Still Too Big To Fail


A few years ago, Time Magazine ran a breezy and sketchy, if somewhat thought-provoking article entitled "25 People to Blame for the Financial Crisis" beginning in '07-'08.   It said

President Clinton's tenure was characterized by economic prosperity and financial deregulation, which in many ways set the stage for the excesses of recent years. Among his biggest strokes of free-wheeling capitalism was the Gramm-Leach-Bliley Act, which repealed the Glass-Steagall Act, a cornerstone of Depression-era regulation. He also signed the Commodity Futures Modernization Act, which exempted credit-default swaps from regulation. In 1995 Clinton loosened housing rules by rewriting the Community Reinvestment Act, which put added pressure on banks to lend in low-income neighborhoods. It is the subject of heated political and scholarly debate whether any of these moves are to blame for our troubles, but they certainly played a role in creating a permissive lending environment.

In an interview on CNN soon after publication, Clinton denied that either repeal of Glass-Steagall or his Administration's housing policies contributed to the financial collapse.  He was half right.   Ellen Seidman, head of the Office of Thrift Supervision in the late '90s, explains

CRA enforcement became a lower priority for bank regulators after 2001. My successor at the Office of Thrift Supervision, in fact, led an effort-eventually thwarted-to unilaterally loosen CRA regulations for institutions with more than $1 billion in assets. See 70 Fed. Reg. 10023. Nevertheless, CRA regulations were eased more generally in 2005. See 70 Fed. Reg. 44256.

The years that coincided with reduced CRA enforcement are also the years when CRA-covered entities wandered deeper into "higher priced loans," a category that includes, but is not limited to, "exploding ARMs" and other particularly pernicious kinds of loans. Thanks to the valiant efforts of late Fed Governor Ned Gramlich, starting in 2004 we have data about "higher priced loans." In that year, bank, thrifts and their subsidiaries-the entities covered by CRA-made about 37% of high cost loans. By 2006, the bank, thrift and subsidiary percentage was up to 40.9%. That a lack of interest in CRA enforcement coincided with CRA-covered entities getting into higher priced lending does not seem to me an argument for less CRA enforcement. Rather, it's an argument for better enforcement of a statute that, when well enforced, had proven its worth in helping both borrowers and communities.

Finally, it is nevertheless the case that CRA-covered lenders are not the source of the problem. One of CRA's major failings, in fact, is that it only applies to banks and thrifts. Remember all the investment banks who demanded product and then sliced and diced loans until it was impossible to understand their quality?They're not covered. Neither are the independent mortgage banks, the kinds of firms that have gone bankrupt or nearly so because of their abysmal lending practices, who regularly made about 50% of the high cost loans. Bank affiliates, another uncovered group, made about 12% of the high cost loans.

However, the Commodity Futures Modernization Act, a/k/a Gramm-Leach-Blilely, signed by the President as Bill Clinton was heading out the door, did play a major role in the housing collapse.  It wiped out major provisions of Glass-Steagall, including the prohibition on any financial institution being involved in both commercial and investment banking. In so doing, it made a prophet of North Dakota's Byron Dorgan, who on the Senate floor stated "I'll bet one day somebody's going to look back at this and say 'How on earth could we have thought it made sense to allow the banking industry to concentrate through merger and acquisition to become bigger and bigger and bigger. How did we think that was gonna help this country?"

Further deregulation of the financial services industry, especially the Bankruptcy Abuse Prevention and Consumer Protection Act signed by President Bush in 2005, helped precipitate the collapse of the housing industry.  Dodd-Frank did not end "too big to fail" and now we learn from Dealbook, a New York Times blog, that

Criticized for letting Wall Street off the hook after the financial crisis, the Justice Department is building a new model for prosecuting big banks.

In a recent round of actions that shook the financial industry, the government pushed for guilty pleas, rather than just the usual fines and reforms. Prosecutors now aim to apply the approach broadly to financial fraud cases, according to officials involved in the investigations.

Lawyers for several big banks, who spoke on the condition of anonymity, said they were already adjusting their defenses and urging banks to fire employees suspected of wrongdoing in the hope of appeasing authorities.

But critics question whether the new strategy amounts to a symbolic reprimand rather than a sweeping rebuke. So far, the Justice Department has extracted guilty pleas only from remote subsidiaries of big foreign banks, a move that has inflicted reputational damage but little else.

The new strategy first materialized in recent settlements with UBS and the Royal Bank of Scotland, which were accused of manipulating interest rates to bolster profit. As part of a broader deal, the banks’ Japanese subsidiaries pleaded guilty to felony wire fraud.

But the new 'get tough policy' is really the same old, same old.   The article continues

Critics point to the UBS case. Before UBS signed the deal, Japanese authorities assured the bank that a guilty plea would not cost the subsidiary its license, a person involved in the case said. While the case has weighed on the stock price, the subsidiary is operating normally and clients have stayed put, according to people with direct knowledge of the case.

Prosecutors defend their effort, saying it was born from painful experiences over the last decade.

After Arthur Andersen was convicted in 2002, the accounting firm went out of business, taking 28,000 jobs with it. The Supreme Court later overturned the case, prompting the government to alter its approach.    

Matt Taibbi describes the authors as

worried desperately over the issue of whether or not the Japanese subsidiaries would keep their licenses after these guilty pleas. As is often the case – I've personally heard this excuse about a dozen times coming from DC types – regulators are terrified of repeating an Arthur Andersen situation, i.e. punishing a company and seeing massive job losses as a result...

The Arthur Andersen case has become like Wall Street's magic mantra – you hear the name whispered anytime any company gets in trouble. This is a tactic straight out of Blazing Saddles, with banks essentially taking themselves hostage, putting guns to their own heads as they creep sideways out the door: "Back off! Prosecute us and all these jobs will die!"

And prosecutors, just like the idiot town leaders of Mel Brooks's Rockridge, are screaming, "They're just crazy enough to do it!"

And that would be why we need fewer enablers of corporate crime, such as the former President, and more individuals who will face down reluctant bank regulators and, in some fashion, tell them (video, below)

Anyone else want to tell me about the last time you took a Wall Street bank to trial? I just want to note on this, there are district attorneys and U.S. Attorneys who are out there every day squeezing ordinary citizens on sometimes very thin grounds and taking them to trial in order to make an example, as they put it. I'm really concerned that too big to fail has become too big to jail.  That just seems wrong to me.









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