In the fourth part of our series on the financial meltdown, we examine if the problems that led to a collapse have been solved.
Less than 24 hours after his swearing-in ceremony, US Treasury Secretary Timothy Geithner surprised Camden Fine with an invitation to a one-on-one meeting about the financial crisis.
"I about fell out of my chair," said Fine, president of the Independent Community Bankers of America, a Washington-based trade group with about 5000 members.
He was in a corner office overlooking the White House at the Treasury Department the next morning, telling Geithner that behemoths such as Citigroup and Bank of America were a menace, he said.
"They should be broken up and sold off," Fine, 58, said he declared, as Geithner scribbled notes before thanking him for his time and ushering him out into the January chill.
The Treasury Secretary didn't follow through on Fine's suggestion, just as he didn't act on the advice of former Federal Reserve Chairman Paul Volcker, or Federal Deposit Insurance Corp head Sheila Bair, or the dozens of economists and politicians who pressed the White House for measures that would limit the size or activities of US banks.
One year after the demise of Lehman Brothers Holdings paralysed the financial system, "mega-banks", as Fine's group calls them, are as interconnected and inscrutable as ever. The Obama administration's plan for a regulatory overhaul wouldn't force them to shrink or simplify their structure.
"We could have another Lehman Monday," Niall Ferguson, author of the 2008 book The Ascent of Money and a professor of history at Harvard University in Cambridge, Massachusetts, said in an interview.
"The system is essentially unchanged, except that post-Lehman, the survivors have 'too big to fail' tattooed on their chests."
After the deepest recession since the 1930s - the world's largest economy has shrunk 3.9 per cent since the second quarter of last year - and more than US$1.6 trillion ($2.3 trillion) in worldwide losses and writedowns by banks and insurers, President Barack Obama decided on a policy of containment rather than a structural transformation.
His proposal for revamping the way the US monitors and controls banks doesn't include taking apart institutions, supported by taxpayer loans, that have grown in scope and size since Lehman imploded.
The biggest, North Carolina-based Bank of America, had US$2.25 trillion in assets as of June, 31 per cent more than a year earlier, and about 12 per cent of all US deposits.
Instead, the Obama plan would label Bank of America, New York-based Citigroup and others as "systemically important".
It would subject them to capital and liquidity requirements and stricter oversight, relying on the same regulators who didn't understand the consequences of a Lehman failure. And while companies could be dismantled if they got into trouble, they, their creditors and shareholders could also be bailed out with taxpayer money, according to the plan.
The chief architects, Geithner, 48, and National Economic Council Director Lawrence Summers, 54, say they don't think it would be practical to outlaw banks of a certain size or limit trading activities by deposit-taking banks, according to people familiar with their thinking.
They said the two men, who declined to be interviewed, and others on Obama's team believe the lines are too fuzzy between banking and investing products and that forcing the divestiture of units and assets would create bedlam.
"It's a very difficult thing to say as a national policy goal that we're going to limit the success of an American firm," said Tony Fratto, a spokesman for President George W. Bush and former Treasury Secretary Henry Paulson who now heads a Washington consulting firm.
The lesson of September 15, 2008, is that limits may be necessary, according to Fine and other critics of the Government's regulatory proposals.
The President's fix is to empower the Fed to put the brakes on banks, hedge funds, insurers or other financial firms whose crash could have a crippling domino effect.
About 25 companies may qualify based on their assets and on factors such as funding relationships, Fed Chairman Ben Bernanke told the House Financial Services Committee on July 24.
A Financial Services Oversight Council - made up of the heads of the FDIC, the Securities and Exchange Commission, the Commodity Futures Trading Commission and other agencies - would advise the Fed on potential threats.
The Treasury would be able to take over and wind down financial institutions with an authority modelled on powers held by the FDIC, which guarantees deposits and can close and sell failing banks under its jurisdiction. A Consumer Financial Protection Agency could restrict what it viewed as unsuitable products for Americans.
The existence of such a regulatory framework might have averted Lehman's chaotic end because cheap money wouldn't have been allowed to inflate a real estate bubble with questionable mortgages and mortgage derivatives, according to Austan Goolsbee, a member of the President's Council of Economic Advisers.
"One of the fundamental principles of the plan is that if you're menacing to the system, someone is going to regulate you very closely," said Goolsbee. As much as it might mitigate some risks, the Obama strategy is fatally flawed because it fails to force the largest banks to change their behaviour, says Simon Johnson, a former IMF chief economist who is now a professor for finance at the Massachusetts Institute of Technology in Cambridge.
"The biggest problem is it doesn't deal with too-big-to-fail," Johnson said. "It doesn't say anything ... You have to make things a lot smaller."
Volcker, the 82-year-old head of the President's Economic Recovery Advisory Board, would subject money market funds to the same regulatory burdens as banks, demanding they hold capital to protect against losses like those suffered by the Reserve Primary Fund when Lehman's bankruptcy touched off a run and more than 60 per cent of its assets were withdrawn in two days.
Another critical change, according to Volcker, would be to prohibit big, interconnected companies that handle essential services such as deposit-taking and business payments from making high-risk bets with their own money in so-called proprietary trading. Volcker also wouldn't allow non-financial firms to own government-insured deposit-taking companies.
Bair, the FDIC chairman, has taken a different tack: she wants to check growth by charging fees based on the risks banks take. If Lehman had to pay for its gambles, it might not have held US$84 billion in mortgage investments and loaded up on mortgage-backed securities in early 2008, after the subprime crisis began.
For the executives and government officials who met at the New York Fed the weekend before Lehman went bust last September, the right decisions weren't obvious.
Their focus was on mitigating damage from about one million over-the-counter derivatives trades that Lehman had participated in, according to people who attended the meetings.
The men and women in the room weren't prepared when panic struck the US$3.6 trillion money market industry, which provides short-term loans called commercial paper used by corporations such as General Electric to pay everyday bills.
Four US companies - Bank of America, JPMorgan Chase, Citigroup and San Francisco-based Wells Fargo, which bought Wachovia eight months ago - have grown to command 46 per cent of the assets of all FDIC-insured banks, up from 37.7 per cent a year ago.
New York-based Goldman Sachs Group, the world's biggest securities firm before converting to a bank seven days after Lehman went under, ratcheted up its trading risks to a record in the first six months of this year, leading to a 67 per cent jump in revenue from trading and principal investments over the same period last year.
"Nothing has changed except that we have larger players who are more powerful, who are more dependent on government capital and who are harder to regulate than they were to begin with," said Nomi Prins, who was a managing director at Goldman Sachs before leaving in 2002 and becoming a writer. "We're in a far less stable environment."
- BLOOMBERG
