Archive for the ‘Financial crisis’ Category
(UPDATE – A version of this editorial has been reprinted at Advisor Perspectives.)
I think we will look back in ten years’ time and say we should not have done this, but we did because we forgot the lessons of the past.
Senator Byron L. Dorgan on the repeal of the Glass-Steagall Act, 1999
Though the principles of the banking trade may appear somewhat abstruse, the practice is capable of being reduced to strict rules. To depart upon any occasion from those rules, in consequence of some flattering speculation of extraordinary gain, is almost always extremely dangerous and frequently fatal to the banking company which attempts it.
Adam Smith, The Wealth of Nations
Four years ago today, the financial crisis took the world’s economies to the brink of collapse. September 15, 2008, the day Lehman Brothers failed, sending global financial markets into cardiac arrest, was our wedding anniversary. My wife and I were celebrating on the Mediterranean coast of Turkey.
Although the nation survived the financial tsunami of 2008, our capital markets remain in precarious condition. Public trust, severely undermined by revelations of the reckless behavior, lax oversight, and the ensuing instability of our major financial institutions, has yet to be restored. This state of affairs is not good for investors or the nation.
The causes, both here and abroad, will remain a matter of debate, the answers often depending on one’s politics. From my perspective, there can be no doubt that major banks, insurance companies, and other financial players became shockingly over-leveraged in the years leading up to 2008. This dramatic increase in leverage (and the inevitable reduction in the systemic “safety net”) was intentionally obscured, invisible to both regulators and the public. In some cases, it was invisible even to the financial institutions themselves.
This outrageous expansion of financial sector leverage occurred on the heels of a program on Capitol Hill to weaken and dismantle regulations that had protected the industry from this precise crisis for more than 60 years. It was a bold policy experiment – to allow a critical industry, one with tentacles in every facet of our economy, to essentially regulate itself – and it failed in spectacular and costly fashion. Take away the traffic cop and some drivers will take liberties. Dismantle the entire the police force and the world quickly becomes very unsafe for the average citizen.
Practices that were once outlawed or highly supervised: i.e. excessive leverage, negligent lending standards, self-dealing, and proprietary trading (trading against one’s own customers) – became, and largely remain, the norm. If you are a taxpayer, saver, borrower, investor, a Republican or Democrat, you have every right to be appalled. While the egregious abuses that occurred are beyond remediation, we can once again take steps to insure that such excesses do not reoccur.
Yet the banking and finance industry has fought tooth-and-nail against the slightest attempt to re-regulate their broken industry. Simple regulations (and simple is the most effective) such as the Volcker Rule, proposed as a palatable alternative to a full restoration of the Glass-Steagall Act, are first obfuscated and then beaten back by the banking lobby’s pervasive influence in Washington. Glass-Steagall, recall, mandated a separation between commercial and investment banking and was part of a sweeping legislative response to the parallel excesses of the banks during the 1920s, excesses that led to the Great Depression. That prior framework successfully safeguarded the integrity of US banking and our markets until the regulations were gutted during the 1990s and 2000s.
For most of the 20th century, the US capital marketplace stood as the undisputed center of global finance. This was an envied position and one that provided exceptional benefits to our nation. Our stature was founded on a hard-earned trust, built on the qualities of transparency, fairness, and the rule of law throughout our markets – qualities now impaired by our failed experiment in financial sector deregulation. To regain that leadership, we must re-earn the public’s trust. And to accomplish that, some basic “rules of the road” need to be restored such that investors and other participants will not fear they are at a disadvantage in every transaction. “Caveat Emptor” should not have to be the inscription over the US Stock Exchange.
Get the full deck of cards here. My bet is that these will be THE Christmas present in in industry for 2012.
h/t Naked Capitalism
Gillian Tett does a takedown of UK banks, and Barclays in particular, over the LIBOR price fixing scandal in the Financial Times.
Most notably, in recent decades large investment banks in the City of London and Wall Street have increasingly wrapped their activities with an evangelical adherence to the rhetoric of free markets; whenever they have wanted to justify sky-high profits, wacky innovations or, most recently, the need to prevent a new regulatory drive, they have invariably cited the ideals of Adam Smith…
That is the title of a recent OpEd by the always astute Martin Wolf in the Financial times. Wolf argues passionately that in this time of crisis, decisive action and ample credit are both needed to forestall the rising lack of faith in the economic system that is threatening to turn the Eurozone into another 1930s type event.
Before now, I had never really understood how the 1930s could happen. Now I do. All one needs are fragile economies, a rigid monetary regime, intense debate over what must be done, widespread belief that suffering is good, myopic politicians, an inability to co-operate and failure to stay ahead of events.
Dimon repeatedly insisted that the whole operation is Volcker-compliant, and JP Morgan is describing the operation as an effort at hedging gone wrong. Nobody knows exactly what happened, but in general if you just lost $2 billion that’s a good sign that you’re not hedging. The idea of hedging is to accept a small cost in order to insure yourself against the risk of a big loss. Two billion dollars is a big loss even for JP Morgan. So why call it hedging? Presumably because the Volcker Rule allows proprietary trading for the purposes of hedging. This turns out to be a big loophole. As it happens in this case JP Morgan has a big enough capital buffer to eat the loss and they only lost $2 billion rather than $20 billion. But nothing was stopping them from screwing up even worse.
“You could safely say that Iceland holds the world record in household debt relief,” said Lars Christensen, chief emerging markets economist at Danske Bank A/S in Copenhagen. “Iceland followed the textbook example of what is required in a crisis. Any economist would agree with that.”
Note the words I bolded in the above: household debt relief, and not too-big-to-fail bank or insurance company or GSE (Fannie Mae etc) debt relief. And Iceland’s results?
The island’s steps to resurrect itself since 2008, when its banks defaulted on $85 billion, are proving effective. Iceland’s economy will this year outgrow the euro area and the developed world on average, the Organization for Economic Cooperation and Development estimates. It costs about the same to insure against an Icelandic default as it does to guard against a credit event in Belgium.
Everyone from Treasury Secretary Geithner to the IMF’s Christine Lagarde should read the Bloomberg article on the country’s success from which the passages above were excerpted.
Oh, and, Attorney General Eric Holder and the SEC’s Mary Schapiro might just want to read this paragraph:
Iceland’s special prosecutor has said it may indict as many as 90 people, while more than 200, including the former chief executives at the three biggest banks, face criminal charges.
Larus Welding, the former CEO of Glitnir Bank hf, once Iceland’s second biggest, was indicted in December for granting illegal loans and is now waiting to stand trial.
That compares with the U.S., where no top bank executives have faced criminal prosecution for their roles in the subprime mortgage meltdown.
Reuters dissects the failure of the Federal judiciary to prosecute cases against the players in the mortgage meltdown. The documented record of law-breaking that the article exposes is damning, as is the lack of effort by the US Attorney’s Office to take any significant action.
“Why there hasn’t been more robust prosecution is a mystery,” said Raymond Brescia, a visiting professor at Yale Law School
This recent film takes a dispassionate look at one fictional night in the life of one fictionalized investment bank during the heart of the 2008 financial crisis. Excellently scripted and acted, this cerebral study of money and power rings true to what the reality must have been at many a financial firm during that terrifying September. Warning, anyone expecting the typical Hollywood, or reality TV, drama will be disappointed.