A Year After Lehman
A year ago, Lehman Brothers collapsed, sparking a financial meltdown that nearly took the global economy with it. The problem, as many saw it, concerned giant banks taking huge risks and putting greed ahead of responsibility. The solution, one year out, has been to stuff those giant banks with money to prop them up, while making them bigger and allowing them to take exactly the same risks.
One year after the collapse of Lehman Brothers, the surprise is not how much has changed in the financial industry, but how little.
Backstopped by huge federal guarantees, the biggest banks have restructured only around the edges. Employment in the industry has fallen just 8 percent since last September. Only a handful of big hedge funds have closed. Pay is already returning to precrash levels, topped by the 30,000 employees of Goldman Sachs, who are on track to earn an average of $700,000 this year. Nor are major pay cuts likely, according to a report last week from J.P. Morgan Securities. Executives at most big banks have kept their jobs. Financial stocks have soared since their winter lows.
The Obama administration has proposed regulatory changes, but even their backers say they face a difficult road in Congress. For now, banks still sell and trade unregulated derivatives, despite their role in last fall’s chaos. Radical changes like pay caps or restrictions on bank size face overwhelming resistance. Even minor changes, like requiring banks to disclose more about the derivatives they own, are far from certain.
Coming on the same weekend as the 11th-hour bailout of the giant insurer American International Group, and the sale of Merrill Lynch, Lehman’s failure was the climax of a cataclysmic weekend in the financial industry. In the days that followed, nearly everyone seemed to agree that Wall Street was due for fundamental change. Its “heads I win, tails I’m bailed out” model could not continue. Its eight-figure paydays would end.
In fact, though, regulators and lawmakers have spent most of the last year trying to save the financial industry, rather than transform it. In the short run, their efforts have succeeded. Citigroup and other wounded banks have avoided bankruptcy, and the economy has sidestepped a depression. But the same investors and economists who predicted, and in some cases profited from, the collapse last fall say the rescue has come at an extraordinary cost. They warn that if the industry’s systemic risks are not addressed, they could cause an even bigger crisis — in years, not decades. Next time, they say, the credit of the United States government may be at risk.
First Alan Greenspan, and then Ben Bernanke, have offered the biggest forces in the financial industry a "put" - a price at which they will bail out investors for any risky asset they manage to buy. Asset prices have been artificially inflated by the threat of collapse and the overriding principle of "too big to fail". In fact, Lehman is seen by many in the halls of power as an EXAMPLE of too big to fail - as their collapse triggered a crisis, the decree was made that such a collapse can never happen again.
And so we have the big firms growing even bigger. And the level of risk they take on basically the same, although leverage is a little bit reduced (maybe 15:1 instead of 25:1). And the regulatory structure is largely unchanged. The same regulators are accumulating even more power despite having missed all the signs of collapse a year ago.
Here’s a novel thought. Instead of creating more regulations to try to prevent this kind of mess from recurring, why not figure out how to hold regulators accountable when they perform as poorly as they did in recent years?
Edward J. Kane, a professor of finance at Boston College and an authority on the ethical and operational aspects of regulatory failure, has some ideas about how to do this and right our damaged system in the process. He outlined them in a recent paper titled “Unmet Duties in Managing Financial Safety Nets.”
This ugly financial episode we’ve all had to live through makes clear, Mr. Kane says, that taxpayers must protect themselves against two things: the corrupting influence of bureaucratic self-interest among regulators and the political clout wielded by the large institutions they are supposed to police. Finally, he argues, taxpayers must demand that the government publicize the costs of efforts taken to save the financial system from itself.
What we have now is the same self-interested power brokers holding control over the financial industry, and a federal government which has plugged its fingers in the dike, from which they are reluctant to let go lest disaster strike again. The industry has been weaned on these tremendous public investments and become used to them. The exit could be painful and I'm not convinced that the overall industry even welcomes it. They've got a pretty good thing going - the profits get privatized, the risk gets socialized.
To the extent there is a recovery, the President deserves a little credit. Yet he is rapidly squandering the opportunity to truly recast the financial industry into their traditional role, as facilitators of the flow of capital but not hoarders of it. The crisis point was a natural time to make the necessary changes to the system, not after that feeling of crisis has lifted and the Masters of The Universe are playing with house money again. Politically, it gives the sense that the bailouts were simply a handout to industry instead of an exchange of help in the near term for wide-ranging fixes in the long term. The President took to Wall Street today to argue for financial regulatory reform, but it's going to be difficult to get this through while the banks have all the leverage. He's going to say that normalcy cannot lead to complacency. He's going to say that the rules must be tightened to ensure that we never again subsidize the casino that has become Wall Street. That includes a Consumer Financial Protection Agency to protect those who buy mortgages and take out credit cards. It includes reining in derivatives and leverage. It includes accountability for the credit ratings agencies who got their job completely wrong because their incentives were allied with the same interests who sold the crap. It includes the ability to wind down banks that are too big to fail, making them too big to exist.
I'm pessimistic that all of this will actually happen, though. A year after Lehman, it feels like the time for reform has passed. And that's extremely dangerous for the nation.