Tag Archives: financial crisis

The Free Market’s Weak Hand

By James Kwak

“Except where market discipline is undermined by moral hazard, owing, for example, to federal guarantees of private debt, private regulation generally is far better at constraining excessive risk-taking than is government regulation.”

That was Alan Greenspan back in 2003. This is little different from another of his famous maxims, that anti-fraud regulation was unnecessary because the market would not tolerate fraudsters. It is also a key premise of the blame-the-government crowd (Wallison, Pinto, and most of the current Republican Party), which claims that the financial crisis was caused by excessive government intervention in financial markets.

Market discipline clearly failed in the lead-up to the financial crisis. This picture, for example, shows the yield on Citigroup’s subordinate debt, which is supposed to be a channel for market discipline. (The theory is that subordinated debt investors, who suffer losses relatively early, will be especially anxious to monitor their investments.) Note that yields barely budged before 2008—despite the numerous red flags that were clearly visible in 2007 (and the other red flags that were visible in 2006, like the peaking of the housing market).

 

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The Prosecution That Isn’t Happening

By James Kwak

People keep asking why no senior executive has gone to jail for the misdeeds that produced the financial crisis—and cost the United States more than $6 trillion, or $50,000 per household, in lost economic output. The usual answers are that no one did anything wrong (oh, come on) or, more realistically, that it’s too hard to convict individuals in complex financial fraud cases.

At the same time, however, the U.S. Attorney’s office for the Southern District of New York—the district that includes Wall Street—has amassed a 79-0 record in insider trading cases, including yesterday’s jury verdict against Mathew Martoma, a trader at the hedge fund firm SAC Capital Advisors. In Martoma’s case, he obtained confidential information about a clinical trial for a drug being manufactured by two pharmaceutical companies and, according to the jury, convinced his boss, Steven Cohen, to unload the firm’s positions in those two stocks.

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The Wall Street Takeover, Part 2

By James Kwak

Five years later, and things seem marginally better in some areas (the CFPB exists), significantly worse in others (LIBOR, money laundering, London Whale, etc.). There has been some debate recently about whether we have a safer financial system today than before Lehman collapsed. But the fundamental issue, as Simon and I discussed in 13 Bankers, is whether our political system will put the interests of society at large ahead of the interests of large financial institutions. On that score, there is little to be encouraged about.

In 2002, Art Wilmarth wrote a mammoth (262 pages) article titled “The Transformation of the U.S. Financial Services Industry, 1975–2000.” In that article, he identified many of the key trends in the financial sector—consolidation, deregulation, breakdown of Glass-Steagall, complex products, increased risk-taking—that would not only produce a financial crisis but make it so destabilizing for the economy later in the decade. Now he has written a shorter (164 pages) article, “Turning a Blind Eye: Why Washington Keeps Giving into Wall Street,” on the key question: why our government doesn’t do anything about it, even after the financial crisis.

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Five Years Later

By James Kwak

Five years ago, Lehman brothers went bankrupt, AIG was nationalized, Ben Bernanke stared into an abyss, and Mohamed El-Erian asked his wife to take out as much cash from the ATM as she could. And Simon and I started blogging.

I already wrote my anniversary reflections on the financial crisis for The Atlantic. Here I wanted to talk a bit about how this blog started.

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Non-Lessons of the Financial Crisis

By James Kwak

As the fifth anniversary of the Lehman bankruptcy approaches, the Internet is filling up with reflections on the financial crisis and the ensuing years. My main feeling, as expressed in my latest Atlantic column, is amazement at how little we seem to have learned. Looking back, the period in late 2008 and early 2009, when it was obvious that the financial sector would have to change in important, structural ways, now seems like a naïve, youthful delusion. Sure, there are some new rules around the margins, but for the most part little has changed—not just in the financial sector itself, but more importantly in the political and ideological landscape that shapes regulatory policy.

Of course, this isn’t simply the product of collective amnesia. It’s the result of the fact that ideas are shaped by money and political power. And that’s where little has changed.

How The Banks Stole Medicare

By Simon Johnson

The world’s largest banks have been accused of many things in recent years, including taking excessive risk in the run-up to 2008, doing great damage to the American economy by blowing themselves up and then working hard to resist any sensible notions of financial reform.

All of this is true, but it misses what is likely to be the most profound negative impact of the banks’ behavior on most Americans. The banks’ actions led directly to an increase in government debt, which in turn has made the reduction of that debt by “cutting runaway spending” a centerpiece of the Republican presidential campaign to date.

As a result of this pressure, Medicare now stands on the brink of being eliminated as a viable form of social insurance. Yet the executives who lead these banks – and the politicians with whom they work closely – will not be held accountable this election season. Continue reading

What Did the SEC Really Do in 2004?

By James Kwak

Andrew Lo’s review of twenty-one financial crisis books has been getting a fair amount of attention, including a recent mention in The Economist. Simply reading twenty-one books about the financial crisis is a demonstration of stamina that exceeds mine. I should also say at this point that I have no arguments with Lo’s description of 13 Bankers.

Lo’s main point, which he makes near the end of his article, is that it is important to get the facts straight. Too often people accept and repeat other people’s assertions—especially when they are published in reputable sources, and especially especially when those assertions back up their preexisting beliefs. This is a sentiment with which I could not agree more. One of the things I was struck by when writing 13 Bankers was learning that nonfiction books are not routinely fact-checked (Simon and I hire and pay for fact-checkers ourselves). As technology and the Internet produce a vast increase in the amount of writing on any particular subject, the base of actual facts on which all that writing rests remains the same (or even diminishes, as newspapers cut back on their staffs of journalists).

I’m not entirely convinced by Lo’s example, however. He focuses on a 2004 rule change by the SEC. According to Lo, in 2008, Lee Pickard claimed that “a rule change by the SEC in 2004 allowed broker-dealers to greatly increase their leverage, contributing to the financial crisis” (p. 33). That is Lo’s summary, not Pickard’s original. This claim was picked up by other outlets, notably The New York Times, and combined with the observation that investment bank leverage ratios increased from 2004 to 2007, leading to the belief that the SEC’s rule change was a crucial factor behind the fragility of the financial system and hence the crisis.

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How Times Change

By James Kwak

For those waiting, the paperback edition of 13 Bankers went on sale on Tuesday to little fanfare. That’s not surprising; all of the crisis books have been dribbling out in paperback, about 8-10 months after the hardcover editions, to little fanfare. It’s a commentary on how quickly times have changed, and also on the fickle nature of the publishing market. While there is still a lot of residual anger and bitterness over the financial crisis — specifically, over the fact that the big banks played a central role in triggering the crisis, then got massive amounts of bailout money, and now have returned to “health” more quickly than the economy as a whole or the typical household — most people seem resigned to a continuation of the pre-crisis status quo, and what energy remains has perversely gone into railing against the national debt.

The whole story also highlights the importance of timing in publishing. Looking back, we couldn’t have gotten any luckier, with the book going on sale during the Senate debate over financial reform and just two weeks before the SEC sued Goldman, which also happened the day that our Bill Moyers appearance aired, which drove our Amazon ranking up to #6. Today we’d be lucky to crack #600.

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We Are All “Yappers Who Don’t Know Anything”

By James Kwak

According to ex-Lehman executives interviewed by Max Abelson (hat tip Felix Salmon). To summarize, they say that using borderline-legal transactions to massage your balance sheet at the end of a quarter is completely normal, everyone does it, $50 billion is no big deal anyway, only “nonprofessionals” would even notice, and the only reason the bankruptcy examiner made so much noise about it was to justify the fee for his work. (Abelson does point out that, according to internal Lehman emails cited in the report, there were Lehman executives at the time who were worried about what they were doing and did not think it was standard practice.)

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