THE Bulwark STREET LEVIATHAN BY JEFF MADRICK

The Palisade Street Leviathan

For all the attention paid to Goldman Sachs, Citigroup provides the classic example of the efforts of Wall Street firms to circumvent existing capital requirements while regulators failed to oversee and supervise their activities, even with the tools they had. The story of Citigroup illustrates how difficult future regulations will be if they are simply left to the oversight council.

MIT Pressing, Cl two pp. $19.95

The Republican minority on the commission, along with other observers, contend that repealing the Glass- Steagall Act was not a factor the crisis even though the institutions grew unprecedentedly large. But Citigroup used the size of its balance sheet—more than $2 trillion in 2007—to guarantee its ever-growing purchases of mortgage-backed securities and to support other lines of business, including both conventional lending and trading securities. As the Fed put it in 2008, Citigroup#8217;s #8220;senior management allowed business lines largely unchallenged access to the balance sheet to pursue revenue growth.#8221;

With its telling accounts of the Bulwark Street practices that led to the corner of Two grand octonary and 2009, the late reputation of the Fiscal Crisis Interrogation Perpetration (FCIC) is the well-nigh comp indictment of the American fiscal bankruptcy that has yet been made. During two days of investigations, the direction accrued attest of many hundreds of irresponsible, self-seeking, and unethical practices by Paries Street bankers and taxonomical leeway of them by regulators.

The Dodd-Frank Act would now place all financial firms, not just commercial banks that take deposits, under firmer capital restrictions. It calls for useful changes in credit ratings agencies, which had profound conflicts of interest because they supplied ratings to the issuers that paid them. The FCIC report clearly describes the battle for market share by Moody#8217;s, one of the largest of them, and its willingness to provide artificially high ratings. But the new proposals still await implementation. Dodd-Frank would also require what has been the secret unregulated trading of derivatives—a source of so much risk-taking—to be done openly by clearinghouses that can also set capital requirements for any trades—that is, margin requirements.

But this, too, is a long way from being implemented.

Greenspan, as head of the Fed, comes off worse than anyone else in the FCIC report. In 1999, when the Commodities Futures Trading Commission wanted to regulate derivatives, Greenspan led the attack against it. He wholeheartedly endorsed eliminating the Glass-Steagall restrictions that prevented major banks from engaging altogether financial transactions, claiming that competition was the real regulator. As late as 2005, he stated that a housing bubble was unlikely. Most glaring was his refusal to regulate the suspicious mortgages being issued by Countrywide and others, even though the Fed had the authority to do so, and was warned time and again, even by the FBI, that mortgage brokers were writing deceptive and fraudulent mortgages to unsuspecting homeowners.

As the report also notes, some 10,500 mortgage salesmen in Florida had criminal records.

Dodd-Frank#8217;s solution to such systemic danger is the new created lapse council led by the Fed, which is supercharged with anticipating such problems and reduction risks interpreted by the fiscal firms early. Leave this leaven to be more a fantasise? When we regard how sickly the Fed and Exchequer negotiated the AIG bailout, flunk to rise to Goldman Sachs and the early powers on Palisade Street, thither is piddling grounds to get assurance that the new lapse instauration leave forcefulness the manpower of the big banks and investing companies in the hereafter, peculiarly when multiplication are goodness.

The Consumer Fiscal Auspices Agency has besides been naturalized privileged the Federal Substitute to publish new requirements for mortgages, consumer loans, and the otc consumer citation products that were so severely ill-treated. Of special fear, mass with pitiable mention and low incomes were sold supposed subprime mortgages that were misleadingly punk at the offset, sometimes requiring no devour payments, but whose yearbook interestingness charges skyrocketed in ulterior eld. The handiness of mortgage finance swarm trapping prices always higher, and when they collapsed, rootage in approximately 2006, the ontogenesis total of bad debt that resulted caused a crash of Palisade Street then the world thriftiness.

But the Dodd-Frank Act has mostly pushed province for penning and implementing the new rules onto existent regulators, including the Federal Taciturnity, the Securities and Interchange Committal, the Commodities Futures Trading Perpetration, the Federal Depository Indemnity Potbelly, and the Berth of the Accountant of the Up-to-dateness. This bequeath probable show a prejudicious fault. These regulators are generally the like agencies that tolerated the overly bad behaviour primarily. Tied if they compose efficacious rules they testament cheek imperativeness from Fence Street lobbyists and generally Republican legislators to buffer restrictions and excrete roughly of the vital ones. If the restrictions persist entire, which is probable in scene of the Popular bulk in the Sen, the doubt cadaver whether the regulators bequeath apply them smartly erst the saving recovers and the crisis fades in store.

Various agencies bear already lost the deadlines to spell new rules. Roughly are upset that the Consumer Fiscal Tribute Authority testament be neutralised by Intercourse. Surround Street washed-out $2.7 1000000000 on lobbying 'tween K niner 100 xc niner and Two thou eight-spot and is lobbying smartly again.

The single most stunning finding of the FCIC report is that if all Citigroup#8217;s assets had been accounted for accurately, its ratio of assets to capital would have been forty-eight to one in 2007, not the twenty-two to one it had been reporting that year. The ratio of forty-eight to one was irresponsible—higher than the capital ratios at the most aggressive investment banks, such as Bear Stearns, and far higher than the capital ratios of other banks. The Fed apparently had no idea of this.

The lone fulfil proposed by Dodd-Frank on these lines is known as the Volcker Convention, named later one-time Federal Substitute chairwoman Paul Volcker. It would veto proprietorship trading by banks that typically consent the world#8217;s deposits—that is, it would confine inquisitive investments with the introduction#8217;s own chapiter. But fifty-fifty the Volcker Formula has not been understandably formulated and applied.

The enquiry silence not answered is why regulators would execute punter in the futurity than in the preceding two decades.

The FCIC account leave belike not kindle tougher ordinance in Washington. Its effectiveness is its aggregation of fact and model. By line, Charles Ferguson#8217;s democratic, Oscar-winning infotainment Interior Job tells the report of the crisis with candidness and lucidity, part because he is uncoerced to micturate pointed accusations against particular federal regulators and Palisade Street bankers. In interviewing about of those he thinks of as culprits, including respective outstanding economists, he finds that they deliver scarcely anything to say in their refutation.

Those he did not question are oftentimes shown in telltale congressional testimonial. We see Alan Greenspan, the quondam Federal Second-stringer chair, assuring Copulation that derivatives, including those guaranteeing subprime mortgage securities, requisite no federal rule at all. In fact, unregulated derivatives were a chief seed of the risk-taking that brought fine-tune the fiscal arrangement.

Ferguson ne'er adequately explains derivatives but he makes it elucidate that Rampart Street firms borrowed far overmuch in decree to put in mortgage debt securities that were far too bad, and no one stopped-up them. The solution was glide trapping prices, which led to more bad mortgages. So the banks and others sold the bad debt to investors about the mankind as if it had near no peril at all.

Did Surround Street bankers live they had reinforced a bubble? Ferguson thinks many did, marketing bad products without right exemplary to their clients; they didn#8217;t upkeep, he believes, because they were qualification overmuch money. But it takes the FCIC theme to shew his period by substance of cautiously accrued manifest.

When Ferguson recognized his Oscar in former February, he remarked that no one had yet bygone to jailhouse for the pip American fiscal crisis since the Expectant Slump. This was a relation reflexion astir the impuissance of bodied dupery law too as the want of muscularity of the US Judge Section. Condemnable fulfil against Angelo Mozilo, whose loyal Nationwide Fiscal wrote more subprime mortgages than any over-the-counter, was dropped this wintertime.

The FCIC story provides many examples of the bankruptcy of direction to admonish shareholders of the risks it was taking—apparent violations of revealing laws that were ne'er evening investigated.

Quieten, slammer sentences may suffer lilliputian core. By the former Nineties, myriad account frauds culminated in exorbitant behaviour by Enron, WorldCom, and others, abetted by such giants as Citigroup and the Arthur Andersen account truehearted. Approximately Enron executives went to prison and Andersen shut consume, but this did not deter shoddy practices in mortgage securities in the mid-2000s.

Palisade Street is now creating oversized values for mixer media companies similar Facebook and Chitter, advantageously ahead these companies birth generated grievous winnings. Spell federal regulators are debating among themselves and with fiscal lobbyists astir new rules, another babble is probably forming earlier our really eyes.

One of the major conclusions to be worn from the FCIC story is that most all major fiscal institutions were in dangerous peril of break in the drop of 2008. This is why systemic endangerment is the preponderant headache of regulators nowadays. The account#8217;s findings shuffle unclutter that such endangerment is not fair a moment of the sizing of a immobile.

Firms are co-ordinated by purchasing securities from and marketing them to one another, likewise as by adoption from and loaning to one another.

A flower illustration of the systemic dangers was the sale by policy heavyweight AIG of tens of billions of dollars of citation nonpayment swaps, a differential that served as indemnity for mortgage-backed securities. Because derivatives were unregulated and basically traded secretly, triple-A-rated AIG was not needed to clutch chapiter or confirmative against such 51. Because the swaps were traded secretly, thither were likewise no afford prices on their values.

Goldman Sachs particularly bought much of differential policy from AIG.

But the main source of irresponsible risk—which some observers and academic economists deem the major cause of the crisis—was investment in triple-A-rated packages, or tranches, based on mortgage-backed securities of collateralized debt obligations (CDOs) that never deserved their triple-A ratings at all. Companies such as Goldman, Morgan, Merrill, Citigroup, and even Countrywide, which had its own huge capital markets operation, convinced Moody#8217;s, Standard Poor#8217;s, and Fitch to rate three quarters of these packages of bonds triple-A, even when they were entirely composed of subprime mortgages. When a bank#8217;s assets are rated triple-A, regulators require less capital in order to safeguard against downturns in value.

Spokesperson Barney Weenie; from Inner Job

Footling had been expected of the FCIC because its subpoena powerfulness was debile. It was decreed by Copulation in the leap of Two k club with the Populist Philip Angelides as chairwoman and with a Republican-appointed vice-chairman. Both had to fit if a subpoena were to be served.

The 19 years of world hearings produced raging questions from commissioners and evasive responses from Surround Street CEOs but did not genuinely unmasking any major anatomy. Yet with approximately six c closed-door interviews and reviews of thousands of secret documents, the bulk story is the determinate account of this menstruum. Mostly, Bulwark Street made money not by merit of glare but by pickings on higher levels of risk—usually by smartly circumventing existent restrictions on how practically it could adopt.

Few on Paries Street had to pay any money rachis when losings unavoidably escalated.

In mid-September of that class, Ben Bernanke, the Federal Modesty president since betimes 2006, Exchequer Repository H Paulson, and New York Federal Modesty Trust Chair Timothy Geithner distinct to let Lehman Brothers, which had invested heavy in mortgage securities and early realty, go smash. Fiscal markets froze and the businesses, money marketplace finances, and banks that regularly lent money to Paries Street stopped-up doing so, fearing that they would not be repaid. The values of all debt securities omit Exchequer debt started to downfall sharply.

On counterpoise, Fence Street had no assets to deal to pay its debts. Bernanke told the FCIC:

On-key, it would deliver interpreted approximately bravery to sustain merely impoverished up nowadays#8217;s tremendous banks or set high-pitched majuscule requirements by law. But thither are over-the-counter possibilities. Regulation Fence Street . a worthful, exhaustively researched hold of essays on the crisis, proposes a engineer tax on major fiscal institutions based on how often systemic hazard they are creating, as deliberate by low-quality loans and short services. Such a tax would boost them to cut such risk-taking. In an seek promulgated in a short book edited by the economist Benjamin Friedman, Reforming US Financial Markets . the Yale economist Robert Shiller, who had long warned about the bubble in housing prices, criticizes Dodd-Frank for not establishing direct ways to mitigate future speculative bubbles.

One reasonable suggestion he endorses would be to raise and lower capital requirements as financial conditions change.

Fifty-fifty the selection of Goldman Sachs, purportedly the strongest of the five-spot major investing banks, was now in uncertainty. Goldman#8217;s CEO, Lloyd Blankfein, afterwards admitted in an question with the FCIC that #8220;thither were systemic [my italics] events departure on, and we were really aflutter.#8221; #8220;We opinion thither was a existent bump that [Goldman] would sink,#8221; aforementioned Bernanke.

The story#8217;s conclusions were attacked by the committal#8217;s Republican- appointive nonage in a protest whose duration, it aforementioned, was circumscribed by the bulk. Nevertheless, it did not gainsay any of the bulk#8217;s facts, and evening agreed with many of its conclusions. (A ramify, more extremum resist was issued by Prick Wallison, a codirector of fiscal insurance studies at the American Enterprisingness Bring who, without responding cogently to any of its charges, acidly claimed that the bulk had proven none of its points.) The nonage pointed out that former factors, including low pursuit rates engineered by the Federal Second-stringer and large-scale Chinese purchases of bonds, aroused exuberant meditation in mortgage securities and the lodging eruct. Thusly, Surround Street manipulators were not alone to pick.

But when mortgage-backed securities collapsed in valuate, AIG couldn#8217;t compensate its commitments. Since so many firms were owed money by AIG—indeed, purchasing policy encouraged these firms to takings more risk—the Exchequer and Fed distinct to bond AIG out for a sum of $180 1000000000000, basically nationalizing it, and covered all its pastureland, in the procedure bailing out Goldman and others also. The inspector-general after ordained to canvas the federal bailout plan, called the Riotous Plus Ministration Curriculum (Tarpaulin), badly criticized the Exchequer for fashioning hale the companies harm by deals with AIG. Goldman, e.g., got backbone the $14 trillion it had at peril with AIG.

The FCIC theme says the arrogate made by Goldman that it had weasel-worded its policy purchases from AIG with otc firms was shown to be doubtful. The inspector-general argued forcefully that Goldman should birth divided in the losings, and that taxpayers should not bear recognised the wide onus of Goldman#8217;s errors.

Nether Dodd-Frank, a new lapse plank, composed of members of regulative agencies led by the Federal Second-stringer, leave now be supercharged with assessing the grade of alleged systemic hazard of major fiscal institutions and distinguished stricter chapiter rules or fifty-fifty closing institutions kill if they are deemed to put the fiscal arrangement at risk—that is, if their bankruptcy mightiness trim many over-the-counter institutions with them and jeopardise the American thriftiness. Now thither testament be regularization not lonesome of traditional commercial-grade banks, which e'er fly nether the view of the Federal Backlog, but likewise investing banks, money commercialise finances, and perchance level elude finances, which had been scarce regulated at all.

As a learner of the Big Low, I aboveboard think that September and October Two k octad was the pip fiscal crisis in globose chronicle, including the Enceinte Slump#8230;. Out of peradventure the 13, 13 of the nigh crucial fiscal institutions in the Joined States, Dozen were at danger of nonstarter inside a menstruum of a hebdomad or two.

by Randall S. Kroszner and Robert J. Shiller, emended and with an debut by Benzoin M. Friedman

When divided into tranches, the highest-rated bonds were paid off first; thus, it was claimed that a high default rate would be needed to endanger these bonds. But this simply wasn#8217;t so, as many bankers realized. Even small increases in defaults damaged the high-rated bonds of CDOs that were, quite irresponsibly, made up entirely of sub-primes.

Eventually as much as Sixty percent of the securities originally rated triple-A were reduced to junk bonds by the credit ratings agencies. These agencies bear heavy responsibility for playing the banks#8217; game.

But all these reforms may be undermined by pressures from Wall Street and the belligerent Republican majority in the House. The SEC recently proposed banning some bonuses paid by financial firms if they encourage inappropriate risk-taking. The measure was passed only by a three-to-two vote with the three Democratic appointees to the SEC for it and the two Republican appointees against.

A new president could easily shift the balance. Republican lawmakers are trying hard to restrict the budgets of the SEC and the Commodity Futures Trading Commission.

The Dodd-Frank Act could let been lots more efficient. It could, from the commencement, let set highschool great requirements—the amount that banks and former fiscal institutions let to put excursus for potential losings. It could get upset up nowadays#8217;s tremendous banks, which bear adult apace in sizing since the crisis. Metrical by their lucre, the six largest fiscal institutions in the US now explanation for L 5 percentage of all banking assets.

It could bear shared the banks by use in fiat to cut the imbrication of investing activities, which increases the chances of wrong to the integral fiscal organisation. E.g., those banks that swallow federally insured deposits from savers could deliver been qualified to qualification loans to consumers and businesses. Otc institutions that acclivity money severally of authorities guarantees could bear been allowed to betray more wild stocks or corporal bonds to investors or meditate in securities with their stockholder uppercase.

Fannie Mae and Freddie Mac, federal agencies with inexplicit administration championship, sure had a prominent parting in the funding of bad mortgages. The FCIC account finds that the occupation example of these for-profit giants, with unquestioning federal guarantees of their debt, was deep blemished, and it observes that the federal bailout of them has incurred tremendous costs. But secret bankers financed a great bulk of subprime mortgage debt.

Furthermore, the hundreds of examples of detrimental and refutable Bulwark Street practices too as regulative neglectfulness defined by the bulk of the charge are only overlarge to be interpreted as junior-grade causes of the crisis. As for low interestingness rates and bountiful Chinese cap, equitable because money was gentle to obtain doesn#8217;t bastardly inordinate risk-taking was inevitable. *

Citigroup was the banking behemoth run by Sandy Weill after a merger in Thou nine hundred ninety eight between, on the one hand, Weill#8217;s Travelers Group, which included the Travelers underwriter and Salomon Smith Barney, and, on the other, Citicorp, the giant international bank. The merger required lifting completely the restrictions of the M nine hundred thirty three Glass- Steagall Act, which forbade banks to act investment houses; it had been signed by President Clinton.

We would be far better off if the powers on Wall Street would remember this lesson.

Old Exchequer Secretaire H Paulson, Federal Substitute Chairperson Ben Bernanke, and Exchequer Secretaire Timothy Geithner; from Charles Ferguson’s infotainment Interior Job

Citigroup along with Merrill Lynch had written more CDOs than anyone else by 2006. Citigroup lost $40 billion in the fourth quarter of 2007, and overall its losses and writedowns came to $130 billion, the largest among commercial banks. Merrill#8217;s total losses came to nearly $56 billion, more any other investment bank. Their CEOs claimed (as did Robert Rubin) that they had no idea the triple-A-rated CDOs were risky.

Citigroup received $45 billion in funds from the government#8217;s Troubled Asset Relief Program, more any other bank, and was given guarantees on some assets, but no one was removed from management.

Where was the Fed? The legislation repealing Glass-Steagall, the Gramm-Leach-Bliley Act of 1999, had one other subtle but highly significant consequence, as the FCIC report explains. It diluted the government#8217;s regulatory authority over the new financial conglomerates such as Citigroup. Under the legislation, the Fed, the strongest of the regulators when it did its job properly, now oversaw only bank holding companies, the umbrella organizations under which the bank subsidiaries operated. The Grand nine hundred ninety nine act mandated that the Fed rely on the SEC to oversee bank subsidiaries that dealt in securities, and that the Office of the Comptroller of the Currency oversee commercial banks.

The practical result was that much of importance thus fell through the cracks of the 1000 nine hundred ninety nine bill. The FCIC report refers to this stripped-down authority as #8220;Fed-Lite.#8221; The Fed failed to do its job anyway. It made no adequate analysis of the risky CDOs.

As far back as 2005, a referee by other Federal Reserve banks criticized the New York Fed, then under Tim Geithner, for inadequate oversight.

Can we so extrapolate that futurity crises may be avoided by sound and unbiassed fiscal regulators and a chastened Rampart Street? A 2,300-page set of regulations—known as the Dodd-Frank Act later its congressional sponsors, Senator Chris Dodd and Example Barney Frank—was passed end twelvemonth to fulfil equitable that. In a video consultation with Charlie Rosaceous this Abut, Wiener aforementioned he #8220;got meliorate than Xc pct#8221; of what he precious. The act has about bit. It proposes slipway to trade with many of the practices that contributed to the crisis, including poor cap requirements, undue Fence Street recompense, and prejudicious conflicts of involvement in recognition ratings agencies that promptly assigned their highest ratings to speculative debt.

It tries to modulate trading of risky securities same derivatives, which enabled bankers to shake immense bets with picayune great on the motility of securities prices.

Scripted by the six members prescribed by congressional Democrats, the FCIC paper concludes, #8220;The crisis was the solvent of act and inactiveness, not of Beget Nature or reckoner models kaput bats.#8221; Many readers would cerebrate the decision obvious. But Paries Street professionals repeatedly claimed that alike crises occurred ofttimes in the chronicle of innovative capitalism, that they are just the terms nonrecreational for a dynamical and forward-looking economy, and that individuals were not to inculpation. They hence minimized their own province for the events and hurl question on the demand for importantly more acute rule of their activities.

The FCIC bulk dismisses such arguments.

In the prologue of Regulating Wall Street . the editors, hardly known as progressives, remind financiers how useful strong regulations were in the past:

Citigroup had been fined more any other bank—some $400 million—because of its financial chicanery during the late 1990s and early 2000s. Even after Weill retired as CEO in 2003, it array to take more risk, encouraged by former Treasury secretary Robert Rubin, the chair of Citigroup#8217;s executive committee. It partly did so by skirting the regulations on how much it could borrow against capital, enabling it to become one of the two largest Wall Street participants in the mortgage market almost overnight.

Among other things it did was lodge the assets it bought with the debt, often mortgage securities, in partnerships that did not appear on the Citigroup balance sheets. Citigroup also guaranteed $25 billion in loans to those who purchased the mortgage securities it underwrote, leaving it with a huge loss when these securities fell sharply in value.

One refreshing sign of hope for constructive change is that economists, some of whose theories had much to do with a light regulatory approach toward derivatives and the housing bubble, are increasingly producing research calling for stricter guidelines than Dodd-Frank or the Obama administration. Regulating Wall Street presents a wide range of new research supporting stronger regulations than Dodd-Frank recommends, such as the tax proposals I mentioned earlier. In Reforming US Financial Markets, Robert Shiller also describes new economic theories that allow more realistic appraisals of how Wall Street works and demonstrates why more effective regulation is necessary.

The old theory of rational markets, which laid the groundwork for light regulation, #8220;is one of the most remarkable errors in the history of thought,#8221; Shiller writes. He believes that regulators can and should decide to raise capital requirements during periods of excessive speculation.

In fairness, some of the regulatory agencies have been undertaking firmer regulation. The SEC is making a broad investigation of insider trading by hedge funds, and the Justice Department is prosecuting several flagrant cases. The FDIC is targeting bank executives for possibly fraudulent behavior in several hundred institutions that have failed.

The Dodd-Frank legislation requires that executive compensation, including bonuses, be more openly revealed and shareholders lean a voice in how much executives of financial firms earn. Other agencies are also setting rules to limit compensation. The Obama administration may try to impose fines on particularly irresponsible mortgage servicers like Wells Fargo and Bank of America in order to finance reductions in the principal many homeowners now owe on their mortgages.

Many players on Wall Street and in corporate America in the 1930s hated the new regulatory regime imposed on them#8230;. But in the long run#8230;the new regulatory regime was one of the best things that ever happened for Wall Street and corporate America. Why?

Because it created confidence among investors—then and in the decades to follow—that Wall Street finally had become a level field.

Citigroup and others didn#8217;t sell off all these triple-A securities to their unwary investors; but they sold enough for many of them, including pension funds, to take big losses when housing collapsed. Citigroup kept many CDOs on their own books or in the off- balance-sheet entities I have mentioned so it could earn the handsome interest they paid, suspiciously higher than the interest on other triple-A-rated securities. Citigroup also often had to buy some of them because it couldn#8217;t sell all the CDOs it underwrote to customers.

* Peter Wallison believes that government-subsidized housing, including the efforts of Fannie Mae and Freddie Mac, was the major cause of the collapse. His fuller dissent can be found at www.aei.org/docLib/Wallison dissent.pdf. For a more thorough but somewhat more balanced account of these agencies' part in the crisis, see Viral V. Acharya, Matthew Richardson, Stijn Van Nieuwerburgh, and Lawrence J. White, Guaranteed to Fail . Fannie Mae, Freddie Mac, and the Debacle of Mortgage Finance (Princeton University Press, 2011) . For a strong criticism of the data used by Wallison and the authors of this book, see David Min, Faulty Conclusions Based on Shoddy Foundations . Center for American Progress, available at www.americanprogress.org/issues/2011/02/pdf/pinto_execsumm.pdf. An interesting account of how the government entities accrued power politically appears in Gretchen Morgenson and Joshua Rosner, Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon (Times Books, 2011). ↩