Out of Lehman's Ashes Wall Street Gets Most of What It Wants

http://www.bloomberg.com/news/2010-12-28/out-of-lehman-s-ashes-wall-street-gets-what-it-wants-as-government-obliges.html

Out of Lehman's Ashes Wall Street Gets Most of What It Wants
By Christine Harper - Dec 27, 2010 11:01 PM CT



Sachs CEO Lloyd Blankfein and his top deputies are in line to collect  
more than $100 million in delayed 2007 bonuses. Photographer: Chris  
Kleponis/Bloomberg

Dec. 28 (Bloomberg) -- Bloomberg's Christine Harper discusses lobbying  
efforts and influence exerted by Wall Street’s biggest banks over  
government regulations. Harper speaks with Pimm Fox on Bloomberg  
Television's "Surveillance Midday." (Source: Bloomberg)
Wall Street’s biggest banks, whose missteps caused a global financial  
crisis and economic slowdown two years ago, were more agile when it  
came to countering the political and regulatory response.

The U.S. government, promising to make the system safer, buckled under  
many of the financial industry’s protests. Lawmakers spurned changes  
that would wall off deposit-taking banks from riskier trading. They  
declined to limit the size of lenders or ban any form of derivatives.  
Higher capital and liquidity requirements agreed to by regulators  
worldwide have been delayed for years to aid economic recovery.

“We continue to listen to the same people whose errors in judgment  
were central to the problem,” said John Reed, 71, a former co-chief  
executive officer of Citigroup Inc., who estimated only 25 percent of  
needed changes have been enacted. “I’m astounded because we basically  
dropped the world’s biggest economy because of an error in bank  
management.”

The last two years have been the best ever for combined investment- 
banking and trading revenue at Bank of America Corp., JPMorgan Chase &  
Co., Citigroup, Goldman Sachs Group Inc. and Morgan Stanley, according  
to data compiled by Bloomberg. Goldman Sachs CEO Lloyd Blankfein, 56,  
and his top deputies are in line to collect more than $100 million in  
delayed 2007 bonuses -- six months after paying $550 million to settle  
a fraud lawsuit related to the firm’s behavior that year. Citigroup,  
the bank that needed more taxpayer support than any other, has a  
balance sheet 14 percent bigger than it was four years ago.

Army of Lobbyists

Wall Street’s army of lobbyists and its history of contributions to  
politicians weren’t the only keys to success, lawmakers, academics and  
industry executives said. The financial system’s complexity gave  
bankers an advantage in controlling the narrative and dismissing the  
ideas of would-be reformers as infeasible or dangerous. A revolving  
door between government and banking offices contributed to a mind-set  
that what’s good for Wall Street is good for Main Street.

To make their case, bankers and lobbyists characterized proposed  
regulations as stifling innovation, competitiveness and economic  
growth. They said the industry had learned its lessons and that firms  
were adopting changes voluntarily to be more transparent and  
accountable. Successful companies shouldn’t be punished for the sins  
of those that failed, they said.

“It is important to look beyond the rhetoric and ask the tough  
questions about underlying structural changes that promote responsible  
reforms and stability to our financial system, yet support the ability  
of financial firms to innovate and serve the needs of families and  
employers,”Timothy Ryan, CEO of the Securities Industry and Financial  
Markets Association, an industry lobbying group, wrote in a Feb. 5 op- 
ed piece for the Washington Post.

‘Culture of Greed’

That argument resonated with lawmakers under pressure to boost a  
fragile economy and bring down an unemployment rate that has hovered  
near 10 percent since August 2009, its highest level in more than a  
quarter of a century.

“The big financial industry has convinced a lot of people,  
particularly in Congress and on the regulatory side, that they bring  
value to the economy with new instruments and new approaches,” said  
Byron Dorgan, a Democratic senator from North Dakota who is retiring  
this year. “Anybody who wants to do things that seem aggressive is  
called a radical populist.”

U.S. President Barack Obama was elected in 2008, weeks after Lehman  
Brothers Holdings Inc. collapsed in the largest bankruptcy and the  
Federal Reserve and government provided unprecedented support to  
insurance company American International Group Inc. as well as nine of  
the largest banks. Obama, who raised $15 million on Wall Street,  
promised that his administration would “crack down on the culture of  
greed and scheming” that he said led to the financial crisis.

Geithner, Summers

While Obama vowed to change the system, he filled his economic team  
with people who helped create it.

Timothy F. Geithner, 49, who had been responsible for overseeing banks  
including Citigroup while president of the Federal Reserve Bank of New  
York, became Treasury secretary and named a former Goldman Sachs  
lobbyist as his chief of staff. Lawrence H. Summers, 56, who is  
stepping down as Obama’s National Economic Council director, opposed  
derivatives regulation and supported the 1999 repeal of the Depression- 
era Glass-Steagall Act, which separated commercial and investment  
banking, when he served as deputy Treasury secretary and Treasury  
secretary in President Bill Clinton’s administration.

‘Free Pass’

“It was very clear by February 2009 that the banks were going to get a  
free pass,” said Simon Johnson, a former chief economist for the  
International Monetary Fund who is now a professor at the  
Massachusetts Institute of Technology’s Sloan School of Management.  
“You could see from the hiring of Tim Geithner and from the messages  
that he and his team were putting out that this was going to go very  
badly.”

Even when changes were advocated by people who couldn’t be  
characterized as radical populists, their ideas were dismissed as  
unrealistic, misinformed, advancing ulterior motives or damaging to  
U.S. competitiveness.

Such tactics helped bat back suggestions from billionaire hedge fund  
manager George Soros and Berkshire Hathaway Inc. Vice Chairman Charles  
Munger that regulators ban purchases of so-called naked credit-default  
swaps -- contracts that allow speculators to profit if a debt issuer  
defaults.

Geithner was an early opponent of any such ban, arguing at a March  
2009 House Financial Services Committee hearing that it wasn’t  
necessary and wouldn’t help.

“It’s too hard to distinguish what’s a legitimate hedge that has some  
economic value from what people might just feel is a speculative bet  
on some future outcome,” he said.

‘Unbelievably Complicated’

Dorgan, 68, who offered an amendment to the Dodd-Frank bill that would  
have banned such swaps and who wrote a 1994 article for Washington  
Monthly warning about the dangers posed by over-the-counter  
derivatives, said supporters in Congress backed down because they  
didn’t get pressure from their constituents.

“The debate that’s necessary on these subjects is a debate that is so  
unbelievably complicated that the larger financial institutions have  
always controlled the narrative,” Dorgan said. “Even things that were  
fairly mild were contested as anti-business and going to injure and  
ruin the economy.”

Instead Dodd-Frank gave regulators at the Commodity Futures Trading  
Commission and the Securities and Exchange Commission the  
responsibility of writing rules governing the $583 trillion market in  
over-the-counter derivatives. The law, named after Connecticut  
SenatorChristopher Dodd and Massachusetts Representative Barney Frank,  
requires that most derivatives be traded on third-party clearinghouses  
and regulated exchanges.

Private Swaps

The CFTC withdrew a proposed rule on Dec. 9 after at least one  
commissioner, Scott O’Malia, a former aide to Republican Senator Mitch  
McConnell, objected. The rule would have required dealers of private  
swaps to quote prices to all market users before trades could be  
executed on an electronic system. A new version, approved Dec. 16,  
will save dealers billions of dollars, according to Moody’s Investors  
Service, because they will be able to limit price information to  
select participants.

An amendment requiring banks to spin out their swaps-dealing  
operations into separately capitalized units, so they wouldn’t have  
access to government backstops, made it into the Dodd-Frank bill. It  
was diluted at the end to exempt interest-rate and foreign-exchange  
contracts that make up more than 90 percent of the derivatives held by  
U.S. banks.

Banks were also allowed to trade derivatives used to hedge their own  
risks and given up to two years to trade other types of derivatives,  
such as credit-default swaps that aren’t standard enough to be cleared  
through a central counterparty.

Too Big

A suggestion that banks deemed too big to fail should be broken up or  
made small enough to fail -- an idea backed by former Federal Reserve  
Chairman Alan Greenspan, Bank of England Governor Mervyn King and  
hedge-fund manager David Einhorn -- also failed to win support from  
U.S. policy makers, as bank executives argued that size alone didn’t  
make a company risky and that it could be essential for banks to  
compete.

Jamie Dimon, JPMorgan’s CEO, said in a January 2010 interview that  
most of the financial firms that collapsed during the crisis were  
narrowly focused investment banks, insurers, mortgage brokers or  
thrifts, not big integrated conglomerates.

“A lot of companies are big because they’re required to be big because  
of economies of scale,” he said.

Glass-Steagall

The closest the Obama administration came to trying to limit the size  
of banks was in January, when the president proposed levying a fee on  
financial firms with assets of more than $50 billion. The idea was  
never adopted by Congress. Instead, it supported Geithner’s plan for a  
so-called resolution authority that would give regulators the ability  
to manage an orderly wind-down of a large financial company. Critics  
say the authority is unlikely to work in practice because regulators  
won’t have power over a bank’s international operations.

“The resolution authority as drawn up by Dodd-Frank does not apply to  
the megabanks and doesn’t apply to JPMorgan Chase, nor can it because  
that authority only applies to U.S. domestic financial entities,” said  
MIT’s Johnson, a Bloomberg contributor. “If anything, it’s gotten  
worse because we have fewer big banks. The ones that remain are  
undoubtedly too big to fail.”

Even before Obama took office in January 2009, former Federal Reserve  
Chairman Paul A. Volcker, an economic adviser to the president-elect,  
was calling for clear distinctions between banks that take deposits  
and make loans and those that engage in riskier capital markets  
businesses. The recommendation, a modern version of Glass-Steagall,  
was put forward in areport by the Group of 30, an organization of  
current and former central bankers, financial ministers, economists  
and financiers whose board Volcker chairs.

Volcker Rule

Reed, the former Citigroup co-CEO, and David Komansky, a former CEO of  
Merrill Lynch & Co., were among those who said publicly that they  
regretted having played a role in overturning Glass-Steagall. Both of  
their former companies were crippled by investments in mortgage-linked  
securities during the crisis, and Merrill was sold to Bank of America  
in a hastily reached agreement the same weekend Lehman Brothers went  
bankrupt.

“We have to think of the original reasons why Glass-Steagall was  
brought down in the first place, and that is the U.S. banks were  
competing with large, universal banks around the world,” Goldman Sachs  
CEO Blankfein said in a March 2009 interview with Bloomberg  
Television. “So I don’t think we’d turn the clock back.”

The idea was left out of Geithner’s original financial regulation  
proposals and didn’t gain much support until January, after a  
Republican upset a Democrat in a Massachusetts senate race. Obama and  
his economic team, including Volcker, then announced they were  
supporting a so-called Volcker rule that would ban proprietary trading  
at regulated banks and prohibit them from owning hedge funds and  
private equity funds.

Proprietary Trading

E. Gerald Corrigan, a former New York Fed president who worked under  
Volcker at the Fed and is now a managing director at Goldman Sachs,  
told a Senate hearing that banks shouldn’t be prevented from owning  
and sponsoring hedge funds or private equity funds because they  
promote “best industry practice.” He urged a distinction between  
proprietary trading and “market making” for clients or hedging related  
to such market making.

In the final version of Dodd-Frank, the Volcker rule ended up looking  
much more like the Corrigan rule. Banks were allowed to own or sponsor  
hedge funds and private equity funds and even to invest in them as  
long as their holdings didn’t account for more than 3 percent of the  
bank’s capital or 3 percent of the fund’s capital.

The ban on proprietary trading exempted dealing in government and  
agency securities. Regulators were charged with deciding what other  
types of trading would be considered proprietary and which would be  
deemed market-making.

Volcker was disappointed with the final version, according to a person  
with knowledge of his views.

Dodd-Frank

Goldman Sachs Chief Financial Officer David Viniar, who told analysts  
in January that “pure walled-off proprietary trading” accounted for  
about 10 percent of the firm’s revenue, said in October that the  
company had closed one such business and was waiting to see if the  
rules would require other changes.

While the Dodd-Frank Act is the most sweeping financial legislation in  
decades, creating a consumer-protection office for financial products  
and a council of regulators charged with monitoring systemic risk, it  
won’t fundamentally change a U.S. banking system dominated by six  
companies with a combined $9.4 trillion of assets, MIT’s Johnson said.

‘Falls Short’

The law won’t prevent lenders with federally guaranteed deposits from  
gambling in the derivatives markets, though it will place restrictions  
on some types of contracts and require more transparent trading and  
central clearing. It does little to solve the danger posed by  
leveraged firms reliant on fickle markets for funding.

“It’s not my point to say that the legislation enacted is worthless,”  
said Dorgan. “It requires more transparency and disclosure and a  
series of things that are useful, even though it falls short of what I  
think should have been done.”

The Treasury Department takes a more positive view. The law  
“fundamentally changes the landscape of our financial regulatory  
system for the better,” said Steven Adamske, a Treasury spokesman, in  
an e-mailed statement.

“The Obama administration and Secretary Geithner fought hard to enact  
a tough set of reforms that reins in excessive risk on Wall Street,  
protects the economic security of American families on Main Street,  
and makes certain taxpayers are never again put on the hook for the  
reckless acts of a few irresponsible firms,” Adamske said. “It also  
creates a safer, more transparent derivatives market through  
comprehensive reform, bans risky pay practices, and it puts in place  
the strongest consumer protections in history.”

2,300 Reasons

The biggest financial companies increased their spending on lobbying  
in the first nine months of 2010 as they sought to influence the  
legislative outcome, according to Senate records. JPMorgan’s advocacy  
spending grew 35 percent, to $5.8 million from $4.3 million, while  
Goldman Sachs’s jumped 71 percent to $3.6 million.

Banks had “2,300 pages worth of reasons” for spending, said Scott  
Talbott, a lobbyist at the Financial Services Roundtable, which  
represents the largest lenders and insurance firms, referring to the  
size of the Dodd-Frank bill. “The issues on Capitol Hill required more  
attention.”

‘Always There’

Spending during 2010 probably played only a small role in the ability  
of financial companies and trade groups to influence legislators,  
according to Anthony J. Nownes, a political science professor at the  
University of Tennessee in Knoxville whose books on the role of  
lobbyists include “Total Lobbying: What Lobbyists Want (and How They  
Try to Get It)” (Cambridge University Press).

“The idea that they stepped up their activity has some truth, but the  
larger truth is that they always spend a lot of money and this was no  
exception,” Nownes said. “They’re always there, their viewpoints are  
always heard and it is a cumulative effect -- they’ve been saying the  
same things for years and years and years.”

Even as they were spending more on lobbying, the largest U.S. banks  
cut their political giving for the 2010 elections. Of the 10 biggest  
financial firms, only Goldman Sachs, MetLife Inc. and the U.S.  
subsidiary of Deutsche Bank AG spent more from their political action  
committees during the 2009-2010 election cycle than they did in  
2007-2008, according to Federal Election Commission filings.

Talbott said the decrease was partly because of the economic slump,  
and also because some members of Congress refused to take donations  
from banks that received federal funds during the crisis.

Orszag, Lubke

The financial industry is adept at hiring people with experience in  
Congress and government, which gives it an edge in understanding the  
best tactics to use, Nownes said. This month Citigroup recruited  
former Obama administration budget director Peter Orszag as a vice  
chairman in its global banking business, and Goldman Sachs hired Theo  
Lubke from the New York Fed, where he oversaw efforts to make the  
derivatives market safer.

Research shows that lawmakers are more susceptible to lobbying on  
issues that are complex, technical or economic, which benefits the  
banks, Nownes said.

“This certainly was a huge advantage for them, especially in designing  
some of the more intricate details of this piece of legislation,” he  
said. “The more technical and complex, the bigger the informational  
advantage they have.”

Tax on Bonuses

Even in areas that weren’t technical, such as bonuses, the financial  
industry was able to resist tough regulation.

With polls showing strong popular support for limits on pay, former  
British Prime MinisterGordon Brown pressed for a tax on banker bonuses  
and one on financial transactions to deter speculative trading.

Obama didn’t go that far. Instead, the administration appointed  
Washington lawyer Kenneth Feinberg to review pay for the 100 top  
executives at firms receiving “exceptional assistance” from the  
Troubled Asset Relief Program. Feinberg ordered cuts at Bank of  
America, Citigroup and AIG, as well as at two bankrupt car companies  
and their finance divisions.

The administration, while opposing any pay caps, urged regulators to  
require changes that would better align compensation with risk, such  
as paying bonuses in restricted stock. Several banks responded by  
raising bankers’ salaries. So far this year, five Wall Street banks --  
Bank of America, JPMorgan, Citigroup, Goldman Sachs and Morgan Stanley  
-- have set aside more than $91 billion for salaries and bonuses.

Money ‘Paralyzes’

In early 2010, Virginia Senator James Webb and California Senator  
Barbara Boxer, both Democrats, proposed an amendment to a jobs bill  
that would have imposed a 50 percent tax on any bonuses above $400,000  
collected in 2009 by executives at banks that received at least $5  
billion in TARP funds.

The U.S. Chamber of Commerce, which opposed the tax, urged senators to  
reject the idea because it “would likely hamper efforts to resolve the  
ongoing financial crisis, restore economic growth, spur job creation  
and is likely unconstitutional.” The bill never made it to a vote.

“Neither party wanted to touch that issue,” Webb said at the  
Washington Ideas Forum on Oct. 1. “Quite frankly, the way that money  
affects the political process sometimes paralyzes us from doing what  
we should do.”

In a Bloomberg News National Poll conducted Dec. 4 through Dec. 7, 71  
percent of Americans said big bonuses should be banned this year at  
Wall Street firms that took taxpayer bailouts, and 17 percent said  
bonuses above $400,000 should be subject to a one-time 50 percent tax.  
Only 7 percent of the respondents said they consider bonuses a  
reflection of Wall Street’s return to health and an appropriate  
incentive.

Protecting Stockholders

Reed, the former Citigroup executive, said he didn’t understand why  
lawmakers gave so much credit to arguments made by financial-industry  
participants whose job it is to put the interests of their  
shareholders above any concern for the safety of the financial system.

“I’m surprised that the people in Washington think that the  
stockholders are the people that they should protect,” Reed said. “It  
would seem to me that the people who should be protected are the  
overall banking system and the many, many, many companies that depend  
on it.”

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