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. 

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.

The U.S. Department of Justice: Big Banks May Legitimately Be above the Law

The Financial Times reported in 2013 that lawmakers in the U.S. Congress were claiming that the Department of Justice had been “too soft on big banks and their executives by failing to bring criminal cases related to the financial crisis.”[1] In the five years following the financial crisis of 2008, no Wall Street executive was criminally charged with fraud. The U.S. Justice Department chose not to go after the bankers for their lack of due diligence regarding their purchases of sub-prime mortgages from mortgage originators. This in spite of the fact that at Citibank, for example, a manager in the bank’s due diligence department estimated that 50% to 80% of the approved mortgages did not meet the bank’s credit policy, and yet Robert Rubin, the CEO at the time, did not act on the manager’s email. This suggests that a criminal complaint could have been lodged against the bank itself, but then what would be the implications for the financial system should Citibank had gone under after being found criminally guilty? Does it even hold that a guilty verdict would mean bankruptcy? Simply stated, a company can be so large that its failure due to a guilty verdict could harm innocent third parties, including stockholders, employees, suppliers, and even the general public if the bankruptcy triggers a systemic collapse of the financial system. Such concerns are called collateral consequences. After the collapse of Lehman Brothers in September 2008, systemic risk became a particularly salient concern for criminal prosecutors at the U.S. Department of Justice. Swayed by a desire to minimize the potential disproportionate harm to innocent parties from a verdict-triggered major bankruptcy, the prosecutors believed they were obligated to consider collateral consequences even if that meant that the really big banks would be immune from criminal prosecution. To such banks, this could be used as a competitive advantage because keeping within the constraints of law in making money would not apply. I contend, therefore, that the U.S. Government should not have taken collateral consequences into consideration. 

The full essay is "Big Banks above the Law."

 Mythili Raman testifying before Congress. mainjustice.com

1. Shahien Nasiripour and Kara Schannell, “Holder Says Some Banks Are ‘Too Large’,” The Financial Times, March 7, 2013.

Too Big To Fail: The U.S. Is Still at Risk

On March 20, 2013, more than two years after the Dodd-Frank financial reform legislation had become law, Federal Reserve chairman Ben Bernanke made it clear that the problem of too-big-to-fail banks had not been solved. “Too Big To Fail is not solved and gone,” he said in a press conference. “It’s still here.”[1] That is, providing an orderly liquidation process for bankrupt banks would be insufficient in keeping the U.S. economy free of vulnerability from even one of the biggest banks taking down the financial sector merely by going bankrupt. Congress should not have missed or minimized this point while working on the Dodd-Frank Act. The self-interested power of Wall Street in Washington and the need of campaign funds in Congress coalesced to dilute the law in spite of the detriment to the public good.

The full essay is at "Too Big to Fail."

1. Mark Gongloff, “Ben Bernanke: ‘I Agree With ElizabethWarren100 Percent’ On Too Big To Fail,” The Huffington Post, March 20, 2013.

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. 

Undermining the Dodd-Frank Act: An Incessant Desire for Profit

In the Dodd-Frank financial reform Act of 2010, financial firms in the U.S. are required to set aside higher reserves to cover losses on trades of securities, including those that “swap” the risk of default of a given security, such as bonds based on subprime mortgages. Almost immediately, the Wall Street bankers set about minimizing the new hindrance.  

The full essay is at "Undermining the Dodd-Frank Act."

Jack Lew at his confirmation hearing for U.S. Treasury Secretary. Lew had been the chief operating officer at units at Citibank.     NPR

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."

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."

The Market Mechanism: Complicit in E.U. Debt Crisis

According to The New York Times in late 2011, “How European sovereign debt became the new subprime is a story with many culprits, including governments that borrowed beyond their means, regulators who permitted banks to treat the bonds as risk-free and investors who for too long did not make much of a distinction between the bonds of troubled economies like Greece and Italy and those issued by the rock-solid Germany.” In going through these culprits and how they interrelated, it should not be lost that the market mechanism itself can be held as suspect, for at the very least it enabled the furtive games to be played for far too long. Indeed, the market itself did not do a good job for years in providing accurate risk-return relationships.

The full essay is in, "Essays on the E.U. Political Economy," available at Amazon. 

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.

Bank of America Exploited State Tax-Rate Differentials in the E.U.: Systemic Risk and Federalism Blindsided

In 2012, the corporate income tax rate was reduced from 26% to 24 percent. With the comparable rate in Germany at 29% and France at 33 percent, Britain stood to reap the revenue-benefits of a significantly lower tax rate within the European Union. That the 24% rate would be pared down to 21% in 2014 suggests that everything else equal, the state of Britain was set to reap a sustainable competitive advantage over other E.U. states with respect to attracting business, and thus jobs. The move was not without risks, however, which included those that were (and are) less than obvious, such as systemic risk and that to the E.U.'s federal system. 

The full essay is at "Bank of America in the E.U."

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?"

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."

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?"

The Financial Crisis of 2008: On the Role of Negligence Breaching Fiduciary Obligation

Roger Lowenstein laments that “New York Times columnist Joe Nocera lamented that ‘Wall Street bigwigs whose firms took unconscionable risks … aren't even on Justice's radar screen.’ A news story in the Times about a mortgage executive who was convicted of criminal fraud observed, ‘The Justice Dept. has yet to bring charges against an executive who ran a major Wall Street firm leading up to the disaster.’ In the same dispassionate tone, National Public Radio's All Things Considered chimed in, ‘Some of the most publicly reviled figures in the mortgage mess won't face any public accounting.’ New York magazine saw fit to print the estimable opinion of Bernie Madoff, who observed that the dearth of criminal convictions is ‘unbelievable.’ Rolling Stone, which has been beating this drum the longest and with the heaviest hand, reductively asked, ‘Why isn't Wall Street in jail?’”

Lowenstein interprets these sentiments as implying “that the financial crisis was caused by fraud; that people who take big risks should be subject to a criminal investigation; that executives of large financial firms should be criminal suspects after a crash; that public revulsion indicates likely culpability; that it is inconceivable (to Madoff, anyway) that people could lose so much money absent a conspiracy; and that Wall Street bears collective guilt for which a large part of it should be incarcerated.”

Lowenstein argues that “(t)hese assumptions do violence to our system of justice and hinder our understanding of the crisis. The claim that it was ‘caused by financial fraud’ is debatable, but the weight of the evidence is strongly against it. The financial crisis was accompanied by fraud, on the part of mortgage applicants as well as banks. It was caused, more nearly, by a speculative bubble in mortgages, in which bankers, applicants, investors, and regulators were all blind to risk. More broadly, the crash was the result of a tendency in our financial culture, especially after a period of buoyancy, to push leverage and risk-taking to the extreme.”

Lowenstein also ticks off a loose monetary policy (i.e., extremely low interest rates), unaccountability at Fannie Mae and Freddie Mac, weak financial regulation, and an overconfidence in “risk management” methods in arguing that we should not be reductionist in ascribing the crisis to fraud alone or even primarily.  

Analysis at "Negligence in the Financial Crisis of 2008."

Obama's Meeting with Culpable Top Bankers

When he was running for US President, Barak Obama said that the financial crisis provided an opportunity for financial system reform beyond that which is in the interest of the big banks because the power of the latter is temporarily eclipsed and the US Government can take advantage of that.  His assumption is that during normal times, the banking industry essentially owns the Congress (Sen Dick Durbin’s statement just after the banking lobby defeated a foreclosure bill in the US Senate in 2009).  Sadly, the government did not use the eclipse; rather, it has been using the appearance of power and direction in the relumed post-crisis period to engage in window-dressing to assuage populist anger at the banks.

The full essay is at "Obama under Culpable Bankers."

The Federal Reserve Expanded Its Turf in Spite of Having Come Up Short

Testifying before the US Senate Finance Committee on his re-appointment, Ben Bernanke volunteered that the Fed had been “slow” in protecting consumers from high-risk mortgages during the housing bubble and that it should have forced banks to hold more capital for all the risks they were taking on.  “In the area where we had responsibility, the bank holding companies, we should have done more.” he told lawmakers.  The hearing provided new evidence of doubt among lawmakers about the Federal Reserve’s  role as the nation’s guardian of the financial system. “In the face of rising home prices and risky mortgage underwriting, the Fed failed to act,” said Senator Richard Shelby of Alabama, the senior Republican on the banking committee. “Many of the Fed’s responses, in my view, greatly amplified the problem of moral hazard stemming from ‘too big to fail’ treatment of large financial institutions and activities.”  Accordingly, Senator Dodd proposed that the Fed’s powers as a bank regulator ought to be transferred to a new consolidated agency. Even though Bernanke admitted that the Fed made mistakes as a regulator of the bank holding companies, he and other top Fed officials adamantly opposed Dodd's proposal, arguing that the Fed has unique expertise nonetheless and that the Fed's ability to preserve financial stability depends on having the detailed information that only a regulator has about the inner workings of major institutions.

The full essay is at "The Federal Reserve Bank."