“Lessons Not Learned from 2008”

Sydney M. Williams

Thought of the Day

“Lessons Not Learned from 2008”

September 19, 2012

Just over four years ago, the world as we knew it looked like it was coming to an end. And perhaps it did. On September 6, 2008 the Director of the Federal Housing Finance Agency (FHFA) announced he was placing Fannie Mae and Freddie Mac into conservatorship. On Sunday evening, September 14, Lehman elected to file for bankruptcy. Earlier that afternoon, the sale of Merrill Lynch to Bank of America was announced.

Volatility, as measured by the DJIA moving more than 1.5%, had been relatively high all year, but spiked in September with 11 of 22 trading days being in excess of that number. It would peak in October. Indicative of the confusion existent in the market at that time, over the five trading days beginning September 15, the DJIA lost 953.84 points and gained 920.29 points, but losing only 0.3% for the week. As the severity of the crisis began to sink in, markets continued to lose ground until they finally bottomed six months later on March 9, 2009. In the interim, the S&P 500 lost 46% from the Friday before the Lehman collapse, and it wasn’t until December 21, 2010 that the S&P 500 topped where the market had been on that Friday.

Four years ago (September 16, 2008), I commented in a TOTD on the “sense of helplessness” that one felt, and that what was happening was “not only beyond our control but beyond our understanding.” The next day, I noted that the bankruptcies of Lehman and Washington Mutual, the last minute acquisition of Merrill by Bank of America, the governments’ injection of $80 billion into AIG, and the conservatorships of Fannie Mae and Freddie Mac seemed like “a series of controlled explosions.” On the 18th, I wrote: “Economic growth around the world is bound to slow and is likely to be sub-par for the next few years.” For everyone who lived through those few weeks it was frightening – more so than October 19, 1987, because that event was over so quickly.

Despite the fear that those events created, I worry that we may not have learned the lessons we should. Following the collapse of the Internet-Tech bubble in 2000 and the terrorist attack on 9/11, the Federal Reserve had kept interest rates exceptionally low until early 2005, despite a recovery that began in late 2001. Even though the stock market collapse of 2000-2003 wiped out almost $6 trillion, the more important asset for most people was their home. And homeownership was increasing and so were prices. Amendments to the Community Reinvestment Act which were signed into law in 1995 imposed penalties on banks that discriminated against certain borrowers, some of whom did not have the financial wherewithal to qualify for conventional mortgages. Banks, in other words, were forced to make loans that a fiduciary would have nixed. Additionally, the Bush Administration had made a policy decision to increase home ownership. The consequence was a spurt in home prices and an increase in unconventional mortgages, both of which contributed to the ultimate collapse.

We are now more than three years into a recovery, albeit one so feeble as to have kept unemployment at uncomfortably high levels. Nevertheless, the Fed has persisted with continuing low interest rates. From an economic perspective, low rates may have stemmed the bloodletting in the housing market, but they haven’t done much for the rest of the economy. Their most notable effect has been on asset prices. Stocks, bonds and commodities have all risen – doubled or better since the end of December, 2008. Household income, though, is down, and unemployment is up. Seniors and those living on fixed income have seen their income decimated. The yield on 90-Day Treasuries on December 31, 2007 was 3.17%; a year later it was 0.11%, where it remains today. Savers have been sacrificed in favor of borrowers, even though it was leverage that fueled the speculation that created the crisis. The bottom line is that the wealthy have done well, while the middle class has not.

At the moment of panic, which began that Sunday, September 14th with the bankruptcy of Lehman, the focus of the Fed and Treasury was to ensure that the banking system remained intact. The domino effect of collapsing banks was a scary thought. TARP funds were used to shore-up banks, purchase troubled assets and in fact, inject equity capital into banks. Investment banks like Goldman and Morgan Stanley were converted into commercial banks, so as to be able to access the Fed’s Discount Window. In October 2008 the Federal Reserve began paying banks interest on reserves. Historically, according to Bruce Bartlett writing recently in the New York Times, the Fed never paid interest on reserves. Since December 2008, the rate paid to banks on reserves has been 0.25%, providing banks a riskless rate of return, initially as a means of encouraging them to strengthen their balance sheets. Today, according to the Fed, banks are sitting on $1.5 trillion in excess returns, which means that we as taxpayers are paying banks $22.5 billion a year for doing nothing. Does it make sense to continue the practice four years after the event?

Yet with all the talk of banks too big to fail and the need to separate commercial banking from investment banking, the effect of government policy has been to make them even larger. The four largest banks – Bank of America, Citigroup, JP Morgan Chase and Wells Fargo – in 2000 held 22% of all banking assets. By 2009, that number had risen to 39%. Today those four banks represent 55% of $13.247 trillion in U.S. banking assets, with the balance ($5,941 trillion) spread among 8095 banks. If we thought 2008 was frightening, that period would be a walk in the park compared to a similar incident today.

The automobile companies in 2008, because of their overleveraged and undermanaged finance arms (along with union demands and an unprofitable dealer network,) faced bankruptcy. Chrysler and General Motors accepted funds. Chrysler was later sold to Fiat, but we taxpayers still own a slug of General Motors and are underwater on our investment. Among the conditions demanded by government was a settlement that favored union members over non-union members and, critically in terms of bankruptcy law, bond holders were subordinated to union obligations. The consequences of that decision have yet to be felt. Cronyism between big banks, big corporations, big unions and government has increased, not lessened, since the autumn of 2008.

Wall Street was regulated going into the credit crisis of 2008. The problem was a failure of regulators to regulate. A two-way street exists between Wall Street banks, law firms and regulators easing the adoption of rules favorable to banks, and likely permitting regulators to blink when necessary. The Volcker Amendment, which would essentially restrict banks trading for their own account, appears to be losing supporters. As banks have grown in size, so have their lobbying budgets and efforts. The simplest and most effective way of regulating them would be, as I have written before, to limit their ability to leverage – the larger they become, the less leverage they should be able to deploy. Making a few bankers rich is far less important than ensuring the safety of the system for the rest of us.

While Congress was generous in spreading the blame, they, naturally assumed none for themselves. It is what happens when the investigators, the judge and the perpetrator all happen to be the same person. In my opinion, when the final chapter of this period is written Congress will be seen as culpable as any party.

On the positive side of the ledger, to the extent there is one, it is the individual and small business person who have been chastened by events, as they are the ones who suffered the most. But because of their caution and the uncertainty we all face, they are spending less and hiring less. Both Senator Chris Dodd and Representative Barney Frank took advantage of age and tenure to slip away. Good riddance, in my opinion, even if they leave unpunished.

But, in general, I don’t believe we learned very much. Not one banker, nor corporate manager, nor Congressman who aided and abetted a scheme that almost brought our financial system to ruin is in jail. Regulation and taxes are more arcane than they were earlier. The Fed persists in cheapening our currency. Banks continue to get bigger, their very size more threatening than ever. There is much we have not learned.