
Saturday, Jul 12, 2014

Warren's mistake about Wall Street risk-taking


When Sen. Elizabeth Warren, the former law-school professor and self-appointed scourge of Wall Street, gets her history terribly wrong - and proposes a new law based on that lack of understanding - there must be a reckoning.

On July 11, Warren introduced the "21st Century Glass- Steagall Act of 2013," theoretically designed to "reduce risks to the financial system by limiting banks' ability to engage in certain risky activities and limiting conflicts of interest." Warren's allusion to the original Glass-Steagall Act of 1933 - which gave Wall Street's commercial banks and investment banks one year to choose to be one or the other - was intentional, of course.

The firebrand Democrat from Massachusetts - and, apparently, the bill's unlikely co-sponsor, Arizona Sen. John McCain - seems to believe that the 2008 financial crisis was caused by commercial banks taking undue risks with depositors' money. According to Warren, actions by the Federal Reserve Board, the Office of the Comptroller of the Currency, the federal courts and Congress itself - with its 1999 repeal of Glass-Steagall - allowed commercial banks to "engage in an increasing number of risky financial activities that had previously been restricted."


As I have detailed extensively in two books about the financial crisis - "House of Cards," about the collapse of Bear Stearns Cos., and "Money and Power," which in part documents how Goldman Sachs Group Inc. made it through financially unscathed - its causes were many and complex. What was key, though, was institutional investors' justifiable loss of confidence in the quality of the assets on the balance sheets of the large Wall Street investment houses - Bear Stearns, Lehman Brothers, Merrill Lynch and Morgan Stanley.

These banks had been financing their short-term cash needs in the "overnight repo" market. And the nightly lenders - institutional investors such as Fidelity Investments and Federated Investors - used as collateral the piles of mortgaged-backed and other squirrelly, hard-to-value securities that had been building up on the banks' balance sheets. Fidelity and Federated began to question the value of these assets, then finally stopped accepting them as collateral.




Wall Street's ongoing problem is not the risk-taking itself but rather the incentives to engage in it. Bankers, traders and executives earn big bonuses for taking foolish chances with other people's money, but incur no liability - criminal, civil or financial - when things go wrong.

