Stock market boom doesn’t float everyone’s boat

Forgetting history is an American pastime. The current bull market that ranks among the great rallies in stock market history began 10 years ago this month, just about the time when Lady Gaga’s “Poker Face” was the number one song in America.

The stock market party has been going on for a decade, but many Americans have not been invited. The Standard & Poor’s 500 index has soared over 300 percent since March 2009, but the gains are heavily concentrated among the richest families.

The richest families are far more likely to own stocks than are middle- or working-class families. Eighty-nine percent of families with incomes over $100,000 have at least some money in the market, compared with just 21 percent of households earning $30,000 or less, according to a Gallup survey.

Overall, 62 percent of families owned stocks before 2008. That number has fallen to 54 percent, the Gallup poll found. The psychological and financial damage inflicted by the 2008 financial crisis and the subsequent Great Recession continue to weigh heavily on the average American, just as memories of the Great Depression influenced financial habits for decades.

In March 2008, the Financial Meltdown, Financial Apocalypse, Financial Collapse – call it what you will – began, with the feds arranging a shotgun marriage between Bear Stearns and JPMorgan Chase. In March 2008, Bear Stearns, the smallest of the five major Wall Street investment banks, was unable to fund its operations and was bleeding cash, having lost the confidence of the market. The feds were faced with a choice between letting the company fail or taking extraordinary steps to rescue it. They choose the latter.

Bear Stearns was sold to the JPMorgan Chase, with the Federal Reserve providing $29 billion as an inducement to the acquiring bank. Bear Stearns may have ceased to exist as an independent firm, but it continued to haunt the financial world like Marley’s Ghost for months thereafter. Its collapse signaled the real start of the financial crisis. Bear’s demise started a banking liquidity crisis in which financial institutions became unwilling to lend to each other, and credit markets seized up.

A growing number of formerly solid financial institutions were turned into basket cases. After their years of kindergarten management games, shooting up on short-term borrowings, ample use of leverage fueled by low interest rates, and binging on risky trades blew up in their faces. Freezing their lending to businesses and individuals alike caused vast portion of the nation’s business activity to grind to a halt, leading to the Great Recession.

The Financial Meltdown of 2008 was one of the most critical events in American history, a biblical-style plague tanked the stock market by nearly 60 percent in the fall of 2008, killing off other financial and credit markets in the process. Banks and firms either vanished into bankruptcy or had to be rescued by taxpayers. The financial system nearly collapsed, triggering an economic crisis.

The deepest recession in decades wiped out some $11 trillion of wealth and vaporized more than eight million American jobs by September 2009. It froze up the nation’s vast financial credit system, leaving many firms without enough cash to operate. It forced the Federal government to spend $2.8 trillion and commit another $8.2 trillion in taxpayer funds to bail out crippled corporations like General Motors, Chrysler, Citigroup, AIG and a host of other too-big-to-fail private institutions.

In addition to their jobs, it cost millions of Americans their homes, life savings, and hopes for a decent retirement. These Americans were in no position to invest in stocks and benefit from the subsequent run-up in the stock market. By contrast, the wealthy have gotten even richer.

This was a cataclysm far worse than any natural disaster the nation has experienced, and its ripples continue to be felt today.

Originally Published: March 29, 2019.

2008 recession is anything but ancient history

If you think you have heard it all before about the 2008 financial meltdown, then you need to listen more closely. Enough is never enough when it comes to learning about what caused the crisis and the recession that followed.

This month marks the 10th anniversary of the financial crisis that devastated Wall Street and Main Street. While the autumn leaves were falling in September 2008, months of uncertainty crystallized to spark a financial panic.

The crisis, the worst financial downturn since the Great Depression, was triggered by the bursting of a housing price bubble that had been fueled by increased risk in mortgage lending. As a result, millions of Americans lost their jobs, homes, or both.

The crisis had many causes, including too much irresponsible borrowing, foolish investments, the credit bubble that resulted from loose monetary policy, the housing bubble, national housing policies and non-traditional mortgages, relaxed mortgage lending standards, credit ratings and securitization, financial institutions’ concentrated risk, leverage and liquidity risk, 30 years of deregulation, securities firms converting from partnerships to corporations and perverse compensation incentives.

Scratch the familiar refrain of greed as a cause. Greed has been a constant in human affairs for millennia. It was not a new attribute in the lead up to the crisis.

Today the economy is strong, according to official measures. The United States Bureau of Economic Analysis estimates that GDP growth reached 4.1 percent in the second quarter of 2018. Consumer confidence is high and financial markets are flirting with records. The housing market, the epicenter of the crisis, has recovered in many places. Add low unemployment and things are looking good.

Wall Street has profited every year since the recession ended in 2009. Average Wall Street compensation, consisting of salary and bonus, hit $422,000 in 2017, 13 percent higher than the previous year, according to the New York State Comptroller.

In contrast, the latest Census Bureau data shows that the median income for American employees was $59,039 in 2016. Last month the average hourly wage rose 10 cents, to $27.16, according to the Bureau of Labor Statistics. While that was the largest gain since 2009, the increase was roughly equal to inflation, which eats away at purchasing power.

The crisis strikes some people as ancient history. Others, who saw their net worth wiped out are still trying to recover. They want Old Testament justice for the financial institutions that got bailed out from their reckless behavior while ordinary people suffered and continue to tread water thanks to ongoing wage stagnation. The hope is that as it gets hard to fill jobs with the country approaching full employment, wages will go up and the average American will enjoy the recovery.

While many analysts hesitate to blame American families for contributing to the financial crisis, they did play a role, aided and abetted by bankers and mortgage brokers. To put their role in context, consider that highly risky mortgages were attractive, given that real wages in the United States had been stagnant since the early 1970s.

People came to understand the power of leverage, which had previously been available only to wealthy investors. No-down payment mortgages with adjustable rates reduced their initial costs, providing the opportunity to improve their standard of living and enjoy wealth appreciation.

The assumption was that housing prices always increase. The rising value of the house would allow them to refinance and upgrade to a fixed-rate mortgage. When the housing bubble burst, many families were ravaged.

An economy that is strong for some continues to have harmful effects on the physical and emotional health of ordinary Americans. The results are a permanent state of outraged class warfare, declining social mobility, a shrinking middle class, and widening income inequality.

There is much to be mad about and plenty of blame to go around. Wall Street was the ultimate beneficiary of the Great Recession, not Main Street.

Originally Published: September 23, 2018

Too big to jail

Sept. 15 is the 10th anniversary of Lehman Brothers declaring bankruptcy. It was a day after the global money markets seized up, turning a worldwide daisy chain of financial institutions into a ticking bomb. In the wake of the bankruptcy, it seemed likely that the United States financial system as a whole would cease to operate, a financial blackout that would render paychecks, credit cards, and ATMs useless.

Lenders, including large companies, financial institutions, and money market funds, suddenly hoarded cash in the face of growing losses and threats to their own sources of credit. They no longer knew which borrower was a good risk, so they treated all of them as bad risks.

The world experienced the worst financial crisis since the Great Depression of the 1930s and the economy plunged into deep recession. The Federal Reserve and Treasury Department misjudged the scale of the fallout from Lehman’s bankruptcy.

The failure of Lehman Brothers started a chain reaction in financial markets, as it was the first true test of the “too big to fail” hypothesis. Whereas Bear Stearns was sold to JP Morgan in March 2008, Lehman failed to find a buyer in time. The federal government refused to provide financial assistance and the company was forced into bankruptcy. Lehman was the fourth largest investment bank, and its failure sent huge waves across global financial markets. Market volatility peaked, and for some time it seemed that no bank was safe.

Merrill Lynch, the third-largest investment bank, rushed to sell itself to Bank of America that same weekend. Even Goldman Sachs and Morgan Stanley felt the shock and quickly tried to raise capital. The Federal Reserve allowed those two banks to change their charters and become bank holding companies which facilitated their funding via the discount window at the Federal Reserve.

On September 16, the federal government rushed forward with an initial $85 billion in taxpayer cash to bail out AIG, the nation’s largest insurance company. The very next day the nation’s largest money market fund was forced to “break the buck”, that is, report a share value of less than a dollar. The firm’s stake in debt securities issued by Lehman Brothers, with a face value of $785, million was essentially worthless. As a result, the share value fell to 97 cents. (Gasp.)

In the biggest bank failure in United States history, federal regulators seized the assets of Washington Mutual, the sixth largest U.S. bank, on September 27. JP Morgan acquired Washington Mutual’s bank deposits, assets, and their troubled mortgage portfolio from the Federal Deposit Insurance Corporation for $1.9 billion, making it the largest U.S. depository institution.

The crash brought together many forces: stagnant wages, widening inequality, anger about immigration and, above all, a deep distrust of elites and government. The road to recovery has been long for ordinary workers since those white-knuckle days of September 2008, resulting in a wave of nationalism, protectionism, and populism.

The ordinary American scraped by in the aftermath of the crisis, while Wall Street bankers soon returned to wealth and profitability, continuing their well-upholstered lives. The bankers were able to avoid accountability for the financial institutions they ran crashing the economy by trading trillions in fraudulent securities tied to risky or even certain-to-fail mortgages. No senior executive ever had to plea to criminal charges.

Policymakers and prosecutors took the view that prosecuting senior bank executives would cause too much collateral damage to employees, customers, other banks, and the economy. In 2013, then-Attorney General Eric Holder told the Senate Judiciary Committee that he was “concerned that the size of some of these (financial institutions) becomes so large that it… become[s] difficult… to prosecute them when we are hit with indications that… if you do bring a criminal charge, it will have a negative impact on the national economy, perhaps even the world economy.”

In short, they were too big to jail.

Originally Published: September 8, 2018

For big banks, crime pays

Last month federal authorities fined three European banks and arrested eight traders they say tried to manipulate the market in gold, silver, and certain financial products. This allegedly included a practice called “spoofing,” or placing thousands of bids to buy or sell a stock for the sole purpose of moving the stock. The orders are then quickly cancelled.

As usual, the case against Deutsche Bank, HSBA, and UBS was settled for a total of $46.6 million in fines without any of them admitting guilt. The money comes from shareholders, not individual bankers.

While the full extent of the wrongdoing is unknown, these and others of the world’s largest banks have broken the law over and over again, settling with the government each time. Fines don’t deter big banks, which are still out of control almost nine years after the financial crash.

The shameful legacy of the 2008 financial crisis continues. If a bank is “too big to fail,” the worst thing that will befall its senior executives is a comparatively minor fine that will be paid with shareholders’ money.

The 2008 financial crisis devastated the global economy and cost American workers their jobs and homes. After the financial meltdown and subsequent Great Recession, the government did not charge any top bankers or pursue corporate prosecutions for the widespread malfeasance and mortgage fraud that fueled the bubble and led to the crisis.

Some believe bankers control the government. Others believe the banks did nothing wrong. Still others believe there was insufficient evidence to prove beyond a reasonable doubt that any specific individual committed a crime.

Then there are those who believe that prosecuting big banks will result in “collateral consequences” to financial markets and the economy. They argue that too-big-to-fail banks had to be rescued by the government to stave off total economic collapse and this should be considered in deciding whether to file charges. The latter view has prevailed, with the government settling for cash rather than seeking prison sentences. Softball tactics.

In addition to being paid for by shareholders, the settlements lack transparency. They are sealed. The government does not spell out what the company did wrong or how the amount of the fine was determined. How can the public ever know how tough the government really was?

This was not always the case. After the savings and loan scandals of the 1980s, when hundreds of banks failed due to reckless real estate loans, the Department of Justice prosecuted and convicted over a thousand bankers for their transgressions.

But if you are a small family owned bank in Chinatown that’s a different story.

Abacus Federal Saving Bank a small Chinatown-based bank wedged between two noodle shops and catering to poor immigrants in New York, New Jersey and Connecticut – along with 19 of its former employees were charged by the Manhattan District Attorney in a massive mortgage fraud scheme. It was the only bank indicted for mortgage fraud related to the 2008 financial crisis. The 240-count indictment handed down in 2012 claimed that the bankers allegedly falsified loan applications to secure hundreds of millions of dollars in loans for unqualified borrowers through the Federal National Mortgage Association, known as Fannie Mae.

At the time, Abacus was the nation’s 2,651st largest bank with about $300 million in assets. During the trial, it was learned that the bank’s default rate was 0.3 percent during the period covered by the indictment, from May 2005 to February 2010, far below the national average.

After a four-month trial in 2015 that cost the bank more than $10 million, a jury found Abacus and its senior officers not guilty of grand larceny, conspiracy, falsifying business records, mortgage fraud and other charges.

You don’t have to be Sherlock Homes to conclude big banks get away with their crimes for a pittance. No one goes to jail and no one ever gets prosecuted. The fines are just a cost of doing business.

Originally Published: Feb 17, 2018

Hold Wall Street managers to account

At 1:45 a.m. on Monday, Sept. 15, 2008, Lehman Brothers Holdings Inc., the fourth largest investment bank, sought Chapter 11 protection in the biggest bankruptcy proceeding ever filed. There are many reasons why Lehman failed and responsibility is shared by auditors, government officials, regulators, and credit rating agencies.

Looking back, much of the blame for Lehman’s failure and the ensuing financial meltdown that led to the Great Recession resided with senior executives, aka professional managers, in the financial markets who did a poor job of allocating capital and managing risk. They acted less like stewards of their firms and more like the keepers of a guild, accountable only to themselves and focused on short-term results at the expense of long-term performance.

The failure to understand that there are huge risks associated with the pursuit of high returns was a major contributor to the financial meltdown. One way to avoid repeating this disaster would be to require top managers in industries that are important to the public welfare to earn government licenses that testify to their qualifications, just like physicians and lawyers, who must pass tough state exams, and accountants, who must also demonstrate a certain number of years of successful professional work in their field to gain a certified public accountant license.

Why not have the same rigorous licensing requirements for professional managers before they are permitted to hold top management jobs in critical industries and public-sector positions? It has become clear that the challenges of managing large organizations have grown to such a level of complexity that only individuals with the right mix of skills can effectively meet them.

One way to begin professionalizing management is to require anyone graduating with a management degree to pass a comprehensive federal or state exam that tests their mastery of the fundamental body of knowledge they allegedly learned, including accounting, finance, statistics, data analysis and organizational behavior.

During the financial meltdown, Lehman’s top executives could have by no means been described as competent. Ditto for Merrill Lynch, AIG, and so many other firms. Finding incompetent executives among this crowd was like finding sand on the beach; they were clueless to the real dangers of excessive risk taking in the form of the lack of protective equity capital and massive use of leverage built around short-term borrowings.

Despite earning more than managers in any of the world’s other major industries, they were like irresponsible children who had somehow gained access to Cold War missile control rooms, playing with the shiny buttons that could launch nuclear warheads against an unsuspecting world.

Which they ultimately did, wiping out more than $11 trillion of wealth in the process and leaving the American taxpayer to clean up the mess.

In addition to core technical skills, a management licensure test should measure the ability to think critically and consider the moral consequences of decisions. Is it too much to expect a management graduate to be educated about how to leverage the power of markets to create a better world rather than serving only their own selfish interests? Or to possess the ability to think critically, which allows them to solve problems beyond those addressed by their functional training?

For sure, such an examination would increase employers’ faith in a graduates’ competence. It might be wise to make passing the test a periodic requirement to ensure that managers stay current in their knowledge and the ethical challenges posed by an ever-changing business world.

To paraphrase the philosopher George Santayana: those who fail to learn from history are destined to repeat it. The incompetence of senior managers was a driving force behind the 2008 financial meltdown from which many Americans still have not recovered nearly a decade later. The time has come to hold managers to the same standards as other professionals whose competence impacts the well-being of society.

Originally published: September 16, 2017

Too big to jail

The war on drugs is back in fashion. The Justice Department announced a tough new stance that requires prosecutors to pursue the highest charges possible, including those that carry mandatory minimum sentences, for low-level drug users and distributors as the United States continues to supersize the modern prison complex.

But you could combine every gang banger selling crack on a corner in America and they couldn’t generate as much ill-gotten cash as the bankers who engaged in the widespread malfeasance that led to the 2008 financial crisis, which triggered the worst economic crisis since the 1930s.

Despite the gravity – and depravity – of their actions, the number of top Wall Street executives who were prosecuted for fraud related to the financial meltdown is exactly zero, even though they cost millions of Americans their jobs, homes, life savings, and hopes for a decent retirement, and forced the government to hit up those very people to pay for the bailout that saved the country from a financial apocalypse of truly biblical proportions.

Hard to believe, but the truth often is. Meanwhile, the ordinary American is still dealing with the consequences of the financial meltdown; scoring, hustling and struggling to make it in America.

There are many reasons no bankers were jailed, including the complexity of the cases and lack of criminal referrals from regulatory agencies. Prosecutors didn’t want to put executives of “too big to fail” banks in prison, often because they feared that indicting the executives would drive their firms out of business, eliminating jobs and causing serious problems for financial markets and the economy.

In addition, the argument goes that investigating top executives of large firms is difficult because they insulate themselves from day-to- day decision making. In the end, the Department of Justice choked in the clutch. The ordinary American catches the joke that doing the right thing is always harder than simply doing what’s convenient. You would be right to conclude that Lady Justice is blind because she can’t stand to watch what’s happening on the ground.

Those responsible for indicting and prosecuting Wall Street executives seemed to believe that just as there are banks that are too big to fail, there are also people who are “too big to jail”. Instead of targeting individual corporate executives with trial and imprisonment, they almost exclusively settled with corporations for money. Corporate settlements were easier than identifying and prosecuting culpable top executives. Firms could pay the settlements with shareholders’ money; it’s even easier than locking up someone for dealing drugs on a street corner.

It shouldn’t be overlooked that too many in the political elite shill for the top bankers, who come bearing large campaign contributions in both hands. As Illinois Senator Richard Durbin said in 2009, “they own this place”.

More than a century ago, President Theodore Roosevelt noted that concentrated economic power tends to capture political power, which undermines democracy. After 2008, the financial crimes committed with impunity gave rise to a tsunami of anger that washed away normal inhibitions and unleashed the Tea Party and Occupy Wall Street.

Wall Street still exerts inordinate influence over the economy, inequality is near all-time highs and, for the majority of Americans, economic opportunity is close to an all-time low. We send some gangbanger from the hood to prison, but the United States appears to have reached the point where government is afraid to prosecute a Wall Street executive for stealing millions, crashing the economy and wreaking havoc upon millions of people.

A more aggressive response followed the savings and loan crisis of the 1980s and 90s, when hundreds of small banks across the country failed due to reckless real estate loans. Back then the Department of Justice prosecuted over 1,000 people, including top executives at many of the largest failed banks.

These episodes bring to mind Honoré de Balzac’s provocative and memorable line: “Behind every great fortune lies a great crime.”

Originally published: August 5, 2017

Fraud just another way bankers operate

Once upon a time, the “F” word (fraud) was in vogue when dealing with the U.S. banking community. After the savings and loan scandals of the 1980s, more than 1,100 bankers were prosecuted on felony charges and over 800 sent to prison for white-collar crimes, including top executives at many of the largest failed banks. By throwing the savings and loan bankers in jail, the federal government sent a message: if you rip people off, you will pay for it.

No more. The federal government’s response to the 2008 financial crisis couldn’t have been more unlike what it did in the wake of the savings and loan crisis. The Justice Department has taken the position that these cases are too hard to win and the size of some large banks makes it difficult to bring criminal charges against them because they threaten a bank’s existence, which would endanger the economy. This collateral consequences approach basically gives too-big-to-fail banks and their senior executives a get-out-of-jail-free card.

After the man-made 2008 financial meltdown that left millions of Americans jobless and led to a $700 billion taxpayer bailout that dwarfed the savings and loan crisis, not one Wall Street executive went to jail for the events leading up to the crisis.

There were no high-profile big banker prosecutions for the widespread mortgage fraud and financial chicanery that fueled the bubble. These bankers were too big to jail.

Sure, there were prosecutions of small fish like mortgage brokers and loan officers, which is fine if you believe the fraud took place at the bottom of the food chain.

There were billions of dollars in civil settlements but no serious criminal prosecutions.

The notion of accountability is becoming an endangered species. Regulators still treat the banking industry with velvet gloves. Standard fare involves a firm paying a big fine with shareholder money and treating it as a corporate expense that in certain cases is tax deductible. The company promises never to commit such a crime again and in the final analysis it is just a cost of doing business.

For example, Wells Fargo got its rear-end in a sling when it was revealed that since 2011, thousands of employees secretly opened more than two million bogus bank and credit card accounts using unauthorized customer names and signatures.

The fraud was so common that employees had a name for it: sandbagging. The firm fired 5,300 employees involved in the scandal who were trying to hit steep sales targets and refunded $2.6 million in customer fees.

Here again, the government got its pound of flesh in fines rather than by prosecuting wrongdoers. WFC was fined $100 million by the federal Consumer Financial Protection Bureau, $35 million by the Office of the Comptroller of the Currency, and $50 million by the city and county of Los Angeles. The $185 million total amounts to three days of profit for the bank. Last week the California attorney general’s office announced it is conducting a criminal investigation into whether employees at San Francisco-based Wells Fargo committed identity theft in violation of state law during the sales practice scandal.

Also, the U.S. Department of Labor is promising a “top-to-bottom” review of the firm.

It is unclear whether the investigation will focus on employees at the bottom of the food chain or senior executives, the banking industry’s untouchables. But if recent history is any guide, the biggest fish face little risk of prosecution. They may have created the cross-selling practices but were not the ones creating the fake accounts.

There is no mystery here as the American public continues to watch ordinary citizens turned into a veritable basket of deplorables and jailed for minor offenses while the most powerful walk away unpunished and with complete impunity.

As Cassius says in “Julius Caesar,” “The fault, dear Brutus, is not in our stars, but in ourselves.”

Originally Published: Oct 30, 2016

AIG’s $180 billion bailout still stings


Eight years ago this month the global financial system seemed on the verge of collapse, and its rescue led to the greatest depredation on the public purse in American history. There were many crucial events during the month of the long knives, but no corporation was more central to the mess than AIG.

On Sept. 7, 2008, the federal government took control of Freddie Mac and Fannie Mae and injected $100 billion to ensure the troubled mortgage lenders could pay their debts. On September 15, Lehman Brothers announced it would file for Chapter 11 bankruptcy and Bank of America acquired Merrill Lynch for $50 billion.

Then, in the biggest bank failure in U.S. history, the Federal Deposit Insurance Corporation (FDIC) seized the assets of Washington Mutual, the sixth largest U.S. bank, and JPMorgan acquired the bank’s deposits, assets, and troubled mortgage portfolio from the FDIC. On Sept. 21, the Federal Reserve approved Morgan Stanley and Goldman Sachs transition to commercial banks.

While many blamed the investment banks for high leverage, bad risk management and overreliance on faulty internal models, not to be overlooked is the role AIG, the nation’s largest insurance company, played in the crisis. AIG was once one of the largest and most profitable companies in corporate America, with a gold-plated “AAA” credit rating.

But on September 16, the federal government provided an initial $85 billion in taxpayer cash to bail out the firm. In return, AIG became a ward of Uncle Sam, which acquired 79.9 percent ownership of the company. This was only the first of four bailouts for AIG, totaling an estimated $180 billion.

AIG was in worse shape than Lehman Brothers had been. Yet unlike Lehman, the feds chose to save it. The explanation: AIG was regarded as too big, too global, and too interconnected to fail.

After the 1999 repeal of Glass-Steagall, the law that had regulated financial markets for over six decades, President Clinton signed the Commodity Futures Modernization Act (CFMA) in 2000, which effectively removed derivatives such as Credit Default Swaps (CDS) from federal and state regulation, proving once again that regulators exist to protect the interests of the regulated.

CDS are essentially a bet on whether a company will default on its bonds and loans. AIG was a huge player in the CDS business, which allowed the firm to insure asset-based securities containing sub-prime mortgages against default.

Although swaps behave similarly to insurance policies, they were not covered by the same regulations as insurance after passage of the CFMA. When an insurance company sells a policy, it is required to set aside a reserve in case of a loss on the insured object. But since credit default swaps were not classified as insurance contracts, there was no such requirement.

AIG’s CDS business caused it serious financial difficulties in 2007, when the housing bubble burst, home values dropped and holders of sub-prime mortgages defaulted on their loans. By selling these contracts without reserves, the firm left itself unprotected if the assets insured by the swaps defaulted. AIG had insured bonds whose repayments were dependent on sub-prime mortgage payments. Yet it never bothered to put money aside to pay claims, leaving the company without sufficient resources to make good on the insurance.

Taxpayers stepped in to pay in full the dozens of banks whose financial products were insured with AIG swaps. Unlike in corporate bankruptcies, none of these counterparties were forced to take a haircut, requiring the government to pump more public money into the banks.

To add insult to injury, two weeks after the government provided its fourth bailout to AIG in 2009, it was revealed that the firm was paying $165 million in bonuses to retain key employees to unwind the toxic financial waste. Most people understand that if you go to government for a handout, executives should forgo bonuses. Then again, so much of what happened eight years ago this month defied common sense.

Originally Published: Sep 16, 2016.

The merger that hurt

Why the demise of Glass-Steagall helped trigger the 2008 financial meltdown that cost millions of Americans their jobs, homes and savings

This month is the eighth anniversary of the all-enveloping 2008 financial crisis. Wall Street apologists and many of their Washington, D.C., acolytes argue there is zero evidence that the takedown of the Glass-Steagall Act had anything to do with the meltdown, but the assertion ignores the role the rule of unintended consequences played in the crisis.

Glass-Steagall was enacted during the Great Depression to separate Main Street from Wall Street, creating a firewall between consumer-oriented commercial banks and riskier, more speculative investment banks. During the six-plus decades the law was in effect, there were few large bank failures and no financial panics comparable to what happened in 2008.

In the 1980s, Sandy Weil, one of the godfathers of modem finance, began acquiring control of various banks, insurance companies, brokerage firms and similar financial institutions. These were cobbled together into a conglomerate under the umbrella of a publicly traded insurance company known as Travelers Group.

In 1998 Weil proposed a $70 billion merger with Citicorp, America’s second-largest commercial bank. It would be the biggest corporate merger in American history and create the world’s largest one-stop financial services institution.

Touting the need to remain competitive in a globalized industry and customers’ desire for a “one-stop shop” (a supermarket bank), both companies lobbied hard for regulatory approval of the merger. Advocates argued that customers preferred to do all their business -life insurance, credit cards, mortgages, retail brokerage, retirement planning, checking accounts, commercial banking, and securities underwriting and trading -with one financial institution.

But the merger’s one-stop-shopping approach would make a mockery of the Glass-Steagall firewall. The proposed transaction violated its prohibition of combining a depository institution, such as a bank holding company, with other financial companies, such as investment banks and brokerage houses.

Citigroup successfully obtained a temporary waiver for the violation, then intensified decades-old efforts to eliminate the last vestige of depression-era financial market regulation so it could complete themerger. A Republican Congress passed the Financial Services Modernization Act and President Clinton signed it in November 1999. It permitted insurance companies, investment banks, and commercial banks to combine and compete across products and markets, hammering the final nail into the coffin of Glass­ Steagall.

Now liberated, the banking industry embarked upon a decade of concentrating financial power in fewer and fewer hands. Acquisitions of investment banks by commercial banks, such as FleetBoston buying Robertson Stephens and Bank of America buying Montgomery Securities, became commonplace.

Traditional investment banks suddenly faced competition from publicly traded commercial banks with huge reserves of federally insured deposits. The investment banks faced pressure to deliver returns on equity comparable to those of the new financial supermarkets, which also put competitive pressure on traditional investment banking businesses such as mergers and acquisitions, underwriting, and sales and trading.

In response, the investment banks sought to raise their leverage limits so they could borrow more money to engage in proprietary, speculative trading activities. In 2005 they convinced the Securities Exchange Commission to abolish the “net capital” rule that restricted the amount of debt these firms could take from 12-1 to 30-1, meaning the banks could borrow 30 dollars for every dollar of equity they held.

By 2008, increased leverage and speculation on toxic assets would ravage investment banking, leading to the collapse, merger, or restructuring of all five major Wall Street investment banks. During a six­ month period, Bear Stearns collapsed into the arms of JP Morgan, Lehman Brothers filed for bankruptcy protection, Merrill Lynch merged into Bank of America, and Goldman Sachs and Morgan Stanley converted to bank holding companies, giving them access to precious short-term funds from the Federal Reserve’s discount window.

The demise of Glass-Steagall may not have been at the heart of the 2008 financial crisis but it certainly contributed to the lunacy of financial deregulation. Had the law not been neutered, it would have lessened the depth and breath of the crisis that cost millions of Americans their jobs, homes and savings.

Originally Published: Sep 3, 2016

The repeal of a Depression-era banking law and the economic crash of 2008

The causes of the 2008 financial crisis are multiple and complicated. Minor deities of finance and even presidential candidates such as Bernie Sanders argue over whether the repeal of the longstanding Glass­ Steagall Act laid the groundwork for the financial meltdown. Those who don’t think it did overlook one major unintended consequence of repealing Glass Steagall: the excessive use of leverage.

After the 1929 stock market crash and the onset of the Great Depression, Congress passed the iconic Glass-Steagall Act in 1933 to help ensure safer banking practices and restore faith in the financial system. Before the Great Depression, banks had engaged in imprudent stock speculation. In addition to their traditional staid banking services such as taking in deposits and making loans, they also used depositor’s funds to engage in high-stakes gambling on Wall Street.

The act was passed to halt a wave of bank failures and rein in the excesses that contributed to the 1929 Crash. Among other things, Glass-Steagall separated the more stable consumer-oriented commercial banking from riskier investment banking and set up the bank deposit insurance system to protect small savers against bank failures. The business of accepting deposits and making loans was to be kept separate from underwriting and peddling stocks, bonds, and other securities.

The movement to deregulate the American economy began in the 1970s. It spread to air travel, railroads, electric power, telephone service and other industries, including banking. The sustained bull market of the 1990s supported arguments that financial markets could regulate themselves, and bankers lobbied Congress to further emancipate the financial sector.

Citigroup forced Congress’s hand in 1998 when the firm announced it would join forces with the Traveler’s Group in a corporate merger. The $70 billion deal would bring together America’s second largest commercial bank with a sprawling financial conglomerate that offered banking, insurance, and brokerage services. The proposed transaction violated portions of the Glass-Steagall Act, but Citigroup obtained a temporary waiver, completed the merger, and then intensified the decades-old effort to repeal Glass-Steagall.

Just a year earlier, Travelers had become the country’s third largest brokerage house with its acquisition of the investment banking firm Salomon Brothers. Touting the pressures of technological change, diversification, globalization of the banking industry, and both individual and corporate customers’ desire for a “one-stop shop” -a financial supermarket- both firms lobbied hard for approval of the merger.

In 1999 a Republican Congress passed and a Democratic President signed the Gramm-Leach-Bliley Act, essentially repealing Glass-Steagall and removing regulatory barriers between commercial banks, investment banks, and insurers.

Advocates of the universal bank model argued that customers preferred to do all their business – life insurance, retail brokerage, retirement planning, checking accounts, mergers and acquisition advisory, underwriting, and commercial banking lending -with one financial institution.

The universal bank created an uphill battle for the major investment banks like Lehman Brothers and Bear Steams. For example, it was believed that the investment banking arms of universal banks would move into the lucrative securities underwriting business, using loans as bait to get the inside track on underwriting engagements, essentially using depositors’ money to drive investment banking fees.

As public companies, these investment banking firms faced pressure to deliver returns on equity comparable to that of the universal banks. To stay competitive,  they resorted to excessive leverage or borrowing to juice their returns.

In 2004 they received approval from the Securities Exchange Commission to increase their leverage from 12-1 to better than 30-1. The numbers were indeed worrisome. For instance, Bear Steams was leveraged 33 to 1 and before crashing in September 2008 Lehman Brothers had a 35 to 1 leverage ratio, meaning they borrowed 35 dollars for every dollar of capital.

By the winter of 2008, excessive leverage would ravage the investment banking industry, leading to the downfall, merger, or restructuring of all major investment bank firms and unleashing a global recession. And the American taxpayer would learn that free markets are not free.

Originally published: April 30, 2016