Jan. 14, 2010 -- No one expected decades of financial system dysfunction to be remedied overnight. But more than one year after Wall Street missteps sparked chaos and sent the nation spiraling into turmoil, real reform efforts are, at best, limping along, leaving a range of critics impatient – and some of them aghast.
"It's gotten worse," said Simon Johnson, an MIT economics professor who several months ago told Congress that the risks still being taken on Wall Street imperiled taxpayers seriously enough to warrant a government bust-up of "too big to fail" institutions.
Johnson told ABC News.com that the government's failure to adopt any meaningful structural changes or step up policing on Wall Street has resulted in business as usual and created a more precarious economic situation today than when the financial meltdown began in September of 2008.
"The big banks have gotten bigger," Johnson said. "Their problems are getting more dangerous over time."
With the Financial Crisis Inquiry Commission, a bipartisan panel appointed by Congress, grilling key players from Washington today on what caused the financial crisis, ABCNews.com decided to examine some of the root problems to see which ones continue to fester largely unaddressed.
For all of the attention given to the need to reform Wall Street compensation practices, the issue is far from resolved. By month's end, the largest Wall Street banks will have handed out more than $100 billion in year-end "incentive pay," or bonuses. Goldman Sachs alone is expected to pay out more than $20 billion.
The Obama administration appears to be mulling a new form of bank tax and did appoint a special paymaster to regulate the pay practices of bailed-out firms. But the bulk of Wall Street banks are out from under the TARP, and as such are free to dole out pay packages that many critics believe lead to excessive risk taking, with taxpayers ultimately footing the bill.
"Insanity is doing the same thing over and over and expecting a different result," said Nell Minow, cofounder of the Corporate Library. "It seems to me insane to continue with compensation structures that are completely out of line with risk management."
Even billionaire Bill Gates has weighed in on the issue, telling an audience at New York's 92nd Street Y a few months ago that "Wall Street pay is often too high."
In Europe, particularly in the U.K., authorities have taken pointed action, levying stringent taxes on financial bonuses. Here in the U.S., pay reform has been talked about, with the Federal Reserve Board, Department of Treasury and the Federal Deposit Insurance Corporation all bandying ideas about. However, the issue has largely been left to the banks themselves to address.
Indeed, some policies have been adopted by the industry itself to discourage excessive risk-taking with respect to pay, stressed Scott Talbot, senior vice president for government affairs at the Financial Services Roundtable, an industry lobby group.
"You see compensation practices focusing the employee on the long-term, greater use of claw-backs and deferrals, longer vesting schedules for stock options and greater use of stock – those four techniques are essential," he said. "Every institution is using one or some combination of them to eliminate excessive risk-taking."
'Where Are the Cops?'
One of the most glaring holes in the regulatory system has been the startling ineffectiveness of the Securities and Exchange Commission. From its failure to spot Bernard Madoff's Ponzi scheme to its role as enabler of the financial industry's leverage overdose, the SEC has taken its share of lumps in the past year. Yet it remains essentially the same woefully understaffed, some say toothless, agency that failed to curb much, if any, wrongdoing on Wall Street. Some $20 million in extra funds were earmarked for the SEC for its 2010 budget, and its new chairwoman, Mary Schapiro, has vowed to increase enforcement staff. She did bring on a new enforcement chief, former federal prosecutor Robert Khuzami.
Still, MIT's Johnson pointed out, Washington has not succeeded in stepping up its enforcement effort which was supposed to involve some new, tougher, more comprehensive regulatory body.
"Where's the new cop on the beat?" he asked. "I don't see a new cop."
Meanwhile, the SEC has been one of the agencies implicated in "turf wars" between regulators that have been blamed for slowing down the reform process. At one point in late July, Treasury Secretary Tim Geithner became so frustrated that he called the heads of other agencies to a meeting to tell them to fight less over regulatory turf and focus more on getting reform measures passed.
"It was a s**t-storm," one source familiar with the meeting said at the time, while a Treasury spokesman acknowledged that the meeting was planned so Geithner could deliver a "tough message" to fellow agency heads.
Although the Justice Department did this past November create a special task force for financial fraud and empowered it with an array of new prosecutorial powers, most Americans are still wondering when someone other than Bernie Madoff is going to be put away. The only two financial crisis era defendants that were brought to trial, a pair of Bear Stearns Asset Management portfolio managers, were recently acquitted. A current probe into insider trading seems to be escalating which could have a chilling effect on dubious behavior in general.
Bank Risk: Rampant, Unchecked
In several past speeches, Federal Reserve Chairman Ben Bernanke has talked about tougher capital requirements for big banks, while the Senate Committee on Banking, Housing, and Urban Affairs, as part of its proposed financial reform legislation, specifically introduced a measure aimed at preventing excessively large or complex financial companies from bringing down the economy.
But this past year, a number of Wall Street firms, most notoriously Goldman Sachs, actually upped risk. Goldman did bolster its balance sheet and took steps to drastically reduce leverage. However, the firm still borrows around 14 times its equity base to undertake its various trading strategies and during any given overnight period might be tapping short-term swap transaction markets for tens of billions to fund activities while its awaits billions coming in from other counterparties.
The counterparties are themselves are reliant on others in a potentially hazardous daisy chain daisy that didn't register much, if any attention, among average Americans, until, that is, the AIG debacle. The fact that Goldman and other big banks continue to engage in what some critics see as hedge fund style proprietary trading is cause for alarm and some form of action.
Former Fed Chairman Paul Volker testified on Capitol Hill last year, saying that: "As a general matter, I would exclude from commercial banking institutions, which are potential beneficiaries of official [i.e., taxpayer] financial support, certain risky activities entirely suitable for our capital markets. Ownership or sponsorship of hedge funds and private equity funds should be among those prohibited activities. So should in my view a heavy volume of proprietary trading with its inherent risks."
"I'm not sure the government can do anything to end 'too big to fail' even if it wanted to," pointed out Stanford Law School professor Joseph Grundfest, who is a widely recognized expert in securities industry law. "This is a problem that could be literally too big to fix."
'Financial Weapons' Still Widespread
Warren Buffet called derivatives "financial weapons of mass destruction" and lawmakers have vowed to put in place better checks to safeguard against systemic blowups tied to such instruments as Mortgage Backed Securities, Collateralized Debt Obligations and Credit Default Swaps that collectively helped bring the industry to the brink of the abyss.
Goldman Sachs CEO Lloyd Blankfein took heat Wednesday from Phil Angelides, the commissioner of the Financial Crisis Inquiry Commission, for his firm's practices of creating mortgage-backed securities, selling them and then effectively betting against them by engaging in short sales.
"It sounds to me a little bit like selling a car with faulty brakes and then buying an insurance policy on the buyer of those cars," Angelides said. "It doesn't seem to me that that's a practice that inspires confidence in the markets."
Blankfein responded by staunchly and repeatedly pointing to the bank's role as market maker, which, he insisted, inherently involves taking both sides of many trades and hedging those bets.
The Senate and the House want to increase the transparency of derivatives dealing, a mainstay of Wall Street banks, but no one expects much in the way of true reform. Bank lobbyists reportedly were able to effectively get the government to back down on efforts to better regulate certain types of derivatives, according to a recent Wall Street Journal report.
But a spokeswoman for outgoing Senate Banking Chairman Chris Dodd, D-Conn., disputed the report as uninformed, lobbyist propaganda. With the outstanding notional value of derivatives heading toward the mind-boggling quadrillion-dollar mark, if even a segment of the industry were to be more tightly regulated it would be a step in the right direction, said Moshe Silver, a veteran Wall Street compliance officer who writes a blog on compliance and regulatory issues for Hedgeye Risk Management.
"Getting some traction on the ability to regulate half of the derivatives industry might be more than the government even had the right to hope for," Silver said.
Ratings Still for Sale
When the credit crisis first began to manifest itself in 2007 with the collapse of asset-backed instruments, including those subprime debt laden financial piñatas otherwise known as CDOs, a standard industry practice was exposed a la the naked emperor: Wall Street firms were paying rating agencies in exchange for what amounted to Good Housekeeping seals of approval for the often-toxic securities the banks concocted. In some cases, bankers shopped among the three main rating agencies, Standard & Poor's, Moody's Investors Services and Fitch Ratings, trying to secure the highest possible rating.
Spokespersons at all three firms took issue with the notion that any wrongdoing took place with respect to alleged conflicts, and all of them insist that there have been significant changes to their own various proprietary modeling processes through which securities are analyzed for credit worthiness and ratings determined. The SEC, meanwhile, is now taking steps to eliminate certain requirements for ratings in the first place, presumably to rub some of the shine off their veneer of importance.
Many on Capitol Hill have cried out for rating agency reforms and a slew of institutional investor lawsuits have been filed alleging outright collusion between creators of sketchy securities and the ratings providers. Yet, as of now, the practice of Wall Street paying for ratings continues.
Stanford's Grundfest said a straightforward fix exists, and it could be adopted quickly. He advocates the creation of new industry-owned rating agencies to compete with the Big Three, so as to force investors to "eat their own cooking." In other words, create more incentives for real due diligence, he said.
Cheap Money Abounds
Despite being named Time magazine's "Person of the Year," Fed Chairman Ben Bernanke is hardly admired by everyone. A growing chorus of voices, even on Wall Street, is questioning the Fed's monetary policy. Rock-bottom interest rates may have staved off an economic depression, but continuously flooding the globe with cheap money is viewed as one of the root causes of the great financial bubble in the first place.
Said Hedgeye Risk Management's Silver: "There's a growing consensus that Chairman Bernanke is playing a risky game, keeping rates effectively at zero. When you look at figures that show the Fed being the world's second-largest buyer of treasuries it makes us look like a drug dealer who is his own largest customer. It's hard to see how this doesn't end very badly."
Financial regulatory reform, which includes numerous measures, has stalled on Capitol Hill. After the Obama administration unveiled an ambitious plan last summer, the House of Representatives – led by House Financial Services Committee Chairman Barney Frank – passed its measure in the fall. But the Senate has yet to get its proposal out of the Banking Committee. With health care reform still taking center stage, it could be months before any meaningful financial reform measures are passed, if not until next year.
As Geithner himself has noted on numerous occasions, including at a House Financial Services Committee hearing in September: "Time is the enemy of reform."
There are many adages concerning time. It slows for no man. You can't turn back its hands. Concerning problems that nearly wrecked the entire financial system and could again, time, most of all, is of the essence.
With reports from ABC News' Alice Gomstyn.