Today, President Obama went to Wall Street and gave a speech at Federal Hall. Below I present key sections of the speech an my reaction to them. The full speech can be accessed here.
“It was one year ago today that we experienced just such a crisis. As investors and pension-holders watched with dread and dismay, and after a series of emergency meetings often conducted in the dead of the night, several of the world’s largest and oldest financial institutions had fallen, either bankrupt, bought or bailed out: Lehman Brothers, Merrill Lynch, AIG (AIG), Washington Mutual, Wachovia. A week before this began, Fannie Mae (FNM) and Freddie Mac (FRE) had been taken over by the government. Other large firms teetered on the brink of insolvency. Credit markets froze as banks refused to lend not only to families and businesses, but to one another. Five trillion dollars of Americans’ household wealth evaporated in the span of just three months. That was just one year ago.”
What a difference a year makes.
“Congress and the previous administration took difficult but necessary action in the days and months that followed. Nonetheless, when this administration walked through the door in January, the situation remained urgent. The markets had fallen sharply; credit was not flowing. It was feared that the largest banks — those that remained standing — had too little capital and far too much exposure to risky loans. And the consequences had spread far beyond the streets of lower Manhattan. This was no longer just a financial crisis; it had become a full-blown economic crisis, with home prices sinking and businesses struggling to access affordable credit, and the economy shedding an average of 700,000 jobs every single month.”
We have managed to stabilize the situation at least on Wall Street. The stock market is almost back to where it was just before the demise of Lehman Brothers. However, the pain on Main Street continues.
“We could not separate what was happening in the corridors of our financial institutions from what was happening on the factory floors and around the kitchen tables. Home foreclosures linked those who took out home loans and those who repackaged those loans as securities. A lack of access to affordable credit threatened the health of large firms and small businesses, as well as all those whose jobs depended on them. And a weakened financial system weakened the broader economy, which in turn further weakened the financial system.”
He makes a very important point here about the vicious cycle that we were in, it is fairly remarkable that we were able to break that cycle, wheather or not it has been replaced with a virtuous cycle is still an open question, however.
“So the only way to address successfully any of these challenges was to address them together. And this administration, under the outstanding leadership of Tim Geithner and Christy Romer and Larry Summers and others, moved quickly on all fronts, initializing …a financial stability plan to rescue the system from the crisis and restart lending for all those affected by the crisis. By opening and examining the books of large financial firms, we helped restore the availability of two things that had been in short supply: capital and confidence. By taking aggressive and innovative steps in credit markets, we spurred lending not just to banks, but to folks looking to buy homes or cars, take out student loans or finance small businesses. Our home ownership plan has helped responsible homeowners refinance to stem the tide of lost homes and lost home values.”
I’m not really sure that the confidence is warranted — a big part of the improvement in the financial statements of the banks has been due to accounting games, most notably the suspension of mark-to-market accounting. What is more important: reality or the appearance of reality? Often on Wall Street the answer is the latter. The home ownership plan has helped only a small fraction of those in need, but it’s a start.
“And the recovery plan is providing help to the unemployed and tax relief for working families, all the while spurring consumer spending. It’s prevented layoffs of tens of thousands of teachers and police officers and other essential public servants. And thousands of recovery projects are underway all across America, including right here in New York City, putting people to work building wind turbines and solar panels, renovating schools and hospitals, repairing our nation’s roads and bridges.”
Most of the later part — the building of wind turbines, repairing roads and bridges — is still to come. The tax relief and the help to the unemployed kicked in much faster. For many of them, it is about to run out.
“Eight months later, the work of recovery continues. And though I will never be satisfied while people are out of work and our financial system is weakened, we can be confident that the storms of the past two years are beginning to break. In fact, while there continues to be a need for government involvement to stabilize the financial system, that necessity is waning. After months in which public dollars were flowing into our financial system, we’re finally beginning to see money flowing back to taxpayers. This doesn’t mean taxpayers will escape the worst financial crisis in decades entirely unscathed. But banks have repaid more than $70 billion, and in those cases where the government’s stakes have been sold completely, taxpayers have actually earned a 17 percent return on their investment. Just a few months ago, many experts from across the ideological spectrum feared that ensuring financial stability would require even more tax dollars. Instead, we’ve been able to eliminate a $250 billion reserve included in our budget because that fear has not been realized.”
The 17% return was nice, but given the risk that taxpayers were taking it really is not all that great. Now if we actually had someone who had the interests of the taxpayers at heart doing the negotiating, the returns would have been much higher and the deficit much lower. However, this does bear out an important point that was made durring the TARP debate — that these were investments, and not the same thing as an outright expenditure.
“While full recovery of the financial system will take a great deal more time and work, the growing stability resulting from these interventions means we’re beginning to return to normalcy. But here’s what I want to emphasize today: normalcy cannot lead to complacency.”
Seems like complacency is already setting in.
“Unfortunately, there are some in the financial industry who are misreading this moment. Instead of learning the lessons of Lehman and the crisis from which we’re still recovering, they’re choosing to ignore those lessons. I’m convinced they do so not just at their own peril, but at our nation’s. So I want everybody here to hear my words: we will not go back to the days of reckless behavior and unchecked excess that was at the heart of this crisis, where too many were motivated only by the appetite for quick kills and bloated bonuses. Those on Wall Street cannot resume taking risks without regard for consequences, and expect that next time, American taxpayers will be there to break their fall.”
Seems a little late — they are already taking such risks, and not really thinking about the consequences precisely because they expect that the taxpayers will pick up the pieces. This is known as moral hazard, or privatized profits and socialized costs. Aside from fewer competitors, how much has really changed on Wall Street? Not that much that I can tell.
“And that’s why we need strong rules of the road to guard against the kind of systemic risks that we’ve seen. And we have a responsibility to write and enforce these rules to protect consumers of financial products, to protect taxpayers and to protect our economy as a whole. Yes, there must — these rules must be developed in a way that doesn’t stifle innovation and enterprise. And I want to say very clearly here today, we want to work with the financial industry to achieve that end. But the old ways that led to this crisis cannot stand. And to the extent that some have so readily returned to them underscores the need for change and change now. History cannot be allowed to repeat itself.
“So what we’re calling for is for the financial industry to join us in a constructive effort to update the rules and regulatory structure to meet the challenges of this new century. That is what my administration seeks to do. We’ve sought ideas and input from industry leaders and policy experts, academics, consumer advocates and the broader public. And we’ve worked closely with leaders in the Senate and the House, including not only Barney (Frank), but also Senators Chris Dodd and Richard Shelby, and Barney is already working with his counterpart, Sheldon [sic] Bachus. And we intend to pass regulatory reform through Congress.”
The reforms that are being proposed are a nice, if extremely modest first step. Ideally they would be strengthened in Congress. That however, is not likely to happen. Instead, the bank lobby will sink its teeth into the legislation and gut it of all effectiveness. The administration will negotiate with itself in the hope of finding two or three “moderate” members of the opposition to support the reforms, while trying to hold on to the Blue Dogs and others who rely extensively on the Financial Sector for campaign funds. The net result will be fig leaf reform.
“And taken together, we’re proposing the most ambitious overhaul of the financial regulatory system since the Great Depression. But I want to emphasize that these reforms are rooted in a simple principle: we ought to set clear rules of the road that promote transparency and accountability. That’s how we’ll make certain that markets foster responsibility, not recklessness. That’s how we’ll make certain that markets reward those who compete honestly and vigorously within the system, instead of those who are trying to game the system.”
Well if he wants to promote transparency and accountability, a good place to start would be restoring mark-to-market rules for financial institutions. Instead, last spring, we had Congress effectively order FASB to let banks lie about their balance sheets.
“So let me outline specifically what we’re talking about. First, we’re proposing new rules to protect consumers and a new Consumer Financial Protection Agency to enforce those rules. (Applause.) This crisis was not just the result of decisions made by the mightiest of financial firms. It was also the result of decisions made by ordinary Americans to open credit cards and take on mortgages. And while there were many who took out loans they knew they couldn’t afford, there were also millions of Americans who signed contracts they didn’t fully understand offered by lenders who didn’t always tell the truth.”
The proposed CFPA is a vital part of the reform agenda, it is also the part that the banking lobby is gunning the hardest against. I hope it makes it through and actually has some power. My best guess is something called CFPA will end up being created, but it will be largely toothless. Also, it will be important to make sure that the people in charge of the agency are actually concerned about consumer protection. Given the history of regulatory capture, there is a good chance that at some point in the future, the head of that agency will be more concerned about bank profitability than consumer protection.
“Under existing rules, some companies can actually shop for the regulator of their choice — and others, like hedge funds, can operate outside of the regulatory system altogether. We’ve seen the development of financial instruments — like derivatives and credit default swaps — without anyone examining the risks, or regulating all of the players. And we’ve seen lenders profit by providing loans to borrowers who they knew would never repay, because the lender offloaded the loan and the consequences to somebody else. Those who refused to game the system are at a disadvantage.
“Now, one of the main reasons this crisis could take place is that many agencies and regulators were responsible for oversight of individual financial firms and their subsidiaries, but no one was responsible for protecting the system…as a whole. In other words, regulators were charged with seeing the trees, but not the forest. And even then, some firms that posed a ‘systemic risk’ were not regulated as strongly as others, exploiting loopholes in the system to take on greater risk with less scrutiny. As a result, the failure of one firm threatened the viability of many others. We were facing one of the largest financial crises in history, and those responsible for oversight were caught off guard and without the authority to act.”
Yes, regulatory shopping has to stop, and we need some referees on the field who are willing to throw penalty flags.
“And that’s why we’ll create clear accountability and responsibility for regulating large financial firms that pose a systemic risk. While holding the Federal Reserve fully accountable for regulation of the largest, most interconnected firms, we’ll create an oversight council to bring together regulators from across markets to share information, to identify gaps in regulation, and to tackle issues that don’t fit neatly into an organizational chart. We’ll also require these financial firms to meet stronger capital and liquidity requirements and observe greater constraints on their risky behavior. That’s one of the lessons of the past year. The only way to avoid a crisis of this magnitude is to ensure that large firms can’t take risks that threaten our entire financial system, and to make sure that they have the resources to weather even the worst of economic storms.”
A huge part of the problem is that the response to the “too big to fail” problem was to make the biggest institutions even bigger, as Bank of America (BAC) swallowed Countrywide and Merrill, J.P. Morgan (JPM) gobbled up Bear Stearns and Wells Fargo (WFC) snacked on Wachovia. Higher capital requirements across the board, and especially for the largest firms, would help provide more stability to the system. However, another approach that might work better would be some anti-trust type actions to break up the TBTF institutions into several smaller firms, so if one of them went under it would not be a big problem for the system.
“Even as we’ve proposed safeguards to make the failure of large and interconnected firms less likely, we’ve also created — proposed creating what’s called ‘resolution authority’ in the event that such a failure happens and poses a threat to the stability of the financial system This is intended to put an end to the idea that some firms are ‘too big to fail.’ For a market to function, those who invest and lend in that market must believe that their money is actually at risk. And the system as a whole isn’t safe until it is safe from the failure of any individual institution.”
We already have the resolution authority with respect to the banks; however, given the relative sizes of some of the banks that were in trouble and the FDIC, practically it meant that the FDIC could not do anything about some of the most troubled firms.
“There are those who would suggest that we must choose between markets unfettered by even the most modest of regulations, and markets weighed down by onerous regulations that suppress the spirit of enterprise and innovation. If there is one lesson we can learn from last year, it is that this is a false choice. Common-sense rules of the road don’t hinder the market, they make the market stronger. Indeed, they are essential to ensuring that our markets function fairly and freely.
“One year ago, we saw in stark relief how markets can spin out of control; how a lack of common-sense rules can lead to excess and abuse; how close we can come to the brink. One year later, it is incumbent upon us to put in place those reforms that will prevent this kind of crisis from ever happening again, reflecting painful but important lessons that we’ve learned, and that will help us move from a period of reckless irresponsibility, a period of crisis, to one of responsibility and prosperity. That’s what we must do. And I’m confident that’s what we will do.”
The reforms that Obama has proposed for the most part make sense, but are extremely modest in scope, and seem to contain many loopholes. The reforms put in place during the New Deal were far more far reaching. They were also extremely effective at preventing financial panics, at least until they were largely undone during the 1990’s. If we do not institute serious new regulations, of the type and scope of the New Deal reforms, it is not a question of IF we will have another market meltdown, it is just a question of WHEN.
Read the full analyst report on “AIG”
Read the full analyst report on “FNM”
Read the full analyst report on “FRE”
Read the full analyst report on “BAC”
Read the full analyst report on “JPM”
Read the full analyst report on “WFC”
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