer John Bogle; Richard Trumka, the soon-to-be new president of the AFL-CIO; present and former corporate chief executives Jim Rogers of Duke Energy, Lou Gerstner of IBM and Henry Schacht of Cummins; retired Wall Street hands John Whitehead of Goldman Sachs, Pete Peterson of the Blackstone Group and Felix Rohatyn of Lazard Freres; Marty Lipton, Ira Millstein and John Olson, the deans of the corporate bar; and respected academics such as Bill George of Harvard and Lynn Stout of UCLA. Their complaint is that the focus on short-term financial performance by investors, money managers and corporate executives has systematically robbed the economy of the patient capital it needs to produce sustained and vigorous economic growth. And while their recommendations may not be as sexy as a cap on Wall Street bonuses or a ban on high-frequency trading, they get to the root cause of the financial crisis in ways that other reform proposals have not:
Accountants Misled Us Into Crisis The accountants let us down. That is one of the clear lessons of the financial crisis that drove the world into a deep recession. We now know the major banks were hiding dubious assets off their balance sheets and stretching rules if not breaking them. We know that their capital was woefully inadequate for the risks they were taking. Efforts are now being made to improve the rules, with some success. But banks have persuaded politicians on both sides of the Atlantic that the real problem came not when their financial inadequacies were obscured by bad accounting, but when they were revealed as the losses mounted. “There were important aspects of our entire financial system that were operating like a Wild West show, huge unregulated opaque markets,” said the man whose job was to write the accounting rules, Robert H. Herz, the chairman of the Financial Accounting Standards Board. “The crisis highlighted how important better transparency around that system is,” Mr. Herz added in an interview this week. “I would hope that would be a major lesson learned or relearned.” Unfortunately, some seem to have learned exactly the opposite lesson. Accounting rule makers at FASB and its international equivalent, the International Accounting Standards Board, have been lambasted for efforts to improve transparency by forcing banks to disclose what their dodgy assets are actually worth, as opposed to what the banks think they should be worth. Both boards have tried to resist, but have been forced by political pressure to back down on some specifics.
In a Shift, Wall Street Goes to Washington Axis of financial power shifting to D.C. as As financial firms navigate a life more closely connected to government aid and oversight than ever before, they increasingly turn to Washington, closing a chasm that was previously far greater than the 228 miles separating the nation's political and financial capitals. In the year since the investment bank Lehman Brothers collapsed, paralyzing global markets and triggering one of the biggest government forays into the economy in U.S. history, Wall Street has looked south to forge new business strategies, hew to new federal policies and find new talent.. "In the old days, Washington was refereeing from the sideline," said Mohamed A. el-Erian, chief executive officer of Pimco. "In the new world we're going toward, not only is Washington refereeing from the field, but it is also in some respects a player as well. . . . And that changes the dynamics significantly." Washington has become a dominant player. The relationship "has changed in the sense that it's clear that every one of the firms, including Goldman Sachs, recognizes that they would not exist today had the government not stepped in when it did," one former senior bank executive said. Aiming to avoid a repeat of the crisis, Obama administration officials, meanwhile, remain determined to overhaul the regulation of financial firms and markets. These measures, if enacted, would affect the essence of these businesses, altering what kind of activities they could pursue, how they would be shut down if they ran into trouble, and how much capital they must maintain, which directly influences profitability and their ability to lend. "This crisis has and will fundamentally change the relationship between Wall Street and Washington for decades to come," said Richard H. Clarida, an assistant Treasury secretary under President George W. Bush who is now an economics professor at Columbia University. "It's often said that Wall Street is no longer the financial capital, that it's Washington, D.C., and that's certainly true. I don't think this is destined to change. I think this is going to be a fact of life."
Wall St. Speech, Reactions & Consequences
Obama Is `Optimistic' U.S. Financial Rules Overhaul Will Happen This Year President Barack Obama said he is “very optimistic” rules overhauling federal oversight of the financial-services industry will be adopted this year to prevent future crises and keep taxpayers from bailing out Wall Street. The banking industry won’t succeed in efforts to defeat a proposal to create a Consumer Financial Protection Agency, and Obama in a Bloomberg Television interview today rejected opposition in Congress to his plan to give the Federal Reserve new authority to monitor firms for systemic risk. “I’m very optimistic about us getting a set of rules in place that prevent the kind of crisis that we’re seeing from happening again,” Obama said. He also ruled out setting compensation limits on global banks. Obama is rallying support for his proposal to overhaul U.S. financial services regulation one year after the collapse of Lehman Brothers Holdings Inc. as action on the plan stalls in Congress. Lawmakers have held a series of hearings on aspects of the plan since it was released in June. The House in July approved a measure aimed at limiting incentives in executive pay that spur excessive risk taking. The Senate has not yet acted on that bill or advanced other legislation based on the plan. Obama defended his proposal to create an agency focused on protecting consumers when they deal with financial services companies, a plan the banking industry has been fighting. “I don’t think they’re going to succeed in killing it and I’m going to do everything I can to stop them from killing it,” Obama said. He also rejected opposition from Congress to his plan to give the Fed new powers to monitor large firms for systemic risk.“The buck has to stop with someone and I think the Fed is best equipped to do this,” Obama said. House Financial Services Committee Chairman Barney Frank, leading the effort in Congress, said today he expected the House to approve legislation in November that will include rules governing derivatives and resolution of failing non-bank firms.
REMARKS BY THE PRESIDENT ON FINANCIAL RESCUE AND REFORM While full recovery of the financial system will take a great deal more time and work, the growing stability resulting from these interventions means we're beginning to return to normalcy. But here's what I want to emphasize today: Normalcy cannot lead to complacency. Unfortunately, there are some in the financial industry who are misreading this moment. Instead of learning the lessons of Lehman and the crisis from which we're still recovering, they're choosing to ignore those lessons. I'm convinced they do so not just at their own peril, but at our nation's. So I want everybody here to hear my words: We will not go back to the days of reckless behavior and unchecked excess that was at the heart of this crisis, where too many were motivated only by the appetite for quick kills and bloated bonuses. Those on Wall Street cannot resume taking risks without regard for consequences, and expect that next time, American taxpayers will be there to break their fall. And that's why we need strong rules of the road to guard against the kind of systemic risks that we've seen. And we have a responsibility to write and enforce these rules to protect consumers of financial products, to protect taxpayers, and to protect our economy as a whole. Yes, there must -- these rules must be developed in a way that doesn't stifle innovation and enterprise. And I want to say very clearly here today, we want to work with the financial industry to achieve that end. But the old ways that led to this crisis cannot stand. And to the extent that some have so readily returned to them underscores the need for change and change now. History cannot be allowed to repeat itself. So what we're calling for is for the financial industry to join us in a constructive effort to update the rules and regulatory structure to meet the challenges of this new century. And taken together, we're proposing the most ambitious overhaul of the financial regulatory system since the Great Depression. But I want to emphasize that these reforms are rooted in a simple principle: We ought to set clear rules of the road that promote transparency and accountability. That's how we'll make certain that markets foster responsibility, not recklessness. That's how we'll make certain that markets reward those who compete honestly and vigorously within the system, instead of those who are trying to game the system.
Forget Obama's Speech, Here Are 6 Simple Ways to Reform Wall Street A year after the Lehman collapse paralyzed the financial system and the economy, will President Obama back the rhetoric with action? Furthermore, what form should Wall Street regulation take? With that in mind, Barry Ritholtz, CEO of Fusion IQ and author of Bailout Nation, has a list of reforms Wall Street needs. Not coincidentally, most would reverse legislation enacted in the years just prior to the credit crisis and subprime meltdown:
- Reinstate Glass-Steagall Separating banks from brokerage firms guarantees that "when Wall Street hits the wall… it doesn't cause the banks to do the same," says Ritholtz, who claims the Act was a major reason why the economy didn't come crashing down along with stocks in October 1987.
- Repeal the Commodity Futures Modernization Act This rule "allowed derivatives to be exempt from all the rules that affect every other traded financial instrument," and was a root cause of AIG's problems, he says.
- Overturning the so-called Bear Stearns rule allowing leverage beyond 12 to 1 The SEC's 2004 rule change, which eliminated some leverage restrictions on investment banks in favor of capital requirements by type of asset was a mistake, says Ritholtz. "Without overturning that, give us 5-10 years, we'll be right back where we started."
- Continuing to allow high-risk trades to be compensated regardless of profitability This issue is one already being addressed by the so-called Pay Czar Kenneth Feinberg.
- Regulating the non bank sub-prime lenders and mandating (and enforcing) lending standards This one is pretty self-explanatory and one few argue as a key reason for the subprime debacle. Myths of the Collapse
Bigger Picture on Reform
Frank on defeating big banks: Rep. Barney Frank, D-Mass., discusses whether Washington will be able to change Wall Street so taxpayers never have to spend their money bailing out the banks again.
As a Storm Approached, a Few Bankers Acted Wisely WHEN the financial crisis of last year swept through Wall Street, even the bosses of the nation’s biggest banks were put through the wringer. Some executives — those who planned ahead, stockpiled cash and cut risk early on — survived. But those who kept dancing just because the music still played failed. William W. George, a professor of management practice at Harvard Business School who specializes in leadership, had a front-row seat for the crisis as a director of Goldman Sachs. He believes that the devastation wrought on the financial world was a colossal failure of leadership. Professor George, whose book on leadership in crises was published last month, was asked on Tuesday about the lessons that could be drawn from the upheaval. Following are edited and condensed excerpts from the discussion: Q. You have asserted in your new book, “Seven Lessons for Leading in Crisis,” that the global financial crisis was caused by subprime leadership, not subprime securities. Why is that? A. Many of the chief executives on Wall Street were more concerned with the short term in generating fee-based income and did not properly evaluate and price risk. As a consequence, many of them have disappeared from the scene. Q. Which Wall Street chieftains, in your opinion, failed to deliver during the global financial crisis and why? A. Individuals like Richard Fuld, the former chief executive of Lehman Brothers, did not face the reality of the crisis, nor did the people at A.I.G. I can’t say that about John Thain, the former chief executive of Merrill Lynch, and Vikram Pandit, the chief executive of Citigroup, as I think they did face it and I think they understood the difficulties they were in. I think Ken Lewis, the chief executive of Bank of America, is a mixed bag. He took tremendous risks on his firm’s behalf, certainly on the Merrill Lynch deal. There was not an adequate amount of due diligence regarding that deal. Q. From your personal experience on the board of Goldman Sachs, how would you rate the board’s leadership throughout the crisis as well as that of Lloyd Blankfein, chairman and chief executive? A. I think Lloyd Blankfein deserves enormous credit for leading Goldman through this severe crisis in having the proper cash reserves, the excess liquidity, the proper risk management and proper understanding of the volatility of the situation. The board was well prepared by asking tough questions on risk and about liquidity all along. When the subprime problems became visible at the Goldman level in March of 2007, some clear decisions were made by the management and by the board to take its losses and exit that field. Q. Morgan Stanley announced last week that its chief executive, John Mack, who led the firm through the crisis, would be stepping down. How do you think he handled the crisis, and what advice do you have for his successor, James Gorman? A. Let me say John Mack inherited a very bad hand from Phil Purcell, the former chief executive of Morgan Stanley. I think he did a commendable job given what he had to work with. Mr. Gorman has the challenge of building Morgan Stanley as a bank holding company. He needs to clarify his business strategy. Q. What leadership qualities do you believe banking chiefs need to be better prepared for the financial crises of the future? A. I think a deep understanding of markets, because markets are so complex and move so fast, and a good understanding of risk.
A Modest Proposal to End Those Outlandish Bonuses Maybe bankers don’t really need big bonuses. That idea is heretical in financial circles, but it may in fact be valid. The financial system might well work better if most pay at financial institutions came in the form of fixed salary, not sharply varying bonuses. Bankers’ pay might be too high or too low — that is another question — but the mix between fixed and variable looks oddly skewed in favor of the variable. Many bankers accept that their remuneration practices — bonuses often being a big multiple of base salaries — are anomalous in modern economies. When employees of large companies get bonuses, they are typically relatively small: 10 percent to 40 percent of base pay. But bankers think their business is different, for three reasons. Actually, they are more like three myths. Myth No. 1: The lure of a big bonus — and the threat of no bonus — is an incentive to perform well. It’s hard to see why that would be truer for traders, analysts and investment bankers than for doctors, teachers or midlevel executives at a consumer goods company. Employees work well for many reasons: for pay, but also to please customers or please themselves by doing a good job. If anything, the trend in big companies has been away from sharply variable pay, even for salespeople. Myth No. 2: Variable pay is an efficient and fair way to recognize individual performance. Again, that’s old-fashioned. Individual payments determined by straight commission were big at the beginning of the Industrial Revolution. The home seamstress knew what each garment was worth. But most professions have gotten over that. Too many people are involved in a successful enterprise to calculate individual contributions with any precision. The best way to recognize distinctive individual performances is through the labor market. “You’re fired” gives a clear sign to the especially weak, and “If you want a pay rise, show me a job offer” helps the very good find the right remuneration level. Myth No. 3: The bonus-skewed system gives banks added flexibility to respond to market conditions. Paying higher base salaries, it is said, would saddle banks with high fixed costs and enrich bankers come the next crisis. But it hasn’t worked that way. In practice, structuring pay mainly as bonuses encourages banks to pay out too much of their profit when times are good and fire too many people when times are bad. Properly set, higher base salaries and lower bonuses would have the effect of lowering overall pay in good years. And that would leave banks with more profit to store up that could finance the various costs of a downturn — like absorbing loan losses and keeping skilled but underutilized people on the payroll.
Fed Considers Sweeping Rules on Bank Pay The Federal Reserve and the Treasury are preparing broad new rules that would force banks to rein in practices that made multimillionaires out of many financial executives during the housing bubble, officials said.The rules depart from the hands-off approach that dominated bank regulation for the last three decades, but are not as strict as proposals from some European leaders and suggestions from some members of Congress angered by the financial troubles of the last year. Fed officials would give banks wide leeway in how they structure their rewards. They would not prohibit million-dollar pay packages or address issues of fairness. Rather, the rules are intended to restrict pay plans that encourage reckless behavior by rewarding only short-term gains. And because the rules would be applied through the confidential bank examination process, it would be hard for consumers and investors to judge how strictly the rules were being applied. The effort is also meant to be a credible alternative to the call by some European leaders for specific limits on bonuses to financial executives, an idea opposed by the Obama administration. The draft rules, which are expected to be introduced in the next several weeks, would apply not just to the pay and bonuses of top executives but also of traders, loan officers and others. The biggest and most complex institutions, roughly 20 companies, would have to present their compensation plans to bank regulators, who could then demand changes.Fed officials do not plan to impose specific rules on how those banks structure their pay plans. Instead, they are expected to spell out ways in which banks can reduce incentives for excessive risk-taking. For example, examiners will be looking to see whether banks defer bonus compensation for several years, allowing enough time for risks and potential losses to surface. Examiners are also expected to look for banks to link the size of performance bonuses to the riskiness of particular businesses. And they will support “clawbacks” that would enable companies to reclaim money if profits turn out to have been illusory after an executive has been paid.
The Minsky Framework as Conceptual Baseline
Why capitalism fails Since the global financial system started unraveling in dramatic fashion two years ago, distinguished economists have suffered a crisis of their own. Ivy League professors who had trumpeted the dawn of a new era of stability have scrambled to explain how, exactly, the worst financial crisis since the Great Depression had ambushed their entire profession. Amid the hand-wringing and the self-flagellation, a few more cerebral commentators started to speak about the arrival of a “Minsky moment,” and a growing number of insiders began to warn of a coming “Minsky meltdown.” “Minsky” was shorthand for Hyman Minsky, a hitherto obscure macroeconomist who died over a decade ago. Many economists had never heard of him when the crisis struck, and he remains a shadowy figure in the profession. But lately he has begun emerging as perhaps the most prescient big-picture thinker about what, exactly, we are going through. A contrarian amid the conformity of postwar America, an expert in the then-unfashionable subfields of finance and crisis, Minsky was one economist who saw what was coming. He predicted, decades ago, almost exactly the kind of meltdown that recently hammered the global economy.
The Financial Instability Hypothesis Central to Minsky’s view of how financial meltdowns occur is his Financial Instability Hypothesis (FIH) -- what has come to be known as 'an investment theory of the business cycle and a financial theory of investment'. But, what is it all about? Quoting from Minsky . . ."The theoretical argument of the financial instability hypothesis starts from the characterization of the economy as a capitalist economy with expensive capital assets and a complex, sophisticated financial system... The focus is on an accumulating capitalist economy that moves through real calendar time..." "The capital development of a capitalist economy is accompanied by exchanges of present money for future money. The present money pays for resources that go into the production of investment output, whereas the future money is the "profits" which will accrue to the capital asset owning firms (as the capital assets are used in production). As a result of the process by which investment is financed, the control over items in the capital stock by producing units is financed by liabilities--these are commitments to pay money at dates specified or as conditions arise. For each economic unit, the liabilities on its balance sheet determine a time series of prior payment commitments, even as the assets generate a time series of conjectured cash receipts... A part of the financing of the economy can be structured as dated payment commitments in which banks are the central player..." "Thus, in a capitalist economy the past, the present, and the future are linked not only by capital assets and labor force characteristics but also by financial relations. The key financial relationships link the creation and the ownership of capital assets to the structure of financial relations and changes in this structure..." "Three distinct income-debt relations for economic units, which are labeled as hedge, speculative, and Ponzi finance, can be identified. Hedge financing units are those which can fulfill all of their contractual payment obligations by their cash flows. Speculative finance units are units that can meet their payment commitments on "income account" on their liabilities, even as they cannot repay the principle out of income cash flows. Such units need to "roll over" their liabilities: (e.g. issue new debt to meet commitments on maturing debt) For Ponzi units, the cash flows from operations are not sufficient to fulfill either the repayment of principle or the interest due on outstanding debts by their cash flows from operations. Such units can sell assets or borrow. Borrowing to pay interest or selling assets to pay interest (and even dividends) on common stock lowers the equity of a unit, even as it increases liabilities and the prior commitment of future incomes. A unit that Ponzi finances lowers the margin of safety that it offers the holders of its debts."
A Minsky Meltdown: Lessons for Central Bankers Regardless of one’s views on using monetary policy to reduce bubbles, it seems plain that supervisory and regulatory policies could help prevent the kinds of problems we now face. Indeed, this was one of Minsky’s major prescriptions for mitigating financial instability. I am heartened that there is now widespread agreement among policymakers and in Congress on the need to overhaul our supervisory and regulatory system, and broad agreement on the basic elements of reform. Many of the proposals under discussion are intended to strengthen micro-prudential supervision. Micro-prudential supervision aims to insure that individual financial institutions, including any firm with access to the safety net, but particularly those that are systemically important, are well managed and avoid excessive risk. The current system of supervision is characterized by uneven and fragmented supervision, and it’s riddled with gaps that enhance the opportunity for regulatory arbitrage. Such arbitrage was a central component in the excessive risk-taking that led to our current problems. It is now widely agreed that such gaps and overlaps must be eliminated, and systemically important institutions—whether banks, insurance firms, investment firms, or hedge funds—should be subject to consolidated supervision by a single agency. Systemic institutions would be defined by key characteristics, such as size, leverage, reliance on short-term funding, importance as sources of credit or liquidity, and interconnectedness in the financial system—not by the kinds of charters they have. Another critical shortcoming of the current system is that it lacks any legal process to enable supervisors of financial conglomerates and nonbanks to wind down the activities of failed firms in an orderly fashion. The need for a resolution framework that would permit such wind-downs of systemically important firms is also widely accepted. The current crisis has afforded plentiful opportunities for supervisors to reflect on the effectiveness of our current system of micro-prudential supervision. The “lessons learned” will undoubtedly enhance its conduct going forward. But, regardless of how well micro-prudential supervision is executed, on its own it will never be adequate to safeguard the economy from the destructive boom and bust cycles that Minsky considered endemic in capitalistic systems. Analogous to Keynes’ paradox of thrift, the assumption that safe institutions automatically result in a safe system reflects a fallacy of composition. Thus, macro-prudential supervision—to protect the system as a whole—is needed to mitigate financial crises. the effects of the bursting of an earlier asset price bubble—the technology stock boom—with comparatively little damage.
