By William J. Quirk
Four years after the 2008 financial crisis, banks are behaving more recklessly than ever
In 1989, the CEOs of our seven largest banks earned an average of
$2.6 million. In 2007, the average CEO income had risen to $26 million.
The ordinary citizen might believe that this is grotesque
overcompensation, but the financial sector found the pay perfectly
reasonable. A year later, this sort of thinking led us to the brink of
complete financial collapse. The financial crisis of 2008 now looks more
and more like a defining moment, a crisis of capitalism. Globally, it
has produced, in addition to a crippling recession, an unending debt
crisis. Our own escalating, unpayable debt makes the future of U.S.
power increasingly uncertain. Government borrowing and spending policies
have failed to stimulate growth in the economy.
The crisis is, at its heart, a cultural failure combined with a
political collapse. Behavior by bank executives that once was
discouraged by a lifted eyebrow created complex structures abetted by an
aggressive reading of the statutes—anything not explicitly prohibited
was considered permissible. As Mervyn King, governor of the Bank of
England, put it, “There was a cultural tendency to be always on one side
and always to be pushing the limits.” The crisis almost immediately
destroyed the rule of law. Secretary of the Treasury Henry Paulson told The Washington Post in
November 2008: “Even if you don’t have the authorities—and frankly I
didn’t have the authorities for anything—if you take charge, people will
follow. Someone has to pull it all together.” In 2011, Phil Angelides,
chairman of the U.S. Financial Crisis Inquiry Commission, summarized the
problem: “These banks are too big to fail. They’re too big to manage.
They’re too big to regulate. They’re too complex to understand and
they’re too risky to exist. And the bottom line is they offer very
little benefit.”
Four years after the crisis began, another election is upon us. What
have we learned? Where are we now? What are the prospects for meaningful
reform of the financial system? Will our debt crush us? Should we let
it? Is it legitimate? What comes next? An open discussion of these
questions needs to take place now. The health of the financial system,
and of our republic, depends on it.
Yet for the bankers, it is still business as usual. In his book, Bailout, Neil
Barofsky, the former special inspector general in charge of oversight
of TARP (the $700 billion Troubled Asset Relief Program), writes that a
major cost of the bailout is the perpetuation of the existing financial
system: Paulson and his successor, Timothy Geithner,“hadn’t just saved
the banks, they’d also preserved a status quo that was dangerously
broken, and in so doing they might have actually increased the danger
lurking in our financial architecture.”...
Nick Carraway, the narrator of The Great Gatsby, says
that when Jay Gatsby tells him their luncheon companion, Meyer
Wolfsheim, fixed the World Series in 1919, “the idea staggered me.” Nick
says he knew that the Series had been fixed, but he had thought of it
as a thing that just happened, the end of some inevitable chain
of events. “It never occurred to me that one man could start to play
with the faith of fifty million people—with the single-mindedness of a
burglar blowing a safe.”
Like Wolfsheim, the big banks have since 2005 fixed a benchmark
thought by millions to be beyond manipulation or reproach—the London
interbank offered rate. The LIBOR is an average reported by 16 big banks
of what they estimate it would cost them to borrow from another bank.
It is used to set rates on mortgages, credit cards, and many other
personal and commercial loans. The amount of money affected by the rate,
at any given time, is estimated at $800 trillion. The British bank
Barclays routinely altered its submitted rates to push the LIBOR high or
low to benefit bets it had made on interest rate derivatives.
That is, it was fixing the result of its outstanding bets. One Barclays
executive was recorded as saying, “We’re clean but we’re dirty-clean,
rather than clean-clean.” Barclays derivatives traders made at least 257
requests to the bank’s London rate submitters over a four-year period.
The emails between Barclays New York derivatives traders and its London
rate submitters are stark: “For Monday we are very long $3 m cash here
in NY and would like the setting to be set as low as possible …
thanks”; “Always happy to help, leave it to me, Sir”; “Done for you big
boy”; and “Dude. I owe you big time! … I’m opening a bottle of
Bollinger.” Lord Turner, chair of the British regulator, the Financial
Services Authority, expressed disbelief at the blatant behavior on the
New York and London trading floors: “One of the shocking things about
this,” he said, “is that on some occasions, the derivatives trader is
not asking the submitter to change his submission on the basis of a
hidden phone call or a note that he believes is hidden, but by shouting
it across the trading floor.”
A single bank could not have that much effect on a 16-bank average,
and sure enough, the scandal has spread. British regulators found that
Barclays colluded with other big banks, among them JPMorgan Chase,
Citigroup, UBS, Deutsche Bank, and HSBC. The banks seem to have a huge
potential liability to those on the losing side of the fixed bets and to
those who paid too much interest when the LIBOR was fixed too high.
According to the July 7 Economist, “This could well be global
finance’s ‘tobacco moment.’ ” Even now, the problems may persist.
Federal Reserve Chairman Ben Bernanke told the Senate on July 17 that he
“lack[s] full confidence in the rate-setting procedure.” Moreover,
“it’s clear beyond these disclosures that the LIBOR structure is
structurally flawed.” Andrew Tyrie, chair of the British parliamentary
committee investigating the LIBOR, asked Paul Tucker, the deputy
governor of the Bank of England, whether he was confident that it was
now working normally. Tucker replied, “We can’t be confident of anything
after learning of this cesspit.” Lord Turner added, “We would be
fooling ourselves” to assume that trading manipulation was limited to
trades. “There is a degree of cynicism and greed which is really quite
shocking … and that does suggest that there are some very wide cultural
issues that need to be strongly addressed.” In June, Barclays agreed to
pay $450 million to British and American regulators, and arrests in
connection with the LIBOR are thought to be imminent.
In the United States, other financial problems abound. Since 2000,
the public sector has been on a national spending spree at least as
irresponsible as that of the private. In this brief time, the national
debt has nearly quadrupled, from $2.8 trillion in 2000 to $10 trillion
in 2012. The debt is commonly said to be $16 trillion, but that number
erroneously includes debt held in trust funds. The Social Security Trust
Fund, for example, should be excluded, since the government owes that
money to itself, which is like your left pocket owing your right pocket.
Of the $10 trillion debt, $5.3 trillion is owed to foreigners, with
Japan and China the leading holders, at $1 trillion each.In 2012, our
revenues ($2.49 trillion) cover entitlements ($2.25 trillion) and
interest ($225 billion), but nothing more. We cannot pay for the
military ($868 billion) or the rest of the government ($450 billion), so
we’ll borrow $1.3 trillion this year to cover those expenses. The
deficits were predictable. Since 2000, spending has increased by 100
percent from $1.8 trillion to $3.6 trillion, while revenues increased
only 25 percent, from $2 trillion to $2.5 trillion. For more than a
decade, our government has spent money like a sailor on leave.
Inadequate tax revenues combined with rising costs added to the
deficit. The Government Accountability Office last year reported some
astounding total amounts paid to specific banks from all the emergency
programs between December 1, 2007, and July 21, 2010: Citigroup, $2.5
trillion; Morgan Stanley, $2 trillion; Bank of America, $1.3 trillion.
The government also provides ongoing aid to banks with the so-called
carry trade, which allows banks to borrow cheap money from the Fed and
depositors and lend it to the U.S. Treasury for a profitable risk-free
spread.
The 2008 financial crash preceded our last presidential election by
just two months. With another presidential election at hand, we should
ask not only what caused the crisis, but also what steps we have taken
to prevent the next one. President Obama’s theory is that Republican
deregulation policies left Wall Street free to plunder the country,
causing the crash. The cure is renewed regulation under the Dodd-Frank
law passed in 2010. The president, after talking with his economic team
shortly before he was to take office, told the public, “right now the
most important task for us is to stabilize the patient. The economy is
badly damaged; it is very sick. So we have to take whatever steps are
required to make sure that it is stabilized.” Three years later, the
president said he had underestimated the economic crisis. “I think we
understood that it was bad, but we didn’t know how bad it was. … I think
I could have prepared the American people for how bad this was going to
be, had we had a sense of that.” The president, when signing
Dodd-Frank, made a promise: “Because of this law, the American people
will never again be asked to foot the bill for Wall Street’s mistakes.
There will be no more taxpayer-funded bailouts. Period.”
Republican candidate Mitt Romney’s theory is that government
interference in the market—forcing bankers to give mortgages to poor
people—caused the crash, and that the cure is to minimize regulation by
repealing Dodd-Frank: “By the way, when I get rid of Obamacare and I get
rid of Dodd-Frank and I get rid of Sarbanes-Oxley [enacted in 2002
after Enron and related scandals], it doesn’t mean I don’t want to have
any law or any regulation. It means I want to make sure it’s modern,
it’s updated, it goes after the bad guys, but it also encourages the
good guys.”
Neither party proposes that the too-big-to-fail banks be broken up or
that some competition replace the oligopoly. Neither party proposes a
reasonable plan to get rid of the national debt. The current system
gives bankers incentives to take excessive risks, since profits are
private and losses are socialized. Any reform has to start with changing
those perverse incentives.
Underlying this election, largely unspoken, is the worry that the
U.S. debt has become so large that the country’s future is endangered.
The 2010 Simpson-Bowles report on fiscal reform predicts that if
interest rates rise, which seems inevitable, our country’s annual
interest payments could increase to $1 trillion, meaning our annual
deficit will be $2 trillion. That will no doubt further lower the
American standard of living and, according to the Congressional Budget
Office, “weaken the United States’ international leadership.”
The financial sector, from 1997 to 2007, made a bold raid on
Americans who pay local taxes. Traditionally, a city issues
fixed-interest debt with call provisions. A call option allows the city
to redeem its bonds before maturity; if interest rates fall the city can
pay off outstanding bonds and issue new ones at the lower rate. Since
the rate is fixed, cities know what to expect. Although variable
interest rate bonds typically carry a slightly lower interest rate,
cities do not issue them because they can’t surprise taxpayers with new
taxes if interest rates go up. The bankers said to the cities, “We can
arrange for you to get the lower interest of a variable-interest bond.
We’ll pay you if interest rates go up. Just enter into this interest
rate swap—you agree to pay a fixed rate, and we agree to pay you the
variable rate. So you can issue cheaper variable-interest debt, and
we’ll pay you if interest rises.” But the cities had to waive their
right to call their bonds. The deals were just bets—if interest rates
went up, the cities won; if rates went down, they lost. American cities,
transit authorities, and nonprofits reportedly made 1,100 such bets.
When the government dropped interest rates to near zero after the crisis
to help stimulate the economy, the bankers won their enormous bet. But
the cities lost an equally large amount. Without the swap deal, the
cities could have called in their bonds and issued new ones at lower
interest rates, to the benefit of their taxpayers.
Other countries take a dim view of interest rate swaps. In 1990, the
British House of Lords ruled that entering into such arrangements fell
outside the powers of local governments. The banks argued that the swaps
were “akin to insurance” to cover possible risks. The Lords, however,
found that swaps were “more akin to gambling than insurance,” and local
governments are not authorized to gamble. Finland and Poland outlawed
derivatives based on interest rate swaps. Germany, in 2010, banned
synthetic credit default swaps (portfolios of hedged bets) linked to
Eurozone government bonds. The European Union Parliament’s economic and
monetary affairs committee, in 2011, voted 34–8 to ban synthetic credit
default swaps to constrain sovereign debt speculation.
Internationally, banks have consistently lost to cities and other
governmental entities in litigation over interest rate swaps. After
Austria’s state-owned railroad, in 2009, reported a $1.3 billion loss
caused by writing down the value of interest rate swaps, it successfully
sued Deutsche Bank on the grounds that the lender had not disclosed the
risks associated with the derivative. Milan, in March 2012, settled its
civil claims on interest rate swaps against Deutsche Bank, UBS, and
JPMorgan Chase for 455 million Euros. In Germany, the cities of Würzburg
and Hagen were awarded damages for losses caused by interest rate
swaps. Britain’s Financial Services Authority (FSA) announced on June 29
that since 2001, the big British banks were guilty of “mis-selling”
28,000 interest rate swaps to small and medium enterprises. FSA said the
banks had agreed to “provide appropriate redress” to the firms.
In the United States, however, the financial sector, using a device
outlawed and discouraged in other countries, raided local taxpayers. The
bankers always bet on interest rates to go down. Why? Did they intend
to manipulate their bets through their control of the LIBOR? Throughout
the financial crisis, the U.S. government was generous to the bankers.
What about when the shoe is on the other foot? Would the bankers show
any generosity toward our local governments? Lloyd Blankfein, the CEO of
Goldman Sachs, was asked at the June annual shareholders’ meeting if he
would let the City of Oakland out of its disastrous deal. He replied,
“I don’t think we’re in a position to do that.” It would not be fair to
his shareholders.
Could the taxpayers, after these huge losses, still run good schools
and pay for police, fire, and other local services? That, said the
bankers, was not their problem. But it may turn out to be. In July,
British Member of Parliament John Mann asked Paul Tucker whether U.S.
litigation brought by cities against some British banks had caused the
Bank of England to put contingency plans in place. Tucker replied,
“Could the class action suits, or whatever they are called, cause such
financial damage to the firms that it could undermine stability? And
people are starting to think about that too—not conclusively yet, but
people are focused on that.”
Rarely is there a frank discussion of the legitimacy of the debt. Our
leaders present our debt as necessary and our credit rating as sacred.
But can debt be illegitimate? If it is run up without regard to law or
public opinion, must it be binding? This is a question largely ignored.
For the past 40 years, U.S. policy has been to borrow and inflate the
debt away. Since President Nixon took us off the international gold
standard in 1971, prices have at least tripled. Inflation does shrink
the debt, but it has a cost. Weimar Germany, to get rid of its foreign
reparations, inflated its currency until a loaf of bread cost a
wheelbarrow full of money. The inflation also wiped out the savings of
the middle class, leaving it vulnerable to an aberrant appeal—the
downside of this debt-fighting technique is that you can get a Hitler.
What is the nature of debt? Thomas Jefferson wrote in 1821 that there
“does not exist an engine so corruptive of the government and so
demoralizing of the nation as a public debt. It will bring on us more
ruin at home than all the enemies from abroad.” Debt seduces by
providing immediate money while delaying the burden of repayment. It is
undemocratic, since the burden rests on a future that never consented to
the loan. The current legislature has no right to bind future citizens,
to deny those who come after us from a complete freedom of action.
Jefferson’s theory therefore posits that no “generation can contract
debts greater than may be paid during the course of its own existence.”
The “earth belongs in usufruct [trust] to the living,” he wrote; “the
dead have neither powers nor rights over it.” If one generation can
charge another for its debts, “then the earth would belong to the dead
and not to the living generation.” Thus, he concluded, “neither the
representatives of a nation, nor the whole nation itself assembled, can
validly engage debts beyond what they may pay in their own
time.” Our national debt is fairly short term—71 percent of it is due
within five years—but it is constantly rolled over. This year the U.S.
Treasury will borrow $4 trillion to cover the rollover and the new
deficit. Twenty percent of the debt is due in six to 10 years and nine
percent is in 30-year bonds.
The principle that one generation cannot bind another is a moral
imperative, Jefferson believed, and a simple statement of fact. No
current decision or debt can irrevocably bind future generations, which
always have perfect freedom of action, whether they realize it or not.
Chains from the past, Jefferson wrote, are always self-imposed.
The chains on today’s citizenry are a perpetual, unpayable debt. What
if we default? Is the threat so dire? That would probably destroy our
credit. We could not borrow any more. Might that be a blessing in
disguise? After the Revolutionary War, the United States did not
immediately repay the money Congress had borrowed in Europe to finance
it. Our credit was consequently very weak. Alexander Hamilton, believing
a strong national government needed strong credit, viewed the
destruction of our credit as a calamity. Jefferson didn’t want either a
strong government or strong credit: he believed in a weak central
government and pay-as-you-go financing. In 1786, he wrote in a letter
from Paris that “good will arise from the destruction of our credit.”
Indeed, he thought it was essential to the preservation of our
republican government:
I see nothing else which can restrain our
disposition to luxury, and the loss of those manners which alone can
preserve republican government. As it is impossible to prevent credit,
the best way would be to cure its ill effects by giving an instantaneous
recovery to the creditor; this would be reducing purchases on credit to
purchases for ready money. A man would then see a poison painted on
everything he wished but had not ready money to pay for.
In 1798, Jefferson proposed a constitutional amendment to take from
the federal government the power to borrow. It would be, Jefferson wrote
to John Eppes in 1813, “a salutary curb on the spirit of war and
indebtment, which, since the modern theory of the perpetuation of debt,
has drenched the earth with blood, and crushed its inhabitants under
burdens ever accumulating.” No one, it seems, heeded his counsel.
Is the Bush-Obama debt legitimate? Did the country benefit from the
borrowing? It’s hard to see any benefit. Instead, it has drenched the
earth with blood.
What have we learned in the four years since the financial crisis?
The story of the crisis, in broad terms, is simple enough: in 2008 the
banks were stuck with $2 trillion of bad, “toxic” assets. The challenge
posed by the crisis was plain as well: how could the banks shift that
loss to the taxpayer? The government, under both President George W.
Bush and President Obama, agreed to help the banks, telling the public
that there was no choice. It was necessary—even though the government
had to borrow the money—to bail out the banks. In a quarterly report to
Congress, the special counsel for TARP reported that the government
committed an astounding $23.9 trillion to support the banks. Otherwise,
the government said, the sky would fall. Polls said that the people
hated the bailout. They did not think it was necessary to prevent a
catastrophe, and they would oppose it even if a catastrophe were to
result. Today, 71 percent of the public thinks the government should let
banks too big to fail, fail. The people feel that the no-choice bailout
was extortion. They saw the banks bailed out with cheap loans and then
watched the bankers pick up where they left off. Our four biggest banks
now hold more than $7 trillion of assets, up 50 percent since the
crisis. As bank profits doubled, the wealth of American families
plummeted. House values dropped, and almost a quarter of mortgages are
now underwater. Median income has dropped. By almost every measure,
ordinary people are worse off. The sky has fallen—on them. The cause of
the crisis, the people believe, was simple greed together with a
complicit government willing to take on illegitimate debt. Treasury
Secretary Geithner told The New Yorker’s John Cassidy in March
2010, “We saved the economy, but we kind of lost the public doing it.”
Seeing that nothing much has changed, many Americans believe that we
will be back in another crisis within a few years.
One of the major players seems to agree. “What’s a financial crisis?”
Jamie Dimon, chairman and CEO of JPMorgan Chase, rhetorically asked the
Financial Crisis Inquiry Commission: “Well, it’s something that happens
every five to seven years.”
In 1933, following the 1929 stock market crash and the nation’s entry
into the Great Depression, Congress enacted the Glass-Steagall Act to
split commercial banking from investment banking. Commercial
banking—taking deposits and making loans—was necessary to the financial
well-being of the nation and deserved to be supported by the taxpayer
through deposit insurance. Investment banking, however, was clearly part
of the private sector and was on its own. Glass-Steagall said you are
free to take risks if you want, but you do it with your own money and
you get to keep your losses as well as your profits. Investment banking,
after Glass-Steagall, was carried on by partnerships of wealthy
individuals, who were personally liable without limitation for any
losses of the partnership—you could lose your own house because of your
partner’s mistakes. The partners were thus very careful about the risks
they took. From 1933 until Glass-Steagall was repealed in 1999, the few
bank failures we had did not threaten the system.
In the 1970s and ’80s, investment bank partnerships like Goldman
Sachs turned themselves into corporations. They said it was necessary to
compete with foreign banks. In corporations, the officers have no
personal liability for their mistakes; it’s shareholders who can lose
their investment. Now investment bank partners could take risks with
other people’s money—without fear of losing their house.
Once this change was in place, the banks asked Congress to make
several major legal changes. One involved derivatives, which have been
defined in part by the Joint Committee on Taxation as “a wager.” So they
are by definition gambling, and gambling debts have been unenforceable
in common law since medieval England. In the United States, betting was
also illegal because of early-20th-century state laws outlawing “bucket
shops.” Bucket shops took bets on stock prices without buying the
stock—a practice similar to today’s derivatives—and were partially
blamed for the Panic of 1907, after which most states banned them.
Congress obliged the banks by authorizing interstate banking in 1994,
repealing Glass-Steagall in 1999, and immunizing derivatives from state
and federal gambling laws in 2000. The 2000 law also excluded credit
default swaps from the definition of security under the Securities Act of 1933, exempting them from the requirements that stocks and bonds must meet. In 1988 The New York Times editorialized
in favor of repealing Glass-Steagall: “Few economic historians now find
the logic behind Glass-Steagall persuasive.” In 1990, it wrote, “the
notion that banks and stocks were a dangerous mixture makes little
sense.” Lawrence Summers, President Clinton’s Treasury secretary, led
the fight for the 2000 law immunizing derivatives.
Over the next decade, the world saw an explosion of exotic,
“innovative” financial products, including collateralized debt
obligations, credit default swaps, and commodity and swap indices. A
bizarre new language came along with them: synthetic credit risk, straightened curves or curve-flatteners, mezzanine tranche, stress loss, and basis trade.
The innovative products, however, had little or no past performance.
Their complexity made analysis and predictability very difficult. The
huge distribution of poorly understood instruments set the stage for the
financial crisis.
Can the big banks be regulated? Are they too big a dog to discipline?
The Dodd-Frank law’s 2,319 pages are based on the theory that more
regulation will prevent a repeat of the crisis. This seems unlikely:
before the crisis, banking was the most regulated business in the
country. The crisis was a massive regulatory failure. SEC regulators
could not catch Bernie Madoff even after they had been tipped off any
number of times. The problem with Dodd-Frank is that an ambiguous
statute will be followed by extensive regulation drafting, which will be
followed by extensive litigation. Two years after enactment, much of
the law has, by design, not yet been implemented. The Volcker rule is
supposed to prohibit a bank’s purchase of securities and derivatives for
its own account, but it allows such purchases if they are intended to
“mitigate” the “risk” of what the bank already owns. The distinction,
which depends on motivation, will be hard to draw in the real world. The
exception may swallow the rule. The gambling activities that caused
JPMorgan’s multibillion-dollar losses this year are probably legal under
Dodd-Frank.
Dodd-Frank is less a law than a general guide. It calls for 398
regulations, which are still being drafted. The banks, if the
regulations do not suit them, will litigate. In view of the statute’s
complexity and detail, the banks should do well. The regulatory approach
gives every advantage to banks with well-funded lobbyists and lawyers.
Jamie Dimon told the Senate on June 13 that of the more than 100
government regulators permanently on duty at the offices of JPMorgan,
none had noticed the derivatives trades that led to its $5.8 billion
loss. Dodd-Frank adds complexity to a system that needs simplicity. Both
regulators and the courts need simple rules to enforce.
What should Congress have done with derivatives? What can be
done, since they are too complex to be regulated? Even Dimon himself
could not control his own bank’s trade in derivatives. In April he said
rumors of bank losses were a “tempest in a teapot.” On May 10 he
announced that the bank had lost at least $2 billion in trades that
were, according to Dimon, “egregious” and “stupid.” On July 13 Dimon
announced that the bank had lost $5.8 billion and could lose another
$1.7 billion. “Essentially, JPMorgan has been operating a hedge fund
with federal insured deposits within a bank,” said Boston University
professor of finance Mark Williams.
After the financial crisis, derivatives should have lost their
immunity from gambling and securities laws. Congress, however, did not
seriously consider making that happen. It made some effort to bring
derivatives out of the shadow world of unregulated trading. Drafts of
Dodd-Frank proposed that derivatives be traded on exchanges so the
public and regulators would at least know of their existence and
pricing. But the bankers’ lobbyists beat back that modest effort at
reform in the last days before the law passed.
The solution to our problem is clear: the system needs to be
simplified and the bankers’ incentives need to be changed. A return to
Glass-Steagall and a repeal of the gambling immunity for derivatives
would be a good start. Sanford Weill, former CEO of Citigroup, who
lobbied hard in 1999 for the repeal of Glass-Steagall, announced on July
25 that he thought the law should be reinstated, a change of heart so
surprising it has been compared to seeing a unicorn walk down Broadway.
Weill said, “What we should probably do is go and split up investment
banking from banking, have banks be deposit takers, have banks make
commercial loans and real estate loans, have banks do something that’s
not going to risk the taxpayer dollars, that’s not too big to fail.” On
July 27, The New York Times admitted in an editorial that “we were wrong to support” the repeal of Glass-Steagall; the same day, the Financial Times editorialized
in favor of the restoration of Glass-Steagall, writing, “If a bank is
too big to fail, it is too big to exist.” Some argue that Glass-Steagall
might not have prevented the crisis; Summers told NPR on July 30 that
its return would be no panacea. What cannot be disputed, however, is
that it kept the public safe from the banks and the bankers safe from
themselves for more than 60 years.
Why has Congress been so feckless? Why has Congress done so little to
fix this massive, institutional gambling fiasco? The banks, of course,
spend lavishly on lobbying. But where the behavior is so egregious (and
the public’s contempt so clear), the failure to act remains puzzling. As
the 2010 election showed, members of Congress can still lose their
jobs. The financial industry did not want to bring us to the edge of a
cliff. It did not want to risk destroying itself along with us. The
bankers themselves do not understand what they have created—a world so
complex that no one understands it. Because the consequences of taking
action are not predictable, Congress is afraid to act. If you are facing
a house of cards, even prudent action can bring it down and you will be
blamed.
The Bank of England’s Donald Kohn testified on July 17 to Parliament:
The banks on both sides of the Atlantic
need to rebuild public confidence that their pursuit of profits is
consistent with and conforms to the public good—that they are allocating
capital, using savings safely, not exploiting a particular advantage or
exploiting to take advantage of others and that they are doing so in an
honest and upright way—as has been raised in the LIBOR thing. There is a
long way to go.
“Everything works much better,” the late economist Anna Schwartz
said, “when wrong decisions are punished and good decisions make you
rich.” The current arrangement creates incentives favoring risk, since
profits are private and losses shared. Gamblers should gamble with their
own money and keep their losses as well as their profits. We have, as
Lord Turner says, “some very wide cultural issues that need to be
strongly addressed.” The banking leaders who broke the rules should be
prosecuted. A return to Glass-Steagall would help. Otherwise, as Jamie
Dimon tells us, we should expect a crisis every five to seven years. We
are about due.
Thanks to Elizabeth Holland and Kristin Tucker for their research assistance, and to David G. Owen for his editorial insights.