The following is an excellent excerpt from the book “THE END OF WALL STREET” by Roger Lowenstein from Chapter 20 on page 290 and I quote: “The problem of executive pay did not admit to an easy fix. On Wall Street, the habit of extravagance is deeply ingrained (indeed, excessive indulgence is not even recognized as such). Well into the crisis period, when banks such as Citigroup were operating on federal investment and when Citi’s stock was in single digits, Vikram Pandit, the CEO, was observed with a lunch at Le Bernardin, the top-rated restaurant in New York. Pandit looked discerningly at the wine list, saw nothing by the glass that appealed and ordered a $350 bottle so that, as he explained, he could savor “a glass of wine worth drinking.” Pandit drank just one glass; his friend had none. The rest presumably poured down a gilded drain..
Bankers vigorously sought to defend their pay, and their perks. Setting wages is a function of labor markets; the best reform would have aimed at making the market work better. (For instance, forcing companies to seek shareholder approval of their executive pay arrangements would have restored proper control over wages and countered the executives’ sense of entitlement.) The government chose instead to supervise compensation, in various but limited ways. Congress banned cash bonuses for TARP recipients, and a “pay czar,” appointed by [Tim] Geithner, restricted executive salaries at government-controlled firms such as GM and Citi.
More intriguingly, the Federal Reserve set to proscribing bank practices that fostered too much risk, such as paying up-front bonuses for deals that could incur losses later. The government’s hope was that federal suasion would move the banks to reform themselves. To some extent, this occurred. Several banks modified their pay systems along the lines of the Fed’s scheme. Such policies, along with federal scrutiny, exerted at best a modest check on total pay.
The Obama administration proposed a sweeping legislative package to deal with other aspects of reform, including derivatives, mortgage-backed securities, and systemic risk. The complexity of these issues, as well as the eagerness of Congress to weigh in, frustrated the desire for a neat solution. In the 1930s, the New Deal cured many of the ills of Wall Street by requiring corporations to disclose their finances, and creating a new agency (the SEC) to supervise them. No single bullet presented itself this time. Banks lobbied extensively and, partly as a result, reforms in the bill were incremental, not draconian.
Obama proposed to move trading of some derivatives (not all) to an exchange where, presumably, they would be subject to more controls. However the White House measure did not set minimums on collateral, which was the root problem in 2008. Another proposal would make mortgage issuers at least modestly sensitive to loan quality by requiring that they retain a small portion of their loans. Another section, on credit agencies, left them as conflicted and as powerful as ever.
Passage was delayed by vigorous division in Congress, particularly over the question of which agency, post-crash, would head supervision of banks. The issue of “too big to fail,” which Ben Bernanke had called “a top priority” for reform, hung over Washington like a dark cloud. The crisis had bequeathed precisely the moral hazard that [Hank] Paulson had feared. Post-crash, markets presumed that the government would, if necessary, bail out important banks. This meant that big banks could borrow on favorable terms (since the government would not let them fail). Being among the circle of protected was considered such a boon that both the administration and Representative Barney Frank, who managed the bill in the House, initially proposed keeping the list of “too big to fail” institutions secret. Experts consulted by the Congress sensibly advised an opposite tack—that the government discourage banks from becoming (or being) too big by making it undesirable. They proposed that stricter capital requirements and hefty insurance premiums be imposed as a price for bigness. [Alan] Greenspan reckoned that regardless of official policy, the market would conclude that every big bank enjoyed a federal safety net. Therefore, the surest way to prevent moral hazard was to break up Big Banking a la Big Oil. But pending final passage of the legislation, Wall Street institutions emerged from the crisis more protected than ever.
Whether this was entirely to their advantage was debatable. Denial of the right to fail inexorably limits the right to succeed. Even though the legislative proposals were modest, the regulatory climate was noticeably stricter. Banks’ leeway over setting various fees was restricted. Extremely speculative mortgages of the type that flowered during the boom were proscribed. The proposed consumer financial protection agency, if it comes to pass, would be a major headache for banks.
The Fed also elevated the role of regulation. At the Greenspan Fed, only monetary policy mattered. After the crash, the agency returned to the job of assessing bank loans and balance sheets, and with a more skeptical eye toward risk models. Daniel Tarullo, the first Fed governor appointed by President Obama, tartly informed a Senate panel in October ’09, “Things [for banks] are going to change. That means business models. That means the way of assessing risk. That means how you run your institution.”
The central bank emerged from the crash sorely humbled. Bernanke admitted publicly that the crisis had caught him off guard. Going forward, the Fed has a huge stake in ensuring that it is not embarrassed by a bubble again. Presumably, after the economy does recover, the Fed in unlikely to flirt with ultralow interest rates as it did in the ’00s.
International regulators have also promised to crack down on banks’ use of capital. The G20 delegates vowed to raise capital requirements on banks when the world recession eases. If they carry through, it will put a brake on the general level of risk. Compared with the pre-crash era, leverage on Wall Street was already down sharply. Less leverage means fewer assets, fewer trades, and less profit. Indeed, in a world with tougher capital rules, the bubble of the 2000s could not have occurred. [Footnote: The effectiveness of capital requirements will partly depend on whether regulators prevent firms from dodging the intent of the rules, as they did in the past, with shadow banking conducted off the balance sheet.]
Finance was reborn when the panic subsided, but in many respects it was a changed industry—more sheltered, more regulated, more concentrated, and less competitive. The scrappier, smaller firms that previously challenged Goldman Sachs were licking their wounds or had disappeared altogether. Goldman’s only true rival was JPMorgan, now the king of Wall Street. (Goldman and Morgan were among the first to repay their TARP monies.) Commercial banking was exceptionally concentrated, with the four biggest banks claiming almost 40 percent of deposits and two-thirds of credit cards. Effectively, the Wild West model was supplanted with a more European-seeming arrangement, in which a few elite players thrived within the government’s embrace. During 2009, Secretary Geithner conferred with the head of either JPMorgan, Goldman, or Citi an average of once every two days. Goldman still took big risks, but now with the backing (if needed) of the taxpayers. The banks were like Fannie and Freddie before the crash-for-profit institutions with a presumptive lifeline to the Treasury.
In the ’90s and ’00s, Wall Street financed consumer borrowings by selling securities into a global market. Post-crash, this dynamic would be under stress. Household had heavy debts to work through, a process expected to take years. Americans relied more on income, less on Wall Street financings. For regulatory and also cultural reasons (such as high unemployment) expectations downshifted. Wall Street’s impression on American culture seemed to have eroded, its glossy optimism worn to a thrifty nub. Higher saving was itself a rejection of the Wall Street credo; it signaled Americans’ unease about the future. For almost their entire adulthood, baby boomers had assumed that even small accounts (or their homes) would build into appreciable savings and provide for retirements. Now they were mere squirrels, storing acorns for winter.
The drop in spending revised an essential puzzle, prevalent in the Depression years and also in Japan in the ’90s: how to create sufficient demand for goods and labor? As compared with Wall Street’s golden age, government seemed destined to supply more of the answer, bankers less. After all, the recovery had been purchased with massive public-sector spending and loans, and the federal pipeline showed no sign of shutting down.
Everywhere one looked—credit markets, mortgages, the auto industry—the government was playing a conspicuous role in formerly private affairs. The administration was anointing preferred industries (energy, the environment) for investment, a throwback to the fad for industrial planning of the ’70s. Unemployment was higher, the government’s role as a social guarantor larger. Obama seemed close, finally to enacting public health care, a goal pursued by liberals since the New Deal. Indeed, John Maynard Keynes, the twentieth-century British economist and statesman famous for his skepticism of the market, whose ideas had been shunned by a generation of neoconservatives, was reinstated to his previous perch in the canon. A trio of timely books argued that the way out of the recession was to heed Lord Keynes, who emphasized the uncertainty of economic life, and prescribed government fine-tuning as a permanent feature of industrial societies, necessary to balance the ups and downs of the economic cycle. The stimulus itself was pure Keynesian economics, a standard tool of American policymakers through the 1970s that had been shelved during the bubble years.”
(I IMAGINE, LIKE HIS BOOK STATES, IF THE “PROPOSED CONSUMER FINANCIAL PROTECTION AGENCY COMES TO PASS, WOULD BE A MAJOR HEADACHE FOR THE BANKS” IT WAS PASSED AS PART OF THE DODD-FRANK BILL, THANKS TO SENATOR ELIZABETH WARREN IN HER BOOK “A FIGHTING CHANCE” IN CHAPTER 4 ON PAGE 153 TITLED “WHAT $1 MILLION A DAY CAN BUY.” THE PROBLEM—IS RICHARD CORDRAY GOING TO ENFORCE THE REGULATIONS? AS FOR THE ISSUES CONCERNING THE BIG INVESTMENT BANKS AND ALL THOSE WORTHLESS, TOXIC DERIVATIVES THEY’RE TRYING TO PROMOTE, ARE DEFINITELY AFFECTING THE ECONOMY. THE SMALLER RURAL BANKS, IN AN ARTICLE IN BLOOMBERG BUSINESSWEEK FROM OCTOBER 21 – OCTOBER 27, 2013 TILED “GLOBAL ECONOMICS: RURAL BANKS KNOW SOMETHING BIG BANKS DON’T” ON PAGE 17 WRITTEN BY BRENDAN GREELEY, IT STATES THAT IN RURAL AREAS, COMMUNITY BANKS STILL HOLD 70 PERCENT OF DEPOSITS, WHICH HASN’T CHANGED IN 30 YEARS. RURAL BANKS MAKE LOANS TO FARMERS AND THEIR FARMLAND, WHICH IS A REAL ASSET THAT IS GOING UP IN VALUE. JUST THE OPPOSITE OF WHAT TOXIC DERIVATIVES ARE ACCOMPLISHING, WHICH HAVE NO TANGIBLE VALUE AND IT’S DRIVING OUR ECONOMY DEEPER IN DEBT BECAUSE DERIVATIVE AMOUNTS ARE INCREASING DRIVING OUR ECONOMY INTO BANKRUPTCY.
LaVern Isely, Overtaxed Independent Overtaxed Middle Class and Public Citizen and AARP Members