The commitments committee

October 6, 2009

The bursting of the dot-com bubble pales in comparision to the financial crisis. In retrospect, it seems a comic-book lesson about the all-too-obvious consequences of irrational exuberance: What were they thinking?

Yet the Internet bubble was in many ways a warm-up for the much larger credit bubble. The common thread, Jonathan Knee, a senior managing director at Evercore Partners, writes in DealBook, is the enabling role played by financial institutions.

In both crises, a bank had to agree to sponsor the poisonous security, whether shares of a profitless dot-com or a risky debt instrument. Banks leave such decisions to the commitments committee, a “once-hallowed, almost sacred institution.” Knee says:

The seriousness with which these firms undertook decisions to underwrite reflected not only a self-interested preoccupation with the long-term value of their own reputations but a genuine belief that they were playing an important role in protecting the overall integrity of the financial markets.

The fundamental question asked by commitments committees was: should their respective institutions sponsor a particular security? It was not just a cynical assessment of whether there was a market for the stock or bond issuance at hand.

“The Internet boom,” Knee contends, “marked a wholesale break with this tradition.”

Knee, the author of “The Accidental Investment Banker,” sounds almost misty-eyed in recounting the standards of yore. Was Wall Street ever so upright and just? He is also not very convincing in suggesting that the recent consolidation in the financial industry should mean a return to standards because the institutions that remain “have a more deeply vested interested in ensuring the health of the overall system.” Wasn’t that also true in 2007?

Still, he is right to note that regulatory reforms in the wake of the dot-com bust failed because “none spoke to the core question of maintaining underwriting standards.”

That’s an oversight that should not be repeated when Congress takes up an overhaul of financial regulation. The Obama administration has proposed requiring firms to keep some skin in the game in securitizations. That’s a start. There need to be more such incentives for the banks to take their committment committees as seriously as Knee says they once did.

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