Recovery may scuttle stricter financial rules
A year after the demise of legendary Wall Street investment bank Lehman Bros., calls for far-reaching reforms to rein in the financial industry’s excesses remain unanswered -- and may be stymied by increasing signs of a budding economic recovery.
President Obama is headed today to Founders Hall on Wall Street, steps from the heart of the business world, to try to reignite support for his proposed overhaul of financial regulations.
The legislation would permanently expand Washington’s role in overseeing the financial system by creating a new agency to protect consumers, reining in the dark world of derivatives and giving government officials the ability to seize and dismantle large companies whose failures could be catastrophic.
The momentum for those reforms has been weakening recently as banks begin to repay their bailout money, the stock market climbs out of its deep hole and a less-chastened financial industry fights back against the specter of stricter government regulation.
So on the anniversary of Lehman’s collapse, Obama will try to seize back the high ground. He will deliver a major speech that will highlight his administration’s efforts to halt the financial crisis and press Congress to approve changes that he believes are needed to prevent a repeat, the White House said.
“We have to have much stronger rules of the game in place with much stronger constraints on how much risk can take place,” Treasury Secretary Timothy F. Geithner said last week during a town hall forum hosted by CNBC. “People are so angry. . . . We can’t let things go back to the way they were.”
No matter how deep the crisis, however, history shows that fear eventually subsides, greed returns and new market bubbles emerge, financial historian Robert E. Wright said.
“It’s amazing how short Wall Street’s memory is -- and investors’ memory is,” said Wright, a professor at Augustana College in South Dakota who is writing a book titled “Bailouts: Private Profits, Public Risk.”
A year ago, a $700-billion bailout fund didn’t exist, taxpayer money wasn’t invested in banks or automakers, and the federal government didn’t loom powerfully over the entire economy.
But Lehman’s collapse Sept. 14, after it failed to win a government lifeline, triggered a chain reaction of events that rattled capitalism to its core. During the chaotic days that followed, the government began launching the largest set of economic rescue initiatives since the Great Depression to avoid a meltdown of the global financial system.
The extraordinary events dramatically altered the relationship between Washington and Wall Street as regulators strengthened their oversight.
The Securities and Exchange Commission’s enforcement budget has been beefed up. The Federal Reserve this spring put the nation’s 19 largest banks through extensive “stress tests” and ordered 10 of them to boost their capital by a combined $75 billion.
And federal regulators are asking about a quarter of the banks they examine to hold more capital than the 10% minimum that was considered sufficient for years, said Wayne Abernathy, executive vice president for financial institutions policy and regulatory affairs at the American Bankers Assn.
“There’s always a bit of tension between a bank and a regulator . . . but there are periods when you can have more give-and-take during an exam,” he said. “There’s a lot less of that going on.”
But those changes, just like industry self-restraint, probably are only temporary, said Sung Won Sohn, a professor of economics and finance at Cal State Channel Islands in Camarillo.
“There are already concerns that some of the financial institutions are going back to old habits because the economy’s improving,” said Sohn, a former chief economist at Wells Fargo & Co., citing the recent Wall Street rally.
“This crisis fortunately has eased and improved a lot faster than many of us anticipated. That is good,” he said. “But if you believe we need some additional regulations to prevent the financial markets from getting in trouble in the future, the impetus and incentive for that has diminished.”
Geithner last week touted the success of the financial rescue initiatives, while also warning that long-lasting change requires congressional action on the administration’s overhaul package.
But the financial services industry strongly opposes the creation of the new consumer agency, as do some lawmakers, who also balk at granting more power to the Federal Reserve to oversee the financial system for signs of systemic risk.
“Any time you want to increase regulation . . . you’re going to get push-back from the financial community. They made a lot of money in the short run taking on those risks,” said Lee Sachs, a top advisor to Geithner.
“But the world’s learned many lessons over the past couple of years, and we have to ensure those lessons are reflected in the changes we are fighting for on Capitol Hill,” he said.
The long-term effect of the financial crisis triggered by Lehman’s failure will be determined by who wins the battle for new regulations, experts said.
“I’d be very surprised if something didn’t happen,” economist Edward Leamer, director of the quarterly UCLA Anderson Forecast, said of new regulations on financial institutions. “They want to return to their previous behavior. We just can’t let that happen.”
Years of low interest rates provided easy access to money earlier this decade, helping trigger the boom and eventually the crash. Financial firms engaged in increasingly riskier speculation, fueled by a culture on Wall Street that rewarded short-term gains with big bonuses and aided by lax oversight from Washington.
Driven by housing prices that seemed to be rising without end, mortgages became the investment of choice -- and lending standards fell sharply to meet the demand for loans that could be bundled as securities and sold to investors.
It all came undone when the speculative housing bubble burst and many banks and other financial firms started recording record losses.
In March 2008, the Federal Reserve provided an emergency $30-billion loan to help JPMorgan Chase & Co. acquire battered investment bank Bear Stearns Cos.
Then in early September 2008, federal officials committed as much as $200 billion in seizing government-sponsored mortgage giants Fannie Mae and Freddie Mac.
But when Lehman Bros., one of the most aggressive backers of high-risk mortgages, teetered near bankruptcy on Sunday, Sept. 14, former Treasury Secretary Henry M. Paulson and Fed Chairman Ben S. Bernanke decided not to provide government money to secure a sale.
“You had this situation where these banks like Lehman created this massive systemic risk, and the system failed,” said Lawrence McDonald, a former Lehman vice president and author of “A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers.” “You could make a very good case that Lehman was one giant domino.”
News of the collapse of a government rescue of Lehman caused stock markets in the U.S. and worldwide to plummet. In the panicked atmosphere, the Bush administration put up $85 billion in taxpayer funds Sept. 16 to keep insurance giant American International Group Inc. from failing, fearing that the financial system could not withstand the loss of a company that had insured trillions of dollars in financial debt.
By the end of the week, Paulson asked Congress for $700 billion to buy toxic mortgage-backed assets from banks.
The crisis devastated Wall Street, where executives seemed chastened and willing to accept more government oversight.
“Much of the past year has been deeply humbling for my industry,” Goldman Sachs Group Inc. Chief Executive Lloyd C. Blankfein told a Washington group in April. “Meaningful change and effective reform are vital and should naturally emanate from the lessons learned.”
On Wall Street today, Obama will try to make sure that reform, embodied in his overhaul proposal, doesn’t get stalled as memories of last fall’s crisis fade, White House Press Secretary Robert Gibbs told reporters this weekend.
“The goal of the speech will be to discuss again and to remind people how much we have to do to make sure that something like this never happens again,” Gibbs said.
Jaret Seiberg, a financial policy analyst with Concept Capital’s Washington Research Group, believes the crisis will lead to more regulation -- but said it might not be as far-reaching as was once considered likely.
“The level of oversight that the industry never would have accepted 18 months ago is no longer controversial,” Seiberg said. “Now there’s near unanimity that government needs to have a more active role in the financial system. . . . The issue is how much.”
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Times staff writer Peter Nicholas contributed to this report.
