Wall Street Back to Business as Obama's Regulatory Overhaul Loses Momentum

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It was more than a year ago – Sept. 14, 2008 – that Lehman Bros. Holding Co. (OTC: LEHMQ) finally collapsed under the weight of its own bad investments.

But since then, little progress has been made on financial regulatory reform, and many of the large investment banks that received billions of dollars in government bailouts are booking huge profits on the same risky wagers they were making before the financial crisis.

In fact, the five biggest banks in the country – Goldman Sachs Group Inc. (NYSE: GS), JPMorgan Chase & Co. (NYSE: JPM), Citigroup Inc. (NYSE: C), Wells Fargo Corp. (NYSE: WFC), and Bank of America Corp. (NYSE: BAC) – posted second quarter profits totaling $13 billion.

That's more than double what they made in the second quarter of 2008 and almost two-thirds as much as the $20.7 billion they earned in the second quarter of 2007, when the economy was still strong, CNBC reported.

Goldman Sachs reported record earnings in the second quarter. As was the case before the financial meltdown, Goldman leaned heavily on its trading desk for revenue. Trading revenue accounted for 50% of the firm's total revenue. At $6.8 billion, trading revenue was up 186% from the second quarter of 2008.

The bank also saw a massive bump in equity trading where revenue jumped to $2.2 billion – a 110% quarterly increase.

The story was much the same at JPMorgan whose investment-banking operations generated $1.47 billion of profit, almost quadruple the amount earned in last year's second quarter.

Investment-banking fees – which zoomed 29% from a year ago and 62% from the first quarter – totaled $2.2 billion, and were a "record for any investment bank in any quarter," according to JPMorgan Chief Financial Officer Michael J. Cavanagh.

Citigroup and Bank of America- which received some $45 billion in government bailout funds – also topped profit estimates in the second quarter.

Of course, it's not the fact that Wall Street has returned to profitability that's raised the hackles of analysts, it's that Wall Street firms are turning huge profits by employing much of the same risky behavior that led to Lehman's undoing.

"We're seeing the same kind of behavior from the banks, and that could lead to some huge and scary parallels," Simon Johnson, former chief economist with the International Monetary Fund, told CNBC.

For instance, banks are still making bets that put far more money at stake than they have on hand to cover potential losses. The five biggest banks average potential losses from a single day of trading topped $1 billion in the second quarter, up 76% from two years ago, according to regulatory filings.

Even more disconcerting is that banks are still packaging risky mortgages into securities and selling them as investments, which is precisely the behavior that helped inflate the real estate bubble and lead to the financial meltdown.

With the full blessings of ratings agencies, banks are repackaging their money-losing securities into higher-rated ones called re-securitization of real estate mortgage investment conduits, or "re-remics," The New York Times reported. At least $30 billion in residential re-remics have been done this year, according to Morgan Stanley (NYSE: MS).

Wall Street bankers have even set out to create new and exotic financial products, including the securitized life insurance policies.

Indeed, bankers plan to buy so-called "life settlements," which are life insurance policies that sick and elderly people sell for cash, and package them into bonds for investors. This essentially creates a whole new bond market that lets firms gamble on the lives of thousands of people.

Many analysts fear that insurers will have to raise premiums, because they could end up paying more death claims out to investors than they previously had anticipated. That is, if a policy is purchased and packaged into a security, investors will keep paying the premiums that might have otherwise been abandoned by policyholders. If that's the case insurance companies will have based their premiums on false assumptions.

"The securitization of life settlements adds another element of possible risk to an industry that is already in need of enhanced regulations, more transparency and consumer safeguards," U.S. Sen. Herb Kohl, D-Wis., told The Times.

Meanwhile, the regulatory overhaul that U.S. President Barack Obama proposed back in June has been derailed by lobbyists and cast aside by a Congress that is preoccupied with the heated debate over healthcare reform.

Obama's Overhaul Losing Traction

President Obama on June 17 proposed a sweeping overhaul of the U.S. financial regulatory system.

Under President Obama's proposal:

  • Hedge funds and other private pools of capital would have to register with the U.S. Securities and Exchange Commission (SEC).
  • Many financial institutions would be required to increase capital reserves to protect against unexpected losses, and companies would also have to keep part of the credit risk for loans they have packaged into securities.
  • The Federal Deposit Insurance Company (FDIC) would have the power to seize and break up large financial companies that are under duress.
  • The U.S. Federal Reserve would be granted more powers over payments and settlements systems in U.S. financial markets to prevent a breakdown that officials fear could destabilize the economy.
  • The Office of Thrift Supervision would be merged with the Office of the Comptroller of Currency.
  • A new consumer protection agency would be created. That agency would write rules related to mortgages, credit cards and other consumer products, taking away powers previously held by the Fed.

However, the proposal has lost much of the momentum it would have had earlier this year. Now that the U.S. economy is seemingly back on track and many banks have paid back their huge government loans, much of the anger over Wall Street's hand in the financial crisis has dissipated.

"As we get a little more distance from the actual collapse and things begin to stabilize, then people think we don't need to take as much drastic action," Michael Bernstein, an expert in political and economic history who is currently serving as provost at Tulane University, told NPR. "That's a very disappointing reality."

In fact, a large portion of the anti-business rhetoric that provided the backdrop to the financial crisis has been replaced by public rants against big government and the vehement debate over healthcare reform that has consumed Congress.

"The president has offered a reform proposal that would grant broad new authorities to government bureaucrats while intruding in private markets and restricting personal choice," Spencer Bachus of Alabama, the senior Republican on the House Financial Services Committee told The Times. "The obvious lesson of the events of September 2008 is that we need smarter regulation, not more regulation, not more government bureaucracy, and not more incentives to engage in harmful business practices."

Meanwhile, big financial institutions and community banks have unified against several pillars of the proposal, including the creation of a new consumer protection agency, and tighter regulation and more transparency regarding derivatives and credit default swaps – the very instruments that have been blamed for exacerbating the financial crisis. They've also lobbied hard against restrictions on executive pay, The Times reported.

On the one-year anniversary of Lehman's collapse, President Obama again sounded the call for reform, warning that "there are some in the financial industry who are misreading this moment."

"I want everybody here to hear my words," Obama said in a speech at Federal Hall in New York. "We will not go back to the days of reckless behavior and unchecked excess at the heart of this crisis, where too many were motivated only by the appetite for quick kills and bloated bonuses. Those on Wall Street cannot resume taking risks without regard for consequences, and expect that next time, American taxpayers will be there to break their fall."

Still, many in Congress continue to bristle at the prospect of more government oversight.

"President Obama supports changes that push us in the wrong direction," Rep. Tom Price of Georgia, chairman of the conservative Republican Study Committee, told The Washington Times.

But as Congress continues to substitute rhetoric for action, America's largest financial institutions are growing more powerful and analysts see a precious opportunity for real reform slipping away.

"The clock is ticking and we're at a cross roads," Travis Plunkett, chief lobbyist for the Consumer Federation of America, told CNNMoney. "If we don't see a substantial move this fall, financial reform may wither on the vine."

Rep. Barney Frank, D-MA, who leads the House Financial Services Committee and largely supports Obama's plan, will begin marking up the bill in October and is expected to have legislation to the floor of the House by the end of next month or early November.

News and Related Story Links:

  • CNBC:
    Wall Street Taking Same Risks That Caused Crisis: Analysts

Join the conversation. Click here to jump to comments…

  1. Vince Celli | September 17, 2009

    Wall Street created the economic mess we are currently in and the American Public has reacted by questioning Obama's health care plan and holding "Tea Parties". Its a little like polishing up the windows while the house is burning down. With the present set up unchanged its almost inevitable the house will continue to burn.
    The sad fact is that most are even unaware of the need for a fire department.

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