As Day 1 of the Financial Crisis Inquiry Commission goes on, it’s getting better. It turns out that, after getting past the first few committee members, the questions improved. An interesting one came from Keith Hennessey. He asked about the banks being too big to fail. He wanted to know if a) the market assumed that these banks would be rescued by the government, due to their size and interconnectedness before the crisis and b) if the banks internally assumed that they would be rescued if something went wrong.
The reason I find this so question important is because one major criticism about the banks is that they knowingly took big risks because they assumed that the government would bail them out if anything went wrong. I’ve long thought this was incorrect, but that the banks just made really big, really bad bets — and they wouldn’t have if they had known better. Of course, too big to fail has become a problem since then, because the government has proven that it will, in fact, bail out big institutions.
The bank CEOs all responded in the same way. None of them believed that there was a market perception that any bank, no matter how large, had an implicit government guarantee. As proof, Morgan Stanley Chairman John Mack pointed to Lehman Brothers. Certainly, its fate made crystal clear that banks could fail. Its stock price plummeting in the days leading up to its failure indicated the market’s belief that failure was possible.
And Goldman Sachs CEO Lloyd Blankfein added another point. Even some of the banks that didn’t technically fail, because acquired — like Bear Sterns and Wachovia — effectively failed, with their equity becoming virtually worthless. Equity investors certainly never believed the big bank stocks would be okay no matter what. He also mentioned that their corporate debt spreads expanded substantially, indicating that bank creditors felt the same way.
When asked about internal discussions, all four denied that there was any kind of assumption ever discussed that the government would rescue their banks. Again, they pointed to Lehman as proof that they could fail. And by the way, these guys were under oath. So if an e-mail did surface indicating otherwise, they could face perjury.
Now, the question of whether it was assumed banks could fail prior to the crisis and after the Treasury’s stress tests were completed are separate issues. Hennessey also asked about whether the market views those institutions that underwent the stress tests as now being too big to fail. Their answer here was different.
Here, Blankfein responded that he believes the market perceives that the government will now intervene if any of those large banks were on the brink of failure. But he also thinks that this will change in the next few years.
That belief was underscored by Hennessey’s follow-up asking the CEOs their view of a non-bank resolution authority. Both Bank of America CEO Brian Moynihan and John Mack agreed that this regulatory goal was a good one. They join JP Morgan CEO Jamie Dimon, who has already asserted in a Washington Post op-ed that the government should make certain that firms can fail.
Other than Hennessey’s line of questioning, there were some other good inquiries made as well. Commissioner Brooklsey Born had some good questions about derivatives. All the CEOs agreed that exchanges and clearing houses would help. Dimon said that he estimated some 70% of derivatives would probably easily fit into those molds, with the rest too customized for exchanges or clearing houses.
I’m listening to the next panel now, and it’s been pretty good so far.
