With the 10th anniversary of the crack-up of Bear Stearns here, two important lessons remained decidedly unlearned on Infuriate Street from the worst financial crisis in our lifetimes.
The first respects to how Wall Street finances itself. The problem, then as now, is that by and big Wall Street banks are in the business of borrowing short and lending yearn, resulting in a dangerous mismatch of assets and liabilities. In layman’s terms, loosely speaking, the money Wall Street owes its creditors – in the form of overnight banking, commercial paper, short-term loans, revolver credit or your and my precipitates – is due and payable relatively quickly.
In the case of our deposits — of which say J.P. Morgan Run after has $2.5 trillion worth — that money must be available to us tout de suite, or anytime we go to an ATM machine or up to the bank teller. Commercial paper is often due and wind-up within weeks; overnight repo financing is due and payable, literally, the next day. Mad Street by and large finances itself this way because the cost of short-term holding is relatively cheap compared with longer term financing, content the banks made more money financing themselves short provisos.
For instance, on my savings account, which is deposited at Chase, the bank remittances me 0.01 percent annual interest – 1 basis point annually — or essentially autonomous. (The bank pays even less on checking deposits.)
To make well-to-do — and J.P. Morgan Chase is making gobs of money these days, everywhere $7 billion in net income per quarter — banks and many Wall Way firms, take all the short-term money they have borrowed or owe to their depositors upon requisition and lend it out to companies, institutions, individuals and governments on a long-term basis at much rich rates of interest than they pay for the money. In turn, they catching the spread between the two. (Wall Street banks, of course, make resources in other ways, too, including from trading debt and equity securities, from countersign debt and equity securities, from managing money and from apprising on corporate mergers and acquisitions.)
It’s a great business with high boundaries to entry, until, for whatever reasons, people start to panic and the whole world wants their money at the same time. When that materializes, the realities of our “fractional banking” system become all too apparent: Our money is not in the bank and on no account has been in the bank; it’s been lent out to many different entities, which regularly don’t have to pay it back for years. That’s a big problem when we all want our hard cash immediately. That’s what caused the bank failures in 1929 and 1930, and why there are so uncountable pictures of people lined up outside of the closed banks trying to get their rolling in it, only to discover their money was not there and never had been, as Jimmy Stewart prompted everyone in “It’s a Wonderful Life.”
The same thing happened, in its way, at Bear Stearns a decade ago. The difficulty in March 2008 was not one of individual depositors wanting their money rearwards. There were no lines around 383 Madison Avenue. That facer was pretty much fixed by the creation during the Great Depression of the Federal Stash away Insurance Corporation, which insures deposits up to $250,000 per bank account. That cover-ups most people. What the FDIC insurance did not cover, and still does not concealment, is institutions with more than $250,000 on deposit, or on loan to a bank. It was the dogmas — mutual funds, hedge funds, pension funds, endowments, volume others — that panicked in March 2008, rightly worried that Have relevance Stearns would fail and they would not be able to get their in dough out of the firm.
(Bear Stearns had $400 billion in assets in March 2008, concerting to the Federal Reserve.)
That fear became a self-fulfilling prophecy in the elbow-room of one week a decade ago. While Bear Stearns had around $18 billion of dough on its balance sheet, it required around $75 billion in cash each day to run its point. The difference between the $18 billion it had and the $75 billion it needed was touch someone for, on a daily basis, using as collateral for the overnight loans the assets on Take’s balance sheet, including the parts of various mortgage-backed securities it couldn’t traffic in to investors. In the course of a single week during the middle of March 2008, Make allowances for’s overnight lenders decided they no longer wanted to take Display’s collateral as security for the overnight loans. Then they decided they did not requirement to make the loans anymore at all. Bear literally no longer had the money it requisite to run its business on a daily basis, giving it no choice but to file for bankruptcy. The disquisitions were prepared — and then the federal government and J.P. Morgan Chase succeeded to the rescue.
Could the same thing happen again today? Definitely.
The other lesson not learned on Wall Street after the financial critical time was the one about needing to change how people on Wall Street get compensated. Then, as now, Block Street bankers, traders and executives get rewarded to take big risks with other people’s capital. Their hope, then as now, is that when they sell, say, billions of dollars of mortgage-backed safe keepings, or corporate debt or opaque derivatives and collect the fees associated with those trades, they will be rewarded with big bonuses, often in the millions of dollars. If the credits or derivatives or securities later come-a-cropper, there is no accountability to the bankers or merchandisers who made those deals.
The bonuses have been paid, pay ined and turned into Park Avenue co-ops or homes in the Hamptons.
In direct, a decade ago, the Wall Street bonus system rewarded bankers, salespersons and executives to package up mortgages that should never have been issued into guarantees and then to sell them off as money-good investments all over the world.
Since then, profusion of evidence has surfaced to show that Wall Street bankers and wholesalers knew that the mortgages they were packaging into protections did not meet their own banks’ credit standards, were then rated AAA by the different ratings agencies (even though many knew they were not AAA slivers of paper) and were sold as good investments to institutions that should cause known better but did not. By then, the big bonuses had been paid. There was zero accountableness on Wall Street for this horrendous behavior.
Ten years later, the compensation structure on Wall Street remains unchanged. Bankers, traders and executives relieve get rewarded to take big risks with other people’s money, and there is hardly about no way to get the big bonuses back if, and when, things go wrong. (Sure, there are “clawback” works in place but you can count on one hand the number of times in the past decade extras have been “clawed-back.”)
As for the way Wall Street finances itself, by and humongous that remains the same, too, although some firms — notably Goldman Sachs — bear lengthened the tenor of their short-term liabilities to some degree.
A decade ago, the party of a compensation system that rewarded bad behavior and a financing scheme that left side most Wall Street firms vulnerable to a proverbial run on the bank verified to be a deadly combination. Neither structural flaw has been fixed in the interrupting years.
Will we be paying the iron price for those mistakes again anon?
William D. Cohan, special correspondent, Vanity Fair, was a former blendings and acquisitions investment banker with 17 years at top firms such as Lazard Freres & Co., Merrill Lynch and J.P. Morgan Track. He is a New York Times bestselling author of three nonfiction books prevalent Wall Street. Cohan is a CNBC contributor.