Monday, Jun 25, 2018
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Banks ‘safer, but not safe enough’


Richard Fuld, former CEO of Lehman Brothers, testifies at a congressional hearing in October, 2008.


NEW YORK — Ruth Porat didn’t see it coming.

The Morgan Stanley banker who advised the Treasury Department on its rescue of Fannie Mae and Freddie Mac in September, 2008, and thought she understood the risks to the financial system had just spent a weekend trying to save Lehman Brothers Holdings Inc. when she got a message: Would she come back to deal with American International Group Inc.?

“The call I got was, ‘We worked on the wrong thing,’ ” Ms. Porat, 55, said in an interview last month at the New York headquarters of the bank where she’s now chief financial officer. That AIG “could vanish that quickly and the impact that could have throughout the country, and that nobody could see it coming, was just staggering.”

Ms. Porat’s own bank almost vanished when hedge funds, spooked by difficulties getting money out of bankrupt Lehman Brothers, pulled more than $128 billion in two weeks from Morgan Stanley. To stay afloat it sold a 20 percent stake, it became a bank holding company and borrowed $107.3 billion from the Federal Reserve on a single day.

Five years after Lehman sank on Sept. 15, 2008, triggering the worst financial crisis since the Great Depression, Morgan Stanley is safe enough to survive a shock that devastating, Ms. Porat said. She and Chief Executive Officer James Gorman, with prodding from regulators, led a drive to cut risk and boost capital to soften the next blow.

While the amount of capital at the six largest U.S. lenders has almost doubled since 2008, policymakers and some Wall Street veterans say that’s not enough. They see a system still too leveraged, complicated and interconnected to withstand a panic, and regulators ill-equipped to head one off — the same conditions that led to the last crisis.

“We’re safer, but we’re not safe enough,” said Stefan Walter, who led global efforts to revise capital rules as general secretary of the Basel Committee on Banking Supervision.

More than 50 bankers, regulators, economists and lawmakers interviewed by Bloomberg News disagreed about what needs to be done. Some said the six biggest U.S. banks have only gotten bigger since 2007 — a 28 percent increase in combined assets, according to data compiled by Bloomberg — making it harder to let them fail. Others said they weren’t troubled by bigness or a system that requires government intervention every now and then, calling it an inevitable cost of financing global business.

Banks “are too big, and I think they’re going to have to be too big,” said David Komansky, CEO of Merrill Lynch & Co. from 1996 to 2002. Mr. Komansky, now a director at BlackRock Inc., the world’s largest asset manager, said he doesn’t have “the horrible distaste for government intervention.’’

Congressional inquiries and more than 300 books about the crisis have identified many villains: Homeowners borrowing beyond their means, banks selling subprime mortgages, government-supported agencies backing the loans, Wall Street packaging them for investors, ratings firms giving seals of approval, regulators offering little objection, and politicians encouraging it all to happen.

Three fundamental flaws stand out. Regulators stripped of power allowed banks to embrace too much risk and load up on toxic debt with short-term funds. Insufficient capital left them little margin for error when those assets plunged in value. A system too large, opaque, and interconnected meant they couldn’t fail without catastrophic consequences for the economy.

Regulators have since pushed banks to cut the amount of borrowed funds they use, what’s known as leverage, hold more easy-to-sell assets and rely less on overnight loans. The 2010 Dodd-Frank Act established a protocol that would, in theory, enable authorities to seize even the largest lenders and dismantle them without bringing down the entire system. An interagency group has been empowered to make sure banking supervisors work together to monitor systemic risk.

That may be insufficient. The largest banks remain Byzantine, with hundreds of subsidiaries around the world, which could thwart efforts to unwind them. Six U.S. regulators with overlapping authority often clash and are besieged by an army of highly paid lobbyists. Leverage is still too high, some regulators and economists say.

The biggest risks could lie in the unknown: Five years after AIG was brought down by billions of dollars of credit-default swaps, there’s little transparency about banks’ trading and derivatives businesses.

“The basic model hasn’t changed much, and it’s still fragile,” said Anil Kashyap, an economics professor at the University of Chicago Booth School of Business. “The banks need much more capital and liquidity. They’re still way short of being safe.”

One reason is the intensity of Wall Street’s pushback. Bank executives, lobbyists and lawyers logged more than 700 meetings with regulators on a section of Dodd-Frank that seeks to curb banks’ trading for their own account, according to data compiled by Kimberly Krawiec, a Duke University law professor. An October, 2011, proposal for implementing the rule, named after former Fed Chairman Paul A. Volcker, generated more than 18,000 letters, many from banks complaining it was too complex and could hurt economic growth.

Regulators still haven’t finished the Volcker rule. The Securities and Exchange Commission has to conduct a cost-benefit analysis, which could lead to further delays. The proposal has so many exemptions that even Mr. Volcker has said he isn’t sure it will do what he wanted.

As of Sept. 3, more than three years after Dodd-Frank was enacted, just 40 percent of 398 rulemaking requirements were completed, according to law firm Davis Polk & Wardwell, which monitors progress.

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