Many, including this blogger, have become upset and outraged as the investigations into the financial debacle continue to come to light through ongoing congressional testimony, books and in the media. Not only have we seen a complete failure of our regulatory system, failures at the rating agencies but we are seeing what can only be considered fraud perpetrated by the investment banking community. What is most troubling is that none of those responsible for regulation have been fired nor has anyone at the rating agencies or investment banks been prosecuted. Perhaps this will come when the final congressional reports are in later this year.
Let’s drill down briefly though each one of these failures.
First, the rating agencies. As a result of their failure they have lost credibility and rightfully so. According to evidence and in congressional testimony the bond rating agencies lost sight of the quality of their ratings by focusing on quantity and market share which was driven by executive compensation incentives. In a classic conflict of interest the rating agencies were paid by the banks for their services and were under constant pressure from those banks to rate their bonds.
The results were a failure to gauge the risks in the collateralized debt obligations (CDO) and a failure to reevaluate those CDOs. Ultimately they did reevaluate and reduce their rating which helped lead to the collapse in the market and resulted in a large profit to the investment banks because of their short position.
What is particularly troubling is that in their testimony neither Raymond McDaniel, CEO of Moody’s, and Kathleen Corbet, the former president of S&P seemed to have a clue as to what was going on. It sounded like this was their way of invoking the 5th.
Secondly, the regulators who are supposed to be the watchdogs for the public failed miserably to do their jobs. Perhaps it is because, according to some, the regulatory agencies are still staffed by Bush-era anti-regulation folks.
In congressional testimony it seemed that the investigators found the irregularities but management failed to act. The banks in effect captured the regulators and were treated as trusted clients or customers of the regulatory agency. This became evident when it was learned that the regulatory agencies depended on the banks to track the findings and report on progress in correcting those findings rather than have an independent tracking system. Of course the banks only gave lip service to correcting irregularities.
In Carl Levin’s opening statement in the congressional hearing looking at the role of the regulators relative to WaMu he said “Like other bank regulators, OTS (Office of Thrift Supervision)was supposed to serve as our first line of defense against unsafe and unsound banking practices. But OTS was a feeble regulator. Instead of policing the economic assault, OTS was more of a spectator on the sidelines, a watchdog with no bite, noting problems and making recommendations, but not acting to correct the flaws and failures it saw.”
One cannot leave the regulatory issue without mentioning Alan Greenspan whose erroneously believed in the self-regulation of the markets and that banks would not, for selfish reasons, do anything to damage the market. It is interesting that both Tim Geithner and Larry Summers bought into this misguided belief at the time.
Lastly, but certainly not least, are the investment banks.
The two major issues when it comes to the banks are their perhaps not illegal but surely questionable practices bordering on fraud, according to William Black, and the issue of too-big-to-fail.
The repeal of the depression era Glass-Steagall act in 1999 which separated commercial from investment banks was the genesis of the problem. It is interesting that Tim Geithner, who at the time was Under Secretary of the Treasury for International Affairs reporting to Robert Rubin and Larry Summers, supported the repeal, acording to William Black. If this true then Tim was at least complicit in causing the problem.
The mashing together of commercial and investment banks gives the banks the ability to gamble with our commercial bank deposits. While our deposits are guaranteed by the FDIC, up to $250K, through fees paid by the banks, those fees are not enough to cover the kinds of losses experienced in this crisis.
If the process of packaging of liar loans into supposedly secure investment products was not bad enough the investment banks then sold them short in proprietary trading. According to Goldman CEO Lloyd Blankfein in his Q&A testimony before the FCIC this was done to manage risk. Blankfein recently made the following statement “We didn’t have a massive short against the housing market, and we certainly did not bet against our clients,” Blankfein says in the prepared remarks released by Goldman. “Rather, we believe that we managed our risk as our shareholders and our regulators would expect.”
In congressional testimony on 4/27/10 we now know that this statement is false.
Sen. McCaskill speaking of synthetic CDOs correctly characterized the practices of the investment banks as gambling, pure and simple. To make matters worse all this gambling involved products that did nothing in terms of real products, jobs and benefits to the economy. Indeed our economy took a big hit as a result of their gambling.
Goldman actions raise questions about their morallity and ethics and were done with complete disregard for the citizens of out country and out economy. Sen. Levin in his opening testimony said “The evidence shows that Goldman repeatedly put its own interest in profits ahead of the interests of its clients in our communities. Its misuse of exotic and complex financial structures helped spread toxic mortgages throughout the financial system. And when the system finally collapsed under the weight of those toxic mortgages, Goldman profited from the collapse.”
To address some of these problems Sec. Geithner in an NPR interview on 4/26/10 said that the proposed bill will “… give the government the authority it did not have before this crisis to limit risk taking limit leverage by these large institutions. But in addition to that, we’re going to put a cap on how large they could get, how concentrated our markets can get in the future by tightening up the existing limit, which restricts banks to having only ten percent of the nation’s total bank deposits.” We will see.
But Robert Reich said it all “The only way to ensure no bank is too big to fail is to make sure no bank is too big, period.”
What to do?
- Put an end to the idea of privitazion of profits and the socialization of losses.
- Reinstate, in full, Glass-Steagall. This will remove from the commercial banking sector the toxic process propriatery trading and short selling of investments being peddled to clients as low risk, sound, investments. This will go along way toward solving many of problems.
- Change the culture at the banks and regulatory agencies to eliminate the kind of short term thinking that says that it does not matter what I do today, I will have moved on by the time this becomes a problem.
- Eliminate the banking culture whereby people are compensated for making a large volume of high risk investment deals.
- Break the banks up so that they never become too-big-to-fail.
- Completely overhall the regulatory agencies and put in place policies that prevent and punish regulatory capture. This includes the use of independent processes for tracking regulatory findings along with strong enforcement capabilities.
- Completely the revise the rating agency model to one under independent Federal control.
- Broker dealers should be required by law to have a clear fiducary responsibility to act in the best interest of their clients.
Finally, let your representatives and the President know that you want, no, demand, change. THE TIME IS NOW!
Reuters: Greed Drove Credit Ratings
Wall Street and the Financial Crisis: The Role of Credit Rating Agencies
Opening Statement of Senator Carl Levin, Senate Permanent Subcommittee on Investigations Hearing, Wall Street and the Financial Crisis
Bill Moyers interview with William Black
A Short Citizen’s Guide to Reforming Wall Street by Robert Reich
Wall Street and the Financial Crisis: The Role of Bank Regulators
Testimony by Lloyd C. Blankfein to the Financial Crisis Inquiry Commission
Wall Street and the Financial Crisis: The Role of Investment Banks
Senate’s regulation bill omits 3 reforms by Robert Reich
See also Wall Street Reform: Part 1.
That’s my view, what’s yours?