Posts Tagged ‘banks’

The new paper by Johns Hopkins University economist Laurence Ball, “The Fed and Lehman Brothers” (pdf), is creating quite a stir. And for good reason.

Fed officials have not been transparent about the Lehman crisis. Their explanations for their actions rest on flawed economic and legal reasoning and dubious factual claims.

Ball, on the basis of exhaustive research, calls out the officials in charge—Treasury Secretary Hank Paulson (played by William Hurt in the clip from Too Big to Fail at the top of the post), Fed chair Ben Bernanke, and New York Fed President Timothy Geithner—for not bailing out Lehman Brothers in September 2008. His argument is that the Federal Reserve did have the authority to rescue Lehman but chose not to—and they chose not to because they acceded authority to Paulson, who “feared the political firestorm that would have followed a rescue.”

Of course the decision not to rescue Lehman Brothers was political. And, if they’d taken the decision to bailout the failed global financial services firm, that would have been political, too.

The fact is, Paulson, Bernanke, and Geithner (as well as mainstream economists and other economic policymakers) were caught in their own logic of deregulating financial institutions and letting “the market” work according to its own rules (because, as Paulson admits, “they were making too much money”). That meant the emergence of a giant financial bubble—based on a toxic mix of subprime mortgages, mortgage-backed securities, and credit-default swaps—that would eventually burst. To save Lehman would have meant questioning those same private, market-based rules—with the hope that letting Lehman go under would restore order and not bring the rest of the financial system to its knees.

But, just so we understand, if they had chosen to rescue Lehman, that also would have been a political decision—to save the bankers that had made enormous profits from fees and bets on both simple and complex financial deals while, from 2007 on, everyone else was suffering from mounting foreclosures, homelessness, and unemployment.

As we know, they took the political decision not to bailout Lehman and then they covered it up, behind a series of stories—they had carefully examined the adequacy of Lehman’s collateral and they lacked the legal authority to intervene—that are convincingly disputed by Ball. Documenting the lack of transparency on the part of U.S. financial authorities about the decisions that were and were not taken in 2008 (from Bear Sterns through Lehman Brothers to AIG) is the real significance of Ball’s investigation.

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But it’s not the real political issue. Whether or not to rescue Lehman pales into insignificance when compared to two other events: the decision to let the financial system spiral out of control, and the decision not to nationalize the major financial institutions. The fact is, profits in the financial sector were enormous, reaching 40 percent of total domestic profits by the mid-2000s. It was a political decision to allow those profits to grow, even as the financial mechanisms that generated those profits were creating the financial fragility that led to the crash of 2007-08.

And then, after the crash, when the U.S. government owned an increasingly large share of the financial sector (from AIG to Ally Bank, the former GM financing arm), it was a political decision not to nationalize—or, better, not to effectively utilize the de facto nationalization of—the financial institutions it had rescued. The Obama administration and the Fed could have taken over decisionmaking in the banks, insurance companies, and government-sponsored enterprises it then owned (in exchange for the direct bailouts and other financial commitments) but they chose not to, preferring instead to negotiate payback plans and return them as quickly as possible to private ownership. That, too, was a political decision.

Ball admits “We will never know what Lehman Brothers’ long-term fate would have been if the Fed rescued it from its liquidity crisis.” True.

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But we do know what the fate of the U.S. economy has been as the result of two, much more important political decisions—to deregulate financial markets beginning in the 1990s and to not nationalize the major financial institutions after they were rescued with trillions of dollars of public financing and commitments. The first decision led directly to the crash of 2007-08, the second to the Second Great Depression and further concentration of Too Big to Fail financial institutions.

And, in the United States and around the world, we’re still living through the disastrous consequences of both of those essentially political decisions.

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The Wall Street banks responsible for the spectacular crash of 2007-08 have mostly been let off the hook.

According to a review conducted by the Wall Street Journal, which examined 156 criminal and civil cases brought by the Justice Department, Securities and Exchange Commission, and Commodity Futures Trading Commission against 10 of the largest Wall Street banks since 2009,

In 81% of those cases, individual employees were neither identified nor charged. A total of 47 bank employees were charged in relation to the cases. One was a boardroom-level executive . .

Most of the bankers who were charged pleaded guilty to criminal counts or agreed to settle a civil case, with those facing civil charges paying a median penalty of $61,000. Of the 11 people who went to trial or a hearing and had a ruling on their case, six were found not liable or had the case dismissed. That left a total of five bank employees at any level against whom the government won a contested case.

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The United States still has the highest incarceration rate in the world—but the U.S. prison population doesn’t, and won’t, include the executives of Wall Street banks.

Here we are in 2016, almost eight years after the financial crash that brought the world economy to it knees (and ruined countless homeowners and threw millions of people out of work), and nothing has been done to solve the problem of Too Big to Fail banks.

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In fact, as everyone knows (and as Stephanie Fontana points out), those banks are now ever bigger and the financial sector even more concentrated.

A small number of massive banks dominate this powerful industry with the five largest banks collectively holding $6.9 trillion in assets – 44 percent of total U.S. bank assets as of the end of September.

So, where are we in the current debate? One major-party candidate (Donald Trump) simply wants to scrap the existing reforms to the financial sector (contained in Dodd-Frank). Another (Hillary Clinton) wants just to enforce the minor changes contained in the new regulations. Only the third candidate (Bernie Sanders) suggests we deal with the problem by breaking up Too Big to Fail banks and bringing back something like the Glass-Steagall Act.

Here’s the irony: the folks who run one of the bankers’ banks, the Federal Bank of Minneapolis, recognize that the existence of Too Big to Fail banks continues to be a problem. And conservative University of Chicago finance economist Luigi Zingales, in his talk at the Minneapolis conference, argues that Too Big to Fail banks have too much power, both economically and politically; the so-called Volcker Rule has been captured and rendered useless; and, belatedly, he’s become convinced that something like Glass-Steagall needs to be implemented.

I’m not arguing that breaking up the banks and implementing Glass-Steagall is enough. But shouldn’t that be the starting point for our current debate?