13 Bankers: The Wall Street Takeover and the Next Financial Meltdown (31 page)

Taking over sick megabanks would also have political benefits. As in Korea a decade before, effective reform would require confronting the political roots of the crisis—the disproportionate political power of Wall Street. The right time for that confrontation was when the banks were at their weakest and most dependent on government aid. Bailing out the banks unconditionally put the government in the position of having to ask for favors later—favors that the banks would have no reason to return. By contrast, taking them over would have weakened or eliminated their ability to resist the regulatory reforms necessary to ensure long-term financial stability and economic growth.

Finally, takeover was only fair. Bankers who had run their institutions into the ground would no longer collect seven- or eight-figure bonuses made possible only by government bailouts. Shareholders who had gambled on highly leveraged banks would lose their money. Creditors who had lent blindly would lose part of their money. Taxpayers footing the largest part of the bill would at least have the possibility of making money as banks recovered. This is how capitalism is supposed to work. Failure should be punished, not rewarded. The government should be the backstop protecting society against a financial collapse, but it should exact a price for that protection. Reflecting on the emerging market crises of the 1990s in his 2000 American Economics Association lecture, Summers had emphasized, “Prompt action needs to be taken to maintain financial stability, by moving quickly to support healthy institutions and by intervening in unhealthy institutions. The loss of confidence in the financial system and episodes of bank panics were not caused by early and necessary interventions in insolvent institutions.”
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Instead, by providing serial bailouts with no meaningful conditions attached, the Bush and Obama administrations both rewarded failure and backed away from the tough medicine needed to restore a well-functioning financial sector.

As we wrote in
The Atlantic
in March 2009, “The challenges the United States faces are familiar territory to the people at the IMF. If you hid the name of the country and just showed them the numbers, there is no doubt what old IMF hands would say: nationalize troubled banks and break them up as necessary.”
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However, the administration took pains to deny that this was even a plausible option. In a February interview, when asked about “nationalization,” Geithner responded, “It’s not the right strategy for the country for basic practical reasons that our system will be stronger if it remains in private hands with support from the government to make sure those institutions can play their critical role going forward.”
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Then and elsewhere, Geithner carefully avoided even using the word “nationalization,” as if saying it might unnerve the private sector. The administration was successful in sending the message that no major banks would be taken over on its watch, and it was a message that Wall Street heard loud and clear.

Another issue that Wall Street cared deeply about was executive compensation. By the time the Obama administration came into office, one sore point with the public was that banks receiving government assistance were subject only to weak limits on compensation (boards of directors had to ensure that senior executives’ compensation packages did not motivate them to take excessive risks, bonuses based on materially inaccurate information had to be clawed back, and golden parachutes to top executives were prohibited
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). To the public, that meant that taxpayer money could pass straight through to bankers’ Ferraris and vacation homes in the Hamptons. Some administration insiders, including top political adviser David Axelrod, pressed for greater restrictions on compensation.
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Because of a provision of the economic stimulus package passed by Congress in February, the final rule issued in June 2009 was slightly stricter—limiting the bonuses payable to certain executives, requiring that they be paid in long-term restricted stock, and requiring a nonbinding shareholder vote on executive compensation
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—but tight restrictions and close monitoring applied only to a handful of companies receiving “exceptional assistance” from the government.
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Even the relatively mild limits were too much for most of the megabanks, who rushed to pay back their TARP money as quickly as possible—weakening their balance sheets (by paying back cash they didn’t need to pay back) so they could say they were free of government support, even as they profited from the cheap money supplied by the Federal Reserve. The main effect of the rule was to tilt the playing field against the banks that had received exceptional assistance (Citigroup and Bank of America) and therefore were subject to stricter compensation limits, making it harder for them to attract and retain key people. Any systematic attempt to curb the perverse incentives created by banking industry compensation practices was kicked down the road to a future regulatory reform bill.

The Obama administration did not uniformly support banks’ interests, but what the banks could not win in the White House, they often won in Congress. On February 18, President Obama announced his “Homeowner Affordability and Stability Plan,” which contained a provision allowing judges to modify the terms of home mortgages for borrowers who were in bankruptcy. The idea was that if a borrower’s house was worth far less than the mortgage, a bankruptcy judge should be able to reduce the mortgage—just as the judge could reduce the amount owed to almost all other creditors. The banking lobby succeeded in killing this “cramdown” provision in the Senate, with the banks and their industry associations refusing even to negotiate with Senator Richard Durbin while the Obama administration remained on the sidelines. Instead, the bill contained a separate provision
reducing
the amount that banks had to pay the FDIC for deposit insurance.
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This exercise in legislative muscle-flexing showed the continuing power of the big banks on Capitol Hill. Even as they depended on government investments, debt guarantees, and liquidity programs for their survival, they actually increased their lobbying expenditures to fight off potential regulatory reforms.
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On issue after issue, the big banks got what they wanted, and the taxpayer got the bill. The justification for these policies was that anything that threatened to weaken the banks might trigger a resurgence of the panic of September-October 2008. But the result was the same. The large banks used their political power to protect their money machines from government interference, and when those machines exploded they used their size and importance to force the government to bail them out.

BUSINESS AS USUAL

In the end, the major banks got business as usual. The shakeout of 2008 left the big banks even bigger. Bank of America absorbed Countrywide and Merrill Lynch and saw its assets grow from $1.7 trillion at the end of 2007 to $2.3 trillion in September 2009. JPMorgan Chase absorbed Bear Stearns and Washington Mutual and grew from $1.6 trillion to $2.0 trillion. Wells Fargo absorbed Wachovia and grew from under $600 billion to $1.2 trillion.
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This growth occurred against a backdrop of falling asset values and de-leveraging, which meant that most banks were cutting their new lending and getting smaller.

Consolidation among the big banks and the collapse of the nonbank mortgage lenders meant much larger market shares for the fewer but bigger megabanks. Bank of America, JPMorgan Chase, and Wells Fargo all had to be exempted from a federal rule prohibiting any single bank from holding more than 10 percent of all deposits in the country, and from Department of Justice antitrust guidelines intended to limit monopoly power in specific metropolitan regions. By mid-2009, those three banks and Citigroup together controlled half the market for new mortgages and two-thirds of the market for new credit cards.
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Derivatives, which had always been dominated by fewer than twenty dealers, became even more concentrated. At the end of June 2009, five banks together had over 95 percent of the market for derivatives contracts traded by U.S. banks, led by JPMorgan Chase’s 27 percent share.
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The government’s insistence that large banks would not be allowed to fail worked only too well. Large banks were able to borrow money at rates 0.78 percentage points more cheaply than smaller banks, up from an average of 0.29 percentage points from 2000 through 2007. In the banking business, where profits depend on the spread between the interest rate you receive and the interest rate you pay, 0.78 percentage points are a huge financial advantage.
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And what were large banks doing with their newfound market power? They were boosting profits any way they could—increasing fees on deposit accounts, even while their smaller competitors were reducing fees.
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For JPMorgan Chase, the payoff was blowout profits fueled by both its huge footprint in consumer banking and its growing investment banking business. Bank of America and Citigroup, though still fundamentally troubled, managed to keep up the appearance of profits, in part through one-time asset sales, in part through accounting gimmicks. Most surprisingly to the casual observer, the investment banking business, which had seemed on the brink of death in September 2008, roared back to life (even if the major stand-alone investment banks were now technically bank holding companies). In the first quarter of 2009, bond trading departments took advantage of high volatility in the markets to rake in large fees and make money in proprietary trading. There was also widespread speculation (difficult to confirm, given the secretive nature of trading operations) that bank trading profits were boosted by taking advantage of the fact that AIG was trying to unwind its large positions rapidly—which meant that the banks were making money at the expense of a taxpayer-owned company.
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In the second quarter, things got even better. Goldman Sachs reported its largest quarterly profit ever—$3.4 billion—on the backs of a record performance from its bond trading division and $700 million in stock underwriting.
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Those bond trading profits were given a helping hand by the Federal Reserve, which was buying large volumes of securities (to provide liquidity and stimulate the economy) while telegraphing its moves to Wall Street. As one asset management executive said, “You can make big money trading with the government. The government is a huge buyer and seller and Wall Street has all the pricing power.”
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And the $700 million was in part the result of federal bailouts; as the government ordered other banks to issue new stock to raise capital, they were forced to turn to the few remaining investment banks. JPMorgan Chase, Goldman Sachs, and Morgan Stanley alone accounted for 42 percent of the market for equity underwriting in the first half of 2009.
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Finally, Goldman was making money the oldfashioned way—by taking on more risk. As the bank’s president, Gary Cohn, said in August 2009, “Our risk appetite continues to grow year on year, quarter on quarter, as our balance sheet and liquidity continue to grow.”
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And Goldman’s value-at-risk—a quantitative measure of the amount it stood to lose on a given day—after dipping slightly in summer 2008, continued to climb throughout the crisis to levels in 2009 five times as high as in 2002.
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However, the clearest indication that Wall Street was back to business as usual was the amount of money earmarked for bonuses. In the first half of 2009, Goldman Sachs set aside $11.4 billion for employee compensation—an annual rate of over $750,000 per employee and near the record levels of the boom. Even if the government’s strategy was to let the banks earn their way out of their problems, that strategy was being undermined by a bonus culture that diverted the excess profits to employees rather than to capital reserves. High risk and huge payouts—nothing changed, except a strengthened government guarantee. Defending the huge bonuses in St. Paul’s Cathedral in London in October 2009, Goldman Sachs executive Brian Griffiths went Gordon Gekko one better by invoking Jesus: “The injunction of Jesus to love others as ourselves is a recognition of self-interest.… We have to tolerate the inequality as a way to achieving greater prosperity and opportunity for all.”
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Goldman CEO Lloyd Blankfein even claimed to be “doing God’s work” (because banks raise money for companies who employ people and make things).
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The rest of us were not so lucky. While a second Great Depression was averted, the collateral damage to the real economy was enormous. The collapse of the housing bubble tipped the economy into recession in December 2007, leading to the loss of 1.1 million jobs in the first eight months of 2008.
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The fall of Lehman Brothers in September 2008 and the ensuing panic triggered a severe economic contraction, leading to the loss of another 5.8 million jobs over the next twelve months as the economy shrank by 4 percent.
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The unemployment rate doubled from 4.9 percent at the beginning of the recession to 10.2 percent by October 2009; the broadest measure of unemployment, including people who gave up looking for a job and people working part-time who would prefer to work full-time, doubled from 8.7 percent to 17.5 percent—more than one in every six people in the broad workforce.
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