Bank One: Adding to Systemic Risk after the Financial Crisis of 2008

The financial crisis in September 2008 was indeed a crisis, and yet it is stunning how soon the American financial sector sought to undermine governmental efforts to guard against another such crisis. Exactly three years after the crisis, Republicans in Congress  repeatedly invoked the Dodd-Frank Act’s 848-page length and rules on trading derivatives and swaps as examples of government overreach at the expense of much-needed jobs. “Dodd-Frank is adding safety margins to the banking system,” according to Douglas Elliott at the Brookings Institution. “That may mean somewhat fewer jobs in normal years, in exchange for the benefit of avoiding something like what we just went through in the financial crisis, which was an immense job killer.”[1] To scrap the new law in order to save few jobs would thus be short-sighted even with regard to jobs. Wall Street's concern, however, was not jobs, but, rather, the loss of profit off high-risk trading. 

The full essay is at "Bank One and Systemic Risk."

1. Edward Wyatt, “Dodd-Frank Act a Favorite Target for Republicans Laying Blame,” New York Times, September 21, 2011. 

Bank Bonuses and Dividends After the Financial Crisis: On the Power of Banks in European and American Government and Society

Dividends are typically based on how much a bank (or company, moreover) has profited, less whatever capital is needed from the profit. Similarly, bonuses are based, at least theoretically, on how the managers and the nonsupervisory employees alike perform as well as how the bank performs. In their respective ways of shoring up banks amid the financial crisis of 2008, the E.U. and U.S. differed on how easy it would be for banks to pay dividends and bonuses, as well as to have access to governmental funding. These differences reflect both the relative power of the financial sector in the governmental sector and the cultural attitudes toward business.

The full essay is at "Bank Bonuses and Dividends After the Financial Crisis." 

Is the U.S. Congress Too Beholden to the Financial Industry?

That financial deregulation had any traction at all following the financial crisis of 2008 in the U.S. is stunning, for the implication is that Wall Street money has tremendous influence in the U.S. Governent even after Wall Street banks have screwed up (even in triggering a financial crisis!). 

CFTC Chairman Gary Gensler staring down the big banks  

The full essay is at "Is Congress Owned by the Banks?"

President Obama Took Care of Wall Street below a Public Persona of Reform

In April, 2010, President Obama gave a speech in New York City to counter what he called “the furious efforts of industry lobbyists” geared to weakening or stopping the new financial regulations that Obama claimed would be needed to stave off a second Great Depression.[1]  It is telling that the banks that had contributed to the financial crisis of 2008 were trying to diminish or block any new regulation. The very legitimacy of industry calls for deregulation in the wake of a market failure caused in part by the industry flies in the face of the rationale for regulation. In short, the rationale for government regulation has to do with market failures, which includes fraud and over-zealous profit-taking at the expense of the public good. The root of the rationale is the difference between the interests of an organization and society (i.e., the public good). 

The full essay is at "Obama Took Care of Wall Street."

1. Peter Baker, "Obama Issues Sharp Call for Reforms on Wall Street," The New York Times, April 22, 2010.

Regulating Wall Street after a Financial Crisis

On Columbus Day 2011, The New York Times observed that the regulations known as the Volcker rule, “intended to limit trading when the bank's money is at risk, a sweet spot for banks, is seen as a centerpiece of the sprawling financial overhaul of the Dodd-Frank Act of 2010. In anticipation, the nation's biggest banks, like Goldman Sachs and Bank of America, have already shut down their stand-alone proprietary trading desks.”[1] Even so, the long and tortuous route by which any regulation is written was leaving its own mark in the sense that promising loopholes were finding their way into the rule. In other words, the regulated would have a disproportionate influence on the writing of the regulations. This conflict of interest is dangerous from the standpoint of not being vulnerable to another financial crisis in which the greed on Wall Street knows no bounds. 

The full essay is at "Regulating Wall Street after a Financial Crisis."

Morgan Stanley: Systemic Mistrust or Bad Financials after the Financial Crisis?

"Morgan Stanley by any measure is a safe and solid investment bank. Except for one: The amount of trust people have in the whole financial and political system. It's just about zero,” according to Jesse Eisinger of The New York Times in October 2011.[1] Even as there is undoubtedly an element of hyperbole in his conclusion—for zero trust in the financial system and governments would occasion far greater problems than the world faced at the time of Eisinger’s report—his broader point that bankers would be held accountable one way or the other for not having learned their lesson on derivatives (and risk more generally) is valid. The subtext is that even though banks like Morgan Stanley were in actuality in solid financial shape, they deserved the negative repercussions from the systemic skepticism that the banks themselves brought about by virtually ignoring risk analysis in preference to a run of profits and (not coincidentally) bonuses.

The full essay is at "Morgan Stanley after the Financial Crisis."

1. Jesse Eisinger, “Between the Lines, Wall St. Banks Face a Deficit of Trust,” The New York Times, October 12, 2011. 

On the Various Causes of the Financial Crisis of 2008: Have We Learned Anything?

In January, 2011, the Financial Crisis Commission announced its findings. The usual suspects were not much of a surprise; what is particularly notable is how little had changed on Wall Street since the crisis in September of 2008. According to The New York Times, "The report examined the risky mortgage loans that helped build the housing bubble; the packaging of those loans into exotic securities that were sold to investors; and the heedless placement of giant bets on those investments." In spite of the Dodd-Frank Financial Reform Act of 2010 and the panel's report, The New York Times reported that "little on Wall Street has changed." One commissioner, Byron S. Georgiou, a Nevada lawyer, said the financial system was “not really very different” in 2010 from before the crisis. “In fact," he went on, "the concentration of financial assets in the largest commercial and investment banks is really significantly higher today than it was in the run-up to the crisis, as a result of the evisceration of some of the institutions, and the consolidation and merger of others into larger institutions.” Richard Baker, the president of the Managed Funds Association, told The Financial Times, "The most recent financial crisis was caused by institutions that didn't know how to adequately manage risk and were over-leveraged. And I worry that if there is another crisis, it will be because the same institutions have failed to learn from the mistakes of the past." From the testimonies of managers of some of those institutions, one might surmise that the lack of learning in the two years after the crisis was due to a refusal to admit to even a partial role in crisis.  In other words, there appears to have been a crisis of mentality, which, as it contains intractable assumptions and ideological beliefs, as well as stubborn defensiveness, is not easy to dislodge such that legislation past Dodd-Frank could ever be passed.

Lehman was a particularly inept player leading up to the crisis.     Zambio

The full essay is at "Causes of the Financial Crisis."

Decreasing Bank Size by Increasing Capital-Reserve Requirements: Plutocracy in Action?

Although the Dodd-Frank Financial Reform Act was passed in 2010 with some reforms, such as liquidity standards, stress tests, a consumer-protection bureau, and resolution plans, the emphasis on additional capital requirements (i.e., the SIFI surcharges) could be considered as weak because they may not be sufficient should another financial crisis trigger a shutdown in the commercial paperr market (i.e., banks lending to each other). A study by the Federal Reserve Bank of Boston found that even the additional capital requirements in Dodd-Frank would not have been enough for eight of the 26 banks with the largest capital loss during the financial crisis of 2008. As overvalued assets, such as subprime mortgage-backed derivatives, plummet in value, banks can burn through their capital reserves very quickly. A frenzy of short-sellers can quicken the downward cycle even more. This raises the question of whether additional capital resources would quickly be "burnt through" rather than being able to stand for long as a bulwark. The financial crisis showed the cascading effect that can quickly run through a banking sector as fear even between banks widens as one damaged bank impacts another, and another. 

The full essay is at "Manipulating Bank Size by Reserves."

Corporate Appointees in the West Wing: A Counter-Productive Way of Holding Business Accountable

Presidents in governments are called to be leaders, which means advocating a vision of change from the status quo. Otherwise, they are merely administrators. So it would be counter-productive for a U.S. president to fill his administration with people financially invested in the status quo. Yet President Obama did just that, in spite of the fact that his rhetoric envisioned radical change in health insurance and still regulations on Wall Street to prevent another financial crisis. In short, he not only let the regulatees in the room, but also gave them important roles with power that would affect their respective industries.


The full essay is at "Corporate Appointees in the West Wing: A Counter-Productive Way of Holding Business Accountable."

Faster, Higher, Bigger: A Rationale for Regulation

The death of a Georgian luge athlete on the opening day of the 2010 Winter Olympics occurred amid concerns about the speed of the record-setting track at the Whistler Sliding Center. “There were some questions asked by other athletes even before this tragic accident,” said Nikolas Rurua, Georgia’s deputy minister for culture and sports. He added that there had been several crashes in the same area of the track. This is like looking back in a financial crisis to point out that several had preceded that one. It does seem like financial crises may be part of a larger pattern that is based in human nature. I contend that just such an innate propensity to recklessness at the expense of the public good (and one's own!) serves as a rationale for regulation in any country.

Airlander 10, the largest aircraft in the world, crashed on its second test-flight on August 24, 2016.

The full essay is at "Faster, Higher, Bigger!" 

Addressing Systemic Risk: Beyond the Dodd-Frank Act of 2010

After the financial crisis in September 2008 in the U.S., the former chairman of the Federal Reserve, Alan Greenspan, admitted to a Congressional committee that his free-market notion that a market will automatically self-correct itself had a major flaw. He had come to this realization because the financial market for mortgage-backed bonds had failed to correct in terms of price for the dramatic increase in risk. Instead, that market, and that of overnight commercial paper, had seized up rather than simply adjust price to the decreased demand. Fear had paralyzed what had hitherto been thought to be a self-correcting market. The failures of Bear Stearns and Lehman Brothers introduced us to the concept of systemic risk, wherein the failure of a bank (or company) causes a market to collapse. Such a bank is thus too big to fail. If actualized, such risk interferes with even the basic operation of a market, not to mention its self-correcting feature. One question is whether banks that are too big to fail should merely be more adequately regulated or broken up, as the U.S. Supreme Court broke up Standard Oil in 1911.

Alan Greenspan, former chairman of the U.S. Federal Reserve Bank

   The full essay is at "Addressing Systemic Risk: Alan Greenspan."

An Institutional Conflict of Interest at the New York Federal Reserve

According to The New York Times, even after taxpayers rescued Citigroup, regulators at the New York Federal Reserve failed to monitor the company adequately. The regulators, although adequately staffed and proficient in training, failed to move swiftly as the bank’s financial condition deteriorated from as early as 2005, and were overly optimistic about the bank’s prospects as late as December, 2009. From 2006 to 2007, decisions on poorly underwritten loans were changed from “turned down” to “approved.” As many as 80 percent of the loans that Citigroup sold to Fannie Mae, Ginnie Mae and other investors were defective. “Although the dedicated supervisory team is well-qualified and generally has sound knowledge of the organization, there have been significant weaknesses in the execution of the supervisory program,” according to one excerpt of the 2009 review. Tim Geithner, who as president of the New York Fed from 2003 to 2008 was in charge of overseeing Citigroup, went on to become the US Secretary of the Treasury.

The full essay is at Institutional Conflicts of Interest, available at Amazon.

Alan Greenspan on the Self-Regulatory Market

Two days after the LTCM bailout was agreed to in 1998, a worried Alan Greenspan, leaning toward raising rates at the time, cut the federal funds rate. It was not enough to calm the markets, and he cut it again three weeks later. . . . It was not the self-correcting powers of the markets but aggressive central bank intervention plus a new round of irrational speculation that provided a floor under the downward financial prices and the calamitous consequences of bad Wall Street decisions. It was not even the LTCM rescue alone by private banks that saved Wall Street” Madrick, p. 281). “Alan Greenspan learned no lessons from these events about the inherent instability of a completely free market in finance. He still insisted markets regulate themselves” (Madrick, p. 282).

For analysis, see the full essay at "The Self-Regulatory Market."

Source:

Jeff Madrick, Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present (New York: Alfred A. Knoff, 2011).

See also Skip Worden, Essays on the Financial Crisis, available at Amazon.

The Banks’ Consultants: Guarding the Hen House

Leaving it to consultants hired by mortgage servicers to right the wrongs that the services inflicted on foreclosed homeowners was the unhappy consequence of bank regulators giving ambiguous guidance and failing to install viable oversight mechanisms. According to the Government Accounting Office, “regulators risked not achieving the intended goals of identifying as many harmed borrowers as possible.” Even if the reviews had been completed, there was on guarantee that wronged mortgage borrowers would have received any compensation. On the other side of the ledger, the banks had received billions from the U.S. Treasury with no strings attached. Whether intentional or not, the banking regulators put too much stock in the consultants, who, after all, had been hired by the mortgage servicers."

The full essay is at "The Banks' Consultants: A Conflict of Interest." For other cases, see my book, Institutional Conflicts of Interest: Business & Public Policy, available at Amazon.

Sources:

Ben Hallman and Eleazar Melendez, “GAO Foreclosure Report Finds Bank Regulators Failed to Provide ‘Key Oversight’,” The Huffington Post, April 3, 2013.

Dan Fitzpatrick, "'A Dose of Healthy Competition' For Banking Regulators," The Wall Street Journal, April 18, 2013.

Unnecessary Systemic Risk: Banks' Price-Fixing and Racketeering in Side Businesses

A lawsuit filed in a Florida district-court in 2013 alleged that JPMorgan, Goldman Sachs, and the London Metal Exchange (LME) artificially inflated aluminum prices.  The plaintiffs accused the companies of anti-trust practices and racketeering, including the “manipulation of the aluminum market through supply price fixing.”[1] This sounds like what had led to the forced break-up of Rockefeller’s Standard Oil Company, though in that case exactly a century before, the restraint of trade had to do with the company’s main line of business (i.e., oil). In the case of the banks, however, owning commodity assets such as storage facilities and trading in raw materials do not constitute banking. This point triggers a larger question involving the repeal of the Glass-Steagal Act.

Should we allow banks to expand even beyond these functions to owning commodities and related real-estate? What does this do to the banks' systemic risk?    Image Source: salisburyareafoundation.org. 

The full essay is at "Unnecessary Systemic Risk in Banking."

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[1] Melanie Burton, “Glencore, JPMorgan Sued Over Warehouse Aluminium Prices,” Reuters, August 7, 2013.

Can the Federal Reserve Handle Banks Too Big To Fail?

The biggest banks operating in the U.S. reaped an estimated $13 billion of income by taking advantage of the Federal Reserve’s below-market rate of .001% on $7.7 trillion in emergency loans in the wake of the credit freeze in September 2008. Rather than using the additional funds to increase lending, the banks fortified reserves and paid bonuses out to executives. Had member of Congress had been able to anticipate all this, it is possible that they would have prescribed stronger medicine, perhaps even including breaking up the banks with over $1 trillion in assets.

The full essay is at "Can the Fed Handle Banks Too Big to Fail?"

The ECB as the E.U.'s Bank Supervisor: States in the Driver's Seat

Although the establishment of a federal regulator of major banks in the E.U. was as yet not approved by the European Parliament or ratified by the governments of states using the euro as well as any other states opting in, the European Council of Ministers signed off in December 2012 on an amendment that would give the European Central Bank authority over banks that have at least €30 billion in assets, make up more than 20% of their state’s economic output, or operate in at least two states (i.e., interstate banking). At the very least, three banks per state would come under the central bank’s oversight. Other banks would remain the responsibility of state regulators. This is an interesting “working out” of federalism, distinctively European-style.

German Finance Minister Wolfgang Schäuble at the E.U. Council of Ministers discussing the bank supervisor amendment.     WSJ

The full essay is at "The European Central Bank."

Paul Volcker on the Market and Regulation

Paul Volcker, former Chairman of the Federal Reserve, may strike the conventional "wisdom" as an oxymoron regarding the market mechanism and government regulation. I contend that he could have taught that "wisdom" a lesson or two.

The full essay is at "Paul Volcker on the Market and Regulation."

Is Modern Banking Fundamentally Flawed?

Jamie Dimon, CEO of JP Morgan Chase and board member of the New York Federal Reserve (a banking regulatory body), advocates not only that financial regulation reform is not necessary, but also that deregulation is the best course for the American financial sector. Meanwhile, JP Morgan lost $2 billion in an effort to reduce risk. President Obama quickly pointed out that if one of the smartest bankers in the room can preside over such a massive loss, then a deregulated financial sector would likely present us with an unacceptably high level of risk to the entire financial system (and economy). Elizabeth Warren suggested that relying on bankers to regulate themselves would not reduce the systemic risk. The alternative would seem to be strengthening financial regulation, even though—according to Sen. Dick Durbin—“the banks own Congress.”

The full essay is at " Banking as Flawed."

Market or Government: Which Should Reduce Systemic Risk in the Banking Industry?

If the five largest banks—JP Morgan, Bank of America, Citigroup, Goldman Sachs, and Morgan Stanley—are too big to fail and yet substandard operationally on account of their respective complexities (e.g., investment banking added to commercial banking), might it be that the market-based decisions of investors will relegate the giants, which by the way had price-to-book value ratios of between .37 to .77 in May 2012, thereby solving the problem of systemic risk?

The full essay is at "Reducing Systemic Risk: The Market or Government?"