“There is a fundamental weakness in the position of those who insist that the only way to deal with financial institutions that are “too big to fail” is to break them up: their acknowledgment that the central question of how big is “too big” is too hard to answer. This is rarely made explicit, but it is universal. Across the ideological range from Sen. Bernie Sanders (I-Vt.) to Neel Kashkari, president of the Minneapolis branch of the Federal Reserve, the “break ’em up” advocates scrupulously avoid suggesting any size beyond which banks must not be allowed to exist. The reason for this glaring omission — which renders their argument of little practical use for makers of actual decisions — is clear, once the focus is on the meaning of “too big to fail,” as opposed to its invocation as a general expression of distrust of banks. The issue is how to avoid a situation in which an institution has incurred so much debt that its inability to pay threatens the stability of the financial system. In other words, how do we prevent a repetition of the damage caused by the collapse of Lehman Brothers in 2008? Therein lies their dilemma.”–Former Congressman Barney Frank
Source: Deal Breaker
Congressman Barney Frank, a Clinton supporter, has been in the media these days to discuss why Hillary Clinton would make a better President than Senator Senators. But, I paid more attention to his take on how Clinton would take on Wall Street and how to strengthen the Dodd-Frank law. Currently, the Volcker rule, rule in the Dodd-Frank bill and named after Paul Volcker (former Fed chief) restrict US banks from making certain kinds of speculative investments such as trade on the bank’s own accounts that don’t benefit their customers,were to go into effect in April 2014. However, thanks to bank lobbyists and the big banks, the Volcker rule has been pushed into 2017. I started to listen to Congressman Frank’s statement on too big to fail, how to take on Wall Street, and Lehman Brothers.
Here is Frank’s take on Sanders’ too big to fail argument in an interview on PBS:
JEFFREY BROWN: And we get a response now from one of the leading players in the aftermath of the financial crisis.
Barney Frank served as a Democratic congressman from Massachusetts from 1981 until his retirement in 2013. As chairman of the House Financial Services Committee, he played a lead role in crafting the Dodd-Frank law, which enacted the most sweeping changes to U.S. financial regulation since the Great Depression.
Welcome back to you.
The starting point of the critique we have heard is that the banks are bigger than ever, the potential for another bailout remains strong. Dodd-Frank was a start, but didn’t go nearly far enough.
Do you see a different picture?
FORMER REP. BARNEY FRANK (D), Massachusetts: Oh, very much so.
In the first place, both Senator Sanders and Mr. Kashkari continue to evade the biggest question. That is, how big is too big? The crisis which touched off when Lehman Brothers couldn’t make its payment, Lehman Brothers was about $650 billion in assets. We have banks four and five times that size
And the question is, does everybody have to be smaller than Lehman Brothers is today? But that would have consequences. Getting there would be a problem. By the way, it should be very clear, Glass-Steagall doesn’t do it. There is a disconnect between Senator Sanders insisting that the banks be broken down to the point where they won’t by their own size threaten, if they have too much debt, to undermine it.
And Glass-Steagall — Glass-Steagall would reduce — it wouldn’t do anything to Goldman Sachs and to Morgan Stanley, which are almost Glass-Steagall-ized themselves. But looked at Citicorp, or J.P. Morgan Chase, or Bank of America, Wells Fargo, even if they were subject to Glass-Steagall, they would still be well beyond the size that Lehman Brothers was.
There is just a disconnect between saying we’re going to do Glass-Steagall and getting the banks down to a size where, if there was a complete failure, you would get damaged by it.
I found a partial transcript of William K. Black’s testimony on the failure of Lehman Brothers before the House Financial Services Committee in 2010:
CHAIRMAN KANJORSKI: And now we’ll hear from Mr. William K. Black, Associate Professor of Economics and Law, the University of Missouri, Kansas City School of Law. Mr. Black.
BILL BLACK: Members of the Committee, thank you.
You asked earlier for a stern regulator, you have one now in front of you. And we need to be blunt. You haven’t heard much bluntness in hours of testimony.
We stopped a nonprime crisis before it became a crisis in 1991 by supervisory actions.
We did it so effectively that people forgot that it even existed, even though it caused several hundred million dollars of losses — but none to the taxpayer. We did it by preemptive litigation, and by supervision. We broke a raging epidemic of accounting control fraud without new legislation in the period of 1984 through 1986.
Legislation would’ve been helpful, we sought legislation, but we didn’t get it. And we were able to stop that because we didn’t simply consider business as usual.
Lehman’s failure is a story in large part of fraud. And it is fraud that begins at the absolute latest in 2001, and that is with their subprime and liars’ loan operations.
Lehman was the leading purveyor of liars’ loans in the world. For most of this decade, studies of liars’ loans show incidence of fraud of 90%. Lehmans sold this to the world, with reps and warranties that there were no such frauds. If you want to know why we have a global crisis, in large part it is before you. But it hasn’t been discussed today, amazingly.
Financial institution leaders are not engaged in risk when they engage in liars’ loans — liars’ loans will cause a failure. They lose money. The only way to make money is to deceive others by selling bad paper, and that will eventually lead to liability and failure as well.
When people cheat you cannot as a regulator continue business as usual. They go into a different category and you must act completely differently as a regulator. What we’ve gotten instead are sad excuses.
The SEC: we’re told they’re only 24 people in their comprehensive program. Who decided how many people there would be in their comprehensive program? Who decided the staffing? The SEC did. To say that we only had 24 people is not to create an excuse — it’s to give an admission of criminal negligence. Except it’s not criminal, because you’re a federal employee.
In the context of the FDIC, Secretary Geithner testified today that this pushed the financial system to the brink of collapse But Chairman Bernanke testified we sent two people to be on site at Lehman. We sent fiftycredit people to the largest savings and loan in America. It had 30 billion in assets. We had a whole lot less staff than the Fed does.
We forced out the CEO. We replaced the CEO. We did that not through regulation but because of our leverage as creditors. Now I ask you, who had more leverage as creditors in 2008? The Fed, as compared to the Federal Home Loan Bank of San Francisco, 19 years earlier? Incomprehensible greater leverage in the Fed, and it simply was not used.
Let’s start with the repos. We have known since the Enron in 2001 that this is a common scam, in which every major bank that was approached by Enron agreed to help them deceive creditors and investors by doing these kind of transactions.
And so what happened? There was a proposal in 2004 to stop it. And the regulatory heads — there was an interagency effort — killed it. They came out with something pathetic in 2006, and stalled its implication until 2007, but it ‘s meaningless.
We have known for decades that these are frauds. We have known for a decade how to stop them. All of the major regulatory agencies were complicit in that statement, in destroying it. We have a self-fulfilling policy of regulatory failure
because of the leadership in this era.
We have the Fed, the Federal Reserve Bank of New York, finding that this is three card monty. Well what would you do, as a regulator, if you knew that one of the largest enterprises in the world, when the nation is on the brink of economic collapse, is engaged in fraud, three card monty? Would you continue business as usual?
That’s what was done. Oh they met a lot — they say “we only had a nuclear stick.” Sounds like a pretty good stick to use, if you’re on the brink of collapse of the system. But that’s not what the Fed has to do. The Fed is a central bank. Central banks for centuries have gotten rid of the heads of financial institutions. The Bank of England does it with a luncheon. The board of directors are invited. They don’t say “no.” They are sat down.
The head of the Bank of England says “we have lost confidence in the head of your enterprise. We believe Mr. Jones would be an effective replacement. And by 4 o’clock that day, Mr. Jones is running the place. And he has a mandate to clean up all the problems.
Instead, every day that Lehman remained under its leadership, the exposure of the American people to loss grew by hundreds of millions of dollars on average. Auroroa was pumping out up to 300 billion dollars a month in liars’ loans. Losses on those are running roughly 50% to 85 cents on the dollar. It is critical not to do business as usual, to change.
We’ve also heard from Secretary Geithner and Chairman Bernanke — we couldn’t deal with these lenders because we had no authority over them. The Fed had unique authority since 1994 under HOEPA to regulate all mortgage lenders. It finally used it in 2008.
They could’ve stopped Aurora. They could’ve stopped the subprime unit of Lehman that was really a liar’s loan place as well as time went by.
[Kanjorski bangs the gavel]
Thank you very much.
HOEPA stands for Home Ownership and Equity Protection Act. Black is right. Home Ownership and Equity Protection Act was a bill in 1994 under Bill Clinton not only required certain disclosures and clamps restrictions on lenders of high-cost loans but gave Fed boards broad powers to adjust regulations as it sees fit.And Alan Greenspan failed to use his powers when the subprime mortgages became apparent in 2005:
Greenspan has tried to defend himself repeatedly, though as bank after bank has failed he’s retreated to the shadows. But in a 2007 interview with CBS he admitted: “While I was aware a lot of these practices were going on, I had no notion of how significant they had become until very late.”
And here is more on the prepared testimony of William K. Black to House Financial Services Committee hearing:
Lehman senior management, however, responded to problems of fraud and unethical behaviour by cranking up the volume of liar’s loans by Aurora and BNC Mortgage (which specialized in subprime loans).
Lehman had become the only vertically integrated player in the industry, doing everything from making loans to securitizing them for sale to investors.
Lehman was a dominant player on all sides of the business. Through its subsidiaries – Aurora, BNC Mortgage LLC and Finance America – it was one of the 10 largest mortgage lenders in the U.S. The subsidiaries fed nearly all their loans to Lehman, making it one of the largest issuers of mortgage-backed securities. In 2007, Lehman securitized more than $100-billion worth of residential mortgages.
These demands posed a much larger problem: contagion. Because these CDOs were thinly traded, many of them did not yet reflect the loss in value implied by their crumbling mortgage holdings. If Bear Stearns or its lenders began auctioning these CDOs off, and nobody wanted to buy them, prices would plummet, requiring all banks with mortgage exposure to begin adjusting their books with massive writedowns.
Lehman, despite its huge mortgage exposure, appeared less scathed than some. Mr. Fuld was awarded $35-million in total compensation at the end of the year.
Volume of liar’s loans and subprime was everything – as long as Lehman could sell the liar’s loans to other parties. Volume created immense real losses, but it also maximized Mr. Fuld’s compensation. Aurora was originating more than $3 billion a month of such loans in the first half of 2007.
Lehman’s real estate businesses helped sales in the capital markets unit jump 56 percent from 2004 to 2006, faster than from investment banking or asset management, the company said in a filing. Lehman reported record earnings in 2005, 2006 and 2007.
And as for former Lehman CEO, he never mentioned the firm’s huge investment in subprime lending in the former CEO’s testimony to Congress in 2008. From Public Integrity website:
Lehman CEO Richard Fuld, in congressional testimony following Lehman’s collapse, did not mention the firm’s huge investment in subprime lending and said the bank was a “casualty of the crisis of confidence” in the banking system.
And here Fuld’s testimony. Click here. On Saturday, September 13, 2008, Tim Geithner, then president of the Federal Reserve Bank of New York, called a 6:00 pm meeting on the future of Lehman, which included the possibility of an emergency liquidation of its assets. More on NY Times. Lehman was reported that it had been in talks with Bank of America and Barclays for the company’s possible sale. Both Bank of America and Barclays refused to purchase Lehman. Bank of America announced their purchase investment firm Merrill Lynch (which was on the verge of bankruptcy) on September 14, 2008. Bank of America shareholders acquisition on December 5, 2008, and the deal closed January 1, 2009. Lehman filed Chapter 11 bankruptcy on September 15, 2008. Lehman was the fourth-largest investment bank in the United States (behind Goldman Sachs, Morgan Stanley, and Merrill Lynch.) As for Goldman Sachs and Morgan Stanley, these two investment firms were in financial trouble. However, then U.S. Treasury and former Goldman CEO, Hank Paulson come to their rescue. From Wikipedia:
At one point, Hank Paulson offered Morgan Stanley to JPMorgan Chase at no cost, but Jamie Dimon refused the offer. Morgan Stanley and Goldman Sachs, the last two major investment banks in the US, both announced on September 22, 2008 that they would become traditionalbank holding companies regulated by the Federal Reserve. The Federal Reserve’s approval of their bid to become banks ended the ascendancy of securities firms, 75 years after Congress separated them from deposit-taking lenders, and capped weeks of chaos that sent Lehman Brothers Holdings Inc. into bankruptcy and led to the rushed sale of Merrill Lynch & Co. to Bank of America Corp.
And according to The Guardian:
The Federal Reserve’s surprise announcement, which came at 2.30am London time, places the banks under the supervision the bank regulators and gives them easier access to credit to help them ride out the financial crisis.
Thanks to Hank Paulson and Federal Reserve Chief, two of the investment firms (Goldman and Morgan Stanley) became a bank holding companies which placed the firms in receivership of bank regulators supervision and receive bailout monies in 2008, 1 investment firm (Merrill Lynch) is owned by a bank, and the other investment firm, Lehman Brothers, went down in flames.