“(I)t is important to note that the very absence of common-sense regulations able to keep up with a fast-paced financial sector is what created the need for that extraordinary intervention. The lack of sensible rules of the road, so often opposed by those who claim to speak for the free market, led to a rescue far more intrusive than anything any of us, Democrat or Republican, progressive or conservative, would have proposed or predicted.”
— President Barack Obama
Although President Obama made a case for a major regulatory overhaul, there is little possibility of meaningful changes in the near term.
Frequent interventions by the Bush and Obama administrations have used government largess to lift inefficient firms to safety, sparing jobs and limiting pain.
We no longer subscribe to creative destruction. Instead we have shored up our banks and government-sponsored enterprises such as Fannie Mae to prevent a downward spiral that could bring down our capitalistic system.
Hoping to prevent another Great Depression, most economists supported the government intervention following Lehman Brothers’ collapse.
But in the few days after Lehman’s failure, banks stopped lending and we experienced massive runs on our $4 trillion money market funds that were unsustainable Global financial panic erupted.
American policy had promoted a top-heavy banking system because we believed that to compete globally we needed outsized institutions. Our four largest banks control more than 40 percent of all U.S. deposits. Another 8,380 banks share the remaining 60 percent.
What are the next steps?
Several reforms could help, such as a prudent financial-health standard on banking giants. We need to impose bigger capital cushions for banks that rely so much on short-term borrowing or invest in hard-to sell assets. Otherwise they pose a threat to the financial system.
Secondly, we need to change the financial industry’s incentive policies. New rules on regulation should require “claw back” of bonuses if firms suffer losses in subsequent years.
Thirdly, we lack appropriate tools to measure risk. One measurement metric is VAR or “value at risk,” the amount of money that a firm could lose in a given day.
Andrew Sorkin reported in an Sept. 27 New York Times piece, “Taking a Chance on Risk, Again,” that Goldman Sachs’ VAR is now $245 million.
Simon Johnson, a professor at the Sloan School of Management at the Massachusetts Institute of Technology, says that VAR misses everything that matters when it matters because it does not measure unexpected events.
Author Richard Bookstaber supported regulatory overhaul to prevent future meltdowns.
“The financial markets that we have constructed are now so complex, and the speed of transactions so fast, that apparently isolated actions and even minor events can have catastrophic consequences,” Bookstaber wrote.
One year after the collapse of Lehman Brothers, the American financial system resembles most of the developed world. We have accepted government guidance over our leading financial institutions. After the calamitous spillover from letting Lehman Brothers fail, most policymakers no longer subscribe to the disciplines of the marketplace. Instead, we have taken steps to protect numerous institutions that we feel are “too big to fail.”
In the 1930s, the Pecora hearings examined the stock market crash of 1929. The findings led to widespread changes in banking, investing and financial regulation. We now have the Financial Crisis Inquiry Commission.
Its mandate is to examine the causes of our most recent crisis and report its findings Dec. 15. 2010. Given the grim period that followed the collapse of Lehman, the long delay seems interminable.
Originally published in the Sarasota Herald-Tribune
