Another disappointment

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It was another disappointment in a year full of them. What has been missing most of all since the real dimensions of the meltdown became known is a sustained effort to consider our out-of-control financial system as a whole. Both Washington and Wall Street continue to see the financial crisis as a matter of toxic assets, when the entire financial system has become toxic. It is a system of overlarge and untouchable Wall Street institutions that deal in opaque products with government regulators who remain miles behind. The persistence of Wall Street as the whip hand in the global economy has begun to generate doubts about capitalism itself. The remedies being prepared by the Obama administration and the Congress amount to antidotes to the lingering poison in the system from the real-estate bubble; they do little to address the fact that the system is already generating a flood of new poison infecting the whole economy. As commissioner Brooksley Born pointed out during one of the few productive exchanges at the hearing, the four bankers' firms represent about $230 trillion worth of trade in over-the-counter derivatives, much of which is still going unmonitored (prompting another warning recently from Commodity Futures Trade Commission chairman Gary Gensler, who said in a speech that without new rules, the operation of the derivatives market will continue to be like "buying an apple from the supermarket when the price of the apple is kept private" or "buying 100 shares of a stock for your 401[k] with no knowledge of where the market prices the stock").

Bankers and regulators alike continue to characterize the disaster of the past two years as a "perfect storm," but as Angelides himself said, the creation of this system was not an act of God, but of people. Which people? Where are they? You can count on one hand the number of top executives on Wall Street and senior officials in Washington who have owned up to even a sliver of responsibility for a system that was a generation in the making.

Oh, sure, everybody is acutely aware that they have to get on the right side of public outrage. That's no doubt part of the reason why President Obama announced a new $90 billion tax levy today on big financial institutions in order to recoup losses from the TARP bailout program. "My commitment is to recover every single dime the American people are owed. And my determination to achieve this goal is only heightened when I see reports of massive profits and obscene bonuses at the very firms who owe their continued existence to the American people," Obama said. But this is mostly political theater. Yes, the CEOs admitted that they are addressing Wall Street's executive compensation practices, which were so central to the disaster and to the conversion of the entire real economy into a optioned-up race to drive up stock prices, come what may. Regulators—especially FDIC chair Sheila Bair, who remains ahead of the curve—are demanding new pay incentives that reward a focus on long-term corporate value, and promoting "clawbacks" of bonuses and salary for instruments that do poorly. But there's already an internal battle over Bair's proposal, and the Wall Street lobby is hovering in ominous opposition.

Above all, most of the culprits of the crisis remain in power, while those who warned most presciently about the systemic issues remain on the outside looking in. Perhaps the oddest thing about the commission's opening hearing was that Born—one of the very few heroes of the whole sordid financial mess—was the last of the 10 commissioners to ask her questions. That's the position usually reserved at congressional hearings for the most junior member of the panel. I couldn't get a straight answer from commission staff on why the only person in Washington who really predicted and understood the dangers to come, and who is clearly more qualified to chair the commission than Angelides, a political crony of Nancy Pelosi's, had been so seemingly marginalized. It seemed akin to batting A-Rod ninth in the opening game of the World Series.

A commission spokesman assured me that Born would go first the next day. Further inquiries revealed that Born was not entirely happy about starting things out with the CEOs. A distinguished lawyer who, as chairwoman of the Commodity Futures Trading Commission, warned back in 1998 that derivatives were getting out of control, only to find herself crushed by the Wall Street/Washington juggernaut, Born would have preferred to build a case more carefully. She wanted to question junior witnesses first, including key people at the Wall Street firms, and only then confront the CEOs with detailed questions about their practices, according to two sources familiar with the internal discussions (Born herself would not comment, and the commission spokesman denied there was any dispute). Bringing in the CEOs first as a headline-grabber and asking them gentle opening questions, said one observer, was like "making Richard Nixon the first witness in the Watergate hearings." Born was overruled, just as she had been in 1998, but sadly for the country, she was proved right once again. After the hearing, when JPMorgan chairman Jamie Dimon was asked why the CEOs hadn't been more apologetic, he responded that questioners have to be "very specific" about what they want him and the others to apologize for. They weren't.

Instead, Angelides asked Lloyd Blankfein of Goldman Sachs to volunteer "the two most significant" things "for which you could apologize." The Goldman CEO obligingly suggested that taking excessive leverage was a mistake, but added that this was "typical behavior" that everyone was doing. Blankfein also said he regretted some instances of Goldman's two-faced practice of selling and pitching derivatives to customers that the firm would then bet against. But in the next breath, Blankfein seemed to aggressively defend such practices because Goldman was a "market maker" that had to supply products to both sides of a transaction. Angelides never got his apology and didn't bring it up again. Nor did the commission seem to make a lot of progress in pulling together a deep and detailed narrative of what went wrong, which is what it's supposed to be doing; instead the four CEOs, our gurus of greed, were asked for advice about what America should do in the future.

What is needed is both a full understanding of what went wrong and an overhaul that would put Wall Street back in its proper place, and return it to its rightful role as an efficient supplier of capital to the real economy. When an august figure like former Federal Reserve chairman Paul Volcker declares that he hasn't seen any evidence that 20 years' worth of financial innovation has produced economic growth, we all ought to be worried. Only with a thorough overhaul can we restore the nation's flagging faith in our market system.

It's not happening. Even with all the currently proposed fixes, Wall Street is likely to remain the master of Main Street, determining compensation levels and the time horizons for strategy and growth. The financial industry is fighting every effort to dampen speculative practices, even in the derivatives market linked to basic commodities, which continues to inflate the price of oil, rice, wheat, and corn despite plentiful supplies that normally would drive prices lower. In the past decade, a frenzy of buying and holding by Wall Street—and by its customers, funds advised to keep 10 percent of their investments in commodities—has overwhelmed the physical supply and demand. As a result, in the eight years leading up to the financial crisis, "American consumers and businesses spent $1.5 trillion more on energy than they had to" because of derivatives trading, says Peter Beutel, who puts out a widely read newsletter on the energy market.

Will the Financial Crisis Inquiry Commission ever get down to this level of inquiry? Let's hope that it does. But this is not a very promising start.