Washington / New York: Less than 24 hours after his swearing-in ceremony, US treasury secretary Timothy F. Geithner surprised Camden R. Fine with an invitation to a one-on-one meeting about the financial crisis.
System failure: A 15 September 2008 photo of a Lehman Brothers employee in London. Lehman was done in by too much borrowing and too many real estate investments that couldn’t be sold easily. Ben Stallsall / AFP
“I about fell out of my chair,” said Fine, president of the Independent Community Bankers of America, a Washington-based trade group with about 5,000 members. He was at the treasury department the next morning, telling Geithner that behemoths such as Citigroup Inc. and Bank of America Corp. were a menace, he said.
“They should be broken up and sold off,” Fine, 58, said he declared, as Geithner scribbled notes. The treasury secretary didn’t follow through on Fine’s suggestion, just as he didn’t act on the advice of former Federal Reserve (Fed) chairman Paul A. Volcker, or Federal Deposit Insurance Corp. head Sheila C. Bair, or the dozens of economists and politicians who pressed the White House for measures that would limit the size or activities of US banks.
One year after the demise of Lehman Brothers Holdings Inc. paralysed the financial system, “mega-banks”, as Fine’s group calls them, are as inscrutable as ever. The Obama administration’s plan for a regulatory overhaul wouldn’t force them to shrink or simplify their structure.
“We could have another Lehman Monday,” Niall Ferguson, author of The Ascent of Money and a professor of history at Harvard University in Cambridge, Massachusetts, said in an interview. “The system is essentially unchanged, except that post-Lehman, the survivors have ‘too big to fail’ tattooed on their chests.”
After the deepest recession since the 1930s, which has seen the world’s largest economy shrink 3.9% since the second quarter of last year, and at least $1.6 trillion (Rs78 trillion) in worldwide losses and writedowns by banks and insurers, US President Barack Obama decided on a policy of containment rather than a structural transformation.
His proposal for revamping the way the US monitors and controls banks doesn’t include taking apart institutions, supported by taxpayer loans, that have grown in scope and size since Lehman imploded. The biggest, Bank of America, had $2.25 trillion in assets as of June, 31% more than a year earlier, and about 12% of all US deposits.
Instead, the Obama plan would label Bank of America, Citigroup and others as “systemically important”. It would subject them to capital and liquidity requirements and stricter oversight, relying on the same regulators who didn’t understand the consequences of a Lehman failure. While companies could be dismantled if they got into trouble, they, their creditors and shareholders could also be bailed out with taxpayer money, according to the plan.
The chief architects, Geithner, 48, and National Economic Council director Lawrence H. Summers, 54, don’t think it would be practical to outlaw banks of a certain size or limit trading activities by deposit-taking banks, say people familiar with their thinking.
They said the two men, who declined to be interviewed, and others on Obama’s team believe the lines are too fuzzy between banking and investing products and that forcing the divestiture of units and assets would create bedlam.
“It’s a very difficult thing to say as a national policy goal that we’re going to limit the success of an American firm,” said Tony Fratto, 43, a spokesman for former US president George W. Bush and former treasury secretary Henry M. Paulson, who now heads a Washington consulting firm.
The lesson of 15 September 2008, is that limits may be necessary, according to Fine and other critics of the government’s regulatory proposals. Lehman was done in by too much borrowing and too many real estate investments that couldn’t be sold easily. When the property market turned sour—home prices fell by 20% in the two years preceding the bankruptcy, according to the S&P/Case-Schiller home-price index of 20 US cities—and creditors wanted more collateral for loans or their money back, the investment bank had to fold.
“This was a failure of the entire system,” Obama said on 17 June when he introduced his blueprint. “A regulatory regime basically crafted in the wake of a 20th century economic crisis—the Great Depression—was overwhelmed by the speed, scope, and sophistication of a 21st century global economy.”
The President’s fix is to empower the Fed to put the brakes on banks, hedge funds, insurers or other financial firms whose crash could have a crippling domino effect. About 25 companies may qualify based on their assets and on factors such as funding relationships, Fed chairman Ben Bernanke told the House Financial Services Committee on 24 July.
“Most reform proposals acknowledge, perhaps with some consternation, that systemically important institutions are likely to be with us into the indefinite future,” said Daniel K. Tarullo, a member of the Fed’s board of governors, in an interview. “The proposed reforms are oriented toward forcing those institutions to internalize more of the risks they create and thus making it less likely they will create problems for the system as a whole.”
The treasury would be able to take over and wind down financial institutions with an authority modelled on powers held by FDIC, which guarantees deposits and can close and sell failing banks under its jurisdiction. A Consumer Financial Protection Agency could restrict what it viewed as unsuitable products.
The existence of such a regulatory framework might have averted Lehman’s chaotic end because cheap money wouldn’t have been allowed to inflate a real estate bubble with questionable mortgages and mortgage derivatives, according to Austan Goolsbee, a member of the President’s council of economic advisers.
If a consumer agency had existed, lenders wouldn’t have been able to sell so many complex and costly mortgages, said Ralph L. Schlosstein, chief executive of investment bank Evercore Partners Inc. and a supporter of Obama’s.
“There has never been decent regulation of the appropriateness of lending products as opposed to investment products, and the fact that that didn’t exist really allowed trillions of dollars of crap loans that were neither affordable nor understood to be made,” said Schlosstein.
As much as it might mitigate some risks, the Obama strategy is fatally flawed because it fails to force the largest banks to change their behaviour, said Johnson, the former IMF economist who is now a professor of finance at the Massachusetts Institute of Technology in Cambridge.
“The biggest problem is it doesn’t deal with too-big-to-fail,” Johnson said. “It doesn’t say anything.” If constraints aren’t legislated, “complexity will multiply and take on new forms,” and regulators once again won’t be able to keep up, he said. “You have to make things a lot smaller.”
Alison Vekshin and Holly Rosenkranz in Washington and Bob Ivry in New York contributed to this story.
This is the last of a four-part series.