Reflections six years after the financial crisis

It was six years ago that the Federal Reserve and the U.S. Department of the Treasury helped to facilitate the acquisition of Bear Stearns by JP Morgan Chase. The deal was sealed on a Sunday, March 16. JP Morgan Chase bought the bank for $2 per share or about $236 million; 15 months prior the stock market valuation of Bear Stearns was about $20 billion.

Although the mortgage market had started to crumble in 2007, I consider the Bear Stearns event in 2008 to be the beginning of the financial crisis. Several shocking events disrupted the financial markets in the months to come: IndyMac failed in July after comments by Sen. Chuck Schumer triggered a run on the bank, regulators took over Fannie Mae and Freddie Mac in September, Lehman Brothers filed for bankruptcy on Sept. 15, and on Oct. 12 the U.S. Treasury called the heads of nine of the largest financial institutions in for a meeting where Henry Paulson doled out $125 billion.

This sequence of events will be studied by economic historians for decades. Technology and securitization fostered the growth of a global interconnected financial system that outpaced regulatory effectiveness. In fact, our laws, such as the Gramm-Leach-Bliley Act of 1999, only hastened the concentration of assets and made the situation worse. While the FDIC had a fine-tuned system in place for handling small bank failures, the government really didn’t know what to do when the biggest players got in trouble. They made it up as they went along – save Bear Stearns, let Lehman fail – sending all kinds of mixed signals.

The Dodd-Frank Act passed in July 2010 was supposed to codify a procedure for handling the failure of a super-large financial institution. That’s reassuring, although the Washington, D.C.-Wall Street axis remains troubling. Wall Street executives have a long history of putting in stints at Treasury. Jack Lew, the current Treasury Secretary, is a former Citibank employee, which makes me wonder what will happen if Citibank becomes the first institution to test those new big-bank failure proceedings Dodd-Frank gives us. Is it a coincidence that the investment firm to do best during the crisis was Goldman Sachs, Paulson’s former employer? In the end, too-big-to-fail is more a matter of political will than a matter of administrative procedure.

A healthy financial marketplace requires everyone to play by the same rules. We can’t have bureaucrats in Washington, D.C. picking winners and losers. Despite the best intentions of all the elected office-holders and the officials in the various departments and agencies, it just ends up looking like crony capitalism where a select few get special treatment. As a country, we can do better than that.

 

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