TOPICS > Economy

One Year On, Hurdles Remain for Reforming Wall Street

September 18, 2009 at 1:26 PM EDT
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One year after the fall of Lehman Brothers' brought the global economy to the brink of collapse, questions remain as to whether the government has been tough enough on Wall Street. Experts explain why.
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JEFFREY BROWN: Lehman Brothers had declared bankruptcy. The government had pumped tens of billions of dollars into insurance giant AIG. And the market plunged amid questions about the real value of trillions of dollars in securities.

That was the situation one chaotic week just a year ago.

REP. BARNEY FRANK, D-Mass.: If you absolve people from the serious consequences of their own misjudgments…

JEFFREY BROWN: A year later, various proposals continue to be put forth in Congress and elsewhere to change some Wall Street habits. Today, for example, the Federal Reserve confirmed to the NewsHour and other news organizations that it plans to place curbs on compensation policies at major banks. The rules would affect traders, mid-level and top executives, and are intended to discourage excessive risk-taking that is often tied to pay.

This afternoon, President Obama’s top economic adviser, Lawrence Summers, echoed that sentiment in a speech at Georgetown University. More broadly, he called for tougher oversight of Wall Street to prevent the need for future bailouts.

LARRY SUMMERS, White House economic adviser: It is wrong that taxpayers, thousands of miles from Wall Street, should be at risk because our system gives authorities no choice but to commit taxpayer money or to accept collapse and chaos.

JEFFREY BROWN: For its part, Congress may take up legislation later this fall.

And more on Wall Street and regulation now from Lynn Stout, professor of corporate and securities law at UCLA.

Robert Glauber, lecturer in public policy at Harvard’s Kennedy School of Government and former CEO of the National Association of Securities Dealers, he served in the Treasury Department under the first President Bush.

And Gretchen Morgenson, assistant business and financial editor and a columnist at the New York Times.

Curbing executive compensation

Lynn Stout
UCLA Law School
I think the Federal Reserve is making the right move, at least looking at the extent to which pay for performance -- which was interpreted as pay for this year's performance -- contributed to excessive risk-taking.

Lynn Stout, I'll start with you. Explain the problem that the Fed is trying to solve with measures like this latest one we just talked about that focus on how people at financial institutions are paid.

LYNN STOUT, UCLA Law School: Well, I think one of the basic problems that led to the banking crisis in the fall of 2008 can be summed up with the phrase "short-termism." You had a lot of bank executives who were very much focused on getting their bonuses for the end of the year, and as a result they took on a lot of risks, not really thinking about the long-term consequences.

And so I think the Federal Reserve is making the right move, at least looking at the extent to which pay for performance -- which was interpreted as pay for this year's performance -- contributed to excessive risk-taking.

At the same time, I think what has not yet been recognized by the Federal Reserve or by lawmakers generally is that executives are not the only players we need to think about when we think about excessive incentives for short-termism. Many investors may have played a role, too.

JEFFREY BROWN: Well, Gretchen Morgenson, how do you see where we are a year later? Is it business as usual? I note you wrote in a recent column that, "Even though calamitous lending practices laid waste to the nation's economy, surprisingly little has changed." Talk about what you see on Wall Street. Before we get to the regulators, what do you see on Wall Street?

GRETCHEN MORGENSON, The New York Times: Well, I see, obviously, many of the banks have far less leverage on their books than they did, meaning that they are borrowing way less than they did a year ago and before, which really was the cause of the huge problem. They had taken too many risks, borrowed too much money to do so, and that really sank them. So that's changed.

But that is a market-driven change. And I think what's interesting is that you do not see regulatory change in three really important areas, one in the derivatives market, which is an enormous market that is really private contracts between people where there is really no oversight at all. And credit derivatives were really behind some of the biggest failures, in fact, the AIG collapse.

So we see no new regulation on that. There have been proposals, but nothing has, of course, been instituted. That market remains the same and sort of unchecked.

And we see no change at all in the credit rating agencies and the oversight of them. And, really, I think they are at the center of this problem, where they really rated securities far too high, said that they were way less risky than they ultimately turned out to be. So that also is a change that we have not seen anything about.

JEFFREY BROWN: All right. And, Robert Glauber, do you see changes that address the kind of problems that led to the financial crisis?

ROBERT GLAUBER, Harvard University: Well, in terms of the risk behavior on Wall Street, Gretchen's right. Leverage is down, but the aggregate risk isn't down a whole lot at all, and that's quite surprising.

I think one of the reasons is quite ironic. Because the government did a good job of preventing this from becoming a total catastrophe, memories are very short, and these people who basically live off of risk -- this is how you make money -- and, of course, the government knows it and controls that amount of risk -- these people have come back into the pond much more quickly than some people would have thought.

I think, on the other issue of regulatory change, that hasn't happened yet. Gretchen's right. I think that there are a number of issues that have to be addressed. They've gotten, I think, stopped in Congress, because they're worrying about health care. They'll get to them. I hope they get to, among others, the one she mentioned, credit default swaps.

JEFFREY BROWN: Will they get to -- Mr. Glauber, staying with you -- when they get to them, is there then a potential balance problem of dealing with the excessive risk while not killing off the good risk, the good risk-taking?

ROBERT GLAUBER: Oh, Jeffrey, of course you're completely right. The financial services industry is an extraordinarily important industry for the U.S., and we do it very well. What we have to do is get the balance of risk and profit right.

The hope is, from all of us, that when they pass some of these new pieces of legislation, they don't overdo it. They can do it right. They've done it wrong on a number of occasions, but they can do it right, and I very much hope they do. I hope they start with, for example, worrying about credit default swaps.

I hope that they do something about the ability of governments to close down some of these big bank-holding companies and firms like Lehman Brothers in a safe way rather than have to rely on the market bankruptcy process working.

And then, of course, there's this whole question of systemic risk and whether the Fed will be a systemic risk regulator and whether Congress will approve that.

JEFFREY BROWN: Well, Lynn Stout, what do you want to see? You raised this short-termism, as you called it, and you've heard what the others have said about what hasn't happened yet. So what do you think can happen now?

LYNN STOUT: Well, I think the short-termism also is related to the excessive use of derivatives to take speculative positions. I think one of the reasons why so many banks started up proprietary trading divisions that traded in derivatives and one of the reasons why they took on so much risk was that not only were the executives only thinking about next year's bonuses, but a lot of the investors in the market were only thinking a year ahead, as well.

Shareholders have been enjoying increasing power in recent years to influence boards and company executives. And a lot of shareholders, particularly hedge funds and some actively managed mutual funds, tend to focus only 11, 12 months down the road. And they were perfectly happy to see a lot of these risks being taken on as long as they -- at least they hoped -- would be able to sell before the risks came home to roost, as it were.

And also in derivatives, I do think one thing that has been missed is that one of the reasons why the derivatives market has become so large is because Congress passed a statute in 2000 that largely deregulated derivatives. And, again, there are proposals to try and backtrack a little bit and bring them under the eye of a watchful regulator, but right now some of the most commonly spoken of proposals have enormous loopholes in them.

So it does look like Wall Street is thinking that if they can just lie low, they may be able to press the reset button and start the party all over again. And it's really up to Congress to try and prevent that from happening.

The risk of regulating risk

Robert Glauber
Harvard University
The hope is, from all of us, that when they pass some of these new pieces of legislation, they don't overdo it.

JEFFREY BROWN: Will they get to -- Mr. Glauber, staying with you -- when they get to them, is there then a potential balance problem of dealing with the excessive risk while not killing off the good risk, the good risk-taking?

ROBERT GLAUBER: Oh, Jeffrey, of course you're completely right. The financial services industry is an extraordinarily important industry for the U.S., and we do it very well. What we have to do is get the balance of risk and profit right.

The hope is, from all of us, that when they pass some of these new pieces of legislation, they don't overdo it. They can do it right. They've done it wrong on a number of occasions, but they can do it right, and I very much hope they do. I hope they start with, for example, worrying about credit default swaps.

I hope that they do something about the ability of governments to close down some of these big bank-holding companies and firms like Lehman Brothers in a safe way rather than have to rely on the market bankruptcy process working.

And then, of course, there's this whole question of systemic risk and whether the Fed will be a systemic risk regulator and whether Congress will approve that.

JEFFREY BROWN: Well, Lynn Stout, what do you want to see? You raised this short-termism, as you called it, and you've heard what the others have said about what hasn't happened yet. So what do you think can happen now?

LYNN STOUT: Well, I think the short-termism also is related to the excessive use of derivatives to take speculative positions. I think one of the reasons why so many banks started up proprietary trading divisions that traded in derivatives and one of the reasons why they took on so much risk was that not only were the executives only thinking about next year's bonuses, but a lot of the investors in the market were only thinking a year ahead, as well.

Shareholders have been enjoying increasing power in recent years to influence boards and company executives. And a lot of shareholders, particularly hedge funds and some actively managed mutual funds, tend to focus only 11, 12 months down the road. And they were perfectly happy to see a lot of these risks being taken on as long as they -- at least they hoped -- would be able to sell before the risks came home to roost, as it were.

And also in derivatives, I do think one thing that has been missed is that one of the reasons why the derivatives market has become so large is because Congress passed a statute in 2000 that largely deregulated derivatives. And, again, there are proposals to try and backtrack a little bit and bring them under the eye of a watchful regulator, but right now some of the most commonly spoken of proposals have enormous loopholes in them.

So it does look like Wall Street is thinking that if they can just lie low, they may be able to press the reset button and start the party all over again. And it's really up to Congress to try and prevent that from happening.

Stalled reform plans in Washington

Gretchen Morgenson
The New York Times
Maybe it's not so urgent as it was a year ago, when really we were in the ditch in a very big way. I think that is part of it.

JEFFREY BROWN: Well, Gretchen, that's what I wanted to bring you in on. I mean, as a trained observer of Wall Street and what happens in Washington, if so many of these things seem so obvious from a year ago to today, why don't they happen? Why don't we see the kind of changes that all three of you are talking about?

GRETCHEN MORGENSON: Well, I think Bob's right about health care. You know, there's been an obsession about that. And, of course, that's one of the president's, you know, primary objectives. And so that has been a huge fight and taken a little bit of the eye off this ball.

But I also think that we have a market that's recovered, a stock market that's come back from the March lows very nicely. And, you know, there is a complacency that investors get lulled into when the market is rising. Their 401(k) doesn't look as devastated as it was. And so maybe it's not so urgent as it was a year ago, when really we were in the ditch in a very big way. I think that is part of it.

JEFFREY BROWN: And, Mr. Glauber, I mean, you raised this systemic regulator idea, and you've had experience in Washington. This, of course, brings in all kinds of institutions and changes the whole regulatory system of who would exactly do what. So is that -- I guess that must be part of the confusion, as well, in terms of how you go forward?

ROBERT GLAUBER: Well, it is. And it's going to be part of the big debate. The Fed is the obvious choice by many people, because it clearly is the most sophisticated and most knowledgeable, but there are a number of people in Congress that are very worried about giving the Fed more power. And I quite agree with them, but perhaps for a different reason.

What worries me is if the Fed is given this additional power, this is going to increasingly politicize the Fed. If it exercises this power, it will ultimately be doing -- making decisions which will spend taxpayer money to save firms, bail them out in some way. And when that happens, the Fed is going to be overseen more by the politicians, and that is going to jeopardize its independence as it sets monetary policy.

JEFFREY BROWN: What...

ROBERT GLAUBER: So I would -- excuse me.

JEFFREY BROWN: I'm sorry. Go ahead. No, go ahead. I'm sorry.

ROBERT GLAUBER: I would greatly prefer to see the Fed not get this responsibility. I think the place it should go, actually, is to the Treasury Department.

Now, it right now doesn't have the capacity to do it, but it could build that capacity. And the Treasury Department is subject to congressional oversight, it is subject to the votes of taxpayers, and that really is where this kind of responsibility, I think, should be vested.

JEFFREY BROWN: Lynn Stout, I mean, where do you think that should be vested, in Washington or even in the mix between Washington and self-regulation by the industry?

LYNN STOUT: Well, I think that it's a little overoptimistic to expect that regulators can foresee and respond to problems. If the Federal Reserve could have foreseen where we were going, I would like to think we wouldn't be here in the first place.

We actually had a pretty good regulatory system before the wave of deregulation in the end of the 1990s and early 2000s, and although there was a certain amount of fighting over turf between the Securities and Exchange Commission, the SEC, the Commodities Futures Trading Commission, which has a long and very successful track record of preventing speculative bubbles in excess in the futures markets that they have jurisdiction over, and the Federal Reserve and the Treasury.

So I think the problem is not so much that we need to create some new regulator or some new regulatory powers as to go back and look at the kinds of things that worked in the past. For example, we used to have laws that prevented stodgy old commercial banks from merging into and taking on very risking proprietary trading divisions that would try and get profits out of speculating with derivatives. It's because we got rid of those laws that we ended up with banks that were too big to fail.

So there's two strategies. You could try and stop them from failing, but it also might make sense to go back and look at laws that prevented them from becoming too big in the first place.

JEFFREY BROWN: All right. And, Gretchen, we just have 30 seconds, so a last word from you on the mix here of regulation going forward.

GRETCHEN MORGENSON: Well, I couldn't agree with Lynn more. And I think that what is crucial for everyone to talk about openly is how to solve this too-big-to-fail problem. And that is something I have heard very little about, disturbingly little about. And until we really address that issue, I don't think we will have really gone where we need to go.

JEFFREY BROWN: All right, Gretchen Morgenson, Lynn Stout, and Robert Glauber, thank you all three very much.

JUDY WOODRUFF: On our Web site, newshour.pbs.org, we have two perspectives on the fall of Lehman Brothers from the firm's bankruptcy lawyer and from Robert Glauber and two views on the most surprising effects of the financial crisis. Find that and more on our "Business Desk" page.