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). 

After the financial crisis of 2008, the U.S. President wanted more consumer protections, limits on the size of banks and the risks they could take, reforms on executive compensation, and greater transparency for controversial financial securities known as derivatives.  He maintained that each of these safeguards must be in any bill that he would sign. In giving the speech with some of the banking titans in the audience, the President wanted to confront the financial industry more directly through a sharp speech. After having castigated the bankers' “failure of responsibility” in recent years, he called on them to stop resisting tighter regulation through the army of lobbyists staked out then on Capitol Hill. The president’s address at Cooper Union in Lower Manhattan circled back to another speech he had given at the same location in March of 2008 warning of financial manipulation, market bubbles and the concentration of economic power.

Analysis:

At the time of his speech, the President was actually supporting the bills coming out of Congress. These bills would do nothing to forestall or minimize market bubbles and reduce the concentration of economic power.  The bills would not even limit or reduce bank size; instead, higher reserve requirements for the biggest banks was presumed a sufficient incentive for those banks to willing reduce their sizes. Although this approach, which would become law, incorporated the market mechanism (regarding financial disincentives), the assumption that empire-building Wall Street titans would reverse the "business logic" where in the opposite of growth is bankruptcy is very naive. It is remarkable that the president considered this approach as satisfying his requirement that the bill reaching his desk must include something limiting the size of financial institutions (especially when the systemic risk of one big bank failing and taking down the entire financial system had recently been lived through). Paul Volker, Chairman of the Federal Reserve under Reagan, was urging a decrease in the sizes of the five largest banks. 

I submit that Goldman Sachs' $1 million contribution to Obama's presidential campaign may have had something to do with it, as did Wall Street lobbying in Congress. On the eve of the President’s speech, Obama’s chief of staff had met behind closed doors with representatives of Wall Street firms. Fox News reported that Obama's message was the following: we’ve got to trash you in public, but know that we will take care of you in private.  While Fox News was at the time certainly no friend of the President, the account would explain why the President would eventually sign the Dodd-Frank Act of 2010, which except for staggered reserve requirements and a consumer-protection bureau is pretty kind to Wall Street.  

 

Recalling President Andrew Jackson, who successfully took on the bank of the U.S. by refusing to fund it in 1832, and Theodore Roosevelt, who supported the Sherman Anti-trust Act in 1911, we could certainly view Obama as not having been willing to take on the guys who not only had contributed to his 2008 campaign, but could be useful again in 2012 for Obama's reelection.  

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. 

 Mythili Raman testifying before Congress. mainjustice.com

Mythili Raman, Acting Assistant Attorney General in the Criminal Division, argued that collateral factors as a group should be considered. Testifying before Congress on May 22, 2013, she cited “the disproportionate impact on innocent third parties, including the public at large,” as being entirely appropriate for prosecutors to consider.[2] Her reference to the general public means that systemic risk was among the legitimate factors in her view, and yet she also said, “the size of a corporation will never be a factor in and of itself and that no institution is too big to prosecute.”[3] Crucially, her position was that one particular consequence should never be the only factor. “A single collateral consequence cannot be the reason.” However, she added that “collateral consequences are issues that we must and do consider.”[4] Because banks too big to fail tend to have more than one significant collateral consequence (e.g., many stockholders and employees, as well as systemic risk), such banks may be too big to jail.

In testimony before Congress in March 2013, U.S. Attorney General Eric Holder had admitted that the lawyers in his department were wary of the “negative impact” on the economy from prosecuting a large financial institution. “(I)t is a function of the fact that some of these institutions have become too large.” Differing from Raman, he thought the size of large banks “has an inhibiting influence – impact on our ability to bring resolutions that I think would be more appropriate. . . . (a)nd I think that is something that we – you all – need to consider.”[5] I want to unpack this rather robust admission, for it is significant.

Firstly, the Attorney General was hinting at what Sen. Kaufman had observed while in office. Namely, it should not have been the F.B.I.’s concern whether the Wall Street banks continued as viable concerns. In other words, systemic risk or even collateral consequences more generally had no business being considered by prosecutors whose job it was to enforce the law. Including systemic risk among the collateral consequences thus further compromised the rule of law. As Sen. Charles Grassley put it, “It was stunning to hear the nation’s top prosecutor acknowledge that, from the justice department’s perspective, the big banks are too big to jail. This is worrisome for the fair application of justice in our country.”[6]

Secondly, the Attorney General was suggesting that Congress should reduce the size of the biggest banks—those with over $1 trillion in assets. This would have removed the specter of banks being too big to jail. Also, by implication, Holder had concluded that the Dodd-Frank Act would not be sufficient to solve the "too big to fail" problem. That law was premised in part on the theoretically beautiful but practically insufficient assumption that imposing disproportionate capital reserve requirements on the biggest banks would not only be enough to keep them sound even in a financial crisis, but would also prompt the banks' boards to reduce the size of their banks. Besides of cost-advantages in being so large, and getting even larger as the five biggest banks have since done, the psychology of empire-building, which had gripped Lehman's Dick Fuld so, can easily dismiss the disproportionate costs of retaining or enlarging size. 

Regarding the implications for the U.S. Department of Justice should the biggest banks have taken the bait and voluntarily reduced their respective sizes, it is clear that if no systemic risk (i.e., of being too big to fail without taking the whole financial system down) were to exist, then third-party collateral damage would not be disproportionate so the banks (and bankers) could be prosecuted. Accordingly, the Huffington Post observed at the time that lawmakers “may be encouraged to apply even more public pressure on efforts to crack down on big banks.” [7] Lawmakers having received campaign contributions from those banks, however, would hardly do so. In fact, those members of Congress would even defend the large sizes of the biggest banks. 

Exceptions admittedly existed. Rep. Sherman, the chair of the full committee, noted while Raman was testifying that the fact that the Department of Justice considered collateral consequences rather than simply enforced the law was enough justification to break up the big banks. Putting aside the issue of size for the conduct of banking (e.g., whether a gigantic sized bank is necessary to make huge loans or would a syndicate of banks do as good of a job and spread the risk), having powerful people and organizations de facto above the law is something that just cannot be permitted in a republic. So on this basis alone, the rationale goes, society had an overwhelming interest in braking up the largest U.S. banks. 

Unfortunately, being too big to fail has carried (and still carries) with it tremendous political power—muscle that could have been used all too easily to resist legislative proposals (or even public debate) oriented to seriously downsizing the mammoth banks. This has the real problem since economic power became so concentrated in large corporations and banks: can a republic resist the power of its most powerful for the good even of the economy, and the public societal good more generally? Were the big banks pulling the strings that led to Raman’s assertion that collateral consequences “must and should” be considered in deciding whether to prosecute? Whether Raman realized it or not at the time, the implication that the rule of law applied impartially should be compromised by the magnitude of the predicted collateral consequences from a corporate conviction is, euphemistically speaking, troubling.

See “The Untouchables,” Frontline, January 22, 2013 and Essays on the Financial Crisis: Systemic Greed and Arrogant Stupidity, available at Amazon.

1. Shahien Nasiripour and Kara Schannell, “Holder Says Some Banks Are ‘Too Large’,” The Financial Times, March 7, 2013.
2 Congressional Hearing, “Who Is Too Big to Fail: Are Large Financial Institutions Immune from Federal Prosecution?” Financial Services Committee, Oversight and Investigations Sub-Committee, U.S. House of Representatives, May 22, 2013. See also the letter to sub-committee members; Shahien Nasiripour, “Too-Big-To-Jail Dogs Obama’s Justice Department As Government Documents Raise Questions,” The Huffington Post, May 22, 2013.
3. Ibid.
4. Ibid.
5. Nasiripour and Schannell,  “Holder Says Some Banks Are ‘Too Large’,”
6. Ibid.
7. Ibid.

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.

Suggesting that more legislation might be needed, Bernanke said, “Too Big To Fail was a major source of the crisis . . . and we will not have successfully responded to the crisis if we do not address that successfully.”[2] More would be needed to rid the U.S. economy of the threat of banks too big to fail. If holding more capital does not make the big banks safer, “we will have to take additional steps.” This, he said, “is important.” Yet somehow his voice was not adequately heard. Other voices were louder on Capitol Hill.

Meanwhile, Wall Street banks faced little downside. Because the mammoth size of big banks such as Citibank and Bank of America makes their failure a threat to the viability of the financial system and even the overall economy, such size is an advantage to the banks because the bankers can reasonably bet that the U.S. Government would have to bail them out even if they face financial ruin by having taken on too much risk as the economy sours. The sense of invincibility, plus lower borrowing costs, could lead big banks to not only stay big (or even get larger!), but also take bigger risks. Bankers at such banks may even feel free to commit fraud because U.S. Attorney General Eric Holder admitted in 2013 that large banks were nearly immune from government prosecution for crimes, given the risks to the economy from the failure of a convicted bank. What about the fraudulent bankers who sold "crap" while claiming the mortgage-based bonds were sturdy? In short, the risk taken on by a big bank could easily outstrip even the additional capital requirements in the Dodd-Frank Act.

Even apart from reckless banking at the top of the U.S. financial system, if a sizable market in the U.S., such as many of the housing markets, were to collapse all at once, as in 2007-2008, many banks would be hit. The additional reserves would not likely buttress individual banks from the domino effect that was evinced, albeit halted, in September 2008. I submit that more money in reserves would have stopped the cascading momentum. While higher reserves might safeguard a bank while others are intact, the claim seems doubtful at best when the undercurrent from the momentum of many banks being hit at once or in a row is strong. It is no accident, I contend, that the Obama campaign of 2008 accepted $1 million from Goldman Sachs. 

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

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. 

Regulators were leaving room for “significant changes,” according to the Times. Wall Street was “lobbying furiously to tame the Volcker Rule, holding roughly 40 meetings with various regulators, warning that the changes will eat into profits at a difficult time for banks.” Those banks were undoubtedly threatening to charge more to their customers if the rule weren’t weakened. “In essence, the [rule] would upend the banking industry's lucrative, yet risky trading system, forcing powerhouse investment banks to resemble sleepier brokerage firms.” It is difficult to see Morgan Stanley and Goldman Sachs readily becoming mere market-makers and deposit and loan banks without a fight. To be sure, Lloyd Blankfein did insist that his bank was only a market maker when he testified before Sen. Levin’s Senate committee after the credit freeze of 2008.

At the time the Volcker Rule was being proposed, it was already apparent that there would be some wiggle-room for the banks. "Unfortunately, this initial proposal does not deliver on the promise of the Volcker Rule or the requirements of the statute," said Marcus Stanley, policy director of American for Financial Reform, an advocacy group. In the proposal, “a number of controversial exemptions emerged. While the regulation prevents big banks from placing bets on many stocks, corporate bonds and derivatives, it exempts trading in government bonds and foreign currencies. The proposal also provided a path for getting around the ban, for instance, when banks hedge against risk that comes from carrying out a customer's trade. Market-making and underwriting are excused, too, though the line is often fuzzy between these pure client activities and proprietary bets.” Lastly, the proposal would allow “banks to hedge against theoretical or ‘anticipatory’ risk, rather than just clear-and-present problems.” Armed with their lawyers and astute financial wizards, Wall Street banks could conceivably continue with business as usual.

Trading in government bonds and foreign currencies, and hedging even theoretical risk presumably with anything constitute an obstacle course that any Wall Street banker could run without breaking a sweat. With so much on the line and public scrutiny less potent at the regulatory stage, the financial-sector lobbyists could be expected to achieve just enough and then some. Once again, systemic risk would not be a factor, and history could repeat itself.

See: Skip Worden, Institutional Conflicts of Interests, available at Amazon.

1. Ben Protess, “Banking Industry Revamp Moves Step Closer to Law,” The New York Times, October 12, 2011. 

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. 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.

Eisinger points out that, at least as of October 2011, Morgan Stanley “has almost $60 billion in common equity, compared with $36 billion before September 2008, and its ratios are stronger. Its trading book - which is volatile and where any bank can take sudden, large losses - is smaller than it was. Morgan Stanley has more long-term debt and higher deposits, both of which stabilize its finances. The bank has more cash available in case there's a crunch and a smaller amount of Level III assets, which don't have an independently verifiable value and so must be estimated by the bank. Hedge funds have parked a smaller amount of assets at Morgan Stanley. That's good because in the financial crisis, they pulled them from the bank.” But because all of this could be easily wiped out by a run on the bank occasioned or fueled by a wider mistrust of the financial sector, Eisinger brings up the topic of derivatives as a way of showing that the bankers did not in fact learn their lesson (i.e., all the improved stats may be for naught). Accordingly, the bankers deserved the systemic mistrust even at the expense of any effort having resulted in added financial strength.  

According to the reporter, Morgan Stanley had a face value of $56 trillion in derivatives in October 2011. He notes that JP Morgan Chase had more: a face value of $79 trillion. This is the GNP of some countries. Even though the bankers insisted at the time that they had adequately hedged their long positions, the hedges themselves could fail, especially if the derivatives are positively correlated, as in September 2008 when AIG was completely overwhelmed due to the housing-based derivatives caving in virtually all at once.

In other words, those of us capable of learning lessons know that we should not trust hedges in so far as systemic risk is concerned; the system itself can be overwhelmed by the sheer momentum of a really big wave. So we are back to the issue of trust in the entire financial system, which is and ought to be a drag on even stellar financials until the broader lesson is learned. Unfortunately, that lesson may not be in the immediate financial interest of particular banks due to externalities occasioned by moral hazard (e.g., the possibility of being rescued while another bank, such as Lehman, fails).

Even though governments can step in to protect the broader system (unless captured by the regulated), legislators and regulators cannot force bankers to learn their lesson. A mentality to safeguard even one’s own bank as a going concern cannot be imposed; it must be felt and valued from the inside. All too often, bankers are engaged in “managing” regulations as impediments to be minimized rather than stepping back to ask why the regulations exist in the first place. They might exist for the banks’ own good. If so, the banking lobby trying to water down the Volcker Rule might have been working at odds with those institutions that the lobby ostensibly represents. Be careful what you wish for, Wall Street bankers. You might just get it, especially if you have the gold and therefore can make the rules. It would be ironic if the protesters rather than yourselves had your back, even as you ridicule the masses marching below your towering be-windowed edifices of greed.

Source:

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.  
Traders in the banks set about getting around the “margin requirements” by treating the “swaps” as futures, which do not require the higher reserves in Dodd-Frank. Whereas a futures contract for corn to sell at a certain price limits residual risk, swapping the risk of the default of an investment puts a party on the line for the entire investment. Moreover, unlike futures contracts, swaps have significant systemic risk because claims can all be made at once, overwhelming the parties assuming the liability in the swaps (e.g. AIG in September 2008). 
Managers at Wall Street firms have tended to not only minimize safeguards even though they protect the banks (from themselves), but also discount or even dismiss such high-risk, low-probability outcomes as come with risk to a bank as well as the entire financial system (i.e., systemic risk). Meanwhile, less money held in reserve means more money available to be lent or put into high-risk investments such subprime mortgages or bonds based bundles of such high-risk mortgages. 
Accordingly, the gradual trajectory already as of the beginning of 2013 was toward yet another systemic collapse of the financial system should enough housing markets take a down turn. “As the market gravitates to the cheaper platform—and it’s cheaper because it’s unsafe—that creates risk for everyone,” said James Cawley, CEO of trade execution firm Javelin Capital Markets.[1]  Put another way, market participants were operating according to the greatest profit, the greater risk notwithstanding. “In a distress scenario, you basically have what you had from AIG in 2008,” Cawley said; “Then someone has to step in, and we all know who that someone is: the U.S. taxpayer.”[2] So the question at the time was perhaps whether the SEC had the taxpayer’s back or was reflective of, or enabling a cozy revolving door between the federal government and Wall Street firms.
To be sure, the Volcker Rule, part of the Dodd-Frank Act, would, unless weakened, bar banks from short-term proprietary trading (i.e., on their own accounts, except for market-making), and from taking ownership states in private equity funds and hedge funds. U.S. Senator John Hatch speaking at Jack Lew’s confirmation hearing in early 2013 raised the question of whether Lew would act as U.S. Secretary of State to constrain banks’ risky proprietary trading, given that he had headed units at Citigroup that were involved in just such practices that would violate the Volcker Rule. 

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

Lew had been the COO of Alternative Investments at Citi. MAT and Falcon investment funds were sold as low-risk even though those funds were actually hedge funds with high risk.  As COO, Lew refused to offer the misled customers full refunds.  At least fourteen arbitration panels subsequently gave the customers the full refunds they had sought. Although he had not been involved in selling the funds, he did manage units that engaged in risky proprietary trading. The public would be justified in wondering if they too would be left on the hook as taxpayers rather than protected should Lew favor Wall Street's incessant desire for profit over the government's role to place that desire in check for the good of the system/whole.
After Lew, during President Trump's first term, the Federal Reserve Bank voted unanimously in late May, 2018 to weaken the Volcker Rule. The move was consistent with the president's desire to deregulate Wall Street. The flip side of the move that would enhance Wall Street profits was that the government would be doing less to protect the financial system as a whole even though the systemic risk of the largest five banks had increased with their growth. As Senator Dick Durbin had said after the financial crisis when people were looking to Congress to protect even the banks from themselves, “Congress is owned by the banking lobby.” So looking to the legislative branch should the executive be in sync with Wall Street's financial interests may not play well. Even after semi-stringent regulatory constraints have been passed, Wall Street can still have the edge in circumventing or mollifying the speed-bumps even though they are in the bank's own long-term interest, which can come to roust even in the short term as in 2008.

See Essays on the Financial Crisis, available at Amazon.

1. Eleazar Melendez, “Wall Street Setting Itself Up For Next Derivatives Crisis, Market Participants Warn,” The Huffington Post, February 14, 2013.
2. Ibid.

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.
It is admittedly tempting to go with the status quo than be responsible for reforms. If the reformers are also the former perpetrators, their defensiveness and ineptitude mesh well with the continuance of the status quo even if an entire economy the size of an empire is left vulnerable to a future crisis. To comprehend the inherent danger in the sheer continuance of the status quo, it is helpful to digest the panel's findings. 
The crisis commission found "a bias toward deregulation by government officials, and mismanagement by financiers who failed to perceive the risks." The commission concluded, for example, that "Fannie and Freddie had loosened underwriting standards, bought and guaranteed riskier loans and increased their purchases of mortgage-backed securities because they were fearful of losing more market share to Wall Street competitors." These two organizations were not really market participants, as they were guaranteed by the U.S. Government. That government-backed corporations would act so much like private competitive firms undercuts the assumed civic mission that premises government-underwriting. All this ought to have raised a red flag for everyone--not just the panel which stressed the need for a pro-regulation verdict. 

Lehman was a particularly inept player leading up to the crisis.     Zambio

In terms of the private sector, The New York Times reported that the panel "offered new evidence that officials at Citigroup and Merrill Lynch had portrayed mortgage-related investments to investors as being safer than they really were. It noted — Goldman’s denials to the contrary — that 'Goldman has been criticized — and sued — for selling its subprime mortgage securities to clients while simultaneously betting against those securities.'”  The bank's proprietary net-short position could not be justified by simply market-making as a counter-party to its clients, Blankfein's congressional testimony notwithstanding. 
Relatedly, the panel also pointed to problems in executive compensation at the banks. For example, Stanley O’Neal, chief executive of Merrill Lynch, a bank which failed in the crisis, told the commission about a “dawning awareness” through September 2007 that mortgage securities had been causing disastrous losses at the firm; in spite of his incompetence, he walked away weeks later with a severance package worth $161.5 million. The panel might have gone on to point to the historically relatively huge difference between CEO and lower-level manager compensation and questioned the relative merit, but such a conclusion would go beyond the commission's mission to explain the financial crisis.

With regard to the government, The New York Times reported that the panel "showed that the Fed and the Treasury Department had been plunged into uncertainty and hesitation after Bear Stearns was sold to JPMorgan Chase in March 2008, which contributed to a series of “inconsistent” bailout-related decisions later that year." The Federal Reserve was clearly the steward of lending standards in this country,” said one commissioner, John W. Thompson, a technology executive. “They chose not to act.” Furthermore, Sabeth Siddique, a top Fed regulator, described how his 2005 warnings about the surge in “irresponsible loans” had prompted an “ideological turf war” within the Fed — and resistance from bankers who had accused him of “denying the American dream” to potential home borrowers. That is to say, the Federal Reserve, a corporation wholly owned by the U.S. Government, is too beholden to bankers instead of the common good. So we are back to the issue of a government-guaranteed corporation acting like or on behalf of private companies (and badly at that).
We can conclude generally that governmental, governmental-supported, and private institutions, all acting in their self interests, contributed to a "perfect storm" that knocked down Bear Stearns, Lehman Brothers, Countrywide, AIG, and Freddy and Fannie Mae. Systemically, the commercial paper market--lending between banks--seized up and many of the housing markets in the U.S. took a severe fall such that home borrowers awoke to find their homes under water. The Federal Reserve was caught off-guard, as its chairman, Ben Bernanke, had been claiming that the housing markets could be relied on to stay afloat. Relatedly, AIG insured holders of mortgage-based bonds without bothering to hold enough cash in reserves in case of a major decline in the housing markets all at once. Neither the insurer nor the investment banks that had packaged the subprime mortgages into bonds though to investigate whether Countrywide's mortgage producers had pushed through very risky mortgages before selling them to the banks to package. In short, people who were inept believed nonetheless that they could not be wrong. Dick Fuld, Lehman's CEO, had the firm take on too much debt to buy real estate so that eventually his firm would be as big as Goldman Sachs. That such recklessness would be on the behest of a childish desire to be as big as the other banks testifies as to the need for financial regulation that goes beyond the "comfort zone" of Wall Street's bankers and their political campaign "donations."

See also Essays on the Financial Crisis: Systemic Greed and Arrogant Stupidity, available at Amazon.

Source:

Sam Jones, "Hedge Funds Rebuke Goldman," Financial Times, January 28, 2011, p. 18.

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. 
With the $6.2 billion trading loss at JPMorgan Chase in the hindsight, Sen. Sherrod Brown (D-Ohio) and Sen. David Vitter (R-La) in the U.S. Senate proposed a bill that would require banks with more than $400 billion in assets to hold at least 15 percent of those assets in hard capital. The two senators meant this requirement to encourage the multi-trillion-dollar banks to split up into smaller banks. Although it had been argued that gigantic banks are necessary given the size of the loans wanted by the largest corporations, banks had of course been able to form syndicates to finance such mammoth deals. 
The Senate had recently voted 99-0 on a nonbinding resolution to end taxpayer subsidies to too-big-to-fail banks, so the U.S. Senate had Wall Street’s attention. Considering that the U.S. House of Representatives was working on legislation to deregulate derivatives, the chances that the U.S. Government would stand up to Wall Street even to the too-big-to-fail systemic risk were slim to nil. Indeed, the U.S. Department of Justice’s criminal division had been going easy in prosecuting the big banks for fraud out of fear that a conviction would cause a bank collapse (or because President Obama had received very large donations from Wall Street banks including notably Goldman Sachs).
The two senators’ strategy of going about breaking up the biggest banks indirectly by increasing their reserve requirements disproportionately didn't work, at least as of 2019. Advantages of size, including the human desire to empire-build (witness Dick Fuld at Lehman Brothers), could have been expected to outweigh the economic preference for a lower, more proportionate, reserve requirement. With anti-trust laws having been used to break up giants such as Standard Oil and ATT, the thought of breaking up the banks too big to fail even in the wake of the financial crisis was strangely viewed as radical and thus at odds with American incrementalism. The question was simply whether systemic risk should be added to monopoly (i.e., restraint of trade) as an additional rationale for breaking up huge concentrations of private property. This question could have been made explicit, rather than trying to manipulate the big banks to lose some weight.  
The approach of using disproportionately reserves can be critiqued on at least two grounds. First, should one or more of those banks decide to go with the 15% requirement rather than break up into smaller firms, even the additional capital might not be enough to protect a bank during a financial crisis. The study discussed above suggested as much. Second, even if the additional requirements would turn out to be sufficient in a crisis, the approach would obviate a decision by the government on whether systemic risk justifies a cap on how large banks can get. 
I suspect that the U.S. Congress and president backed off in really reforming Wall Street because of its money in campaign finance. In short, the big banks in Wall Street didn't want to shrink. In a system of political economy wherein the economy is regulated by government, rather than vice versa, backing off just because large concentrations of wealth (and thus power--even political) don't like the plans is unacceptable. Moreover, it is a sign of encroaching plutocracy wherein the regulated dictate behind closed doors to the regulators and politicians. Meanwhile, the public, including the economy itself, remains vulnerable. 

See Essays on the Financial Crisis: Systemic Greed and Arrogant Stupidity, available at Amazon.

Sources:

Eric Rosengren, “Bank Capital: Lessons from the U.S. Financial Crisis,” Federal Reserve Bank of Boston, February 25, 2013.
Zach Carter and Ryan Grim, “’Break Up the Banks’ Bill Gains Steam in Senate As Wall Street Lobbyists Cry Foul,” The Huffington Post, April 8, 2013.

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.

The luge is often called the “fastest sport on ice.” Sliders use their legs and shoulders to steer small fiberglass sleds down an icy track, at times approaching or surpassing speeds of 90 m.p.h., according to the Vancouver 2010 Winter Olympics Website. One headline read, “This Winter Games could be the first time the sport sees a competitor hit 100 mph.” Sports Illustrated’s David Epstein, who covered the Olympics, claimed the Whistler course was at the time the fastest in the world, “and not by a little.” He explained that while most luge courses “flatten out” around the 11th turn, the Whistler track “just keeps on dropping, so there’s really kind of no break from gathering speed toward the end.” Epstein reported that some athletes had been complaining about the speed of the course and speculating that the 2010 Winter Games could be the first time a competitor hit 100 mph. “That’s 15 to 20 mph faster than any course in the rest of the world.” Is being faster the overriding point?
Whether we are talking about luge tracks, sky-scrapers, corporations, or passenger jets, the human psyche seems to have an innate proclivity to extend a threshold further—regardless even of how far the extension is from our natural limits. This can be reckless, for we are perhaps by nature inclined to ignore the recklessness involved in going faster or getting bigger.

Not only do we like faster, higher, and bigger; we, like Dick Fuld, the last CEO of Lehman Brothers, are not content until we have hit biggest, for he put the investment bank through so much risk in part so his bank would surpass Goldman Sachs. He wanted to be higher, in the rarified Wall Street club that has included JPMorgan Chase, Citigroup, Solomon Brothers, Bank of America, and Goldman Sachs. If the human susceptibility is as I describe here, a strong rationale for regulation of business exists in any country. We should not limit recklessness to that which occurred from the late 1990's through at least the Financial Crisis of 2008 as large American investment banks bundled sub-prime (i.e., risky) mortgages into bonds, a third of which Moodys rated AAA, and sold even the lower-rated bonds as if even they were safe (while confidentially admitted to themselves that they were "crap"). The human brain simply doesn't function well when in the grip of greed. Interestingly, a group of the large bankers meeting with U.S. Secretary of the Treasury, Henry Paulson, amid the fear in the financial crisis admitted that they had been wracked with greed--so why hadn't the federal government protected them from themselves with financial regulation? The answer is of course the bankers' own lobbying and political campaign contributions. You cannot both corrupt government into functioning as a plutocracy and yet expect that same government to be politically strong enough to act as a constraint on even severe cases of greed.

Airlander 10, the largest aircraft in the world, crashed on its second test-flight on August 24, 2016. 

In 1912, the Titanic ocean-liner was the largest thing built by human beings. In spite of the risk in being the largest, the ship was presumed to be unsinkable. Speaking about the ships a century later, Helen Kearns, a spokesperson for Siim Kallas, who was the E.U. Transportation Commissioner at the time, said, “There are legitimate questions as these vessels have substantially evolved in recent years.” I wonder if “evolved” is the right word. “The boats have gotten a lot bigger, as it’s economically advantageous to have more passengers,” Kearns added, but “the way these vessels have grown in size does mean finding the right balance to make sure regulations are stringent enough to ensure there are procedures like safe evacuations.” She was presuming here that cost-efficiency is a given, and, furthermore, that regulations can make up for any increased risk that comes with size.

Kearns was responding to reports that a cruise ship had hit a rock off Tuscany and partially sank several yards from an island off the coast. In the case of the partial-sinking of the Costa Concordia about twenty feet from an island just off the Tuscany coastline on Friday the 13th in January 2012, there was still confusion regarding how many of the 4,200 souls on board were still missing. That total figure of people who had been on board is about double that of the ill-fated Titanic, which went down in the North Atlantic on April 15, 1912—almost exactly a century earlier. In that case, the White Star Lines pressured the captain to light the fourth boiler to reach New York City early and "make the papers!" It did not occur to anyone that the ship's rudder was made for smaller ships, and thus it could not turn quickly enough to avoid the giant pop-cycle ahead in the cold water.
To put the two accidents in perspective, being twenty feet from an island would undoubtedly have been treated like a godsend to those people on the Titanic who perished in the icy waters of the north Atlantic. Had cruise ships become so large (and complex) that being twenty feet away was deemed to be too far? Or had cruise lines become too bureaucratic, mirroring the tendency in modern corporations generally, as per Max Weber's studies.
We forget that in James Cameron's film, Titanic, the Titanic’s designer says to the White Star Line executive who has just claimed that the Titanic—the biggest ship in the world—cannot sink,  “I assure you, good sir, it is made of iron. The Titanic will sink. It is a mathematical certainty.” A century later, it was taken for granted that Costa could not fall over in the water, yet it did—making it difficult if not impossible to deploy the emergency boats.
Regulation can be thought of as the structural walls separating sections of a ship. In oil tankers, those walls keep the oil from all going to the front or back and capsizing the ship. In the case of ships like the Titanic, the walls were designed to keep water leaking into one section from filling more sections--five were filled in the case of the Titanic because of the way the iceberg tapped along the side of the ship. Regulation does not stop at how ships are designed internally, but includes how big they are. Ideally, regulation realizes that speed, height, and size are themselves subject to regulation because the faster you go, the higher you build, and the bigger your boat or corporation, the faster you'll fall. An instinctual human urge, I submit, discounts or dismisses such risk (a.k.a. recklessness) out of a single-mindedness that narrows cognitive perspective into a fixation. Doubtless a product of eons of natural selection, this instinct is not bound to change anytime soon, so we can take regulation as a given rather than pretend that it is optional. Before the financial crisis, U.S. Federal Reserve Chair, Alan Greenspan, said he was ideologically opposed to regulating the financial sector; he thought a laissez-faire market could control its own volatility and risk. During the crisis, he briefly admitted that he had been wrong. He soon "repented" for his "heresy" and went back to the free-market line even though even competition requires game-rules, especially if the players keep getting bigger. 


Sources:
"Olympic Luger Dies on Track Where Speed Caused Concern," CNN.com, Febuary 13, 2011.
Steven Erlanger, “Oversight of Cruise Lines at Issue After Disaster,” The New York Times, January 17, 2012.

Addressing Systemic Risk: Beyond the Dodd-Frank Act of 2010

After the U.S. financial crisis in September 2008, 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

In March 2013, Alan Greenspan said in a TV interview that banks like JPMorgan that are too big to fail should be allowed to fail. “[What] we ought to do is to allow banks to fail, go through the standard Chapter 11 type of process of liquidation, and allow the markets to adjust accordingly,” said the 87-year-old Greenspan. “That has worked for a very long time.” Had he forgotten his own Congressional testimony in which he had admitted that markets may not “adjust accordingly” to irrational exuberance and systemic risk? Decades of the central banker’s experience had not prepared him for the “financial cliff” that the financial system nearly went over in the fall of 2008. Apparently for Greenspan at least, old habits (of thinking) die hard.

Greenspan said that the Dodd-Frank Act of 2010, which was oriented to saving the banks from their own risky excesses and providing such banks with an orderly liquidation process should they declare bankruptcy, had been a failure. He said the “too big to fail” problem was getting worse, not better. Banks such as JPMorgan had been “gaming” the new regulations, attracted by the high profits gained from risky trades outlawed by the Volcker Rule. That FDIC deposits were used at JPMorgan to make the trades suggests that the taxpayers have been underwriting the continued high risk, at least in part. In other words, free-market capitalism does not completely account for the risk that banks willfully assume even though it can cause the financial sector to suddenly seize up as a big bank goes under.

Greenspan’s answer to the failure of Dodd-Frank involves a return to his faith in the free market, as if the freezing of commercial paper had not occurred in September 2008 after Lehman failed. A year after that crisis, the former central banker had urged the break-up of the big banks too big to fail. “If they’re too big to fail, they’re too big,” Bloomberg News reports Greenspan said in October of 2009. “In 1911 we broke up Standard Oil -- so what happened? The individual parts became more valuable than the whole. Maybe that’s what we need to do.” One might add that the sheer existence of a bank with over $1 trillion in assets is too big for not only the financial markets, but also the republic as well. Even after the banks’ culpability had been made transparent in the financial crisis, Wall Street still had considerable lobbying pull over Congress—enough to get lawmakers to scrap Sen. Dick Durbin’s amendment that would have allowed judges merely to adjust mortgages that are in foreclosure. The allure of large contributions is simply too overpowering to a candidate or elected official for such concentrations of private wealth to be compatible with representative democracy. One or the other must inevitably give way. Relying on chapter 11 bankruptcy and market re-adjustment does not even begin to touch such ramifications.

In short, Dodd-Frank can be viewed as a piece of legislation that did not go far enough. This is perhaps no coincidence, given the power of the banks in Congress. Furthermore, as the $6.2 billion trading loss at JPMorgan demonstrates, bankers are able to evade and obstruct whatever incremental strengthening of financial regulation that lawmakers and regulators are able to enact over the objections of the bankers. The Volcker Rule, which bars the risky proprietary trading of banks, is no match for the wizzes on Wall Street. Systemic risk demands public policy beyond some additional regulation, or even a return to New Deal regulation. Going back to the Glass-Steagall Act of 1933, which had separated investment from commercial banking, would be insufficient, as banks had been gaming that law for decades before it was repealed in 1998 by Bill Clinton and Sen. Phil Gramm. Systemic risk and risks to democracy warrant public policy that changes the economic map, rather than merely giving the existing players some additional instructions or letting them fail and hoping the market will not collapse as a result. Addressing systemic risk warrants a systemic rather than an incremental or laissez-faire approach. I suspect that in addition to the obvious vested powerful interests, an aversion to substantive change and an associated preference for incrementalism account societally for much of the aversion to breaking up the big banks, as they had become ensconced in the system as part of the status quo.

Caroline Fairchild, “Greenspan Says Too Big To Fail Problem ‘Is Getting Worse, Not Better’,” The Huffington Post, March 15, 2013.

For more essays on that financial crisis, see Essays on the Financial Crisis: Systemic Greed and Arrogant Stupidity, available at Amazon.