Dodd-Frank: The Good, The Bad, and The Ugly

The 2008 financial crisis left many people with no homes, jobs, or way of life.  It affected the economy more significantly than any crisis since the Great Depression.  Dodd-Frank was created in response to this catastrophe to assure that it would never happen again.  The law imposes regulation in nearly every aspect of the financial industry, covering investment and commercial banks, insurance companies, rating agencies, hedge funds, and many others.  With the implementation of Dodd-Frank, we must consider the costs and benefits of such a bill.  If there is too much regulation on  banks, for example, they will be less likely to lend, decreasing liquidity in our economy and leading to a lack of economic growth or even a recession.

AIG – Who Insures the Insurers?

 

Following the financial crisis of 2008, the financial industry suffered backlash from the public following a historic and infamous series of events that threatened America’s economy.  From media pundits to organized efforts such as the “Occupy: Wall Street” movement, there has been a continual protest against the ‘injustice’ and corruption of greed that supposedly plagues large financial institutions.  However, many Americans rely on financial services for retirement savings, investment opportunities, the ability to get a mortgage and more.  Despite the complexity of many financial systems, which may be simply understood by the general public, the causes of the crisis held blame with those behind-the-scenes, and an ethical analysis can bring these actors and their decisions to light and provide a clear picture of what was done wrong and why.  Looking into AIG, a major player in the financial crisis, a history of ethically questionable management can be seen, with blatantly unethical choices leading underlying collapse of the financial system in 2008.

A Merger of Corruption

This is a story about greed and corruption, about blind ambition and selfishness.  The merger between Bank of America and Merrill Lynch during the financial crisis is historically significant, and represents the unethical behavior of many executives on Wall Street.  John Thain, former CEO of Merrill Lynch, and Ken Lewis, former CEO of Bank of America, were so focused on their own pursuit of greater compensation and power that they ignored the warning signs and understated the severity of the financial situation.

Revisiting America’s Affair with Financial Institutions

During the financial crisis of 2008, AIG was one of the most critical firms facing failure, and as the US Government stepped in to provide assistance in order to prevent the larger financial system from unraveling.  The outcome of the situation involves an overhaul of regulations a la Dodd-Frank, as well as a number of government-influenced management decisions after giving AIG a multi-billion dollar bailout.  My focus for paper 2 is to analyze the precedent AIG set for establishing a business of such magnitude on practices that could tear down the financial sector of the United States in a matter of weeks, and threaten the greater economy as a whole. 

Too Big to Fail is Too Big

After watching the film, I definitely agree that the notion of firms being  “too big to fail” still exists today, and in more industries than just investment banking. The 2008 financial crisis showed that investment banks are interconnected and rely on each other’s financial wellbeing. In the film, this interconnectedness could be seen after the Lehman Brothers’ bankruptcy filing. Investment banks saw immediate hits to their businesses as a result of the dwindling confidence in the industry. Other firms, such as GE, saw that their operations were affected by the lessening access to capital from investment banks. To the dismay of many, the notion of “too big to fail” means that the government may be required to aid the financial system at large when the market is unstable.

Does Bigger Mean Better?

The Original TBTF one way ticket to icy fun

It should be noted that we have seen the notion of  “too big to fail” long before Congressman Stewart Mckinney’s use in the 1984 Congressional hearing. There was once a ship, a rather large one called the Titanic , whose creators believed that its size and technological advances made it indestructible. The biggest ship of its time, it set off on its maiden voyage to much glory and praise. It was in every sense,  “too Big to fail”. We all know how this story ends. (Side note: Titanic was financed by J.PMorgan). I think it is hard, especially after watching the film, to think the notion of  “too big to fail” does not still exist. The 6 largest banks in the U.S control more than 66% of the $13.1 trillion worth of assets in the economy. These figures stand as evidence as to how much  larger these banks have been allowed to grow. With the events that unfolded in the film, one would think government would put measures in place to make sure the exact opposite of this happened. The financial industry has slowly come under more and more of a monopoly for these larger banks as they absorb smaller banks in their path. It was interesting to see that one of the solutions presented was merging banks to make them even larger despite their already large size was the reason for the problems being faced. There is a dire  need for government intervention to help regulate the market and reduce the power these corporations have over the global market. These banks were given federal funds to increase lending as a way to increase capital in the market. Instead they showed their true greed and reduced lending to one of its lowest levels in years. As former politician David Stockman said, ” If they’re too big to fail, they’re too big to exist. They should be broken up, reduced in size if we’re to have a safe and stable financial market.”(http://marketsanity.com/banks-too-big-to-fail/).  However, with the ongoing shutdown it seems the government has a hard enough time regulating their own day to day business to take control of the market.  These institutions should have never been given the power to cripple the entire global economy. But as the saying goes, the bigger they are, the harder they fall.

The Ultimate Fiscal Consolidation

The notion of “Too Big to Fail” not only still exists today, but it is even more relevant to our current financial system in the United States than ever before. As shown in the film, the ‘great recession’ of 2008-2009 ultimately marked the first time that people really started to question the size and power of some of our largest financial institutions. Up until this point, US Banks, for the most part, were perceived as highly respected and admired institutions that were a symbol of America’s economic strength. Rather than limiting the size of these banks, popular opinion of the 1980s and 1990s was that it would be in our best interest to let them grow as much as possible so that they could effectively compete with giants of the industry abroad in Europe and Japan. Ultimately, it was this popular belief, coupled with pressure from Wall Street’s most powerful figures, which prompted arguably the most notable piece of financial legislation of my life time: the Gramm-Leach-Bliley Act of 1999. Under this law, the concept of ‘Universal Banks’ reemerged in the US for the first time since the 1930s as investment banks could once again participate in commercial banking activities and vice versa. Ultimately, it was this change, commonly referred to as the fall of Glass-Steagall , that set the stage for the emergence of institutions that are in fact ‘Too Big to Fail’.

As shown in the movie, major financial institutions played a pivotal role in the financial crisis, some for good reasons and others for very bad reasons. Clearly, it was the irresponsible and overzealous actions of numerous institutions that directly contributed to the crisis. Yet at the same time, it was the cooperation of the whole industry that ultimately helped to save it from a complete collapse. That being said, one of the most significant outcomes of the 2008 financial crisis was a wide scale consolidation of Wall Street. Prior to 2008, there were dozens of banks that were seen as significant financial institutions in terms of size and market share. However the crisis completely changed the layout of the industry as the strongest banks seized control of the market. As noted in the film, 10 banks now control 77% of all US bank assets and, even more staggering, the six largest banks control 67% percent of total assets (http://consciouslifenews.com/big-fail-bigger-before/1165613/). Although there has been a slight resurgence over the past couple of years, the number of mid-size and boutique banks dropped substantially as they did not have the financial might to withstand the crisis and so were forced to declare bankruptcy or be acquired by megabanks such as J.P. Morgan or Bank of America.

Seeing these staggering market share figures, it is hard to argue that the notion of “Too Big to Fail” no longer exists. All of these banks that were deemed critical to the US economy in 2008 are now bigger and therefore even more critical than ever. Ultimately, without these banks, the US economy would likely cease to be relevant and if that doesn’t mean that they are ‘Too Big to Fail’ then I don’t know what does.

To conclude this post, I would like to point out that most believe that the solution to this problem would be to simply reduce the size of the banks. While this is probably a smart idea, I strongly believe that the size of the banks was not the cause of the crisis and that all of the support to reinstate Glass-Steagall is not warranted. The main reason that our banks are still considered some of the strongest in the world is because they are not limited to choosing between being an Investment Bank or a Commercial Bank. Where was J.P. Morgan 20 years ago? While it was certainly a strong bank, it was not considered one of the 10 most powerful in the world. And now, along with the likes of Goldman Sachs and other US banks, it is arguably the most respected institutions in the world. Once again, the problem with our financial system was not that banks were getting big, but it was their ability to take on too much leverage due to the lack of strong regulatory agents in the US. I have attached an insightful article below by one of our own professors, William Gruver, which speaks more about this issue.

http://www.directorship.com/smart-reform/