One from the News and Two on the Financial Crisis from the Editorial Pages

A period has been placed at the end of one of the sentences of American financial history with Morgan Stanley and Goldman Sachs, which had been the last two remaining independent investment banks on Wall Street transforming themselves into banks:

Goldman Sachs and Morgan Stanley, the last big independent investment banks on Wall Street, will transform themselves into bank holding companies subject to far greater regulation, the Federal Reserve said Sunday night, a move that fundamentally reshapes an era of high finance that defined the modern Gilded Age.

The firms requested the change themselves, even as Congress and the Bush administration rushed to pass a $700 billion rescue of financial firms. It was a blunt acknowledgment that their model of finance and investing had become too risky and that they needed the cushion of bank deposits that had kept big commercial banks like Bank of America and JPMorgan Chase relatively safe amid the recent turmoil.

It also is a turning point for the high-rolling culture of Wall Street, with its seven-figure bonuses and lavish perks for even midlevel executives. It effectively returns Wall Street to the way it was structured before Congress passed a law during the Great Depression separating investment banking from commercial banking, known as the Glass-Steagall Act.

By becoming bank holding companies, the firms are agreeing to significantly tighter regulations and much closer supervision by bank examiners from several government agencies rather than only the Securities and Exchange Commission. Now, the firms will look more like commercial banks, with more disclosure, higher capital reserves and less risk-taking.

The war on what to do about the ongoing crisis in the financial sector continues in the editorial pages of the country’s newspapers. I find myself substantially in agreement with the LA Times:

Rather than looking backward for someone to blame, McCain and Obama should be focusing on the problem in front of us. Financial institutions are buckling under the weight of hundreds of billions of dollars in investments that have lost their market value. The main question for politicians isn’t whether to act — the comments Friday by congressional leaders and top administration officials made it clear that Washington will undertake something extraordinary — but what to extract from the companies that are helped and how to prevent the problems from recurring.

and in disagreement with the Christian Science Monitor’s call for an auto da fé with Congress playing the role of Grand Inquisitor:

Americans need to hear a full-throated debate by lawmakers about the range of players in this mortgage maelstrom who either lied, took on too much debt, or failed to check creditworthiness as these loans were issued and then sold up the financial food chain to the point where it has become nearly impossible to determine their value.

They also need to hear about the government’s role in encouraging a housing bubble – and that will mean Congress needs to look at itself. No longer should federal support for owning a home be based on the false premise that housing prices will always go up or that taxpayers are the final backstop for mortgage holders.

There are two pressing matters before the Congress and, frankly, time’s a wastin’. First, there needs to be a determination of the risk that the troubles in the financial sector will translate into the larger economy. If the risk is low or in some manner circumscribed, then those who are calling for inaction or gradual action are right. The affected firms should be allowed to suffer the consequences of their own folly and mismanagement. But, if as I suspect the risk of a general meltdown is high, then there is no recourse other than to act. The only question remaining is the proper course of action and half measures are only called for if half measures will do.

This is not the time to pontificate about moral hazard which would have been a fine debate when it could actually have prevented the situation unfolding before us now. Nor is it the time to fix blame. There will be plenty of time for that when the storm has passed.

3 comments… add one
  • So, are the investment firms changing into banks as part of their deal with Paulson and Bernakke, or on their own volition? If it’s the latter, does that mean we can take some time to breathe before writing a blank check? After all, bank regulations mean more transparency, more transparency means better pricing, better pricing means more liquidity, right? Or am I missing something?

  • PD Shaw Link

    There’s an old framing device: the courts look to the past to judge their cases; the legislature plans for the future in passing laws and the executive acts in the present.

    It’s a little simplistic and in this case the executive can’t act simply in the present when it wants to spend near a trillion dollars. Power of the purse and all. But the burden is on the legislature to address its own shortcomings: it needs a majority of 535 politicians. If it can’t do that promptly, then it will have to choose between the President’s burden and Congress’ fault.

  • Larry Link

    Debate is needed, and that debate need not take months to work through, but dialog is absolutely a must. If the bomb is falling, there isn’t much to do but duck and cover and hope you survive, if the bomb has not actually been dropped, then there is still time for dialog, and then the best possible course of action can be taken.

    The big question is, are we getting all the facts, what exactly are we taking action on? I don’t think we have a clear enough picture of the problem..and so we need to take some time to think about what we are about to do, to act or not to act…this is the question..

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