The crackdown on bank misbehavior masks a troubling reality

By Bethany McLean
August 7, 2013

“Ex Goldman Trader Found Guilty for Misleading Investors.” “Bond Deal Draws Fine for UBS.” “JPMorgan Settles Electricity Manipulation Case for $410 million.” “Deutsche Bank Net Profit Halves on Charge For Potential Legal Costs.” “US Sues Bank of America Over Mortgage Securities.” “Senate Opens Probe of Banks’ Commodities Businesses.” “US Regulators Find Evidence of Banks Fixing Derivatives Rates.” “Goldman Sachs Sued for Allegedly Inflating Aluminum Prices.”

So goes a sampling of headlines about the banking industry from the past week — yes, just one week. We seem to be living in an era where bankers can do no right. I can’t put it any better than a smart hedge fund friend of mine, who upon reading the news about the $410 million that JPMorgan paid to make allegations that it manipulated energy markets go away, sent me an email. “I am a bank friendly type,” he said. But, he added, in typically terse trader talk, “Something structurally amiss when so much financial activity is borderline.”

By one measurement, the problem has gotten worse by an order of magnitude in recent years. In the annual letter he writes to shareholders, Robert Wilmers, the chairman and CEO of M&T Bank, has started keeping track of the fines, sanctions and legal awards levied against the “Big Six” bank holding companies. In 2011, those penalties were $13.9 billion. In 2012, they more than doubled to $29.3 billion. Wilmers writes that the past two years represent the majority of the cumulative $52 billion in charges, from 236 separate actions in eight countries, over the past 11 years. Wilmers also cites a study done by M&T, according to which the top six banks have been cited 1,150 times by the Wall Street Journal and the New York Times in articles about their improper activities. Perhaps not surprisingly, the biggest bank, JPMorgan, accounts for a sizable chunk of all this. According to a report by Josh Rosner, a managing director at independent research consultancy Graham Fisher & Co, JPMorgan has paid $8.5 billion in fines between 2009 and 2012, or about 12 percent of its net income over that period.

The results aren’t in for 2013 yet, but so far, the tune is more of the same. In addition to all of last week’s news, there’s the $8.5 billion that 13 banks agreed to pay to address allegations of robo-signing. Barclays, while not a “Big Six” bank, was also ordered to pay $488 million by FERC; that bank, along with RBS and UBS, has also agreed to pay a combined settlement that is well over $1 billion to settle charges that they manipulated the key interest rate called Libor.

How you explain those numbers depends on where you sit. In his letter, Wilmers embraces the argument that a predisposition to wrongdoing is now built into the system, in part because of the decline of traditional banking and the merger of commercial and investment banking. Money center banks, which are desperate to pump up their profits, have increasingly invested in things they know nothing about, whether it be emerging market debt or subprime mortgages. At the same time, Wall Street firms have pushed the envelope in developing newfangled ways for their customers to lose money. (Oops — I meant newfangled ways to help “markets remain efficient and liquid.”) Then, commercial banks have used their balance sheets to inject steroids into Wall Street’s products. Or as Wilmers writes, “One’s cash from deposits and the other’s creativity led to a symbiotic relationship, enhanced by the closeness of geography.”

Another way to think about this is that the combination of investment and commercial banking has brought a tidal wave of government-backed money to businesses that should be purely risk-based. There’s too much money chasing too little return, and the winner takes all. Toss in some rules that are oftentimes too stupid to be respected, therefore inviting gaming, and what do you expect? Banks are constantly going to be right up against the line of wrongdoing, if not over it. Or as my friend writes, “You know it is because some combination of competition, over capacity, resource misallocation, too much money dangled too easily in front of kids. Leads to cutthroat, childish and sometimes borderline behavior.”

If you’re a regulator, the story is simpler. You’ve gotten tired of reading that you kowtow to your banking clients. (Hell hath no fury like a regulator scorned.) You know you screwed up in the financial crisis, or in FERC’s case, back in the Enron years. Funding is tight. There’s a need and a desire to show that you’re an enforcer. That said, you don’t want to risk putting your clients out of business. So you don’t charge individuals, and you allow banks to neither admit nor deny guilt, and shareholders pay the big fines. Everyone seems happy.

Of course, if you’re a bank, you think the numbers are B.S. You think you’ve been unfairly blamed for the financial crisis, that the spate of enforcement actions are to some degree political, and that regulators have gone wild. They’ve lost their collaborative attitude. But because your overseers allow you to neither admit nor deny guilt, as well as to spend shareholders’ money to make the problem go away — and not incidentally, the fines don’t appear to impact executive compensation — pay you do. (See Goldman Sachs, Abacus.)

There’s probably some truth to all these points of view. Look at JPMorgan’s recent settlement with FERC. Banks are in the energy business (pause to think about how weird that is) thanks in part to rulings by the Federal Reserve, which has always believed, often mistakenly, that allowing banks new ways to make money would strengthen the system. Less-regulated investment banks like Goldman Sachs, which turned into bank holding companies during the financial crisis, have been trading energy for a long time. But can today’s banks be trusted with playing a role in what we all pay for power? (This is all now in flux.) As for the regulator, there’s no question that FERC, which was humiliated by the events in California at the turn of the century, is determined to be more aggressive.

JPMorgan, for its part, wants to make money. There’s nothing wrong with that. But in a highly competitive, rules-driven world, especially when the rules seem to invite bad behavior, that can lead to problems. As blogger Matt Levine put it, “FERC built a terrible box, and the box had some buttons that were labeled ‘push here for money,’ and JPMorgan pushed them and got money.” According to newspaper reports, FERC originally wanted around $1 billion in fines and the traders’ heads on a platter. In the end, it was business as usual: JPMorgan paid about half that, no individual traders were charged, and the firm didn’t have to admit or deny any guilt.

On the surface, everyone seems willing to live with the current state of affairs. But the apparent calm masks how seriously messed up this all is.  Look again at the JPMorgan settlement. According to the New York Times, FERC accused the bank of  “turning money-losing power plants into powerful profits centers,” and alleged that a senior executive gave “false and misleading statements under oath.” But the end result — a mere fine — is totally out of synch with that damning language. This makes people cynical about the system. How can you have these apparently bad actors be somehow immune from any serious repercussions? It “smells of cronyism, which is third world stuff,” writes another friend of mine, who, by the way, is not an Occupy Wall Street type, but rather a somewhat buttoned down professional investor. “Scares me.”

Supporters of the banks offer an easy answer to the lack of charges (and it might occasionally be true), which is that the actions aren’t actually that bad. The whole thing is just a show, meant to make the regulators look tough and capable and the banks look contrite. But that’s not OK either, because a functioning economy needs a functioning financial system, one in which people have a basic degree of trust. A constant flood of news about supposed malfeasance does not inspire trust.

In a recent piece in the New York Review of Books, former Federal Reserve chair Paul Volcker weighed in on the incredibly slow implementation of financial reform. “The present overlaps and loopholes in Dodd-Frank and other regulations provide a wonderful obstacle course that plays into the hands of lobbyists resisting change,” he wrote. “The end result is to undercut the market need for clarity and the broader interest of citizens and taxpayers.” I worry that the end result of Volcker’s “wonderful obstacle course” will be a wonderful playground, chock full of badly designed buttons that banks can press to make money. The regulators will bring charges, no one will pay in any meaningful way, we’ll all get more and more cynical and distrustful, and the show will go on. That is, until all the banks press the buttons at the same time, at which point we’ll have another financial crisis. Come to think of it, maybe that wouldn’t be such a bad thing: It might inspire us to think about a financial system that actually makes sense.

PHOTO: Former Goldman Sachs bond trader Fabrice Tourre leaves the Manhattan Federal Court in New York August 1, 2013. REUTERS/Keith Bedford

25 comments

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Hopefully the latest financial crisis has opened everyone’s eyes to the fact that our financial system is ruled by gamblers who only bet with other people’s money. As we continue to bounce from crisis to crisis,Main street remains far too tolerant of Wall street’s thievery. We can only pray the next financial crisis will finally be the straw that breaks this greedy camel’s back.

Posted by changeling | Report as abusive

So the financial “system” of the United States has been ALLOWED to degenerate into a shell game where those who “make the market” routinely rig it and obfuscate that fact. Regulators can not or will not regulate (take your pick). The banking “business”, once staid and respectable, has become the “wild west” without roads or maps, selling anything and everything to anyone and everyone.

Genuine investor individuals are routinely and fraudulently led to slaughter again and again, but there is so much government “monopoly money” spewing from the presses that no one would notice if all small investors go bankrupt. I think it’s time “we, the people” got a firm PINCHING hold on the ear of “our” politicians and let them know they’re history if we don’t see some heads and long sentences for this nonsense QUICK!

In the end, no matter what the game the “house” (in this case the government, bureaucrats, regulators and lobbyists) always wins and the taxpayer, “we, the people” is always left holding the bag. Are we really this stupid?

Posted by OneOfTheSheep | Report as abusive

52 billion is simply the cost of doing business for them when the US taxpayer paid in 6 trillion to bail them out. It is less than 1%.

Posted by BidnisMan | Report as abusive

It also the wrong sort of crackdown – looking for rogues when the whole system is rotten by design. What really needs to be fixed is central banking and fractional lending aspect which gives banks seemingly infinite funds to loan out underwritten by the taxpayer. Bad apples did not cause 2008 – it was Alan Greenspan ‘keeping rates low’ which did the real damage. Let interest rates float and keep fiat money fixed in supply – then banks will take care of themselves as they are no longer underwritten.

Posted by BidnisMan | Report as abusive

The regulatory model is broken.

Posted by highlandlad | Report as abusive

The people who are supposed to be controlling the wrongdoing of Corporate America are getting their campaign war chests filled by Corporate America. I’ll fill your campaign war chest if you deregulate my industry. Nothing is going to change until we get corporate money out of our political system. Corporate money is destroying our democracy.

Posted by Des3Maisons | Report as abusive

No, I would say the majority of these allegations come from a corrupt political environment.

Posted by BSBee | Report as abusive

Banks should be banks. Lend money, collect interest, that’s it.

No commodities, no hedging on ‘inverse put options,’ no ‘creative financial instruments.’

The banks have done a poor job of self-policing to keep the Corzine / Madoff types out. Since bank deposits are federally backed, and since banks have proven incapable of policing themselves, regulations and strict enforcement are therefore in order.

Posted by AlkalineState | Report as abusive

The troubling reality is the hundreds and hundreds of articles i’ve read on this topic & all saying the same thing. Really old troubling news over & over again.

Posted by Will321 | Report as abusive

the question being…why do politicians running for office need millions of dollars to do so….and where do they get it from? when that situation is solved, then Banking might become normal again..maybe.

Posted by rikfre | Report as abusive

It’S the political environment which activates the belief that government is an active collaborationist or whose main focus is elsewhere,and muted that fosters this swindling(it is what it IS)of America.It didn’t start with Enron but it was hard to ignore the positive signs of political opportunity that ignited the “ERA OF GEKKO”.Hands off”let Reagan be Reagan”,chips fall where they may,Supply side Trickle Down….and on and on.These people are “snatchin’ pocketbooks” and need to be locked up like any other felon.

Posted by jj717 | Report as abusive

Sadly, Ms. McLean is probably right that it will take another crisis to change things. It will be ironic that the well-meaning attempts to prevent a catastrophe in 2009 guarantee another one some time in the future. Or it won’t… and we’ll just keep running an economic system to benefit the superrich at the expense of everyone else. The alternative is too horrible to contemplate. The superrich will fight for their status and wealth the same way that despots have for all of human history. It’s happening right now on a smaller scale across the Arab world. Syria’s Assad is acting just as any Wall St. banker will act should the masses get uppity and demand change.

Posted by silliness | Report as abusive

Other than @BidnisMan (business man?) who blames it all on Alan Greenspan, everyone’s right. Well, I’m being hasty. It IS the Federal Reserve’s fault for allowing banks to own electric power plants and participate, then manipulate, energy-based commodity markets. That is appalling.

Before dismantling the Fed, I’d like to see commercial and investment banking separated again, by whatever means necessary, Glass-Steagall or otherwise.

Ms. McLean wrote an excellent article. I tried to tell my one acquaintance in Hedgefund-landia who is among the 0.001%. He told me that I should stop reading fringe and conspiracy publications. Given the fact that Goldman-Sachs became a bank holding company in 2008 and got TARP funds, I wonder: Could the JOBS Act (the recently approved portion that allows hedge funds to do general solicitation) and the fact that Vanguard and other mutual funds use hedge funds as portfolio managers, be used to convince the Fed to allow hedge funds to become de facto banks too? Of course, there would be a financially-engineered or Bayesian probability-based incentive policy that would provide FDIC coverage and access to the Fed discount window if conditions, and the price, were right.

Posted by EllieK | Report as abusive

When only one broker (not even a real banker) goes to jail, for the entire financial crisis, why would anyone possibly think that bankers were even capable of doing anything ‘on the up-and-up’…..

Posted by edgyinchina | Report as abusive

What we see is that no matter what the system just does not work the wait it should.

Posted by Anuncios360PT | Report as abusive

There really is a relatively simple way to “fix” the financial services sector. In fact to fix all of the sectors starting with Government itself. Call for a public referendum vote on two things;

1. Term Limits for Congress and SCOTUS (indeed for all public officials)
2. Campaign finance reform.

These two things will forever change the government. If we don’t do them then things may change but generally for the worse, and only for an election cycle or two. As long as the people are complaining only about their favorite brand of graft, waste, abuse etc.. and only offering solutions to those individual issues, then no consensus will ever be reached. We all tend to focus on symptoms, not the actual root problem. We can’t fix 10,000 little problems, we can fix the system so it can though!

Posted by tmc | Report as abusive

Use the China model. Nationalize the banks, any racketeering = death penalty.

Posted by AlkalineState | Report as abusive

“a functioning economy needs a functioning financial system.”

Agreed. It does not need a banking system, at least one that is one big cartel, headed by a Central Bank, and functioning on fractional (or now zero) reserve lending.

It never made any sense to take saved value (deposits), multiply them by 10 (or more) and then lend out that larger amount (and earn interest on “money” for which there was never any prior value created). This was ALWAYS a fraud, and allowed banks to skim massive amounts of value from the economy over the years. All this did was enrich banks, pull demand forward, create the illusion of wealth via asset inflation and debase everyone’s savings, thus hampering capital formation. Debasing the dollar was Job One for 80 years.

Some ideas are so stupid that it takes PhD’s to believe (and then promulgate) them.

Posted by dc.sunsets | Report as abusive

The only people who should be allowed to create credit are producers, and then only temporarily. It’s called the Real Bills Doctrine and until it was deposed by the Era of Central Banking it facilitated trade and robust, honest economic activity.

We’ve lived with the con artistry of the Fractional Reserve system for so long we don’t even recognize it for the criminal enterprise it is.

Not to worry, however. After fomenting the greatest Credit Bubble in recorded history, the eventual denouement will likely discredit central banks and their ilk for centuries to come.

Posted by dc.sunsets | Report as abusive

I have a question. If you took a bottom half minor league baseball team w/ an average $75,000 salary & pitted them against a top major team w/ a $5million+ average salary which one do you think would win?

Financial regulators try their hardest but honestly the Fed’s do not attract the top or most aggressive talent. In many ways we have set up failure. The regulators are expected to be outmaneuvered & recent changes have made matters worse in two ways. First, by broadening trading options & merging finance industries we have increase the room for regulators to be out maneuvered. Second, the dramatic increase in regulation has given regulators more low priority work to get tripped up on. In the end, too much time is spent on small time fringe violations at the expense of the Maddoff”s, LTC, & London Whale.

Posted by slotowner | Report as abusive

Gamblers playing with OPM (Other People’s Money) are gamblers not bankers. That they occasionally cheat and win doesn’t alter that fact. Reinstate Glass-Steagall and let depositor’s money be loaned out to small businesses instead of being gambled on derivatives.

Posted by QuietThinker | Report as abusive

Re-instating Glass-Steagal will never happen. It’s just not done. Any new legislation coming close to it will be watered down by lobbies as Dodd-Frank was. Even if it made it thru the gauntlet, the banksters would just create new financial instruments and organizations that it doesn’t cover. So, again, see my comment above on Term Limits and campaign finance reform.

Posted by tmc | Report as abusive

One simple capital requirement, in my opinion 8 percent of tangible equity to assets ratio, such as the one Thomas M. Hoenig of the FDIC is proposing would do more good than the wholeDodd-Frank Act. In fact any other type of micromanagement would only constitute an expression of regulatory hubris. Throw all risk-weighting out! It distorts all allocation of bank credit in the real economy

http://subprimeregulations.blogspot.com/ 2013/08/the-convenient-myth-which-suppor ts.html

Posted by PerKurowski | Report as abusive

Obviously, we will have another financial “crisis.” That is why the system is set up this way. The next time the World Bank/IMF/FR system or other shadow workers need to harvest America, presto! If the money markets or banks intended to have consumer protections in place, they would be in place. Consumer protections make it harder to harvest the investors capital at will.

Posted by 2Borknot2B | Report as abusive

” Pop goes the weasel ! “

Posted by CharlesMalloy | Report as abusive