“But the greatest engine of change has been…capital requirements, set by the central banks of governments around the world…In 2010, central banks agreed that the large commercial banks needed double or even triple their capital buffers…

…Riskier ventures required even more capital. The most immediate impact of these rules has been to serve as a sort of brake on business activity, given the hassle and cost of raising more capital. And indeed, when banks today explain why they are moving into or abandoning certain businesses, they almost always cite capital requirements as their main motivation. The Federal Reserve official in charge of these regulations, Daniel Tarullo, was recently named “the most powerful man in banking” by The Wall Street Journal. Tarullo is now pushing to raise the capital requirements even higher for the very largest banks, like JPMorgan and Citigroup, and there are signs that this could do what Bernie Sanders could not: force the biggest banks to split themselves up. Among the many shrinking banks, one of the most noteworthy is Goldman Sachs, a villain of the crisis and the firm everyone assumed would outsmart the regulators. In large part because of the capital requirements and their quieting effect on all sorts of trading, Goldman has slashed staff from the risky, lucrative lines of business it used to dominate. Now the firm is focusing its efforts on less risky places, where capital requirements are lower….Even highly capitalized banks can still suffer unexpected losses. But in addition to discouraging risky activity, capital also serves as money that banks can afford to lose in a crisis……The nation’s eight most important banks now have 66 percent more capital than they did at the end of 2009, and the Fed recently said, after extensive testing, that the nation’s 33 largest banks could survive a two-year depression….and lose hundreds of billions of dollars….and still have more capital than the new rules require.”Nathaniel Popper, “Has Wall Street Been Tamed?”, The New York Times Magazine, August 7, 2016

“As I have discussed several times elsewhere on this blog, former Fed Chair Greenspan made clear in his paper “The Crisis” that governments, through their central banks, established the capital requirements for banks and not the private sector, and that central bankers deliberately set them at a level that did not take into account the once-or-twice-in-a-century economic or financial crisis, because the cost of doing so was felt to be too big a permanent drag on economic activity and jobs. As Greenspan said in this paper, “The sovereign must then recapitalize/guarantee its banks”. Why do governments take the paramount responsibility to establish the capital requirements and monitor bank safety and soundness and NOT the private banking sector and/or its private creditors? Because governments insure most of nearly every bank’s unsecured liabilities, via federal deposit insurance. This well-intended government distortion of free, fair, and rational markets for bank liabilities logically requires that the government then take the paramount role in establishing capital levels for the banking industry. How does this distort the marketplace? Just read this article and the excerpt above…these government capital rules have caused massive changes in banks’ business activities and operations, assets and asset size, risk taking, etc. And the government, post crisis, has now clearly admitted they were wrong about the appropriate level of pre-crisis capital for banks. How have they admitted fault? Just read the excerpt above….they have increased bank capital levels by massive amounts post-crisis and even eight years on, still think they need to be increased further. How, pre-crisis, then was it the fault of private bankers, following the government’s capital and other rules (and serving the marketplace, where in the case of mortgages trillions of dollars were lent, bought/sold/securitized), that they found themselves to be undercapitalized in a once-or-twice-in-a-century financial crisis?”, Mike Perry, former Chairman and CEO, IndyMac Bank

Magazine

Has Wall Street Been Tamed?

On Money

By NATHANIEL POPPER

image001

Credit Illustration by Andrew Rae

Before the financial crisis, bankers were often regarded as greedy and self-­interested. The mortgage melt down ­ratcheted that reputation into something much scarier: an existential threat to the global economy. Since 2008, the banks have seemed to many people like an active volcano does to the villagers below. Americans don’t really understand banks, or know what causes them to blow up, but they’ve seen enough to be afraid.

And to hear the public discussion about the issue these days, we still have good reason to be scared. The Republican presidential candidates generally agreed that Wall Street banks remain dangerously too big to fail. On the left, Bernie Sanders built that notion — and demands for a major policy response to it — into the foundation of his campaign. From Hollywood, we got “The Big Short” and its judgment, in the words of Ryan Gosling’s character, that “the banks took the money the American people gave them and used it to lobby the Congress to kill big reform.”

I began writing about the industry in early 2010, just after the worst of the crisis passed and right before Congress enacted its landmark effort to clean up Wall Street, what’s now known as Dodd-Frank. I was in Washington when the final version of the law was released. Along with all the discussion about its being the most significant reform of Wall Street since the Great Depression, I remember the confusion as we flipped through the thousands of pages, trying to pick out what would really matter, looking for where the lobbyists had won. Six years later, as I plan a move to the West Coast for a slightly different reporting beat, I keep returning to this question of how much has really changed. Is the system any safer than when I began?

Dodd-Frank was designed, in essence, to check the pre-­crisis excesses that ultimately required the government to bail out the largest banks. But upon its unveiling, it did seem as though some of the most consequential efforts to transform the banks had been edited out at the industry’s behest. The law didn’t seem to address many of the risky practices that transmuted a downturn in the subprime-­mortgage market into a global conflagration. Perhaps most consequential, as Sanders has not tired of reminding us, the biggest banks were not broken up. Just a day after the law was passed, a bank analyst made a prediction for me: “After the dust settles and they’ve crossed all the T’s, there’s probably not going to be much difference in how the banking industry looks. That’s the long and short of it.”

Among the many shrinking banks, one of the most noteworthy is Goldman Sachs, a villain of the crisis and the firm everyone assumed would outsmart the regulators.

JPMorgan Chase, the nation’s largest bank, has shrunk since 2014, but it entered 2016 with 50 percent more assets than it had in 2007, in great part because of its acquisition (on the cheap) of Bear Stearns and Washington Mutual in 2008. Early this spring, the top banking regulators announced that because of their size and complexity, five of the eight largest banks, including JPMorgan, still didn’t have workable plans to avoid going out of business without taking the economy down with them — suggesting that they would probably need to be bailed out if they began to collapse again.

So are they headed toward failure? To judge the likelihood of that, the first thing to consider is what types of risk they’re taking on. And on that front, at least, the changes have been far more notable than most Americans realize. For starters, Dodd-Frank’s “Volcker Rule” forced the banks to get rid of the trading desks where they made enormous speculative bets for their own profit. There was some talk that the banks would find a way around the rule, but almost every bank has disbanded these trading teams or sold them to hedge funds. And this is just one of the risky businesses that the big banks have jettisoned in recent years. The most risky — and profitable — units at all the banks before the crisis were the so-­called fixed-­income divisions, where the banks created and traded bonds and derivatives. In 2006, these departments were the single largest sources of revenue at banks like Goldman Sachs and Morgan Stanley. Today, by contrast, the amount of money the big banks make from their fixed-­income divisions is less than half of what it was at the peak in 2009, and it continues to fall.

There are multiple reasons for this evolution, including global economic shocks like the Greek debt crisis and the new trading rules in Dodd-Frank. But the greatest engine of change has been some rather arcane accounting rules, known as capital requirements, set by the central banks of governments around the world. Put most simply, capital requirements force banks to raise a specific amount of money (usually from investors) for every dollar they lend or trade. In 2010, central banks agreed that the large commercial banks needed to double or even triple their capital buffers. Riskier ventures require even more capital.

The most immediate impact of these rules has been to serve as a sort of brake on business activity, given the hassle and cost of raising more capital. And indeed, when banks today explain why they are moving into or abandoning certain businesses, they almost always cite capital requirements as their main motivation. The Federal Reserve official in charge of these regulations, Daniel Tarullo, was recently called “the most powerful man in banking” by The Wall Street Journal. Tarullo is now pushing to raise the capital requirements even higher for the very largest banks, like JPMorgan and Citigroup, and there are signs that this could do what Bernie Sanders could not: force the biggest banks to split themselves up.

image002

Credit Illustration by Andrew Rae

Among the many shrinking banks, one of the most noteworthy is Goldman Sachs, a villain of the crisis and the firm everyone assumed would outsmart the regulators. In large part because of capital requirements and their quieting effect on all sorts of trading, Goldman has slashed staff from the risky, lucrative lines of businesses it used to dominate. Now the firm is focusing its efforts in less risky places, where capital requirements are lower. Its newest products are savings accounts and consumer loans, plebeian products that Goldman would never have deigned to offer before the crisis. The company as a whole has shrunk by nearly a quarter since its peak.

Even highly capitalized banks can still suffer unexpected losses. But in addition to discouraging risky activity, capital also serves as money that banks can afford to lose in a crisis. Unlike the debt that banks loaded up on before the crisis, capital does not have to be repaid in the event of a loss. Having this sort of cushion can in turn stop losses from spiraling out into and threatening the rest of the economy. The nation’s eight most important banks now have 66 percent more capital than they did at the end of 2009, and the Fed recently said, after extensive testing, that the nation’s 33 largest banks could survive a two-year depression — and lose hundreds of billions of dollars — and still have more capital than the new rules require.

Michael Lewis, the author of “The Big Short,” has been one of many industry critics to complain that the biggest continuing problem in the financial industry is that the incentives haven’t changed: Bankers are encouraged to take short-term risks, without bearing the losses if those risks cause long-term damage. In fact, pay packages have changed more than Lewis lets on. Some traders now receive their bonuses over several years, in case past deals go sour, and regulators are currently codifying those practices.

But to focus on pay packages misses how capital requirements have changed incentives for the entire system. I hear constantly from traders who say that the daily work of buying and selling bonds or stocks, and thus the amount of money they can take home, is constrained by the capital limits. This helps explain why at Goldman, for example, the average pay per employee has fallen 24 percent since 2010 and 39 percent since 2007. This also illuminates why Wall Street is in decline as the career path of choice at elite colleges and business schools.

People still have other concerns about Wall Street, including cases of fraud and market manipulation, so the banks are unlikely to disappear as political fodder in a presidential campaign between two New Yorkers for whom Wall Street is a recurring issue. Each side is likely to signal its intent to get tough on the industry that nearly wiped out the economy. But if Wall Street remains a volcano, it’s one I now feel far more safe living underneath.

Nathaniel Popper is a reporter for The Times and the author of “Digital Gold: Bitcoin and the Inside Story of the Misfits and Millionaires Trying to Reinvent Money.” Adam Davidson will return next month.

A version of this article appears in print on August 7, 2016, on page MM14 of the Sunday Magazine with the headline: Has Wall Street Been Tamed?.

Posted on August 11, 2016, in Postings. Bookmark the permalink. Leave a comment.

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