I just saw the movie Inside Job that dissects the financial meltdown of 2008 and I highly recommend it for both novices and those knowledgeable about the details of how the financial crisis occurred. Most of us know about the role of banks and financial institutions in making loans without carrying out due diligence in assessing the creditworthiness of borrowers. The movie explains why so many people lost their jobs and homes and places blame squarely on the shoulders of the financial services industry that packaged home mortgage loans as securitized assets and sold them off to other investors thereby transferring the risk to those investors. The movie points to the sale of credit default swaps by AIG to the investors as a way to hedge against the risk of default by purchasing insurance to protect one's interests. AIG was virtually wiped out and couldn't pay off on the insurance policies when the value of the underlying homes declined precipitously. AIG needed a $182 billion bailout by the government to stay afloat.
I experienced a lot of emotions after leaving the theatre. I was angry with an entire industry that placed greed above all else and financially engineered transactions without concern for who might get hurt while the offenders pulled in compensation packages in the hundreds of millions. I wondered where was the government oversight of Fannie Mae and Freddie Mac, two government-sponsored enterprises that purchase home mortgage loans from banks? The taxpayer bailouts of these entities could cost as much as $363 billion through 2013, according to government projections. What was and should have been the role of the SEC and the Commodities Future Trading Commission? Were those in Congress simply asleep at the wheel or was it the lobbying payments by the industry that contributed to the lax oversight? Where were the auditors who should have been investigating the quality of the loans and securitized assets?
How can we avoid another financial meltdown in the future? Some yearn for the "good old days" when the Glass-Steagall Act prevented the merger of commercial and investment banks. Back in the mid 1990s, the former chairman of the Federal Reserve, Alan Greenspan, along with former Goldman Sachs partner Robert Rubin, Bill Clinton’s Treasury Secretary, signaled that the Clinton administration was ready to repeal the Act. A year later Sandy Weill set in motion the forces that would finally end Glass-Steagall. Weill proposed the most audacious financial merger in American history: he would merge one of the largest insurance companies (Travelers), one of the largest investment banks (Salomon Smith Barney), and the largest commercial banks (Citibank) in America. The problem was the merger was illegal in terms of Glass-Steagall. So, Congress was convinced by Greenspan and Rubin to repeal the Act after the fact. It did just that and Rubin became the vice chairman of the emerging Citigroup while Weill became its chairman and CEO.
I do not believe our economic system can handle another crisis of similar proportions. Yet, according to the movie, that may be where we're headed because the banks are bigger -- stable ones such as Bank of America have taken over shaky ones like Countrywide. Consolidation in the financial services industry following the takeover of Bear Stearns and the demise of Lehman Brothers means less competition. And then there is the massive Citigroup.
Are these institutions too big to fail? Should they be forced to break up into smaller segments? Will that make a difference with respect to the possibility of another wave of risky transactions that create systemic risk in the system? I do not see any signs that the financial services industry recognizes its ethical failings and has committed to act in the interests of its stakeholders (i.e., shareholders, customers, employees, and the public good) and not in its own self-interests. Perhaps I'm too much of a cynic. Let me know what you think.