“I knew Steve Eisman (of The Big Short). I disagree with a lot of what he says in his recent NYT’s OpEd about the financial crisis. After reading it, it’s clear to me that Eisman is mostly a “balance sheet” financial analyst, who studied the publicly-available securities information of financial companies and MBS and made the right call to short (Doesn’t this disprove the Red Herring of securities disclosure fraud?), but he is no great sage about the economic decisions (many distorted by well-intended government policies and the Fed) at the root of the financial crisis…

…I don’t have time to rebut every claim in his OpEd, with which I disagree, but often when I read these liberal views regarding the financial crisis, they can’t stick with their main argument…..that greedy and reckless bankers and lack of/poor government regulation caused the crisis…..eventually they “leak out” some of the real truth. See the excerpt below. As Eisman says, it’s one of “the underlying causes.” Eisman says, “credit was allowed to be democratized.” Think about that line and especially the words “allowed” and “democratized.” Greedy bankers wouldn’t do that Mr. Eisman, unless forced or coerced to do so by government incentives/policies/regulations. Ah, the truth!!!! P.S. By the way, Eisman also has personal incentive to take “the liberal view,” to defend his (and others) short selling, which helped foster a panic and drove markets and assets well below their long-term intrinsic value. Don’t believe me? Look at the price recoveries and read Howard Marks of Oaktree’s recent (2016) newsletters. Short sellers like Eisman (or others) may even have illegally coordinated their trading and/or fostered their version of the crisis, with the mainstream media and liberal politicians, using them as “tools” to help their short selling strategies and avoid public criticism. They got a book and a movie, didn’t they? If there weren’t evil bankers and poor regulation, then the short selling might have been evil, right? Don’t agree Mr. Eisman? I will debate you anytime and anywhere and let the public decide who is right.”, Mike Perry, former Chairman and CEO, IndyMac Bank

“The central economic problem of our time….the lack of personal income growth for most Americans, which was one of the underlying causes of the financial crisis. In lieu of rising incomes, credit was allowed to be democratized. Living standards were maintained only because increased credit supplemented deteriorating incomes. That helps explain, post-crisis, why United States growth is slow: Without easy credit, consumers cannot increase spending, because their incomes have fallen since 2007.”, Steven Eisman, “Don’t Break Up the Banks. They’re Not Our Real Problem”, The New York Times, February 7, 2016

The Opinion Pages

Don’t Break Up the Banks. They’re Not Our Real Problem.


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Credit Yehteh

IN the movie “The Big Short,” Steve Carell plays a slightly altered version of me. In real life, I am a portfolio manager and financial services analyst who over a 25-year career has, at times, been highly critical of bank behavior.

More than eight years after the financial crisis, many people say that the large banks still pose a threat to the economy and should be broken up. Such a view captures the justifiable anger many Americans still feel toward the large banks. But I don’t agree. Breaking up the banks would ignore the significant progress made by regulators to reduce the risks posed by these institutions, and it wouldn’t address what I believe is the central problem with the economy today.

First, let’s analyze why the financial crisis occurred. If I could sum up the catastrophe in one word, it would be “leverage.” Using borrowed money, the financial system made huge bets just when losses were about to explode because of subprime mortgage loans.

In the first quarter of 2001, Citigroup’s assets stood at $1 trillion, a level it had taken the entire 20th century to reach. By 2007, only six years later, that balance sheet had doubled to $2 trillion. Ditto for Goldman Sachs. In 2000, the investment bank’s assets stood at $275 billion. Eight years later, its balance sheet had grown to over $1 trillion.

Leverage caused the explosion in these balance sheets. In the first quarter of 2001, Citigroup was leveraged 21 to one (meaning it had $21 of assets, including debt and shareholder equity, for every dollar of shareholder equity alone). By mid-2007, leverage had climbed to 33 to one.

The explosion in leverage occurred for several reasons, but one underappreciated factor has to do with psychology and corporate culture. An entire generation of Wall Street executives came of age in the 1990s and 2000s. Their incomes started to rise after the recession of the early 1990s, going up in virtually a straight line until the financial crisis. Each year they made more, and each year the balance sheets of their respective firms grew. The system fed on itself.

Unfortunately, Wall Street mistook leverage for genius. Then came the irresistible force known as subprime loans.

Subprime mortgages were typically 30-year loans with a low teaser interest rate for the first two or three years and a reset rate that was significantly higher. The lenders making these loans cared only that the borrower could pay the teaser rate. Borrowers were forced to refinance frequently — which everyone connected to the industry loved because it was a fee bonanza. The large banks repackaged and re-securitized the loans over and over again, also generating big revenues. Meanwhile, credit standards were lowered to the point where anyone with a pulse could get a loan.

As long as housing prices kept going up, this whole process could continue. For consumers, this was a disaster. For the financial system, it was a time bomb. It never dawned on either lenders or regulators that housing prices kept going up mainly because underwriting standards were getting looser. By the spring of 2007, subprime mortgage credit losses were soaring and the securitization market froze. In this macabre game of musical chairs, whoever was left holding the loans was dead. Among the biggest holders were large banks and brokerage firms.

And their regulators had been oblivious to the coming disaster. Before the crisis, bank regulators had two jobs: regulating the safety and soundness of the banks and protecting the consumer. They did a horrendous job on both. One of the most important aspects of the Dodd-Frank financial reform act of 2010 was the division of labor. Today, the Federal Reserve regulates safety and soundness and the new Consumer Finance Protection Board looks after consumers dealing with all financial institutions. This is a significant improvement.

Under the new regulatory regime, the leverage of the large banks has been reduced. While Citigroup’s leverage peaked at 33 to one, today it stands at less than 10 to one. The Federal Reserve has forced similar reductions in leverage across the board. Risky proprietary trading desks have been eliminated at banks by the Volcker Rule, part of Dodd-Frank. And while the consumer protection board has been around for only a few years, it seems to have made progress in safeguarding consumers from the more egregious practices of the financial-services industry.

This new system is not perfect. The problem of derivatives — they can increase risk, rather than reduce it, as they were designed to do — has not been completely solved. The so-called living wills (plans the banks must file with regulators in case they run into serious trouble and have to be dismantled) are not complete. And the regulators will have to deal with some of the consequences of the Volcker Rule, such as reduced liquidity in the buying and selling of bonds and other parts of the fixed income market. Yet it is simply a fact that the United States financial system is much less risky than it was before. That does not mean that losses cannot occur, but United States banks are in much better shape to withstand them.

It’s no longer accurate to say that the large banks pose a systemic danger to the American economy. Some argue that they should be broken up solely because they are too politically powerful. Perhaps so, although that power hasn’t managed to prevent regulators from dismantling bank leverage and risk. Furthermore, no advocate of a breakup has come forward with a plan on how to do it. Large banks are global, complex, integrated institutions. Breaking them apart would be incredibly difficult, long and disruptive, and the banks might have to freeze loan growth during the process, slowing our economy even further.

Now that we have a new bank regulatory regime that seems to be working, we should not complicate it with breakup proposals whose ultimate implications are unclear at best. But it is absolutely crucial that the new regulations not be rolled back. The Federal Reserve should continue its annual stress tests of the large banks. Calls for restricting the

The central economic problem of our time is income inequality, especially the lack of personal income growth for most Americans, which was one of the underlying causes of the financial crisis. In lieu of rising incomes, credit was allowed to be democratized. Living standards were maintained only because increased credit supplemented deteriorating incomes. That helps explain, post-crisis, why United States growth is slow: Without easy credit, consumers cannot increase spending, because their incomes have fallen since 2007.

If we want a stronger economy, improving the distribution and growth of personal income should be our focus. Breaking up the big banks will not help, and might even hurt.

Steve Eisman is a managing director of the investment firm Neuberger Berman.

A version of this op-ed appears in print on February 7, 2016, on page SR2 of the National edition with the headline: Break Up the Banks? Bad Idea


Posted on February 9, 2016, in Postings. Bookmark the permalink. Leave a comment.

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