It's been a year since the $600 billion bankruptcy filing of
But for all the talk and hand wringing (and billions in direct government equity stakes in major banks and loan and debt guarantees) there's also been little real progress on how, or if, Washington might regulate its way out of this kind of mess in the future. Don't expect that to change anytime soon, as markets become more, not less, complex and interconnected.
Despite multiple layers of government oversight and industry self-policing, dangerous gaps in regulation allowed a speculative bubble to build, and then burst, rocking the financial system as it hasn't been since the Great Depression. Its corollary, the belief that the government would step in to prevent an important bank from collapsing, created a sense of complacency about the risks being created. Yet neither the gaps nor the "too big to fail" concept have been eliminated.
In late August, representatives from the Securities and Exchange Commission and the Commodities Futures Trading Commission met to find a way to divide and conquer securities markets regulation, a feat made more difficult by the explosion in trading of complex derivatives and credit-related financial products in shadow off-exchange markets that aren't under direct supervision. These over-the-counter financial products are largely to blame for the collapse of Lehman and other major financial companies, including
The meetings are a precursor to the upcoming debates on the Obama administration's regulatory reforms, which some have criticized for stopping far short of the sweeping reforms ushered in by Franklin Roosevelt in the 1930s as his response to the Depression-era banking crisis. One of the biggest changes would be the naming of the Federal Reserve, already the lender of last resort, as the overseer of "systemic risks." That raises the possibility the central bank could soon be in the business of monitoring activities in corners of the market that have been seen beyond reach, including hedge funds.
Some of the proposals are bound to be mired in political infighting and turf guarding among the various federal agencies. The Federal Deposit Insurance Corp is already on record saying it favored the creation of a systemic risk council, not a single regulator, to oversee the risks undertaken by the biggest financial companies. As FDIC Chairman Sheila Bair noted in a recent opinion column in the New York Times, "The truth is, no regulatory structure--be it a single regulator as in Britain or the multiregulator system we have in the United States--performed well in the crisis."
Other proposals to close gaps in oversight include the creation of a regulatory agency for consumer financial protection, the consolidation of two federal regulatory agencies into one national bank regulator, and the bestowing of new powers on government agencies charged with overseeing banks, such as the ability to seize a non-bank financial company. Lehman, not a chartered commercial bank, fell as the government claimed to stand by helplessly watching. Rival investment banks
Having the power to seize a non-bank financial company would hopefully work to end the idea that any one company is too big to fail, Bair has said. But Lehman's collapse exposes another lesson the then-Treasury Secretary Henry Paulson seemed to be trying to avoid: in fact, "too big to fail" is alive and well.
For months regulators have acknowledged that some financial companies had simply grown too large and unwieldy and that dismantling them to a smaller size and more focused business would be to the benefit of the financial markets in general.
By the time Lehman collapsed, after a mid-September weekend of frenzied negotiations among a dozen or so Wall Street chiefs at the Federal Reserve Bank of New York, the government had already taken control of mortgage titans
Paulson was eager to prove he wouldn't let too big to fail change his mind about helping Lehman. But the subsequent freezing up of the credit and money markets--Lehman was a huge counterparty--prompted much second guessing about his failure to step in. A week later, spooked by the reverberations Lehman's collapse had on the markets, Paulson was proposing a $700 billion bailout originally intended as a government program to buy troubled assets from banks but which morphed into a program in which the government would take direct equity stakes in the major banks to prop up the system. Two of those banks, Citigroup and
By this spring, the rescue had morphed into a big confidence boosting operation designed to buy banks enough time to earn their way out of their troubles, including a round of stress testing of the 19 biggest, presumably most important, banks and a round a capital-raising. By identifying these banks, and forcing them through a stress test that seemed geared for success, the government basically signaled which companies it views as too big to fail.
One solution advocated by Bair and others: break up big banks. Citigroup is splitting itself up after years of empire building that created a company many considered to unwieldy to manage effectively.
But that won't really fix things. Lehman was far from the biggest Wall Street bank, in fact it was the smallest of the big four still standing after the collapse of another relatively small firm, Bear Stearns, in March. Interconnectedness was the problem. And in our increasingly sophisticated and complex global financial system, it still is. How to eliminate that risk? This may be tough to swallow, but the truth is that you can't.
