Opinion

The Great Debate

Are too-big-to-fail banks being cut down to size?

Financial institution representatives are sworn in before testifying at the Financial Crisis Inquiry Commission hearing on Capitol Hill in Washington

The massive $16-billion mortgage fraud settlement agreement just reached by Bank of America and federal authorities — only the latest in a string of such settlements — makes it easy to lose sight of what good shape banks are in.

Banks are now far better capitalized, with tighter credit processes and better risk accounting. The bigger Wall Street houses have also jettisoned many of their most volatile trading operations. Yet most have still managed to turn in decent earnings. That is a tribute to the steady and generally thoughtful imposition of the new Dodd-Frank and Basel III regulations, the rules on “stress-testing” balance sheets and the controversial Volcker Rule that limits speculative proprietary trading operations.

And the feds are keeping on the pressure, as demonstrated by their rejection of almost all the “living will” plans submitted by the major banks, which are supposed to prevent the kind of disorderly collapse that Lehman Brothers went through in 2008.  These living will impositions are designed either to reduce the riskiness of bank holdings or to make the financial institutions post more capital and reserves to cushion against reverses.

A Bank of America sign is shown on a building in downtown Los Angeles, CaliforniaWhile these reforms were badly needed after the virtual wholesale deregulation of the 1990s, they almost all raise costs and limit flexibility. But that is far from the worst problem facing the banks. The regulatory impact on revenues and profits is likely to be dwarfed by the pain banks will experience after the inevitable removal of their current federal life-support systems.

The Federal Reserve has taken extraordinary measures to entice banks to lend money. It has used two main tools. The first, called quantitative easing or “QE,” has entailed the Fed buying massive quantities of securities normally held by private financial institutions. The second has been to keep the fed funds rate, or the rate at which major banks lend their short-term funds to each other, at unusually low levels.

Stress and the Citi

Markets are still absorbing the Federal Reserve’s surprising smack-down of Citigroup. Under its chief executive officer, Michael Corbat, Citi had greatly strengthened its capital base — indeed, it had one of the best capital ratios of all the big banks — and had proposed modest dividend increases and stock buybacks.  Instead, City was the only big American bank that failed its review.

The Fed announcement, perhaps harking back to the Alan Greenspan tradition, was gnomic, to say the least. The Citi bombshell was buried in a few lines in both the press release and the much longer official statement.

While acknowledging Citi’s stronger capital position, the Fed stated that the rejection was based on “qualitative” weaknesses, including the bank’s “[in]ability to develop scenarios … that adequately reflect and stress its full range of business activities and exposures.” The bank will eventually be handed a detailed bill of particulars, perhaps in a week or so.

Are banks too big to indict?

The great 19th century English jurist, Sir James Fitzjames Stephens, once wrote that murderers were hung not for reasons of revenge or deterrence — but to underscore what a serious breach of the social compact had been committed.

Federal District Judge Jed S. Rakoff was making a similar point when he recently called attention to the lack of criminal prosecutions in the wake of the 2008 financial crisis. Consider the 1980s Savings and Loan crisis. The losses were minuscule compared to this recent paroxysm, but they still led to hundreds of criminal convictions.

That looks highly unlikely here. The federal statute of limitations for fraud, generally five years, is rapidly running down. There are reportedly a few cases in process. But the odds are that if there are any indictments, they will be in the pattern of the indictment of Goldman Sachs banker Fabrice Tourre, who has been left holding the bag for a complex scheme to load up clients with worthless securities. Email trails leave little doubt that far more senior figures were aware of the purpose of the deal. The firm also executed other similar deals that haven’t been prosecuted.

What’s behind JPMorgan’s push for worker training?

Just a few weeks before federal prosecutors announced a nearly $2 billion settlement with JPMorgan Chase over Bernie Madoff’s fraudulent accounts, chairman and chief executive officer Jamie Dimon sat alongside former Congressman and White House Chief of Staff Rahm Emanuel at an Aspen Institute forum in the biology lab of Malcolm X College to tout the embattled bank’s five-year, $250 million, multi-city investment in job training. The bank would commit $15 million for “workplace readiness and demand-driven training” in Chicago.

JPMorgan is not alone in its quest to change how it is seen. Goldman Sachs recently extended its 10,000 Small Businesses plan to Detroit, the latest of a number of cities to receive cash from the investment bank. There’s a reason beyond the corporate charity push for all the giving. The financial industry is facing a sea change in electoral politics. It is increasingly operating in a polarized political system that has placed a premium on accountability. Populist and ideologically extreme constituencies are needed for primaries and general elections in which fewer middle-of-the-road voters participate. Loyalties change quickly if pols don’t sway the way their bases want. Elected and would-be elected officials can rely on campaign cash from super PACs and independent expenditures involving wealthy contributors like Sheldon Adelson, George Soros and David Koch. Campaigners don’t have to rely as much on Wall Street as a unit.

Politicians, especially Democrats, benefit from denouncing financiers. As Ben White and Maggie Haberman reported in Politico, “at both ends of the political spectrum, the titans of American finance today find themselves alienated from politics to a surprising degree.” White and Haberman document an environment in which President Obama labels them “fat cats,” the left demonizes and the Tea Party Republicans just shun. So when someone like White House Senior Adviser Valerie Jarrett mentioned Goldman Sachs’ 10,000 Small Businesses in an interview with White, it shows the benefits an outfit like JPMorgan get from courting charitable initiatives, even if they delve into murky policy terrain.

Are the big banks winning?

The Dodd-Frank Act to re-regulate the big banks was intentionally tough. It was passed in the wake of the 2008-2009 financial crash to end cowboy banking; require far more capital  and much less leverage, and rein in the trading-desk geniuses who pumped up serial bubbles. Since Congress is a poor forum for crafting such a complex statute, the details were left to the expert regulatory agencies.

The big banks pay lip-service to the goals of Dodd-Frank — but they’re mounting bitter, rearguard actions in federal courts to block meaningful constraints and regulations on procedural and other grounds. This is an ominous turn of events, since these banks have the legal firepower to overwhelm budget-constrained U.S. regulatory agencies.

While Dodd-Frank is aimed at preventing another cycle of bubble-and-bust, shrinking the financial sector is crucial for other reasons. One is a mass of evidence demonstrating that hyper-financialized economies have lower growth. Another is the appalling ethical record of large financial companies. The chance of making huge paydays by risking other people’s money, it seems, can sometimes derange moral compasses.

from Commentaries:

Giving props to Wall Street’s risks

Wall Street would like you to believe that when investment banks take on risk they are largely doing it for the benefit of investors -- maybe even you and me.

Bankers say much of the capital that their firms put at risk each day is to complete trades for big corporations, mutual funds, pension funds, hedge funds and university endowments. And contrary to the conventional wisdom, proprietary trading -- bets made for a bank's own behalf -- is really just a small part of their business.

Lately, Wall Street's captains of capitalism have been aggressive in pushing the "we take big risks for our customers, not for ourselves" line of argument.

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