Catastrophic Consequences
Congressional inquiries and more than 300 books about the crisis have identified many villains: homeowners borrowing beyond their means, banks selling subprime mortgages, government-supported agencies backing the loans, Wall Street packaging them for investors, ratings firms giving seals of approval, regulators offering little objection and politicians encouraging it all to happen.
Three fundamental flaws stand out. Regulators stripped of power allowed banks to embrace too much risk and load up on toxic debt with short-term funds. Insufficient capital left them little margin for error when those assets plunged in value. A system too large, opaque and interconnected meant they couldn’t fail without catastrophic consequences for the economy.
Morgan Stanley’s Gorman, 55, summed it up in a speech in Florida in 2010, soon after taking over as CEO.
“What caused the financial crisis?” the CEO asked. “Illiquid assets, funded short-term, held by overleveraged institutions that were inadequately capitalized.”
Byzantine Banks
Regulators have since pushed banks to cut the amount of borrowed funds they use, what’s known as leverage, hold more easy-to-sell assets and rely less on overnight loans. The 2010 Dodd-Frank Act established a protocol that would, in theory, enable authorities to seize even the largest lenders and dismantle them without bringing down the entire system. An interagency group has been empowered to make sure banking supervisors work together to monitor systemic risk.
That may be insufficient. The largest banks remain Byzantine, with hundreds of subsidiaries around the world, which could thwart efforts to unwind them. Six U.S. regulators with overlapping authority often clash and are besieged by an army of highly paid lobbyists. Leverage is still too high, some regulators and economists say.
The biggest risks could lie in the unknown: Five years after AIG was brought down by billions of dollars of credit- default swaps, there’s little transparency about banks’ trading and derivatives businesses or their counterparties.
‘Way Short’