John Minchillo, Occupy Wall Street demonstration (detail), October 15, 2011.
Allan Tannenbaum, Occupy Wall Street demonstration, New York City (detail), 2011.
“WITH THIS BILL, THE AMERICAN FINANCIAL SYSTEM
takes a major step forward toward the 21st Century—one that will benefit American consumers, business and the national economy.”1
Secretary of the Treasury Lawrence H. Summers used these words on November 5, 1999, to applaud the passage of the Financial Services Modernization Act, also known as the Gramm-Leach-Bliley Act in honor of its three Republican sponsors, Senator Phil Gramm of Texas and Representatives Jim Leach of Iowa and Thomas J. Bliley Jr. of Virginia. Passed with bipartisan support and signed by Democratic President Bill Clinton, the act officially ended the 66-year reign of the Glass-Steagall Banking Act of 1933, enacted during Franklin Roosevelt’s New Deal to separate commercial and investment banking. (See Chapter Six.)
In reality, the Glass-Steagall Act was virtually a dead letter by 1999. A series of federal laws, agency and court decisions, and allowances from the Federal Reserve and the White House had gradually permitted various commercial banks and investment banks to merge, meaning that both types of institution could once again speculate in the market by issuing, selling, and buying securities. By the 1990s, New York investment banks had pioneered and were profiting from a global market in new financial securities that Wall Street commercial banks also wanted to sell. New York City bankers, notably Sandy Weill of Citigroup, had been key advocates for the repeal of Glass-Steagall. (At a tense moment in congressional negotiations to get the new law passed, Phil Gramm had turned to a Citigroup lobbyist and said, “You get Sandy Weill on the phone right now. Tell him to call the White House and get [them] moving.” Weill did call President Clinton on October 21, 1999, and the law was passed shortly thereafter.) As The New York Times noted, critics among consumer advocacy groups warned that the new law would create “behemoths that will raise fees … and put the stability of the financial system at risk.” One opponent, Senator Byron Dorgan, a North Dakota Democrat, predicted that “we will look back in 10 years’ time and say we should not have done this but we did because we forgot the lessons of the past, and that that which was true in the 1930’s is true in 2010.” In response, the measure’s proponents argued that American banks would now have more flexibility and freedom from federal regulation in order to compete in the global economy and provide capital for domestic growth. Senator Charles Schumer of New York, a supporter of the bill, warned, “The future of America’s dominance as the financial center of the world is at stake.” In signing the new law, President Clinton essentially declared the era of New Deal banking regulation over. “We have done right by the American people,” the president commented.2
Signing of the Gramm-Leach-Bliley Act, November 12, 1999.
© Ron Sachs/CNP/Sygma/Corbis
President Bill Clinton signs the Gramm-Leach-Bliley Act as Secretary of the Treasury Lawrence Summers (far left) and Federal Reserve Board Chairman Alan Greenspan (second from left) look on.
Business did indeed boom for New York’s banks in the first few years of the new century. To be sure, there were jarring events as well, especially the bursting in March 2000 of the so-called “dot-com bubble,” in which overenthusiastic investing in the stocks of commercial websites was followed by slumping financial markets. The terrorist attacks of September 11, 2001, shook the economy and also physically damaged the offices of Lehman Brothers and American Express at 3 World Financial Center, and led to the eventual demolition of Merrill Lynch’s offices in 4 World Trade Center and the Deutsche Bank building on Liberty Street. Among them the four firms lost 19 employees that day, among the more than 2,600 deaths in Lower Manhattan. The attack drove Wall Street banks to makeshift headquarters in Midtown and New Jersey, and initially seemed to jeopardize the future of the financial district itself as businesses contemplated moving permanently out of the city. Yet by 2003, many displaced financial firms had returned to Lower or Midtown Manhattan, and a rebounding housing and mortgage market was buoying the American and global economies. New York banks were central to the packaging and selling of the mortgage-backed securities that drove this nationwide expansion of home buying and building. However, when in 2007 and 2008, the housing and mortgage markets collapsed and a worldwide “Great Recession” brought economic woes unrivaled since the 1930s, those same banks faced massive losses, bankruptcy, and potential dissolution, threatening the future health of the nation’s and world’s economies.
The crisis spurred the Federal Reserve System and the U.S. Treasury Department into “bailing out” banks and launching an array of controversial regulatory efforts unmatched since the New Deal era. Once again, New York City’s banks were at the fulcrum of economic turbulence and of Washington’s efforts to revive the American economy. Once again they also became targets for popular outrage directed at their power, wealth, and evident sway over the financial well-being of billions of people. Even so, the status of New York as the commanding city of modern banking was becoming tenuous in the early 21st century. Global rivals—including cities whose growth New York banks had promoted—vied for their own shares of the world’s credit and investment markets. Would New York remain the capital of capital? This question, along with the changes wrought by the crisis of 2007–2008, is one of the new realities confronting bankers, investors, managers, workers, borrowers, consumers, voters, and politicians in New York and around the world.
The New Century
Despite the occasional “blip,” the new century at first appeared to promise an era of continual prosperity for Wall Street and global financial markets, fueled by American mortgage loans and the derivatives based on them. Low interest rates maintained by Federal Reserve Chairman Alan Greenspan during the late 1990s and early 2000s helped stimulate home buying. So did a glut of global capital, tens of billions of dollars invested by Chinese, European, and other foreign banks, institutions, and governments, all seeking safe and profitable investments and willing to lend to American home buyers. Investment banks, the government-sponsored mortgage “twins” Freddie Mac and Fannie Mae, and now commercial banks freed from Glass-Steagall era regulations all packaged mortgage-backed securities for sale to these customers. The securities included Collateralized Mortgage Obligations (CMOs), pools of thousands of home mortgages sliced into different levels of risk for different investors and sold to them as interest-bearing bonds (see Chapter Eight). Greenspan publicly championed securitized mortgages as a safe and reliable way to spur global financial growth and the vigor of the American economy, best left to the strategies of the mortgage lenders and bankers. “Regulation is not only unnecessary in these [derivative] markets, it is potentially damaging,” he stated in 2002.3
How Many? How Big?
In the late 1990s and early 2000s, “Quant” financial engineers at numerous banks and investment funds perfected a new and even more complex form of mortgage derivative, the Collateralized Debt Obligation, or CDO. The CDO supposedly reduced risk to investors even more than did conventional CMOs by taking the same idea to the next level. A CDO consisted of slices of hundreds or thousands of CMOs, which themselves consisted of slices of thousands of individual American mortgages. This slicing up of multitudes of mortgages allegedly spread the risk of default so widely that investors were protected against potential financial loss. If an individual homeowner in Arizona—or for that matter, multiple mortgage holders scattered across the country—defaulted, bondholders in New York, Frankfurt, Beijing, Paris, Tokyo, Dubai, Athens, Johannesburg, and Brasilia were protected from significant loss, since those defaults were divided up and mixed into literally thousands of CDOs, and they made up only a microscopic fraction of any given “healthy” CDO. On this basis, Quants engineered even more complex financial instruments: CDOs squared, CDOs cubed, and synthetic CDOs (first marketed by J. P. Morgan & Co. in 1998), which further distanced investors from direct knowledge of the home loans they were based on. By 2003, world production of CDOs backed by mortgages and other structured capital (credit card accounts, car and student loans, and other debt) was valued at $50 billion; three years later, it had climbed to $225 billion.
A Glossary of the Financial Crisis
Collateralized debt obligation (CDO)
A security created by bundling together mortgage-backed securities. Usually, the riskier tranches from the original pool of loans are bundled together to form a CDO. Like the mortgage-backed securities that underlie them, CDOs are divided into tranches of their own. “CDOs squared” are created by bundling together tranches of other CDOs. By late 2006, the majority of CDOs were purchased not by traditional investors, but by managers who incorporated them into CDOs squared.
Credit default swap (CDS)
In a credit default swap, the purchaser transfers to the seller the risk from an underlying debt. When the owner of a security backed by debt, such as a mortgage-backed security, purchases a CDS, the seller assumes the risk of default from the underlying mortgages. In essence, a credit default swap is insurance against default, but because it is classified as a derivative, it is not regulated by the laws and regulations governing insurance policies. Investors can also use CDSs to short (bet against) securities they believe will lose money.
Derivatives
Financial contracts whose prices are “derived” or determined from the value of an underlying asset, rate, index, or event. Derivatives can be used to speculate on changes in prices or rates over time, or to limit exposure to risk from those changes. Interest rate swaps, futures, mortgage-backed securities, collateralized debt obligations, and credit default swaps are kinds of derivatives.
Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation)
Government-sponsored enterprises created and implicitly backed by the federal government to provide mortgage credit to the national housing market by purchasing mortgages from banks, thrifts, and mortgage companies. Fannie (founded in 1938) and Freddie (1970) often securitized and guaranteed their mortgage portfolios and resold them to investors.
Government-sponsored enterprise (GSE)
A private corporation created by the federal government to pursue particular public policy goals.
Mortgage-backed security (MBS)
A financial product created by moving principal and interest payments on a group of mortgages into a single pool. In privately issued securities, this pool is usually divided into tranches.
Proprietary trading
Investments made by financial services firms using their own capital, with the goal of generating profits directly for the firm. Proprietary trading (or “prop trading”) can create conflicts of interest, as banks speculate in the same securities that they package and sell to other investors.
Securitization
The process by which multiple loans, for example, mortgages, credit card debt, or auto loans, are bundled together and sold to investors as securities. Borrowers pay interest and principal payments into a loan pool, and the revenue is sold to investors as bonds, which make payments over time. The resulting securities are collateralized, or backed, by the value of the original mortgages.
Shadow banking system
Investment funds and other financial entities that operate in global capital markets outside of the regulatory framework established for commercial banks. The shadow banking system includes financial instruments devised by commercial banks to keep certain assets and debts off their official balance sheets.
Short selling
The practice of borrowing a security and selling it with the intention to repurchase it at a later time and return it to the owner. If the price of the security falls, the short seller profits. Short selling (or “shorting”) allows investors to bet against a security or market.
Short-term hybrid adjustable-rate mortgage (hybrid ARMS)
These 30-year loans typically have a deceptively low “teaser” rate for the first few years, which is then recalculated to a variable interest rate, resulting in a significantly higher monthly payment. Hybrid ARMS formed about 70 percent of subprime mortgage loans between 2000 and 2007.
Structured finance
The mechanisms by which mortgages, including risky subprime mortgages, are transformed into apparently safe investment vehicles, such as mortgage-backed securities. Examples of structured finance products include mortgage-backed securities and collateralized debt obligations.
Subprime mortgage
A mortgage issued to a borrower with poor credit or a troubled financial history. Subprime borrowers pay a higher interest rate to offset their increased risk of default.
Synthetic CDO
A CDO created by bundling together credit default swaps, allowing investors to bet on the performance of an asset without actually owning a share in it. The proliferation of synthetic CDOs increased the number of investors exposed to the risk of default in the housing market in the years before the financial crisis.
“Too big to fail”
Phrase used to describe a corporation or bank so large that the government decides that its failure would cause significant harm to the broader economy. For example, the failure of a large financial firm could lead to losses for banks, investment funds, pension funds, and thousands of other entities invested in the firm or its securities, to the point where the health of the global financial system is endangered.
Tranche
From the French word meaning “slice.” Tranches are created by dividing the cash flow from a mortgage pool into a series of security offerings. Each tranche offers a different “slice” or level of the profits and risk from the original loan pool. In the event of default, those receiving a lower rate of return are paid off first and those receiving higher returns are paid off last.
—Bernard J. Lillis
CDOs became globally popular investments in part because the American credit rating agencies Moody’s, Standard & Poor’s, and Fitch Ratings (all with headquarters in Lower Manhattan) gave them high grades, signifying that the bonds were safe investments. Though approved by the Securities and Exchange Commission, the agencies were not disinterested parties; they were paid lucrative fees from the mortgage companies, banks, and Fannie Mae and Freddie Mac for rating their securities. A rating agency might lose such fees to a rival company if it graded CDOs too critically, so the raters had an incentive to play down the riskiness of these instruments. Their high ratings concealed the fact that investors would actually be vulnerable to losses if the American housing or mortgage market ever went into a downturn, since widespread inability by homeowners to make their monthly mortgage payments would cut off payments to CDO owners and send the market value of the CDOs spiraling downward. The CDO was so complex an instrument, so dependent on abstruse Quant pricing formulas that even bank CEOs and investors did not fully understand it. “When the bankers start using a lot of Greek letters to explain the mathematics that go into the models,” a Wall Street investor later commented, “you know there is a problem.” The billionaire investor Warren Buffett put it more succinctly in 2008: “Beware of geeks bearing formulas.”4
Banks, insurance companies, traders, and investors also resorted to the credit default swap (CDS), an instrument that became popular in 1998 after it was developed by Quants at Bankers Trust and J. P. Morgan & Co. Essentially a form of insurance, the CDS was a contract that allowed CDO owners to pay a fee to another party who would cover their loss if the CDO’s value declined. At the same time, many owners were willing to make money by selling insurance on their own CDOs to outside investors, committing themselves to paying large amounts to the investors if the instruments declined in value, but betting that such a decline would not happen. Many investors bought and sold swaps speculatively, wagering on the fluctuating market value of the swaps and the CDOs to which they were linked. Gambling on the continuing profitability of CDOs could be enormously lucrative, but it also exposed sellers of swaps to massive losses if the value of CDOs ever declined.
In the London office of the New York-based American International Group (AIG), the world’s largest insurance corporation, Brooklyn-born Joseph Cassano made millions of dollars in the early and mid-2000s by selling credit default swaps, confident that CDO values would remain high. But in doing so, he also committed AIG to pay out $80 billion to cover losses if CDOs slumped in price, including billions to Lehman Brothers and other CDO-owning banks. Unlike conventional insurance that had to conform to government safeguards, swaps existed in an unregulated “shadow” world where reckless investments might expose sellers and buyers to great loss. In the United States, another new federal law, the Commodity Futures Modernization Act of 2000, largely exempted swaps from government regulation. Were AIG’s bets on the continued health of the CDO market ever to prove unwise, the results would be catastrophic for the company and its clients.
Trading derivatives, rather than making loans or issuing stocks and bonds for corporations, increasingly dominated banking.
Anticipating profits and eager to compete for global market share, New York investment and commercial banks increasingly originated, bought, and sold CDOs and CDSs. By the mid-2000s, Merrill Lynch, Bear Stearns, Goldman Sachs, Lehman Brothers, Citigroup, and JPMorgan Chase, as well as non-New York giants such as Wells Fargo, all possessed divisions or subsidiaries that were writing mortgages and turning them into mortgage-backed securities for sale; millions and sometimes billions of dollars in these securities also remained in the banks’ own investment portfolios. Billions more were invested in the so-called “shadow banking system,” consisting of hedge funds, money market funds, and new instruments (such as Structured Investment Vehicles, pioneered by Citigroup in 1988) that legally sheltered riskier securities from the scrutiny of bank regulators. Trading derivatives, rather than making loans or issuing stocks and bonds for corporations, increasingly dominated banking.5
Meanwhile, to fuel their ability to invest in the mortgage-based markets, Wall Street commercial and investment banks continually borrowed massive sums from other banks, hedge funds, pension funds, and other investors far in excess of the deposit reserves and other assets they kept on hand. By 2008, the short-term debt of the nation’s 10 largest banks and investment banks stood at $2.6 trillion. Several of the investment banks owed sums 30 times the amount of capital they actually held in reserve, a situation that would have alarmed regulators in earlier eras, and did alarm various risk managers and observers both inside and outside the banks. Warnings about risky practices voiced by Madelyn Antonic and Michael Gelband at Lehman Brothers, Karen Weaver at Deutsche Bank, Mark Zandi at Moody’s, U.S. Comptroller of the Currency John C. Dugan, and others were largely ignored. By mid-decade, New York banks, hedge funds, pension funds, insurance companies, and institutional investors were entangled in every facet of a derivatives market that was fueled by a boom in home buying, driven by low interest rates and easy credit requirements.
Subprime
Underpinning this vast expansion of securitization was the work of the retail mortgage lenders, such as the California-based firm Countrywide Financial Services, which issued mortgages to home buyers and then turned over bundles of mortgages to the government-sponsored entities Fannie Mae and Freddie Mac, and increasingly to Wall Street banks, for transformation into derivatives to be sold to investors. Founded in New York City by Angelo Mozilo and David Loeb in 1968, by 2006 Countrywide was the nation’s leading private mortgage writer, responsible that year for $463 billion in mortgage originations (from which Mozilo personally earned $43 million based on fees and his holdings of Countrywide stock). Like other mortgage brokers and bankers, the Bronx-born Mozilo liked to emphasize that, by making loans available to large numbers of low-and moderate-income Americans, the booming mortgage market was democratizing access to credit. In a 2003 speech, he asserted that “expanding the American dream of homeownership must continue to be our mission, not solely for the purpose of benefiting corporate America, but more importantly, to make our country a better place.” Mozilo’s comments harmonized with the 1977 federal Community Reinvestment Act that encouraged banks to make loans and investment in poor neighborhoods. They also accorded with the agendas of President George W. Bush’s Department of Housing and Urban Development and of congressional Republicans and Democrats, who asserted that the mortgage market would equalize credit opportunities and elevate poor Americans to homeownership.6
By the mid-2000s, the ease with which borrowers could obtain mortgages reached a level unmatched in American history. Increasingly, the mortgage industry and banks turned from issuing “prime” mortgages (home loans to borrowers with high credit ratings, considered likely to make their monthly mortgage payments) to “subprime” mortgages (loans to borrowers with low credit ratings and histories of defaults or late payments). In order to generate a continuing flow of CMOs and CDOs and the fees they provided, Countrywide, some 200 other mortgage-originating firms, and Fannie Mae and Freddie Mac wrote ever-larger numbers of mortgages for home buyers with dubious or negative credit histories, many of them in poor communities across the country. By mid-decade, the major New York City commercial and investment banks were also issuing tens of billions of dollars’ worth of subprime-based CDOs. Between 2000 and 2007, firms, banks, and Fannie Mae and Freddie Mac sold about $1.8 trillion in securities backed by American subprime mortgages.
What’s a CDO?
Wall Street giants like Citigroup and Merrill Lynch were severely shaken by their losses on an arcane innovation in finance: collateralized debt obligations, or CDOs. Worldwide, there was more than $1.3 trillion invested in CDOs. Residential mortgage-backed securities, or RMBS, made up 56 percent of assets in CDOs. So the slump in housing had a huge ripple effect on these investments.
Produced by Felix Salmon, Maryanne Murray, Jeffrey Cane, Jackie Myint, and Shazna Nessa.
Copyright 2007 and 2013/Upstart Business Journal. All rights reserved. Reprinted with permission.
1. Full Flow
During a boom, mortgages pump out so much money that it fills all the buckets, including those of the CDO, which has a waterfall of its own.
• Think of mortgage payments as small trickles of water that all flow down into a much larger pipe. When a bank creates a security backed by mortgage payments, it diverts that pipe into a bucket. That bucket, or an AAA-rated tranche, is then sold to investors.
• The bucket can’t hold all the water, so the bank puts another bucket underneath, and another under that. The buckets below have lower ratings because they have a greater risk of not filling up with water (and they pay a higher yield as a result).
• A CDO can be made up of all these buckets, or tranches, as well as the tranches of other asset-backed securities.
• The CDO is constructed so that even if some of the lower buckets of the mortgage-backed security run dry, there will still be enough liquidity to fill the top-rated tranche of the CDO.
2. Partial Flow
If some borrowers start to default, then not all buckets of the mortgage-backed security will become filled.
3. Severe Dehydration
But when all the lower branches of the mortgage-backed security run dry, there’s no money left for the CDO.
• What was the mistake that banks made? They thought that the risk of a CDO was minimized by its diversity: If borrowers were defaulting in Florida, they could still count on payments from California. But during the financial crisis, different kinds of mortgages defaulted at the same time—leaving no money for even the super senior AAA tranche, which was meant to be completely safe.
To sign up borrowers, companies and banks offered a tempting array of mortgages that virtually eliminated credit requirements for applicants. By 2006, borrowers could obtain “NINA” (no income, no asset) mortgages for which they did not have to prove creditworthiness. Many borrowers signed up for adjustable-rate mortgages with Countrywide, Wall Street banks, or the Seattle-based thrift Washington Mutual, not understanding that an initially low monthly “teaser” payment rate could escalate dramatically after the first two years of the loan. In turn, the interest paid by subprime mortgage holders kept yields high for CDO owners. In New York City itself, subprime mortgages tended to be sold in poorer, predominantly minority-inhabited neighborhoods. In 2006, for example, subprime mortgages (as measured by the New York State Comptroller) constituted 55 percent, 54.3 percent, and 51.4 percent, respectively, of all mortgages issued in Brownsville/Ocean Hill in Brooklyn, Jamaica in Queens, and University Heights/Morris Heights in the Bronx. By contrast, subprimes represented only 2.9 percent, 8.4 percent, and 9.5 percent of all mortgages issued that year in the wealthier, predominantly white Upper East Side in Manhattan, Forest Hills/Rego Park in Queens, and Park Slope/Carroll Gardens in Brooklyn. Meanwhile, buyers of CMOs and CDOs derived from the millions of mortgages being issued nationwide continued to believe that securitization had eliminated risk and that swaps protected them from catastrophic loss. In fact, hundreds of billions of dollars in soon-to-be “toxic” assets had been mixed into the portfolios of banks, insurance companies, hedge funds, pension funds, Structured Investment Vehicles, and individual accounts the world over.7
Crisis
In summer 2007, crisis erupted on Wall Street. Over the preceding year, prices on the American housing market had declined for the first time in 13 years, and the rate of delinquent payments on subprime mortgages ticked sharply upward. “The most dangerous delusion today is that the banking system is the picture of health,” economist Stephanie Pomboy had warned investors in April 2006. Across the country, many subprime borrowers were finding that they could not afford to meet the monthly payment schedules on their home mortgages. Speculative buyers who had availed themselves of initially cheap “teaser” loan rates to buy and then resell houses for profit were also defaulting on their mortgages. Even holders of many prime mortgages, jolted when their adjustable payment rates shot up, found that they could not pay their debt. The booming American mortgage market was slowing down, with no end in sight. By mid-2007, 200,000 homeowners were losing their homes to foreclosure each month. If millions of borrowers could not make their monthly payments, money would not flow forth from these borrowers to owners of CMOs and CDOs, for whom such payments were investment profits they counted on to repay their own debts. The systemwide financial losses that these complex securities were supposed to eliminate were becoming a reality.8
Banks and the Labor Force
The crisis “was like watching popcorn … you didn't know where it would pop next.”
JPMorgan Chase banker
As the ratings agencies downgraded tens of billions of dollars in mortgage-backed securities, anxious pension funds and other investors retreated from CDOs, triggering a sharp fall in prices and thus jeopardizing all those who had bet large sums in the swap market against the likelihood of just such a decline. In mid-July, the Wall Street investment bank Bear Stearns disclosed that two of its subprime hedge funds had lost almost all their $1.5 billion value due to downward-trending prices and demands for payment by the funds’ creditors, JPMorgan Chase, Citigroup, and Merrill Lynch. Meanwhile, the mortgage crisis spread to Europe; in August 2007, BNP Paribas, the largest bank in France, froze investment funds holding American mortgage-backed CDOs, which convinced the European Central Bank to lend unlimited funds to European banks so that lending and borrowing could continue. The CDO, an instrument widely disseminated and popularized by Wall Street firms, was sparking a contagious global crisis.
The severity of the downturn surprised most officials and economists at the Federal Reserve Board and the Treasury Department, who had not anticipated such disturbances. Worried banks were curtailing their loans to other banks, bringing on a “liquidity crisis” that could slow down all economic activity. In response, Ben Bernanke, who had succeeded Greenspan as chairman of the Federal Reserve in 2006, repeatedly lowered interest rates to banks to stimulate lending. Timothy Geithner, president of the Federal Reserve Bank of New York and Bernanke’s agent in the city, made $38 billion in loans to banks to keep credit flowing. In March 2008, Bernanke, Geithner, and Henry Paulson, Secretary of the Treasury and the former CEO of Goldman Sachs, became convinced that the impending bankruptcy of the ailing Bear Stearns would cause further panic and might topple other banks and funds. They devised a plan through which Bear Stearns’s majority shareholders agreed to sell their stock to JPMorgan Chase, salvaging much of Bear Stearns’s business. As negotiations progressed, bankers crossed between the Bear Stearns and Morgan headquarters on opposite sides of East 47th Street for round-the-clock meetings, sending out for food and clean clothes. (John Oros of J. C. Flowers & Co., a private equity firm that also bid for Bear Stearns, later joked that “this is what Brooks Brothers lives on, investment bankers who don’t go home, just sitting in offices getting new shirts.”) On March 16, Bear Stearns ceased to exist as an independent bank.9
Meanwhile, the crisis continued and worsened. “It was like watching popcorn,” a JPMorgan Chase banker later recalled. “You didn’t know where it would pop next.” Seeking the lifeblood of credit and capital, heavily indebted banks and hedge funds were now caught between the plummeting value of their CDOs, which made them difficult and costly to sell, and the increasing hesitancy of other banks to make loans without much stiffer repayment and collateral conditions. The Bank of New York Mellon (direct descendant of Alexander Hamilton’s 1784 bank) and JPMorgan Chase, two commercial banks that provided loans on a daily basis to most Wall Street investment banks, were increasingly leery of debt- and risk-laden borrowers. The effect was a chain reaction throughout the credit system, as highly leveraged banks, fearing they would not be able to repay their own loans or secure new credit, curtailed loans to others. As Thomas Russo of Lehman Brothers commented privately in April 2008, “banks will hoard capital unless and until they can borrow the money.” A worldwide credit freeze, choking off money to businesses, workers, and consumers, and a “Great Recession,” the worst since the 1930s, was the result.10
Meltdown
By summer 2008, the risk of a worldwide financial depression seemed to hinge on the interlinked fate of several massive institutions, including leading New York City investment and commercial banks. Enmeshed in the CDO market, commercial real estate, and corporate loans, Lehman Brothers had lost nearly $3 billion in the second quarter of 2008. Citigroup had written down $40 billion of its assets over the previous year, while Merrill Lynch lost over $19 billion, or $52 million a day, between July 2007 and July 2008. Fannie Mae and Freddie Mac, the government-sponsored enterprises that bought about half of all American mortgages, now owned or guaranteed about $1 trillion in subprime and adjustable-rate loans. Mortgage defaults and foreclosures continued to rise; in August 2008, 303,879 delinquent American homeowners lost their homes, a new monthly record. Fearing the impending collapse of Fannie Mae and Freddie Mac, Paulson, backed by Congress and President Bush, organized a “bailout” of the twin enterprises in early September, agreeing to invest up to $200 billion in government money in exchange for four-fifths of their common stock and ultimately a new role for the Treasury Department as conservator of the twins’ business. The government had essentially taken over the entities that owned or backed some $11 trillion in American mortgages.
The next potential falling domino was Lehman Brothers, but Paulson, worried that another federal rescue of a Wall Street institution would encourage further reckless investment by seeming to guarantee inevitable government bailouts, refused to intervene as he had in Bear Stearns’s case. Paulson convinced President Bush that a line had to be drawn to force the banks and markets to stabilize themselves. Presidential candidates John McCain and Barack Obama and many in Congress also publicly opposed a bailout for Lehman.
The New Yorker, September 29, 2008.
Copyright © 2013 Condé Nast.
Drawing by Eric Drooker.
All rights reserved.
Originally published in The New Yorker.
Reprinted by permission.
Eric Drooker’s magazine cover captured the mood of the moment. The New York Stock Exchange on Broad Street is at left, with Wall Street in the background.
Instead, Geithner, Paulson, and Bernanke turned the Federal Reserve Bank of New York at 33 Liberty Street into a command post for the most tumultuous weekend in Wall Street’s history. “You’re not going to believe this,” JPMorgan Chase CEO Jamie Dimon told Steven Black, Co-CEO of his investment division, on the afternoon of Friday, September 12, 2008. “We’ve been invited with our closest friends to a cocktail reception at the Fed with Geithner and Paulson.” The summoned CEOs of Wall Street’s largest banks—Dimon, John Thain of Merrill Lynch, Lloyd Blankfein of Goldman Sachs, Vikram Pandit of Citigroup, Brady Dougan of Credit Suisse, Robert Kelly of Bank of New York Mellon, Robert Wolf of UBS America, John Mack of Morgan Stanley, and representatives of Deutsche Bank and the Royal Bank of Scotland—convened in a conference room five floors above the vault where the New York Fed stored 540,000 bars of gold worth $250 billion. In an echo of the Jekyll Island meeting where the founding of the Federal Reserve had been planned by New York City financiers 98 years before, the bankers dodged reporters waiting for them as they entered 33 Liberty Street. Paulson and Geithner, intimating that a Lehman bankruptcy would jeopardize the remaining banks, told them that they had to concoct a plan to save Lehman without government aid. “We’re here to facilitate,” Geithner, flanked by Paulson and Securities and Exchange Commission head Christopher Cox, told them. “You guys need to come up with a solution.”11
The CEOs broke into three groups, one to assess Lehman Brothers’ riskiest assets, another to try to hatch a plan for buying Lehman, and a “doomsday” group to come up with emergency measures if Lehman failed. Over the next several days, some 200 bankers, lawyers, and government regulators, many from Washington, crowded into the conference room and shuttled between meetings at 33 Liberty Street, Lehman Brothers headquarters near Times Square, and other Midtown and Wall Street offices. Barclays Bank came close to buying Lehman Brothers, but balked when the Federal Reserve refused to provide interim guarantees on Lehman trades. Lehman banker Michael Gelband warned Geithner’s number two, Christine Cummings, that chaos would follow a bankruptcy: “You’re unleashing the forces of evil,” he told her. But federal officials remained adamant that another bailout was impossible. On Sunday evening, September 14, Lehman bankers and employees, some of them stunned and in tears, streamed out of their headquarters at 745 Seventh Avenue between 49th and 50th Streets, carrying boxes and suitcases full of their personal belongings; the exodus of some 9,000 Lehman workers from Midtown offices would continue the following day. On Monday, September 15, Lehman Brothers, valued at $691 billion, filed for bankruptcy, the largest business to do so in American history. Markets plunged on the news, with the Dow Jones Industrial Average dropping 500 points the day following Lehman’s failure, the worst decline since the September 2001 terrorist attacks.12
The contagion now seemed to jeopardize Wall Street’s other major banks, as frightened investors and financial institutions, fearing further collapses, stopped lending to each other. Hedge fund and money market fund clients pulled accounts out of investment banks, depriving them of short-term credit, much like the panicking depositors who started “bank runs” during the 19th century and the early years of the Great Depression. Even before Lehman’s fall, mergers, so recently a strategy for bank expansion, were becoming a tactic of survival for vulnerable banks facing collapse. Paulson and Geithner encouraged stronger banks to absorb weaker banks, hoping thereby to prevent further failures and panic. Ken Lewis, CEO of the Charlotte, North Carolina-based Bank of America, flew to New York to discuss buying Merrill Lynch in a meeting with Merrill’s CEO, John Thain, on Sunday, September 14. After returning to the New York Fed a few hours later, Thain was greeted by John Mack, Morgan Stanley’s CEO, with the question, “Shouldn’t we be talking?” Morgan Stanley now began its own courting of Merrill Lynch, with Thain and Mack holding meetings in the Upper East Side apartment of a Morgan Stanley executive. “Bankers’ propositions had become as casual as those of college students,” the writer Roger Lowenstein later noted, with the 33 Liberty Street conference room serving as a marriage, or at least dating, market for banks such as Citigroup, Wachovia, Goldman Sachs, JPMorgan Chase, and others. Informed by Ken Lewis that Bank of America was close to buying Merrill Lynch, a move that might soothe the financial markets, Henry Paulson cornered Thain at the New York Fed: “John, Ken tells me you have a deal. You will do this deal!” By Sunday’s end, Bank of America had bought Merrill Lynch for about $50 billion, and the latter ceased to exist as an independent investment bank.13
Chris Hondros, Lehman Brothers files for bankruptcy protection, September 15, 2008.
Getty Images
A former Lehman Brothers employee leaves the bankrupt investment bank’s Midtown headquarters, September 15, 2008.
Simultaneously, the insurance giant AIG faced collapse due to its vast holdings in credit default swaps that came due as CDOs plunged in price. As meetings continued at 33 Liberty Street, Goldman Sachs and JPMorgan Chase bankers worked with Geithner’s staff and Eric Dinallo, New York State’s Superintendent of Insurance, to try to keep AIG from failing. They did not succeed in convincing other banks to help create a financial lifeline for AIG. But whereas Lehman Brothers had been deemed expendable, the prospect of an AIG bankruptcy raised the specter of businesses around the nation and the world, suddenly deprived of insurance, grinding to a halt. Bernanke, a scholar of the Great Depression, was becoming anxious that another large failure might bring the global economy down with it. “The federal government has decided AIG is too important, systemically, to fail,” Treasury official Dan Jester announced at 33 Liberty Street on Tuesday, September 16. In exchange for an $85 billion government loan, AIG would sign over 79.9 percent of its stock, essentially making the company a ward of the government. Accompanied by a security guard, Kathy Shannon, AIG’s corporate secretary, retrieved tens of billions of dollars in AIG stock certificates from a safe at 70 Pine Street, the company’s headquarters, and walked them over to 33 Liberty Street to put the collateral of the world’s largest insurer into the hands of the federal government.14
Largest U.S. Commercial Banks
TARP
The fate of banks changed on an unpredictable, almost day-today basis over the ensuing weeks and months. On September 21, the Federal Reserve agreed to permit the two largest remaining American investment banks, New York-based Goldman Sachs and Morgan Stanley, to become bank holding companies, allowing them to borrow from the Fed in the same way that commercial banks did. Twelve days later, on October 3, President Bush signed into law the Emergency Economic Stabilization Act of 2008, which initiated the Troubled Asset Relief Program, or TARP. Under TARP, Secretary of the Treasury Paulson could spend up to $700 billion in federal money to purchase “troubled” or “toxic” assets—mostly mortgage-backed securities—from the nation’s banks. Eventually these would be auctioned off to private investors and firms. In exchange for taking the CDOs and other securities, the Treasury would be injecting massive amounts of liquidity into banks, funds that banks would hopefully use to resume lending, restoring investor confidence and kick-starting the stalled economy.
Commercial and Industrial Loans by Foreign Branches
In 2008, the U.S. Treasury and the Federal Reserve played an emergency role unprecedented in American history in terms of the scope and size of the financial rescue effort.
But American and world stock markets continued to plunge. With European and Asian central banks taking over private banks or guaranteeing their deposits in an effort to contain the damage, top U.S. regulators resorted to a drastic plan. On October 14, in a meeting at the Treasury Department in Washington, Paulson, Bernanke, and Sheila Bair, chair of the Federal Deposit Insurance Corporation, sat down opposite the CEOs of the nation’s nine most important surviving banks—Dimon of JPMorgan Chase, Pandit of Citigroup, Blankfein of Goldman Sachs, Thain of Merrill Lynch (now a subsidiary of Bank of America), Mack of Morgan Stanley, Lewis of Bank of America, Robert Kelly of Bank of New York Mellon, Richard Kovacevich of the San Francisco-based Wells Fargo, and Ronald Logue of the Boston-based State Street Corporation. Paulson told them that the Treasury was going to guarantee their debts, permitting them to borrow money at lower interest rates since lenders knew the government was backing the banks. Paulson also told them that the Treasury was going to buy preferred stock in each bank, thereby giving the federal government part ownership of and voting rights in their banks in return for massive infusions of capital. The idea of direct government capitalization replaced the idea of buying up toxic assets, which regulators concluded would not provide banks with sufficient capital to resume lending. Banks would be encouraged and expected to buy back their preferred stock from the government once they were back on their feet.
The so-called “bailout” echoed earlier efforts by the federal government to salvage and stabilize the Wall Street financial markets. The Grant administration had sold government gold in 1869 to avert a crisis, President Herbert Hoover’s Reconstruction Finance Corporation made loans to—and bought stock in—6,000 banks in 1932, and Franklin Roosevelt’s “bank holiday” in 1933 had initiated the New Deal’s banking reforms. Later, Congress spent $105 billion to rescue ailing savings and loan institutions in the late 1980s and early 1990s. Additionally, the White House had collaborated with the banker J. P. Morgan and his Wall Street associates to stabilize markets during the panics of 1893 and 1907, but those interventions had positioned Morgan to serve as a “central bank” for the nation in the years before the Federal Reserve System was created to play that part; in essence, Wall Street had helped Washington cope with the crises, rather than vice versa. Now, in 2008, the U.S. Treasury and the Federal Reserve played an emergency role unprecedented in American history in terms of the scope and size of the financial rescue effort.
The revision of the TARP program ultimately put $418 billion in federal money into 650 banks and other corporations, including the automotive giants General Motors and Chrysler (which had been damaged by their own significant forays into consumer finance and securitization of debt). In New York, Citigroup and JPMorgan Chase each received $25 billion in initial TARP funds, Morgan Stanley and Goldman Sachs each got $10 billion, AIG got $40 billion, and Bank of New York Mellon got $3 billion—all told, more than a quarter of the total TARP expenditures. Within a year, these infusions had restored the banks and credit markets to stability: with TARP money in hand, banks now resumed lending, at lower (and more affordable) interest rates, to other banks and corporations.
At Work
Government intervention, however, did not end there. Fearing that Citigroup might fail and that another bankruptcy on the scale of Lehman Brothers would be disastrous, in late 2008 and 2009 the U.S. Treasury provided an additional $20 billion in aid to Citigroup and guaranteed $306 billion of its loans and securities. In return the government obtained substantial control of the bank, which lasted until 2010 when the government sold its remaining Citigroup stock. In total, Merrill Lynch, Citigroup, and Morgan Stanley each received almost $2 trillion in emergency government aid during the crisis, while Bear Stearns received just under $1 trillion in loans and Goldman Sachs more than $500 billion. These loans, which were disclosed in late 2010, dwarfed the TARP expenditures.
Responding to the Great Recession
Allan Tannenbaum, Occupy Wall Street demonstration, New York City, 2011.
Allan Tannenbaum
Occupy Wall Street (OWS) emerged as a decentralized protest movement in late 2011 in the wake of the world banking crisis, inspiring devotion and frustration in equal measure. The idea for Occupy Wall Street was first proposed by the Canadian activist firm Adbusters, which had suggested a march on Wall Street against corruption, economic inequality, and corporate irresponsibility. On September 17, 2011, a group of several thousand carried out this demonstration and then filled Zuccotti Park, a privately owned plaza two blocks from Wall Street. Since the rules of the park stipulated that it be open 24 hours a day, the New York Police Department could not remove protesters as they could from city-owned property. The occupation was on.
Over the following weeks, several thousand demonstrators made their way to Zuccotti Park to take part in Occupy Wall Street (OWS), along with thousands of curious bystanders, sympathizers, opponents, journalists, and celebrities who visited for varying lengths of time. Occupiers included socialists, anarchists, libertarians, and others, often united only by their shared antipathy to what they perceived as corporate greed, vast and growing inequalities in wealth and opportunity, and government collusion in rescuing large banks at taxpayer expense. Lacking any preconceived hierarchical leadership, OWS evolved a system of governance called the General Assembly that sought to use direct democracy to achieve a consensus on day-to-day and strategic concerns. Facilitators used hand signals and the “people’s mike,” a system in which listeners repeated a speaker’s words, to coordinate the crowd camped out in the park. Activities included repeated protest marches down Wall Street to the site of the New York Stock Exchange and bank offices, a march over the Brooklyn Bridge in which more than 700 people were arrested, and an attempted takeover of Times Square. An internal group calling themselves the “Anarchive” documented the events as they unfolded. Meanwhile, “Occupy” movements were started in other cities, inspired by news coverage and publicity about OWS activities.
John Minchillo, Occupy Wall Street demonstration, October 15, 2011.
Associated Press
The specific demands of Occupy Wall Street were diverse, sometimes vague, and often sweeping in their insistence on dramatic change. Some demanded that the Glass-Steagall Act be restored, while others called for the abolition of the Federal Reserve. The placards that members carried suggested the sometimes contradictory range of their concerns: “Hey Banksters, I Want My Kids’ Future Back,” “Jesus Was a Marxist,” “Resurrect the Middle Class—It Just Takes Empathy,” “No Job Yet—All I Have Is Student Debt,” “Democracy (99) Vs. Aristocracy (1),” “Lobbying Is Institutionalized Bribery,” “Democracy Is Hard, But at Least We Are Doing It,” and hundreds more.
Ultimately, the New York police, supported by Mayor Michael Bloomberg, forcibly evicted OWS from Zuccotti Park on November 15, 2011, on the grounds that the occupiers were disrupting traffic and business. Although the movement has continued to exist, it is even more diffuse and ideologically fragmented than during the months when Zuccotti Park was its focal point. Perhaps its most lasting remnant is the notion, embraced by some and denied by others, that “99 percent” of the people have been exploited by a small, very wealthy, and privileged minority based in the nation’s financial sector—an idea with a long heritage in American politics, with New York banks repeatedly a principal target. Sometimes consciously and sometimes not, occupiers invoked grievances that had mobilized earlier generations of Populists, progressives, and other insurgents troubled by the purportedly unaccountable concentration of wealth and power in the hands of New York’s bankers.
—Daniel London + Steven H. Jaffe
Paulson and Bernanke … presided over an expansion of government’s role in banking not seen since the New Deal.
By February 2009, when President Barack Obama signed a “stimulus bill,” the American Recovery and Reinvestment Act, to pump $787 billion in government money and tax cuts into the weakened economy, Wall Street, and Washington’s presence in its affairs, had been transformed in ways hard to imagine only a few months earlier. Lehman Brothers no longer existed, while Bear Stearns and Merrill Lynch had been absorbed by other banks. Morgan Stanley and Goldman Sachs were now under the purview of the Federal Reserve, not the Securities and Exchange Commission. The government now directly managed Fannie Mae and Freddie Mac and was part owner of the nation’s banks. Believing that banks and other financial institutions were now irrevocably intertwined, Bernanke’s Federal Reserve had rewritten rules, allowing investment banks as well as commercial banks to borrow directly from the Fed to try to restore liquidity and calm the credit markets. Bernanke had also invoked policies dating to the Hoover and Roosevelt administrations of the depression era to enable airlines, industrial companies, and other retailers to bypass the banks completely and borrow short-term credit from the Fed. The Fed bought billions of dollars in mortgages, credit card debt, and student loans to offset the credit freeze among banks.
To be sure, this was not a one-sided government takeover: the mutual interdependence of Wall Street and Washington continued. In his first seven months as Obama’s Secretary of the Treasury, for example, Timothy Geithner conferred with the heads of JPMorgan Chase, Goldman Sachs, and Citigroup a total of 80 times. But the quarter-century-long era of deregulation was over. Ironically, Paulson and Bernanke, two moderate conservatives who believed in the primacy of free markets, had presided over an expansion of government’s role in banking not seen since the New Deal, one that utterly surpassed it in terms of the sheer volume of federal money and guarantees pumped into the financial sector.
The Great Recession
Although banks, once they were freed from the troubled assets, began repaying their TARP funds with interest to the government ($405 billion, about 97 percent of the TARP investment, not adjusted for inflation, was repaid by December 2012), the idea that taxpayers had bailed out wealthy banks rankled many Americans, especially in light of the damage done. The National Bureau of Economic Research would later declare that the American recession had begun in December 2007 and ended in mid-2009. But the jobless rate, which had stood at 4.4 percent in May 2007, did not peak at 10 percent until October 2009 and remained above 8 percent until September 2012, when it dipped to 7.8 percent. Unemployment remained high despite Obama’s stimulus bill and Bernanke’s efforts to encourage lending through Federal Reserve rate cuts and massive purchases of government bonds that injected money into banks. The American economy lost some 8 million jobs due to the crisis. These were the worst American employment figures since the Great Depression. By October 2009, the total wealth of Americans had declined from $64 trillion to $51 trillion since the start of the meltdown.
New York City’s local economy also suffered. Between August 2008 and August 2009, the city lost about 100,000 private sector jobs, and the city’s unemployment rate stood at 9.5 percent at the latter date. Retail sales had fallen by 8 to 10 percent over the year; the office vacancy rate in Midtown Manhattan had hit a 12-year high of over 12 percent, double what it had been a year earlier; and residential sales in the city had declined by 50 percent. In a reflection of the mortgage-based nature of the crisis, the rate of foreclosure filings per 1,000 households in the city rose from 5.3 to 6.9 between 2006 and 2009 (the change in the national rate was from 5.8 to 22); the foreclosure rate per 1,000 homeowners in the city rose over the same years from 15.8 to 20.9 (only about one-third of all New York City residents own their homes rather than renting). In all, 22,886 foreclosures were filed on mortgages in New York City in 2009. Tellingly, in the 10 New York City neighborhoods with the highest foreclosure filing rates in 2009 (all of them predominantly African American or Latino neighborhoods in the Bronx, Brooklyn, and Queens) between 37.3 percent and 55 percent of all mortgages issued in 2006 were at subprime rates. By comparison, the 10 neighborhoods with the lowest foreclosure filing rates in 2009 had subprime mortgage rates between only 2.9 percent (the Upper East Side) and 19.9 percent (Astoria, Queens), of all mortgages issued in 2006.
Protest sign from Occupy Wall Street, 2011.
Occupy Wall Street Archives
This placard, carried by a Washington Heights resident during the Occupy Wall Street protest, demanded reforms including a return to the 1933 Glass-Steagall separation of commercial and investment banks.
The lingering downturn aggravated resentment over the growing disparity between financial sector income and that of the rest of the population, especially when banks and investment firms granted sizeable bonuses and exit packages to executives who arguably had helped produce the crisis in which their banks lost at least $100 billion on CDOs. For example, as the underlying problems simmered in 2006, The New York Times later revealed, some 50 Goldman Sachs employees each earned at least $20 million, while 100 traders and bankers at Merrill Lynch split $500 million in bonuses. As the crisis intensified in late 2007, several bank boards fired their CEOs, but Merrill Lynch’s Stanley O’Neal was terminated with a settlement package of $161 million, and Chuck Prince left Citigroup with $80 million. In firing Joseph Cassano, AIG granted him a $34 million bonus on top of the $280 million he had earned over the previous eight years. While TARP provisions temporarily regulated executive compensation for banks and firms receiving government money, Wall Street seemed unchastened by the meltdown: in 2009, New York financial firms awarded over $20 billion in bonuses to their traders, brokers, and bankers. Conversely, by late 2010, average American family incomes stood below levels reached over a decade earlier.
Angry critics, activists, and ordinary people blamed the crisis on varying causes. Numerous liberals and leftists attributed the meltdown to a deregulated finance capitalism that they saw as rewarding the purveyors of incomprehensible securities while inflicting economic hardship on the other “99 percent” of the population. Some conservatives and libertarians blamed the government’s housing agenda, pointing to the Community Reinvestment Act and other federal policies that they charged promoted the rise of subprime mortgages and mortgage-backed securities. Some on both the right and the left agreed that the government had created “moral hazard,” encouraging bankers, traders, and investors to believe that banks were “too big to fail” and Washington would always rescue large financiers (despite the exceptional example of Lehman Brothers), thereby freeing them to bring on crises by gambling recklessly. Echoing century-old Populist concerns about the ability of big bankers to reap rewards even in the face of widespread hardship, Congresswoman Deborah Pryce, an Ohio Republican, wanted Paulson to explain how TARP “is not a bailout of Wall Street executives and their golden parachutes.”15
The inconsistent, piecemeal nature of the bailouts also came in for criticism. Why, for example, had Lehman Brothers been sacrificed while comparable banks had been saved? Why were Bear Stearns and AIG creditors rescued but owners of Fannie Mae common stock expected to bear big losses? On editorial pages, news shows, and talk radio, in political meetings and popular demonstrations, Americans debated an array of suggested responses to the crisis, including caps on executive pay, new capital reserve requirements to keep commercial and investment banks from borrowing too much, and reforms to prevent ratings agencies from awarding high grades to “toxic” securities. In a sign of changed times, Alan Greenspan suggested in 2009 that breaking up big banks would be wise, and Sandy Weill mused in 2012 that the Glass-Steagall separation of commercial and investment banking should be restored.
Top Ten Financial Centers
Global Financial Centres Index QI 2012
Source: Z/Yen Group
Since 2007, the London-based Y/Zen Group has published the Global Financial Centres Index, which examines and ranks the major financial centers worldwide in terms of competitiveness. The results are drawn from external indices and responses to an online questionnaire.
1 Johannes Mann,
Aerial view of Swiss
Re in London.
© Johannes Mann/Corbis
2 Caroline Purser,
New York City
skyline.
Getty Images
3 Wilfred Y. Wong,
Central and Victoria
Harbour, Hong Kong.
Getty Images
4 David Joyner,
Singapore skyline.
Getty Images
5 City Skyline,
Shinjuku District,
Tokyo.
© Radius Images/Corbis
6 Allan Baxter,
Skyline of Zurich
and Limmat River.
Getty Images
7 David Joyner,
Chicago skyline.
Getty Images
8 Tom Bonaventure,
Sunny Panorama of the Pudong skyline.
Getty Images
9 Sungjin Kim,
Cityscape of Seoul with bridge.
Getty Images
10 David Joyner,
Toronto skyline.
Getty Images
The ongoing economic downturn helped to spark the Tea Party movement on the right in 2010 and the Occupy Wall Street movement on the left in 2011. In Washington, the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in July 2010 promised a broad and detailed reform of the American banking system, including implementation of the Volcker Rule (named for its proponent, former Federal Reserve Chairman Paul Volcker) prohibiting banks from engaging in certain types of speculative investment of no benefit to their customers. Whereas the Glass-Steagall law of 1933, however, had produced a relatively simple and straightforward separation of commercial and investment banking, Dodd-Frank, a 2,300-page document, required a protracted and complex process of deliberation by lawmakers and agency functionaries, while bank lobbyists also sought to shape the provisions. Meanwhile, the rules known as Basel III, drafted by the Basel Committee on Banking Supervision, a Swiss-based international regulatory body, were written to go into effect before the year 2020. To be enforced by the Federal Reserve, Basel III was designed to put in place capital reserve and risk management requirements in an effort to prevent a repeat of the high bank debt and liquidity crisis that helped to bring about the global meltdown of 2007-2008. The full impact of these regulations on Wall Street operations remains to be seen. As Americans ponder the implications of deregulation and re-regulation, New York City remains the principal stage for the nation’s financial dramas, its banks the most conspicuous targets in arguments over the morality, politics, and proper role of concentrated credit and capital.
The Global Future
If, despite traumas and changes, New York City endured as the nation’s financial headquarters, its identity as the world’s banking hub, a role it had played for decades, faced serious challenges in the new century. In the early 2000s, even before the meltdown, the city seemed to be losing out to global financial centers like Hong Kong, Singapore, and London. Press stories pointed to startling statistics: in 2007, less than 15 percent of the world’s new initial public offerings of stock shares were brought to market on one of the New York exchanges. As recently as the 1990s, that figure had topped 74 percent. And even though today most of the world’s biggest banks are located in Europe (the largest American bank, JPMorgan Chase, was number nine on that list in 2012), by 2050 the emerging economies of the developing world are expected to overtake the industrialized nations.
New York City’s identity as the world's banking hub … faced serious challenges in the new century.
Post meltdown statistics suggested a mixed picture in which New York’s surviving commercial and investment banks remained central players in national and global finance, yet had plenty of company. In 2009, the four largest American commercial banks—Bank of America, Citigroup, JPMorgan Chase, and Wells Fargo—between them accounted for almost 40 percent of deposits and two-thirds of all credit cards in the country. Citigroup was New York City-based, the commercial division of the New York-based JPMorgan Chase was located in Chicago, and Bank of America remained headquartered in North Carolina and Wells Fargo in California. In worldwide investment banking, Wall Street still dominated in fee income (the revenues banks accrued by charging various fees to account holders, as opposed to revenues from interest on loans): in 2012, the top five earners (in descending order, JPMorgan Chase, Goldman Sachs, Morgan Stanley, Citigroup, and the Merrill Lynch division of Bank of America) were all based in New York. Their aggregate fee income that year totaled over $17.5 billion, while the combined fee income of the next six high-earning banks (all of them German, Swiss, British, or Canadian) amounted to $11.4 billion. Another set of numbers from 2012, however, told a somewhat different story. The list of the world’s 10 biggest banks measured by their assets included only one New York-based institution, JPMorgan Chase at number nine, with over $2.3 trillion in assets; by contrast, the largest bank, the Industrial and Commercial Bank of China, held over $2.7 trillion, and the other eight banks were all European or Asian. In sum, Beijing, London, Zurich, Geneva, Frankfurt, Tokyo, Paris, and other world cities were giving New York a run for its money.
In 2010, the historian Youssef Cassis argued that New York remained the world’s leading financial center, reflecting its traditional role as the money capital of the United States; London was nipping at Gotham’s heels through its dominant position in international business; and Tokyo remained Asia’s leading financial city. After these top three, six other cities—Frankfurt, Paris, Zurich, Geneva, Singapore, and Hong Kong—continued to flex their financial muscles. Another study by the Z/Yen Group, meanwhile, concluded that London was already pulling ahead of New York as a center of global financial competitiveness. In the future, the ongoing rise of China and other Asian economies and the impact of Basel III in reconfiguring the assets and income of banks globally may well continue to reshape New York’s position in the banking hierarchy. Although banking and finance today are conducted in ways that often make physical location seem trivial, the economic, social, and cultural impact of banks on their home cities, and the ways cities shape the banks within their boundaries, guarantee that New York’s role as a banking metropolis will continue to influence its identity.
Caroline Purser, New York City skyline, September 12, 2011.
Getty Images
It is impossible to foresee what the next century will bring to New York City as a capital of capital. For banks, the United States has the advantage of being a stable capitalist nation, and New York continues to be one of the world’s most desirable addresses. But history shows that the future will most likely be shaped by how profit and risk are balanced, and how accountable the financial system is for its own actions. Ultimately, the question asked today is the same one raised in the 1790s, the 1830s, the 1890s, the 1910s, and the 1930s: how can the city and the nation balance their own needs with those of a banking system that they cannot afford to be without?
Endnotes
1 “With this bill”: “Clinton Signs Legislation Overhauling Banking Laws,” The New York Times, November 13, 1999, A1.
2 “You get Sandy”: Amey Stone and Mike Brewster, King of Capital: Sandy Weill and the Making of Citigroup (New York: Wiley, 2002), 256; “behemoths that will,” “We have done”: Ibid., A1; “we will look”: Stephen Labaton, “Congress Passes Wide-Ranging Bill Easing Bank Laws,” The New York Times, November 5, 1999, A1; “The future of”: 145 Cong. Rec. 28,326 (Nov. 4, 1999) (statement of Sen. Schumer).
3 “Regulation is not”: Roger Lowenstein, The End of Wall Street (New York: Penguin, 2011), 262.
4 “When the bankers”: Jeff Madrick, Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present (New York: Vintage, 2011), 377; “Beware of geeks”: Richard Dooling, “The Rise of the Machines,” The New York Times, October 12, 2008, WK12.
5 “shadow banking system”: Lowenstein, The End of Wall Street, 57.
6 “expanding the American”: Ibid., 17–18.
8 “The most dangerous”: Ibid., 65.
9 “liquidity crisis,” “this is what”: Ibid., 97, 127n.
10 “It was like,” “banks will hoard”: Ibid., 98, 135.
11 “You’re not going,” “We’re here to”: Ibid., 179.
12 “You’re unleashing the”: Ibid., 199.
13 “Shouldn’t we be,” “Bankers’ propositions had,” “John, Ken tells”: Ibid., 187, 193.
14 “The federal government”: Ibid., 210.
15 “moral hazard”: Ibid., 142, 176, 291; Madrick, Age of Greed, 402–403; “is not a bailout”: Ibid., 243.
