Why money never learns on Wall Street

I f the size of Wall Street bonuses is a gauge of how much has changed since the banking crisis five years ago, then the financial sector has learned little from the calamitous mistakes that led to the crisis.

Even though 2008 was a disastrous year for Wall Street, executives still shared $18 billion in bonuses, the sixth largest annual bonus bonanza, although this figure was down from a staggering $32.9 billion in 2007.

Last year the figure stood at $20 billion, an average increase of 9 per cent on the previous year, according to the reports of the New York state comptroller who tracks the industry. So bonuses have started to rise again despite a massive reduction in the number of US financial jobs which were lost over the five-year crisis. The comptroller puts total job losses at 28,000, while just 8,500 new jobs have been created.

US lawmakers responded to the paralysing financial crisis caused by the failure of Lehman Brothers, the country's fourth largest investment bank, in September 2008 by introducing the Dodd-Frank act, legislation that ran to 2,300 pages overhauling the financial system to put manners on Wall Street.

Passed three years ago, the act puts the onus on the various US regulatory agencies to come up with ways to adopt the new rules. They are still far from being fully implemented, and Wall Street firms spend hundreds of million of dollars a year lobbying to water down the regulations.

"We are three years down the road here with Dodd-Frank and we are only a third of the way through with many of the hardest rules yet to be implemented," Daniel Gallagher, a Republican commissioner at the Securities and Exchange Commission, the US markets regulator, told The Irish Times in May.

The act's co-author, Barney Frank, a former congressman, regrets how slowly the regulations are being introduced, but says their onset is still a deterrent. The "single biggest cause" of the crisis – the sale of mortgages to people who could never have repaid them – has ended, he says.

“While the financial community is fighting against accepting full responsibility for what they did, and trying to blame others and resisting some of the changes, they were sufficiently chastened so people on the whole are not engaging in the kind of activities that they did before.”

Congress could not force prescriptive rules on regulators, Frank said, but had to give broad authority to financial supervisors because it would restrict the ability to regulate in the future.

“The more specifically you regulate something, the easier it is for clever people to evade that regulation by minor changes so you don’t give the regulators the power to progress,” he said.

He acknowledges that conservatives’ control of the court system in the District of Columbia where regulations are being challenged has made the court “a terrible opponent of regulation” but this was “a delaying factor, not a killing factor”.

Setback for regulations
The Republicans regaining the House of Representatives also caused a setback for the new regulations, he said, because they have starved funding to the Commodity Futures Trading Commission, which monitors the secretive and highly lucrative $600 trillion derivatives market for complex financial instruments that helped cause the worst financial crisis since the 1930s. Derivatives are contracts between two parties and have no intrinsic value; instead their value derives from the value of an underlying entity, such as an asset or interest rate.

Famously described by investor Warren Buffett as "financial weapons of mass destruction," derivatives helped to fell insurer American International Group and Lehman Brothers. An intense lobbying campaign has meant the commission, under the authority of the 2010 Dodd-Frank act, is only regulating less than a fifth of the global market for derivatives, says financial news agency Bloomberg.
Self-destructive streak
"Wall Street's attitude has not changed a bit which is unfortunate because it is self-destructive. What the banks have failed to come to grips with is – it is not a sustainable business model to continue to rip off your customers," said Lynn Stout, a professor of business law at Cornell University. "Eventually the customers disappear and the banks are finding their businesses disappearing. The people who are in charge of the banks right now are not thinking that long term. They are just thinking about getting their bonuses three months from now."

President Barack Obama has urged regulators to move faster to introduce the new rules following comments by his treasury secretary Jack Lew that the administration would look beyond the Dodd-Frank act if the dangers posed by "too-big-to-fail" banks were not confronted this year.

The four largest US banks, JP Morgan Chase, Bank of America, Citigroup and Wells Fargo, are bigger now than they were five years ago. This still leaves the US government in a position where it would be forced to act again if one failed.

John Thain, the chief executive of Merrill Lynch when the crisis struck, said last week there was less risk in the financial system now than five years ago, but that the biggest banks have grown even larger to the point where regulators couldn't handle another failure.

The key was to have “the mechanism to either merge or wind down or break into parts these financial institutions, but in a controlled way, and the mechanism to do that is not clear yet”.

“If you take one of those large firms, they are so big, they are so interconnected, they are such a part of the financial system that even today it would be hard to manage,” the banker warned.

In July financial regulators in Washington moved to strengthen the system against another too-big-to-fail calamity by unveiling a new rule that, if introduced, will force banks to double the capital they hold to protect against losses. Europeans have gone further, roughly quadrupling the minimum amount of capital financial institutions must hold from the pre-crisis level.

Curbing top bankers' pay
Frank defends how far his legislation went, saying it removed wide-ranging powers from the federal government to rush to the aid of a financial institution.

“The legislation does mean that if a large financial institution gets itself too heavily indebted to pay its debt, it will not be bailed out. Some of the debts may have to be paid but only after the institution is done away with.”

Lawmakers tried to empower shareholders to curb top banker pay, says Frank, but they chose not to act.

He still believes that changes to bank pay policy are a “work-in-progress” and that regulators will devise rules where bankers are penalised for mistakes, just as they are rewarded for successes.

Five years on from the worst financial crisis in generations, there is still much work to be done to prevent a repeat of the mistakes of the past in an industry that is reluctant to change its ways.