Can a Financial Meltdown Happen Again?

Happy New Year. Most people in the financial industry are likely happy to see the 2009 calendar go in the trash and have high hopes that 2010 brings a continued recovery for the battered sector. The American Economic Association is currently gathered in Atlanta, and while most agree that the worst is behind us, they are skeptical about real progress being made to avoid a similar crisis in the future. In fact, count Tom Sargent, an economist from NYU, among those who think the response so far has actually made us more vulnerable to a deeper crisis! The logic goes that the bailout has created an expectation of future bailouts for big banks, and as a result management will feel emboldened to take even more risk, knowing that the government safety net will be there. Some wonder, like we have at GlobalRiskJobs, that the window for real meaningful reform may be closing. One of the current problems is that bank lending, especially in light of the collapse of the shadow banking system, is crucial to sustaining this fragile recovery. Hence, any Draconian measures the regulators might enact must not forestall banks' willingness to lend. Other economists worry that central banks' interventions have exposed them to greater financial and political risk which could hinder their effectiveness in future crises.

Also at the top of today's news is the decision by US Senator Chris Dodd (D-CT), the chairman of the Senate banking committee and a central figure in the government’s financial bailout of 2008 and the economic stimulus package adopted last year, not to seek reelection. What effect will his lame-duck status on pending financial reform legislation? Only time will tell. Will he ignore the demands of the special interests on the left? Will he go back to his roots and stand with the banks and financial firms who traditionally donated to his campaigns? Or, will he ignore partisanship altogether as he exits and push for simply the most effective reform that he can? Interesting questions as we start the new year and push toward the finish line on financial reform.

House Could Vote Friday on Financial Overhaul

The bigger they come, they harder they.....get hit? The giant banks could be the biggest losers in Congress' efforts to overhaul financial regulation. A populist groundswell in the majority Democrat House of Representatives has led to the addition of amendments that are unfriendly to the largest financial institutions. The bill seems to be going way beyond what the White House envisioned when it sent its proposal to Congress last June. The House bill contains much of what the White Hose wanted: powers to take over/break up large companies, new consumer protection rules, tougher regulation of derivatives, executive pay limits. The Senate bill differs considerably, so real change may not be imminent.

Some of the highlights aimed at policing the Big Banks:

• Regulators would be able to block healthy banks from certain practices or mergers, and even order a bank to shrink if it posed systemic risk.
• Financial companies with more than $50B of assets wold have to pay into a $150B fund to deal with future collapses of large financial institutions.
• The government would be able to order certain large banks to split off their commercial bank from their investment bank if regulators are concerned.
• Large banks would have to submit to consumer compliance exams from a new Federal Agency, while many small banks would be exempt.
  

Geithner Running Point on Reform

Although healthcare reform seemed to be pushing ahead of financial reform in the political dialogue race, President Obama's Lehman Anniversary speech on Wall Street last week seems to have re-energized the movement somewhat. While GlobalRiskJobs and Risk Talent Associates are definitely seeing an increase in activity on the financial risk and compliance front, we definitely expected more to see more robust signs of recovery on the hiring front at this point in the year. One of the preconditions to a wholesale shift has always been a more intense regulatory/reporting environment, which we still believe will come, but things have been slow to develop largely because of the traffic jam in Washington. So, with Geithner's focus now moving from crisis manager to running the point on financial reform, we will see where it takes us. Geithner seems to have simplified the message, focusing on three key points that legislators should consider when enacting financial reform: 1) offer “substantial” new protections to consumers and investors, 2) make the financial system less vulnerable to crisis, and 3) protect taxpayers from having to bail out future crises.

Are some of the regulators past the point of fixing? Bloomberg commentator Susan Antilla wonders as much about the SEC in a recent piece. She looks at Judge Rakoff's beat-down of the SEC-Bank of America settlement as just the latest example of a regulator that needs an overhaul. Meanwhile, the SEC is seeking more power to oversee derivatives markets.

GlobalRiskBlog favorite Andy Kessler weighs in on bank pay controls in today's Wall Street Journal. Kessler argues that it was excessive leverage, rather than excessive risk that drove the financial system to the brink of disaster.

As the G-20 convenes in Pittsburgh, U.S. and European leaders remain divided on how much capital the world's largest financial institutions should keep on hand to meet unexpected losses. Most agree that a major lesson of the Crisis is that higher capital requirements are essential, and G-20 leaders hope to have an agreement on new standards by the end of 2010, with implementation by the end of 2012.

Congress has turned its attention to the Rating Agencies. New allegations by a recently departed Moody's analyst named Eric Kolchinsky have added fuel to the debate over the role and influence of credit ratings and whether recent reforms are sufficient to prevent a repeat of past missteps.

The FDIC is being criticized for its handling of many of the recent bank failures. A recent report about the failure of Colorado-based New Frontier Bank criticizes the agency and other regulators for not being aggressive enough in handling the brewing financial crisis.

And finally, the controversial filmmaker Michael Moore is back in the headlines with "Capitalism: A Love Story", a scathing look at the financial system through the lens of the Crisis.

(un)Happy Anniversary!

Well, we have begun to be treated to the first of what are sure to be dozens of pieces marking Tuesday's One Year Anniversary of the death of Lehman Brothers. Everyone should remember just how dire the global financial situation seemed in the wake of Lehman's bankruptcy. We at Risk Talent Associates and GlobalRiskJobs certainly remember, as like many who make their living in and around Wall Street, it was a time like no other. "Bulge Bracket" firms disappearing seemingly overnight, stock markets plunging, and of course, the layoffs. Yet, even in those darkest of days, we advised that things would indeed get better at some point, and job seekers needed to get up off the canvas and be ready for that time. Certainly, the first order of business was to use all means necessary to stabilize the system, but when that financial triage was finished, players (particularly regulators) would turn their attention to figuring out how to never let us get in that position again. As I stated in the blog last week, much of that push to reform has been bogged down in political wrangling, shifting of the topic to healthcare, etc. But, just as we start to doubt the Administration's resolve, Here comes President Obama to Wall Street to stoke the fire of reform by reminding us of where we were a year ago. Obama’s speech apparently will focus on the need to take the next series of steps on financial regulatory reform, enacting safeguards to ensure such a crisis doesn’t happen again. Let's hope he can jump start the process and push us through this period of "regulatory limbo".

As we consider the Lehman collapse a year later, there will be many arguments either way that letting Lehman fail was either the right/wrong thing to do. Joe Nocera of the NY Times had a good piece on Saturday where he reconsiders the Lehman failure. My own thoughts about this haven't changed much over the year. I believe that when a Bear Stearns failure became inevitable, the Powers-that-Be (Paulson, Bernanke, et. al.) decided they would give the U.S. banks and investment banks a "Mulligan". Against the pure capitalist philosophy of non-intervention, they rushed in to arrange the orderly sale of Bear to JPM. In its wake, the warning was given: the next guy wouldn't be so lucky. Whether that "next guy" was going to be Lehman, Merrill, Morgan Stanley or someone else (not Goldman of course, being too well-connected), it seemed pretty clear there was going to be some BIG financial institution that would become a lab rat for too-big-to-fail. Unfortunately for its employees and investors, lehman won the race to the bottom and the experiment was in full force. Everyone would find out just what happens and how far-reaching the repercussions are when one of these institutions fails. Well, the rest is well-documented and we can probably say the result was the ability of Paulson to light a fire under Congress and get the resources to fight the crisis. Step 2, however, is far from complete. We still need to figure out how to structure or regulate the system in a way that allows risk taking without the collateral damage that was clearly part of the Lehman failure. Maybe Obama can get that process back on track this week.

Financial Reform Movement in Retreat?

It looks like the Obama administration is tempering its ambitions for financial regulatory reform. It seems that the potential political brouhaha that would accompany a reduction in the number of agencies overseeing the financial markets would expend too much political capital. Instead, the administration will focus on securing broader powers for existing regulators to limit risk-taking. While the revamp of oversight will dramatically change the regulatory environment for finance, has the US missed an historic opportunity to completely overhaul the arcane regulatory framework of US finance? Possibly. It seemed as if the financial crisis presented lawmakers with a clear path to reworking the system. As time has passed and the global financial system has stabilized somewhat, the outcry for major structural change has become less loud. reform hawks will no doubt be disappointed by anything short of wholesale change to the system and will lament the loss of reform momentum.

The links:

• Te Obama administration wants Europeans to put their banks through much more rigorous public stress tests to ensure survival in a slipping economy.
  
• Deloitte & Touche released its 6th Global Risk Management Survey. The survey indicates that banks and other financial institutions continue to have significant opportunities to strengthen their risk management processes and tools.
• As plans for banks to leave TARP solidify, the WSJ wonders what to do about Citigroup.
• The 10 banks that got the green light to repay TARP include: Goldman Sachs, JPMorganChase, Morgan Stanley, American Express, Bank of New York Mellon, BB&T, Capital One, Northern Trust, State Street and US Bancorp.
• SIFMA Chief Executive Tim Ryan says that Wall Street accepts its share of responsibility for the crisis and intends to partner with the governments to overhaul the regulatory system.
• Morgan Stanley says there has been a fierce rally in leveraged loan CDO's.