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Bankers and Their Wounds

Irwin M. Stelzer

Bank of America likes to top rival J.P. Morgan Chase in as many ways as possible. Except one. The $16-to-$17 billion check it is about to write to cover the fine for sins committed before the financial crisis tops the previous record of $13 billion paid by J.P. Morgan Chase just nine months ago. Add fines paid by Bank of America in connection with other activities, and the total take from the bank’s shareholders easily tops $22 billion. That’s certainly is real money, but not so much as to prevent Bank of America from raising its dividend last week. In fairness it must be said that the bank’s CEO, Brian Moynihan, has reason to feel aggrieved: the fines it is about to pay relate to mortgage-market misconduct by two bankruptcy-threatened financial institutions it did not own at the time, but bought under pressure from the Federal Reserve Board and the Treasury Department, which government agencies feared a worsening panic if those institutions failed. If you want loyalty and understanding from the government, the saying goes, buy a dog.

Other malefactors of great wealth, to borrow from populist president Teddy Roosevelt, include Standard Chartered and other foreign banks, who have contributed about $15 billion to the government’s haul. The total take stands at something like $120 billion, with an estimated $150 billion still to come, partly as a result of the regulators’ decision to increase fines so as to reimburse communities adversely affected by the financial crisis. A cynic might think that these fines are less about bank regulation and more about creating a large pot of cash for the feds to distribute as benefits to friends.

Big banks also have had to agree to a variety of changes in the way they do business in order to meet the requirements of the 2,000 page Dodd-Frank bank-reform law and the 10,000 pages of regulations it has spawned at the half-way point in the reg-writing exercise. Capital requirements are higher, which means that profits will be lower. Unprofitable customers are being fired. Some risky businesses, such as proprietary- and commodity-trading, are being sold or cut back in favor of expanding wealth management, which does not involve risking the banks’ capital. To comply with the Volcker Rule, which limited big banks’ investments in private equity and hedge funds, Goldman Sachs earlier this week by pulled still more cash from one of its largest internal hedge funds. “It’s our money and we can do what we want with it” bows to the possibility that if the banks get it wrong they might pull the financial system down with them. Or require another round of taxpayer bail-outs.

Which brings us to the question of “living wills.” Residents of Main Street deposit such wills with their physicians or relatives to provide guidance to how they want to be treated when they are in no condition to give instructions — crudely put, how much effort to go through before pulling the plug on life-prolonging devices. Some residents of Wall Street, the largest banks, deposit living wills (some running to more than 10,000 pages) with the Federal Reserve System to provide a guide to winding down their lives without requiring a taxpayer bail-out to prevent a meltdown of the financial system should the bank go bust. The idea is to eliminate too-big-to fail.

Unfortunately, the banks’ physicians, the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC), now say that the wills filed with them in 2013 by some eleven banks “provide no credible or clear path through bankruptcy that doesn’t require unrealistic assumptions and direct or indirect public support.” The stunned banks, which received no effective warning before the feds released the news to the press, have gone back to the drawing boards to file revised wills for submission next year. As if the week were not made bad enough by the collapse of a possible Fox Entertainment-Time Warner deal, and with it the loss of some $420 million in fees for several banks.

Regulators and politicians continue their quest for the financial Holy Grail that will allow them to sleep well after allowing a major bank to go under. The questionable assumption on which this quest is based is that whatever development drives one bank under will leave the other big banks unaffected. Regulators are hoping that they won’t find themselves with an epidemic of related failures, uselessly poring over eleven wills to learn the wishes of each failing patient.

The revising of living wills is to be no pro forma exercise. If the banks fail to come up with satisfactory instructions for the handling of their forced departure from the world of living financial institutions, regulators are threatening to raise capital requirements further, or force the banks to adopt less complex legal structures, or if all else fails to exit many of the businesses in which they remain players. The theory underlying these latter possible solutions is a new but still dim awareness by regulators that the problem is less too-big-to-fail than too-complex-to manage.

The executives of our largest banks have in effect confessed that they cannot adequately supervise their institutions. We have had the London Whale, price-fixing in the Libor market, rogue elephants of all sorts trampling on the internal controls of the major banks. Some few executives have had to slink off into retirement, golf clubs over their shoulders, personal fortunes intact. But the costs of these management failures are borne largely by shareholders, and by managers only to the extent that their extraordinary bonuses are sometimes pared or collection postponed. That is insufficient punishment to persuade top executives to grow the size and complexity of their institutions only so long as they can exercise responsibility for their operation. After all, if the bonuses to which bankers have grown accustomed are rewards for their contribution to their banks’ success, surely that implies that they are equally responsible for any failures of management on their watch.

Here our antitrust laws provide some guidance. When several companies were convicted some fifty years ago of conspiring to fix the prices of electrical equipment, key conspirators did jail time. Such cartelization immediately became rarer. When Gordon Brown included criminalization of such behavior in his revision of UK competition laws, there were howls of anguish from executives arguing that it is unreasonable to hold them responsible for the performance of their corporations — except at bonus time in good years. Populist critics are not entirely wrong to complain that bankers have inflicted huge wounds on the capitalist economies, but none has been punished. To cite only one example, it must take more than a rogue banker to create and market securities that the firm pushing them is shorting because it believes they will decline in value. Perhaps this sort of thing would stop if regulators decided that executives important enough to be in the bonus pool are important enough to be held responsible for its misfeasances. Then, they might heed singer Lena Horne’s advice, “If you can’t take the punishment, baby, please don’t commit the crime.”

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