At its peak, financial industry earned a staggering 40 percent of all US corporate profits, four times what they earned in 1980, while the average Wall Street paycheck doubled, and top bonuses sextupled. Not surprisingly, the finance lobby is the strongest campaign contributor in Washington, with an astonishing $475 million during the 2008 election cycle, almost $60 million more than two decades ago. The finance lobby is known as the FIRE lobby—Finance, Insurance, and Real Estate, and it includes basically anyone who makes money by handling money. That includes big money-center banks, small community banks, Wall Street investment banks, insurance companies, mortgage brokers, hedge funds, credit card issuers, trade groups (ISDA), private equity firms, credit unions, and more. To understand just how extravagant the finance lobby’s power is, we need to understand some history first.
The beginning could be the $100 billion bailout of the savings and loan industry that happened in 1992. Another milestone is placed in 1998, when Long-Term Capital Management (LTCM) – the largest start-up hedge fund ever, imploded and very nearly took the global financial system down with it. The New York Fed stepped in and arranged a bailout, convincing Wall Street that LTCM was too big to fail. A few months later, an interagency report concluded that all participants in our financial system should face tough constraints on the amount of leverage they assume. The last thing the finance lobby ever wanted was accepting constraints of any kind.
Since then, two critical actions have been taken by Congress: the Financial Services Modernization Act (FSMA) followed-up by the Commodity Futures Modernization Act (CFMA). The FSMA was designed to tear down the 1933 Glass-Steagall Act, a law that has enforced a fire wall between commercial and investment banks. After spending $209 million in 1998 alone, Wall Street lobbyists got what they wanted: Citigroup and JP Morgan Chase became the first too-big-to-fail financial giants. In addition to that, the finance lobby was eager to make sure that the world of derivatives remained largely unregulated, and the Wall Street banks would be allowed to bet on anything.
The biggest injustice money managers commit is the tax shelter against IRS. The tax avoidance, called the carried interest rule, assumes declaring the annual compensation as capital gain, as opposed to ordinary income. That means the money mangers get taxed at 15 percent instead of 35 percent. In June 2007 alone, when lobbying for the carried interest rule reached a bump in the road, private equity firms contributed nearly $800,000 to the Democratic Party. It was money well spent, since that investment has allowed the hedge fund industry to keep a billion-dollar loophole.
The finance lobby successfully convinced the public that deregulating finance was not only safe, but good for both Wall Street and Main Street. After Lehman Brothers collapse, even Alan Greenspan, one of the biggest supporters of self-regulation, was admitting that there was a flaw in the free-market concept. Last year, the public opinion was vividly asking for a real change in Washington vis-à-vis the financial industry regulations. With the success of the $700 billion bailout in check, the sense of urgency for political action on Wall Street has considerably dissolved. Bottom line, despite nearly pushing the world economy into a prolonged depression, the finance lobby could be simply labeled too-big-to-fight.
Hi Toni, I am new on your website, but I like the 4-5 articles that I read so far. Regarding the Glass-Steagall act, what do you think about the following ideea? Instead of trying to put back into play the the Glass-Steagall act, why not ask all the too big to fail banks to keep separate balance sheets for both the investment and the commercial side of the business. The Government should pass a legislation that in this way, the banks act like 2 separate entities, and in case one entity fails, the other entity stays in the business without being responsible for the failing business line. The investment banking side of the business should not be able to access capital from the FED – just the commercial side.
In this way the entire bank cannot complain that they have to serve clients and businesses in the entire world that are using services from both the commercial side and the investment banking side, and the investment banking side can go on with BAU activity, so for example the derivatives trading can stay unregulated. In this way, if the Investment Bank side fails, the commercial side is ok, and there is no system risk. The shareholders will not get completely screwed, at least they will still have the shares representing only the commercial bank business line – which should be worth something. The only people that will lose are the other investment banks who were taking the other side of the trade or if they received loans from other parties, and is a fair game, in everything there is a counterparty risk – that is what the margin calls are for.
Catalin,
I have a good news and a bad news. The good news: I am glad you found some interesting stuff on my blog. The bad news: your idea is 100% preposterous. Why?
1. A kid could figure out that there will be no “firewall” between two entities within the same organization, ever.
2. If you separate the two, why not splitting the company into 2 stand-alone firms
3. The shareholders would arbitrage between Goldman investment bank and Goldman commercial bank?
And the list go on forever. Looking forward to seeing better proposals.
Toni,
1. By keeping 2 distinct balance sheets, income statements and cash flows, a regulator can easily detect what money IS used for and where IT comeS from, Especially if there are proper penalties put into place for the CFO (long jail time). Is not hard to have a couple of forensic accountants to check whether there are any cash movements from the comercial to the investment banking side.
2. the argument against splitting the companies into 2 diferent entities is simple: they have clients worldwide who are using services from both the commercial and the investment bank sides. Not mentioning that you can create competitive advantages for the foreign big banks that can have both the Investment Banking, Insurance and Comercial business lines in case not everybody has to follow the same regulations. What if in Europe is ok to have investment banks and commercial banks together, but not in US?
3. there will be no arbitrage since the company stays listed as one entity – Goldman Sachs, not Goldman Sachs Investment Banking nor Goldman Sachs Commercial Bank. Just the reporting is separate, the shareholders are the same for both with the same percentages.
My point is very simple. Have a small set of common sense rules and regulations that will be strictly enforced, and let the free market stay free. Why an investment bank shouldn’t be allowed to run a commercial bank business ? Let the banks be run like they should be run without the government accusing them of not lending, when JPM for example lost over 1B from bad credit card loans. Why should JPM be punnished with Glass-Steagall act? Their business did not need the 20 B bailout; they were the ones who helped in this crisis – Bear and WaMu cases.
Catalin,
You really like this plan. Good for you.
With regard to JPM not needing the TARP money, that is not true. The same goes for the BSC and WaMu. Practically, JPM got BSC for nothing…the Madison building was worth more than they paid for. Please, wake up!
well, regarding JPM – BSC let’s not forget JPM got BSC trading book as well, and their exposure to subprime lending. BSC exposure to subprime was about 250 B, while their equity was 15 – 20 B (before JPM offer of $2/share). BSC would not have been able to survive otherwise, so the price that was paid for them was fair in my mind. At least the shareholders got the 10$/share in the end.
Is not that I really like the plan, but the ideea that the big banks should just be broken because the entire fault belong to them is completely false. On the other hand you have to ensure that there is no such thing as too big to fail, but not by braking up the banks. Let’s not forget Barney Frank when he said that he wants to “roll the dice” when it comes to subprime landing, and why were Freddie and Fannie created for? Bankers may have a fault in this equation, but far much smaller than the Government did – and still nobody regulates the Government, and nobody, not even Barney Frank accepts any responsability for this mess.
I agree that BSC was doomed to die. JPM paid $9.35 per BSC share, roughly $1.2 B in total.
However, MBS portfolio (except the subprime paper) – worth roughly $30 B, has been purchased by NY Fed, with JPM assuming the $1.15 B equity piece. The only piece JPM was exposed to was $2 billion SUBPRIME
At the end of 2007, BSC had $395 B in TOTAL ASSETS and $384 in Total Liabilities. Not bad.
How could they hold 5/8 of their assets in subprime???
If you are on the Street you should have known all these.
Sorry, I misspoke, I was refering to level 2 and level three assets. My point was that having 220 to 250 billion in level 2 and level 3 assets, means that a small change in these assets will wipe out their entire 15 B worth of equity at that time…
The border between Level 2 and Level 3 assets is a fuzzy one. Just for the record, I remember BSC reporting $20 B worth of Level 3 assets.
also regarding “If you are on the Street you should have known all these”, I am actually near the Street and in many situations I know a lot more. A research/modeling analyst can sometimes (many times) be more helpful than an MBA. I will just resume stating that if you would look at the data, since 2004 – 2005 you could see the housing market is a bubble. Well it took until the prices stop rising in 2007 which made the people that just bought houses (or refinanced) unable to refinance. That was actually the pick of the iceberg. Some research analyst were keep saying that the housing is in the buble, while the Street analysts never listened and they end up lossing their jobs…
Just an FYI, if you take the consumer staples spyder for example and allocate the resources to all the firms based on the following formula (ROA/Price to Sales)*(Credit Stress/debt to total assets) – For Credit Stress you can use the spread between 3 month LIBOR vs 3 Months treasuries, or just the 30 day commercial paper. You will see that this model beats the Street by a lot… actually if you would have invested 10K in 1999 when State Street created the Spyder, you would have the same money now, give or take. The index that I just summarized above which actually is my own creation (not read somewhere or things like that) will more than double your investment. Is a fact that 70% of fund managers are underperforming the market (S&P500) after the fees and expenses are taken into consideration. Can you imagine how many fund managers can beat a simple index like the one that I just summarized above?!?!? If they would actually teach a simple linear regression class in the MBA program the Street guys would be so much smarter.
How does an MBA fit into the whole discussion? What does an analyst have to do with my article? You are completely off the track.
For future reference, please keep the propaganda for youself. On my blog, ads are not permitted.
FYI: the HPI peaked long before 2007.
Toni,
Have you seen “Capitalism: A Love Story” by Michael Moore ? If yes, what do you think about it ?
Bogdan Cicioc
Bogdan,
I have not. However, I saw “Fahrenheit 9/11″ and I made my mind of his style. For that movie, I would give him a B- grade, with plenty of room for improvement. He might have done a similar job on the Wall Street subject, if not worse…Do you recommend it?
Toni,
First of all, it is funny how Moore is so harsh on capitalism and blame the crisis on it, but “no problem” that due to capitalism he got millions for his productions.
CLS I would say is around F9/11. I would give it 8 but I just watched the “BBC The Love of Money” series and in terms of financial crisis content, it is part of another upper league in comparison with CLS. Of course, some would say that CLS is “awesome” because it has the “hihi haha” scenes and thus entertaining, but personally if I want to look for that I prefer a different plot.
Even though I didn’t expect to find some interesting info about the crisis in CLS for my research, I did some: the part where the guy who handled the VIP loans at Countrywide, tells the real story of predatory lending to whom and at with what discounts was made, especially when a senator speaks to the nation about “mortgage delinquencies”. Another good part is the one with the secret life insurance policies where corporations like Bank Of America, Citi, Walmart, P&G, Nestle, AT&T etc take. A lawyer says that “basically the broker here is complaining that not enough employees are dying” … “you are more valuable to the company dead than alive”. Did you know about this “Dead Peasants” insurances which kind of negatively amazed me ? Also the part with “government Goldman”.
Overall, a good watch on a Friday night, but exactly like you said, plenty of room for improvement especially if anyone was looking to see more about the financial crisis itself.
Bogdan
Bogdan,
One of these days i am going to watch it and I will give you my feedback. There are things that I knew about them and I am sure I could find new things too.
Toni,
I just found it and watched. It was interesting for me.
As I got it, I was just wondering, people from over there (US,Canada) do really all the time buy the DVD / watch it in cinemas ? because over here, we go for the “free” P2P alternative pretty much every time. Definitely I refer to home users here.
Dany
Dany,
Believe it or not, people in US pay around $10 for a movie on the big screen. There are movies that cash in 20 to 30 million dollars over their first weekend. Eventually some of these end-up in low hundreds or sometimes close to a billion dollars. It is a good business.
Toni,
Broke: The New American Dream by Michael Covel they say is good, at least it has very good reviews on amazon. Unfortunately, definitely no cinema will play it here … I guess they do that there right ?
Bogdan
Toni,
I did not follow along the events and that’s why I’m asking you:
1) where is all the bailout money now?
2) where are the losses (liar’s loans) and all that ? Are they acknowledged somewhere or placed under the rug with accounting “sutff”?
3) how comes GS was the only bank who did get away without huge losses from the hot potato game with CDOs and all that?
Thx,
Dany
Dany,
As you recall, more than half of the original $700 billion in TARP money, has been paid out to large and medium-sized financial institutions, as well as the auto manufacturing companies. Almost $165 billion has been repaid so far by the big banks, but AIG and the auto industry have a small chance of repaying the loans ever.
All the writedowns and credit losses are real numbers and they hit the bottom line of all banks and financial institutions.
GS had its losses…but they hedged in early 2007 for the whole debacle that followed. Watch the ABX 2007-1 index and that gives you a good idea.
Toni,
Thx. I see … those bad loans couldn’t be recovered if let’s say housing prices will start increasing ? or the houses which the banks have/had after foreclosures are already sold ?
And also, how did GS hedge ? What did the buy or sell ?
Dany
Dany,
The $1+ trillion of losses are Realized not Unrealized. So, the number cannot reverse.
GS bought ABCDS index across ratings.
Dany,
Yes GS hedged for that but still continued to sell “AAA” MBS’s worldwide … ain’t that great ?
Toni,
How do you feel about that ? Isn’t the hedge in this case not that “politically correct” ?
Bogdan
Bogdan,
You know that Wall Street si not the most ethical place in the world…Don’t worry…it is the same everywhere you go.
By the way, let’s have a chat offline, one of these days!
Toni,
“Our assets are our people, capital and reputation. If any of these is ever diminished, the last is the most difficult to restore.” GS
They got that one right didn’t they ?
BogdanC
Bogdan,
Unfortunately they are not alone in this game. With regard to the final outcome, I will believe when I see.
… I mean already sold at distressed prices and the difference being the loss on the balance sheet right ?
For mortgages, once foreclosure triggers, the bank starts recording losses. For Structured Finance deals, once the pool of assets’ losses eat-up different tranches, the SF bonds lose value.
Toni,
For how long can a bank keep in its property the houses ? Let’s say if they could have waited for the housing sector to recover and sell them at a good price ?
Dany
Dany,
Once the asset become REO, the bank sells the property immediately. The banks are in the business of making money not in the business of real assets.
Toni,
I see that but legally can they hold the house for how long ? is there a limit or that can keep it as long as they want ?
Dany
Dany,
Once the bank owns the property, it can do whatever it pleases to: rent it out, hold it, sell it, etc.
Does anyone know when health insurance will become available in a different form than it is right now? I know the long term care insurance part of it.
Ronald,
As you know, the Republicans are trying to delay the whole process via the Supreme Court…My best guess, we will have the new law effective in 2014…
What do you think?