Dysfunctional Financial System

by Rana Foroohar,

Tapes of what really happens between bankers and regulators show how far we have to go.

Carmen Segarra

Consider one of the shady deals highlighted on the secret tapes of New York Fed meetings, which former Federal Reserve bank examiner Carmen Segarra in 2012, made with a spy recorder before she was let go and which were made public on Sept. 26 in a joint report by ProPublica and This American Life. The 2012 transaction with Banco Santander, initiated in the midst of the European debt crisis, ensured that the Spanish bank would look better on paper than it really was at the time. Santander paid Goldman a $40 million fee to hold shares in a Brazilian subsidiary so that it could meet European Banking Authority rules. The Fed employees, who work inside the banks they examine (yes, it’s literally an inside job), knew the deal was dodgy. One even compared it to Goldman’s “getting paid to watch a briefcase.” But it was technically legal, and nobody wanted to make a fuss, so the transaction went through.

It’s hard to know where to begin with what’s problematic here. I’ll focus on the least sexy but perhaps most important point: existing capital requirements–the cash that banks are obligated to hold to offset risk–are pathetic. Despite all the postcrisis backslapping in Washington about how banks have become safer, our system as a whole has not. No too-big-to-fail institution currently is required to keep more than 3% of its holdings in cash (a figure that will rise to 5% and 6% in 2018), which means banks can fund 97% of their own investments with debt. No company outside the financial sector would dream of conducting daily business with that much risk.

Of course, if you start telling financiers they should use more than a few percentage points of their own money when they gamble, they’ll throw a fit. They will tell you that would make it impossible for them to lend to real businesses. They will also uncork lots of complex financial terms–“Tier 1 capital,” “liquidity ratios,” “risk-weighted off-balance-sheet exposures”–that tend to suffocate useful (a.k.a. comprehensible) debate. Financiers use insider jargon to intimidate and obfuscate. This is something we need to fight. In banking, as in so many things, complexity is the enemy. The right questions are the simplest ones: Are financial institutions doing things that provide a clear, measurable benefit to the real economy? Sadly, the answer is often no.

One thing we’ve learned since the crisis is that bailing out Wall Street didn’t help Main Street. Credit to individuals and many businesses plummeted during and after the bailouts and remains below precrisis levels today. Numerous experts believe that the size of the financial sector is slowing growth in the real economy by sucking the monetary oxygen out of the room. Banks don’t want to lend; they want to trade, often via esoteric deals that do almost nothing for anyone outside Wall Street.

After all, if finance can’t justify itself by showing it’s actually doing what it was set up to do–take in deposits and lend them back to all of us–what can justify it?

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