Copyright 2010 Marketwatch
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January 13, 2010 Wednesday
SECTION: BUSINESS AND FINANCIAL NEWS
LENGTH: 1635 words
HEADLINE: Big bank CEOs admonished for their role in financial crisis
BYLINE: By Ronald D. Orol, MarketWatch
WASHINGTON _ As the White House and Congress consider a host of new regulations for Wall Street, a commission studying the financial crisis harshly criticized the heads of the nation’s biggest banks Wednesday for their role in the near collapse of the economy in 2008.
“How do you go to the rating agencies and persuade them to give these subprime mortgage-related securities the highest ratings, at the same time as you have internal information that leads you to believe that in fact those securities may fail?” Phil Angelides, the chairman of the inquiry panel, asked Goldman Sachs Group Inc. Chief Executive Lloyd Blankfein.
Angelides and many other members of the inquiry committee _ which is charged with identifying the root cause of the financial crisis and making recommendations by December _ lashed out at investment-bank executives, comparing the practice of packaging and selling “toxic” mortgage securities with that of someone who sells a car with faulty brakes and buys an insurance policy for it.
Panel members asked questions about bank-executive bonuses they saw as excessive; a lack of provisions to “claw back” bank-employee pay when things are bad; and a need for investment banks to have “skin in the game” by retaining an interest in packaged securities they sell to investors.
In response to panelists and reporters, the top executives _ which included Jamie Dimon of J.P. Morgan Chase & Co., John Mack of Morgan Stanley and Brian Moynihan, the new head of Bank of America Corp. _ defended their practices and argued that they should not be broken up, as some are suggesting, because their large size creates economies of scale necessary to compete globally.
Responding to criticism of how investment banks packaged and sold toxic securities, Blankfein said that the purchasers of those securities were professionals who understood the risks they were taking.
“The act of selling (mortgage securities), it reduced our risk,” Blankfein said. “Everybody that bought those securities were professionals dedicated to this business and wanted exposure.”
However, he added that knowing now what happened, he would do anything not to be in the same position.
“People can examine what our due-diligence processes were, but they were robust,” Blankfein said. “Would I do more now? People who say I wouldn’t change a thing, I think (that) is crazy. Knowing now what happened, whatever the standards were, it didn’t work out well. Of course I would do something different.”
Angelides also queried Blankfein on whether his firm took any specific steps in the wake of a 2004 regulatory warning that mortgage fraud was so high in the country that there existed the potential for an epidemic.
“Did you take any specific steps in the wake of that 2004 crisis to evaluate the mortgages?” Angelides asked.
“We did not know at any moment what would happen next,” Blankfein replied. “There were people in the market that thought that the market was going down and others who thought, ‘Gee, these prices have gone down so much that the prices will bounce up again.'”
Dimon refuted concerns that J.P. Morgan was too big, saying that being large is necessary to take advantage of economies of scale. Some critics are calling the 1999 repeal of the Glass-Steagall Act a fatal mistake that led financial institutions to load up on debt financing, and becoming so large that taxpayers had to invest billions in the largest entities to keep them from imploding and unsettling the markets.
Glass-Steagall was a statute approved in 1933 that prohibited commercial banks with retail depositors from engaging in investment-banking activities, such as owning full-service brokerages.
“J.P. Morgan does business in 100 different countries. You can’t do that if you are small,” Dimon told reporters. “Did Glass-Steagall cause the problem? Most of these problems are investment banks, finance companies, insurance companies, mortgage brokers and thrifts. They were not because of the combination of commercial banking and investment banking.”
Dimon also addressed the charge that investment banks are using taxpayer dollars that helped prop them up to lobby Congress against regulations that are necessary to make sure such a crisis doesn’t happen again.
“The regulators should have looked at what they could have done better to avoid the problem,” he said. “Lobbyists have the right to raise their issues with government, and that is what democracy is about.”
However, John Taylor, president of the National Community Reinvestment Coalition, called for big banks to call off their lobbyists. “Given Congress’ inability to push meaningful reform to date, unless and until the commission can break the back of Wall Street’s political influence by making clear their abusive and malfeasant behavior, I am not optimistic that we’ll see movement for strong and effective regulations,” he said.
Angelides, a former California state treasurer, heads the 10-member inquiry commission, which has subpoena power. Congress authorized it to provide ideas and recommendations as lawmakers rewrite many rules of finance in response. Serving as vice chairman is Bill Thomas, a former Republican congressman who once headed the House Ways and Means Committee.
The bankers cautioned against going too far in responding to the financial crisis that took the economy to the brink in 2008.
“If we abandon, as opposed to regulate, market mechanisms created decades ago such as derivatives, we may end up constraining access to capital and the efficient hedging and distribution of risk, when we do come through this crisis,” Blankfein said.
FCIC commissioner Byron Georgiou suggested that a lack of accountability contributed to the financial crisis.
“If all the individuals involved in the creation of these financial instruments had to ‘eat their own cooking,’ they may not have created them,” he said.
Georgiou suggested requiring that investment-bank originators of packaged securities take their fees not in cash, but “in significant part in the securities they create.” The packaged-mortgage product’s originator would be required to hold the stake, known as “skin in the game,” until maturity of the security, he added.
A similar “skin in the game” provision is included in legislation approved by the House in December. “If the security failed to perform as represented to us, the originators would lose their prospective income and their bonus,” according to Georgiou.
He said such “skin in the game” would improve the quality of diligence exercised in the origination of the security, knowing that firms’ financial future was tied to the success or failure of their securities.
“I would ask for each of you whether the volume created of illiquid toxic securities contributed significantly to the global crisis could have been reduced by some such mechanism, by placing financial responsibility on who it belongs on those who originate the financial instrument.”
Morgan Stanley’s Mack said the bank he oversees kept some of the securities and it did not work out, so “we did eat our own cooking and we choked on it.”
Mack added he supported such a “skin in the game” approach, but it would create an issue for investors. “I would welcome that; you would have to give us some leeway, the markets are volatile, to hedge it. Other than that, I wouldn’t mind it. Without that we would probably curtail our investments.”
The bankers also were chided for failing to do enough to help keep troubled homeowners in their houses. In response to questions from reporters about an Obama administration mortgage-modification program, Mack of Morgan Stanley said his bank has been “aggressive.”
Homeowner-advocacy groups have criticized major bank executives for failing to convert three-month trial modifications completed under the program into permanent modifications.
“We are making progress on modifications,” Mack told reporters. “You have to start somewhere. We have been aggressive on it. If it makes sense to extend it, we’ll try to do that.”
Recently eliminated Securities and Exchange Commission leverage limits and other restrictions for large investment banks, which resulted in major debt expansion at so-called “too big to fail” institutions, will also come under scrutiny.
“This is the first hearing and expect many of the witnesses we have testifying before us to be invited back again,” said Angelides.
Bankers were questioned about a possible proposal being floated by the Obama administration that would charge big banks special fees, based on their leverage or other metrics, to raise $120 billion that could be used to cover the remaining costs of the $700-billion bank-bailout package and to reduce the deficit. The proposal could be released as soon as Thursday.
In an interview with reporters, J.P. Morgan’s Dimon said he had not seen the proposal and declined to comment. He did say that any fees or costs charged to big banks are going to be passed on to their customers.
“All businesses pass their costs on to their customers; that is not un-normal,” Dimon said.
The chief executive did indicate support for legislation under consideration on Capitol Hill that would have big financial institutions pay fees to cover the cost of dismantling a failing megabank, so that its collapse doesn’t cause collateral damage to the markets.
“When you talk about enhanced resolution authority, I think industry should pay for that,” Dimon said.
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