September 15, 2008 — it was a Monday — is a date deeply etched in financial history. Stock in the insurance giant AIG slumped on fears that it couldn’t raise cash to cover losses on its mortgage-related debt. Bank of America said it would buy Merrill Lynch in what was seen as a shotgun marriage. But the seminal event of the day was the 158-year-old investment bank Lehman Brothers filing for bankruptcy protection after trying to finance too many risky assets with too little capital. That was the symbolic moment when a meltdown in America’s sub-prime mortgage market and the securitized products derived from those mortgages became the 2008 global financial crisis.
That crisis laid bare the vulnerability of the U.S. financial system on a scale not seen in generations. It triggered the worst recession since the Great Depression, and its effects were felt worldwide. It exposed, as the U.S. Treasury has noted, fragmented and antiquated regulations that allowed a large swather of America’s economy — its financial services industry — to operate with little or no oversight. It shined a harsh spotlight on the high-risk, high-reward culture of the financial sector, and the extent of the deep divide between the interests of Wall Street and Main Street that had been 30 years in the making as a result of globalization and deregulation.
Five years on, the system is far from fully healed. Time is often the main cure for debt problems. So deep were those of 2007-08 (U.S. households alone lost some $20 trillion of net worth in over those two years), that the time needed is commensurately long. A painstakingly slow recovery was almost inevitable.
In the meantime, U.S. banks, or at least those that were bailed out and survived, have been more or less made whole. They are better capitalized than they were, mostly less leveraged, and less dependent on short-term wholesale funding, though at nearly 40% that is still elevated. The housing market slump has bottomed out. Home prices, in places, are recovering. The 9 million jobs lost on Main Street as a result of the crisis are being replaced more slowly, and mostly at lower wages and with fewer benefits, cementing effects on middle-class standards of living that will be felt for years. The broad measure of unemployment in the U.S. is still a third higher than it was at the height of the recession that followed the collapse of the dotcom bubble at the beginning of the century.
Financial-markets reform has been sweeping in theory but not in practice. The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act has written into law some front-end consumer protections. It has brought financial institutions under (or under greater) federal regulatory oversight. There remains, though, a largely unregulated $60-trillion shadow banking industry. In the now more tightly regulated formal banking sector, Dodd-Frank’s impact has been whittled away by the financial-services lobby carving out an extension here, delaying some rule-making there, and by resource constraints on and turf squabbles between the putative regulatory agencies.
Dodd-Frank became law three years ago, and the rules and regulations for 60% of its nearly 400 provisions have still not been made final. Even a simple law like the proposed Volcker Rule to separate banks’ investment banking, private equity and proprietary trading businesses from their consumer deposit-taking and lending operations remains unwritten.
The appetite for regulation, reflecting the popular resentment against banks in the immediate aftermath of the 2008 crisis, has waned. The debate over how to hold senior bankers to account for failures is far from over in Europe, but in the U.S. it is increasingly confined to policymakers and technocrats. Legal sanctions for top executives remain a largely remote threat. Similarly with the international coordination of financial-markets reform. Readily embraced by international leaders staring down both barrels of a global recession five years ago, that, too, has lessened with the passing of time (and as national interests regain their sway over domestic politicians).
The opportunity for structural reforms to promote financial stability and greater macroprudential regulation has passed — and was imperfectly taken. Worse still, the culture of the financial-services industry has remained immune to change. Few enter a career on Wall Street for its higher social purpose. Most want to be wealthy — a perfectly legitimate and, for most, fulfilling ambition, and one financial services are a better route to achieving that than most other careers. Success demands brains, contacts, drive, the competitiveness of a professional athlete and the constitution of an ox to handle the long hours.
The higher the stakes you can play for, the more you can make. But it is a hard-charging Darwinian world. That encourages a culture of risk-taking at firms across the industry, attracts those with a propensity to be risk-takers, and provides them with incentives biased toward returns rather than towards considering the risks involved in attaining them. At some point in every cycle, risk-taking gets pushed to the point of recklessness. In the 2008 financial crisis it reached the point of systemic risk. Good judgement may have flown out of the window but at what point, if any, does bad judgement become culpable? When does reckless misconduct in the management of a bank become a crime, as the U.K. is proposing to make it?
The U.S. Securities and Exchange Commission has charged more than 150 firms and individuals in relation to the financial crisis. Yet no top executive at any large Wall Street firm or commercial bank has to date been convicted of a criminal charge relating to the 2008 crisis, even if out-of-court settlements for mortgage mis-selling have been plentiful. One of the reasons successful criminal prosecutions are rare after any financial crash is the difficulty of pinning blame on a single individual for risks and decisions taken throughout a firm. And the bigger the organization, the harder that becomes — as the big banks, now bigger than ever, well know.
Since 2008, big banks have become more cautious and improved their governance, even if that is a matter of degree on both scores. They have sought to improve their risk management, though with the purpose of better understanding their risks, not necessarily of cutting them back. The tenacity with which they have fought to continue to be free to trade on their own account with other people’s money underscores how important they see that being to their ability to make money.
The learned behavior of the 2008 crisis is twofold: that penalties for reckless risk taking will be written off as a cost of business unless they materially offset the potential reward; and even if the recklessness is large enough to put the financial system at risk, Wall Street is too important to the economy not to be bailed out regardless of the cost to Main Street. If that was implicitly true of Wall Street’s culture before September 15, 2008, it remains just as true on September 15, 2013.