Everything moves faster on Wall Street, whether it's winning, losing -- or forgetting.
On New York's Seventh Avenue, between 49th Street and 50th Street, there is no evidence today to suggest that this is where the investment bank Lehman Brothers had its offices until a year ago.
The digital screen that encircles the front of the building has been reprogrammed, to reflect the change from the past to the future. The background color is now blue instead of green, and the name on the screen is no longer Lehman Brothers, but Barclays Capital, the building's new owner. The financial world hates losers.
The bank, founded by three German immigrants, existed for 158 years. It survived the American Civil War, two world wars, the Great Depression and the terrorist attacks of Sept. 11, 2001.
Lehman Brothers quickly grew from small to big and then, in furious bursts, mushroomed from big to too big. Finally, in the night between Sunday and Monday, Sept. 15, the deeply traditional firm collapsed.
In the end, there were more risks than assets on Lehman's books. Its bankers' good sense had been trumped by greed. The blend of brilliance and arrogance, ambition and megalomania typical of the industry had proven to be fatal.
Calling the President
Investment bankers are known for their extreme ideas, so it comes as no surprise that Lehman employees believed in the impossible until the very end. In that dramatic night, they persuaded George Walker to put in a call to the president at the White House.
In addition to being the head of Lehman's investment management division at the time, Walker is a second cousin of then-President George W. Bush. "You have to make it clear to him what will happen if $6 billion in credit default swaps, $30 billion in leveraged loans, $40 to 60 billion in residential mortgage-backed securities and another $30 to 40 billion in commercial mortgage-backed securities suddenly go up in smoke," one colleague urged Walker.
Walker reached for the phone, dialed the White House and said that he had to talk to the president, explaining that he was his cousin.
The White House operator placed Walker on hold. After a few anxious minutes, the operator cheerfully informed him that the president was unavailable at the moment.
Lehman Brothers' last outrageous idea had failed. Overnight, a real estate crisis had turned into a global financial earthquake.
Shaking in Terror
Until the morning of Sept. 15, 2008, the demise of an investment bank was considered an impossibility. Surely the masters of the universe couldn't die -- or could they?
The collapse of Lehman Brothers came as a shock to everyone in the financial district. As Wall Street looked on in horror, the flow of money dried up. Before long, what had begun as a tremor at the epicenter of global finance became something that those involved could no longer control without outside assistance. Greed had turned into fear. Bankers who until recently had delighted in taking risks suddenly found their hands shaking in terror.
It became clear that the powerful of the financial world were powerless to cope with the risks that had accumulated over the years. Most of all, it was suddenly apparent that their perceptions of those risks had been completely unrealistic.
"Bear Stearns' balance sheet, liquidity and capital remain strong," said CEO Alan Schwartz back in March 2008, while Alan Greenberg, chairman of the bank's executive committee, called liquidity rumors about the company "totally ridiculous." About a week later, competitor JPMorgan Chase acquired the bank in a deal backed by generous federal funds.
In the summer of 2008, Deutsche Bank CEO Josef Ackermann said that there were no systemic risks in the global financial system. Lehman Brothers imploded a short time later.
Apparently even the head of Lehman Brothers failed to recognize the internal crisis within his company until it was too late. Only a week before the collapse, he rebuffed a takeover bid from a Korean bank, arguing that the offer was too low.
One year has passed since that dramatic night in September when Lehman Brothers collapsed once and for all. The people involved wrote history: the darkest chapter in economic history since the Great Depression 80 years earlier.
Since then, the world has suffered an estimated $15 trillion (€10.3 trillion) loss of wealth, or about 35 times the German national budget. Entire countries -- most notably Iceland, but also Hungary and Latvia -- have teetered on the brink of collapse. The International Monetary Fund (IMF) has already pledged twice as much in aid to ailing countries as it lent to nations affected by the Asian financial crisis in the mid-1990s.
Although its onset was delayed, the ensuing social crisis was all the more relentless, spelling the loss of 59 million jobs worldwide and up to 850,000 monthly additions to the unemployment rolls in the United States alone. Now that its scrapping premium program to stimulate car sales has expired, Germany is also expected to see a sharp rise in unemployment, especially when benefits associated with state-supported short-time work programs come to an end.
Today, the failure to rescue Lehman Brothers is widely viewed as the last serious blunder of the Bush era, a period already rife with mistakes. After that, both the US government and the US Federal Reserve quickly shifted into hyperactive mode, nationalizing banks, acquiring worthless real estate and pumping more money into the economy than ever before in history. In the United States alone, the Fed and the government have already made about $11 trillion available to save the economy -- roughly the equivalent of all US corporate earnings in this century.
These efforts have helped soften the shock waves of the global financial upheaval in recent months. Although there is still rumbling within the global economy, governments and central banks have managed to avert the complete collapse of the economic system -- so far.
Can Capitalism Learn from Its Mistakes?
But after the hectic months of crisis management, key questions still remain unanswered. What lessons has the world learned from the near-collapse of its financial markets? Is capitalism more than just an accident-prone system? Is it adaptive, capable of learning from its mistakes?
Part of the reason that the Lehman collapse came as such a shock to the financial system was that the culprit, in this case, was not its black sheep but its golden child. Lehman was the benchmark by which others were judged, the rule and not the exception in American casino capitalism.
This is why questions about the rules of the game are so important today. If they are not fundamentally changed, the world could soon be on the brink of disaster once again. A second shock wave emanating from the interior of the financial industry, would destroy much in its path -- and possibly even our faith in the ability of elected politicians to assert themselves in the face of powerful economic interests.
One year after the crisis, there is widespread unanimity over its causes: Banks that were too big in the first place were able to acquire too much money too easily, money that they then handled recklessly. As a result, governments now know exactly what ought to be done. Capital requirements for banks need to be increased. And their transactions must become more transparent, instead of being kept off balance sheets and tucked away in subsidiaries known as "special purpose entities."
In addition, bankers' bonuses need to be limited and tied to long-term performance -- as opposed to the current system of compensation based on short-term results, which only promotes extremely risky behavior.
Aversion to Regulation
But there is considerable debate over how exactly these realizations are to be translated into concrete rules and regulations. The representatives of the world's 20 biggest economies are now trying to agree on compromises before their leaders meet next week in Pittsburgh for the G-20 summit. It will become clear at the meeting just how serious governments are about reorganizing the financial markets. The Pittsburgh summit will also reveal whether the elites in New York and Washington, where the transitions from lucrative bank jobs to government positions are traditionally smooth, will truly play along.
The Americans have always had a natural aversion to all forms of regulation. And yet, under President Barack Obama, they have proven to be unusually cooperative in negotiations. Nevertheless, Obama and Treasury Secretary Timothy Geithner are under tremendous pressure from the Wall Street lobby. The Fed and its chairman, Ben Bernanke, are also far from enthusiastic about many proposed changes to the regulatory framework.
One more change was added to the list last week, with a surprising proposal by German Finance Minister Peer Steinbrück and his party colleague Frank-Walter Steinmeier, who is the center-left Social Democratic Party's chancellor candidate in Germany's upcoming national elections, to introduce a worldwide tax on financial market transactions. The idea is to track all the transactions on the world's financial markets, from foreign currency transactions to trading in derivatives and securities. Steinbrück also anticipates that such a tax -- which is modeled on the late economist James Tobin's proposal for a tax on foreign currency transactions -- could generate worldwide revenues numbering in the triple-digit billions.
The two SPD politicians envision that the tax will force banks, insurance companies and investment funds to help pay for fixing the consequences of the international financial crisis. "In the end, it shouldn't just be the taxpayers who are saddled with the costs of the crisis," Steinmeier told the Süddeutsche Zeitung newspaper. Steinbrück added that the practice of "binge drinking" in the financial markets must come to an end.
The German finance minister also announced his intention to promote his and Steinmeier's vision of a Tobin-style tax in Pittsburgh. This is surprising, because there has been no mention whatsoever of the Steinmeier/Steinbrück proposal in the preparatory sessions leading up to the G-20 meeting.
Interestingly, Steinbrück was always opposed to such a tax in the past. It is seen as detrimental to growth, because it increases the cost of financial transactions across the board, even those that are economically indispensable and not in the least bit speculative. Besides, the tax only makes sense if it is introduced everywhere in the world, otherwise the entire market for financial products would migrate to non-participating countries. Hence the chances of it ever being implemented are next to zero.
However, the proposal could help the SPD in the German election campaign. And indeed, Chancellor Angela Merkel's office was quick to announce her intention to check whether a tax on speculation could have a chance on the international level. But the proposal is clearly too late for Pittsburgh in any case.
It remains to be seen what concrete measures the G-20 agree on in Pittsburgh. But whatever they decide seems likely to be insufficient. The central causes of the crisis have been a taboo subject until now.
For instance, the issue of monetary policy is not addressed in the proposals put forward so far, even though the central banks' practice of flooding markets with cheap money over the last 15 to 20 years led to the creation and bursting of one bubble after the next.
Another question that has not been discussed until the last few weeks is what to do about banks that are too big to be allowed to fail. Many banks have grown larger as a result of mergers following the Lehman collapse, making them an even greater threat to the financial system.
Nevertheless, there has been no lack of good intentions, at least not in the first months following the Lehman bankruptcy.
Lord Adair Turner, the chairman of London's Financial Services Authority (FSA), said that he wanted to contribute to making sure that the "biggest financial crisis in the history of market capitalism" did not repeat itself. London's competitiveness as a financial center was not "a major aim," he told Prospect magazine -- saving the world was apparently more important.
Even America became humble for a few moments. Many graduates of the Harvard Business School, an important training ground for the bastions of capitalism, took a public oath to serve the greater good in the future, and not just their own interests.
Obama seemed to be the right president at the right time. "Capitalism will be different," Treasury Secretary Geithner promised. We will all have to change, the president added. "A culture of irresponsibility," he said, had taken "root from Wall Street to Washington to Main Street." At the G-20 summit in London this spring, Obama apologized before the global public for America's mistakes.
Bonuses Are Back
In the ensuing months, bank regulators, central bankers and politicians got to work, eager to get to the root of the problem. All financial products in all countries were to be regulated. Blind spots in the financial system, such as subsidiaries of giant banks in places like the tiny Bahamas, were to be eliminated. And early warning systems -- a sort of worldwide system of market regulation -- were to be installed.
Europeans, as if anticipating a future world government, even advocated establishing a global economic council whose task would be to monitor activity in the world economic system.
Russian Prime Minister Vladimir Putin expressed what many politicians in the West were thinking. "This is not the irresponsibility of specific individuals but the irresponsibility of the system, which claimed leadership," he said, adding that there could be "no return" to the former conditions.
The vast majority of humanity probably agrees, and yet this will not be enough to tame market capitalism. More deep-seated reforms must now be implemented, a task that becomes more and more difficult as time passes. There are many indications that although the world is poorer as a result of the financial crisis, it has not necessarily learned from the experience.
Business is back in full swing in the financial sector, now that the government is using taxpayers' money to guarantee the high risks. For this reason, there are many on Wall Street who would prefer to see nothing changed. They no longer believe in the need for reform, particularly when it affects their compensation. The new buzzword among stockbrokers is "BAB" -- "Bonuses Are Back."
The pace of strict bank regulation has been downgraded from full speed ahead to sluggish. Senior IMF officials, including Managing Director Dominique Strauss-Kahn, fear that the momentum behind radical measures is gone.
One year after the Lehman collapse, Americans and Europeans meeting in Pittsburgh for the G-20 summit want to prove to their citizens what they can do if they make a concerted effort. They want to show that they are capable of drawing conclusions, even when they are unwelcome among the powerful in the financial sector.
The Europeans, at any rate, will travel to Pittsburgh with the best intentions and with thick folders packed with proposals. For months, Europe's central bankers and finance ministers have been busy drafting stricter rules for global finance.
In mid-July, the Basel Committee on Banking Supervision, which now includes the representatives of 27 countries, approved astonishingly detailed regulations, which could find their way into national laws by the end of 2010. The Basel rules would require banks to maintain larger capital reserves, particularly for risky financial products. For instance, the securitization of mortgage loans into complex bundles -- which played a fatal role in the financial crisis -- would be made significantly more expensive, and thus far less attractive, for financial institutions.
The Basel committee includes representatives of Germany's central bank, the Bundesbank, and its banking regulator BaFin. Both organizations are proud of the progress that has already been made. Two years ago, say officials close to Bundesbank President Axel Weber, much of what is being done today would have been unthinkable.
If the proposed Basel rules become reality, lenders could be forced to establish capital reserves in good times, which they could then deplete in bad times without becoming a burden on the government.
Joining Forces against the Americans
On this issue, Deutsche Bank CEO Ackermann sees eye-to-eye with reformers. "The banking industry has too little capital and is too highly leveraged. We almost stripped ourselves bare, so that there were hardly any reserves left," he said last week at a banking conference in Frankfurt.
But will the United States play along? Experts at Berlin's Finance Ministry have not failed to notice that Washington's willingness to enact reforms is declining in proportion to the pace of economic recovery. Merkel, for her part, knows that her prospects of succeeding in Pittsburgh will be maximized if a united Europe joins forces against the Americans.
Her natural partner on such issues as limiting executive compensation, is French President Nicolas Sarkozy. In a letter the chancellor and Sarkozy drafted, and British Prime Minister Gordon Brown signed, shortly before the meeting of G-20 finance ministers two weekends ago, the three leaders advocated limiting executive bonuses for bankers.
Among the G-20 leaders, Brown had been, until now, the strongest opponent of more regulation. Nevertheless, the German, British and French leaders are in agreement in the joint letter, which is formally addressed to the Swedish president of the European Council and the Obama administration. They call for a ban on guaranteed bonus payments, which enable investment bankers to continue to cash in even after taking their banks to the brink of financial ruin with their speculative behavior. For Brown, whose economy is more dependent on the financial industry than most, and which profited handsomely from it in the good years, ideas like this are nothing short of heretical. As chancellor of the Exchequer, he celebrated London's investment bankers as modern-day heroes.
Whether he is really serious about pushing for a reform of banking compensation in Pittsburgh is debatable. Brown's chancellor of the Exchequer, Alistair Darling, has already begun to raise doubts surrounding his own prime minister's positions. A "global pay policy," he told the Independent, would not be feasible.
For the British and the Americans alike, it is not easy to reform the financial architecture of the London City or Wall Street without jeopardizing the prosperity these financial centers generated in better days. As recently as 2008, the US financial sector was responsible for about 40 percent of American corporate profits. Seventy percent of all international bonds and about half of all stocks are traded in London's City financial district. In 2006, the financial sector employed 6.5 million Britons, who in turn produced 10.1 percent of the gross domestic product. Some fear that if regulation becomes too stringent, a share of the business could migrate to Shanghai, Hong Kong or even Moscow.
Who Got Us into this Mess?
Lawrence McDonald can offer answers to anyone who hopes to understand why reforming Wall Street is so difficult. The former Lehman Brothers vice president already has a new job with an investment firm with offices on Madison Avenue.
McDonald wants to continue where he left off -- or, as he says, was forced to leave off.
When the former Lehman bankers get together socially today, they ask themselves questions like: Who got us into this mess? Why was our boss allowed to do as he pleased for so long?
McDonald speaks about the people responsible for the collapse in the third person, making himself sound like a survivor of the debacle rather than someone who might have helped to cause it. "The fact is," he says, "that eight people ruined an organization in which more than 20,000 employees were doing a good job and making money."
The 31st floor was to blame, he says, or, more specifically, the largely invisible boss of bosses, who would have his driver call ahead to make sure that the elevator would be waiting for him when his limousine arrived at Lehman headquarters.
Treating the Symptoms
Traders were long aware that the real estate boom was built on shaky footing, particularly once they realized that many new borrowers were not even able to make their first mortgage payment -- despite the booming economy. At that point, they knew that mortgage companies were busy convincing people to take on mortgages they could never afford, not even at low interest rates.
But didn't bankers at Lehman convert the loans into securities, dividing up and repackaging the risks again and again, until risks no longer looked like risks, but rather extremely profitable investments?
Well, okay, says McDonald, perhaps it was a few more than the eight executives at the top. "Let's say it was 1,000 people, but it was still a small group."
He insists that he and most others at Lehman worked hard and went home "flat" every day -- and that their pay was not excessive. For someone like McDonald, annual compensation in the range of $500,000, plus stock, is a given. And in New York, bankers think that isn't much.
On the Back Burner
The Obama administration could reluctantly end up on the side of people like McDonald. The new president currently needs all the strength he can muster in the fight for healthcare reform, as he faces up against the pharmaceutical lobby, doctors, the Republicans and, in recent weeks, a majority of voters.
At this point, Obama can ill afford to fight another major domestic political battle. One more opponent with economic clout is one opponent too many, particularly as Wall Street's major players funded a large part of his election campaign. And the next election is already around the corner.
Obama understands the Europeans and their concerns. He even sounds like a European himself at times. But the question is whether, at present, he can achieve what they are asking of him. He is probably not even able to reach the goals he has set for himself.
He needs new jobs, new tax revenues and new consumer confidence to reinvigorate his presidency now that it has begun to falter. New rules for the financial industry have not disappeared from the White House's list of priorities, but they have been put on the back burner.
In his statement leading up to the G-20 summit, Obama sounded as if he intended to declare an end to the financial crisis in Pittsburgh. He said that industrial production has either stabilized or is growing in all of the 20 leading industrialized nations. He said that world trade is expanding. And he said that the burdens on the financial system have decreased considerably, as US banks have returned to raising the capital they need. The statement, which the White House released in Washington last Tuesday, seemed to suggest that Obama was issuing an all-clear signal for the economy.
Slowed, not Stopped
But the reality is that the crisis has only been slowed down, not stopped. The pathogen that caused it remains inside the system. Government bailout funds act as antibiotics, suppressing the pathogen's destructive action, and yet they do not cure the underlying problem.
This explains why officials at the Fed are unconvinced by the politicians' declarations of victory over the crisis. According to a senior Fed official who chooses to remain anonymous, there is a "substantial risk of further loan defaults." Dennis Lockhart, the CEO of the Federal Reserve Bank of Atlanta, has even warned publicly of the need for caution. "We should remain a little bit restrained in declaring victory," Lockhart said.
IMF chief Dominique Strauss-Kahn also insists that the danger is not over yet. In a computer simulation, the assumptions of further bank failures and another sharp decline in economic growth were inserted into an IMF stress test known internally as the "Early Warning Exercise."
The results were shocking. According to the exercise, Ireland, many Eastern European countries and even Britain would not survive a second wave of global economic tremors on their own, and would be forced to request international assistance.
For the already unpopular Prime Minister Brown, it would spell an inglorious end to his term in office. The grim prospects that the IMF simulation has conjured up even prompted the British members of the organization's executive board to ask that individual countries no longer be identified in such stress tests.
The US Federal Reserve is also familiar with the outcome of the simulations. Its experts, knowing full well how shaky the foundations of the financial world are, have tried to downplay the impression that the world could soon return to normalcy.
Alarming sentences were leaked, probably not entirely by accident, from the most recent meeting of the Federal Open Market Committee. The US economy was still vulnerable to shocks, said one member of the committee. Bernanke and the remaining seven members of the Fed's Board of Governors decided to keep the prime rate at 0.00 to 0.25 percent indefinitely. Cheap money is the blood transfusion the Fed injects whenever problems arise in the economy's bloodstream.
The government-run Federal Deposit Insurance Corporation has announced that it now classifies 416 financial institutions (up from 315 in the previous quarter) as "problem banks." This is the highest such figure since the last American banking crisis raged 15 years ago.
It is becoming increasingly clear that there are tremendous side-effects to the methods used to combat the crisis to date. Though preventing the collapse of the world economy, they also created new hazards and amplified existing problems. One day, historians may look back and say that the crisis of 2008 was fended off by laying the groundwork for the next crisis.
It has been one year since the Lehman bankruptcy, and the world is still a dangerous place. Bank balance sheets are less of a reflection of reality than ever before.
According to IMF calculations, banks have only purged about one-third of now-worthless assets from their balance sheets. In other words, the sharp rises in prices on the stock markets are based in part on fantasy numbers.
The government supports this retouching of balance sheets. Financial regulators are currently refraining from implementing existing accounting rules. In particular, the rule that requires virtually all securities to be listed on balance sheets at current market prices has been quietly suspended.
In the first few months following the Lehman collapse, the declines in market prices brought on by the crisis led to a series of balance-sheet adjustments, which in turn resulted in additional sales of securities.
This downward spiral placed more and more banks in jeopardy. Only when accounting rules were de facto suspended did a stability of sorts set in -- but it was deceptive.
At the present time, banks -- with the support of regulators -- can apply an almost unprecedented level of creativity in accounting for their risks. "The fire extinguishers actually fuelled the fire," says Martin Hellwig of the Max Planck Institute in Bonn.
The Big Get Bigger
Individual major banks have also become more -- not less -- influential during the course of the crisis. Many lenders have disappeared, while others have slipped under the protective umbrella of the industry leaders.
Before the crisis erupted, the notion that certain banks were "too big to fail" was seen as a threat to the stability of the world's financial architecture. The problem has only grown since then, with the crisis making the big players even bigger.
The trend toward concentration is continuing, encouraged by the US government, which has devised new antitrust regulations for takeovers to facilitate the acquisition of troubled banks.
After acquiring Wachovia, previously the fourth-largest bank in the US market, Wells Fargo now manages 138 percent more assets than before the crisis. By acquiring Bear Stearns and Washington Mutual, JPMorgan Chase increased its total assets by 39 percent. Bank of America doubled its total assets when it acquired Merrill Lynch and mortgage lender Countrywide. "The oligopoly has tightened," says Mark Zandi, chief economist at Moody's Economy.com.
As a result, the world's biggest financial institutions have reached a critical mass that, as in a nuclear reactor, can lead to uncontrolled chain reactions -- even more so than before the crisis. If one of these banks collapses, it will not only bring down the financial sector, but the economies of several countries as well. No nation can afford to allow such mega-banks to fail. As Fed chief Ben Bernanke says: "When the elephant falls down, all the grass gets crushed as well."
Does this mean that today's newly swollen giants will be more cautious this time around? Have they learned from the crisis?
They have learned, but they've learned the wrong lesson. In retrospect, the Lehman Brothers case no longer seems quite as horrifying to the major banks. In fact, it is almost reassuring. They know now that there will be no repeat of the Lehman debacle. The government will not allow a second major player to fail. In a worst-case scenario, a large Wall Street bank can fall back on the US Treasury -- provided it is seen as a "systemic risk."
This realization is like a life insurance policy for the big banks, but it also encourages renewed reckless behavior. Experts refer to this logic as "moral hazard," because it means that those who take high risks are suddenly behaving rationally. The banks are always the ones to profit, while the government is expected to pay for losses that could jeopardize the banks' existence. But this is precisely what leads to the risk of an even bigger disaster.
This is why Bundesbank President Axel Weber wants to force major banks to establish large capital reserves. It would put them at a disadvantage compared with smaller banks, but this seems to be the only way to curb their aspirations to continue growing.
The Weber proposal is not revolutionary, but it is prudent. Nevertheless, it has been met with massive resistance among some that would be affected by it. Indeed, Wall Street has already dispatched its lobbyists to Washington.
Oriented toward Growth
The lobbying industry itself is likely to emerge a winner from the Wall Street disaster. In 2008, US companies spent $3.3 billion on lobbying activities, or more than twice as much as they did 10 years ago. Some of the most successful lobbying firms are those with ties to the Democrats, like the firm run by Tony Podesta, the brother of John Podesta, who managed Obama's transition into the White House.
Money and politics are closely connected in the United States. Connecticut Senator Christopher Dodd, who heads the Senate Banking Committee, collected millions in campaign contributions last year, mainly from the very finance and banking sector he is now expected to rein in.
Limiting the size of a bank would be as painful for Wall Street as capping bonuses, because bank CEOs are oriented toward growth. Their ambition, their entire way of thinking and, in many cases, their compensation is based on growth.
'Large Banks Are Useful'
Deutsche Bank CEO Josef Ackermann has also joined the ranks of the coalition opposing size restrictions for banks. "Large banks are useful to the economy and business," Ackermann wrote in an opinion piece for the Financial Times, and yet he fails to elucidate how Germany, Europe or the global economy are to cope with the failure of a major player.
Ironically, it is precisely the experienced financial market experts who are advocating more radical measures. London's City, warned London's FSA chairman Lord Adair Turner, had grown beyond a "socially reasonable size." Turner says he can envision a Tobin-style tax on financial transactions.
Ideally, the major banks should be de-consolidated, says former IMF chief economist Simon Johnson, now a professor at the Massachusetts Institute of Technology. "Banks that are too big to fail must now be considered too big to exist," he says.
Hedge fund guru George Soros even believes that certain transactions should simply be prohibited. According to Soros, credit default swaps, which can be used to bet against companies on a large scale, are " toxic and should be used only by prescription."
Although the market for credit default swaps is shrinking, $27 trillion are still invested in these highly risky securities. Regulators are attempting to tame the beast, but how successful their efforts are will only become clear the next time the market goes haywire.
Knight in Shining Armor
There is one bank, however, that played a key role in the development of the crisis and that is being discussed by experts worldwide. This bank will even have a place at the table with world leaders in Pittsburgh.
It would be impossible to comprehend the financial crisis without understanding its role. This bank is not headquartered on Wall Street but in Washington. The Federal Reserve, America's central bank, is one of the country's largest and unquestionably most powerful institutions, with 12 regional banks under its wing and more than 16,000 employees. And the Fed's headquarters are located only three blocks from the White House.
The Fed determines the prime rate, sets rules for the lending industry, supervises banks and ensures that the American financial system remains solvent at all times. Many see it as a knight in shining armor in times of global economic turmoil, because it buys up toxic assets, provides liquidity to banks and keeps interest rates low, making it easier for companies to invest.
Nevertheless, the Fed played a central role in the development of the crisis. It provided the extra -- and most importantly cheap -- money that stimulated the fantasies of Wall Street bankers. Without the constant expansion of the dollar money supply, a wave of speculation like the one that swept through the US real estate market could not have developed.
To make sure that no one looks too carefully over the Fed's shoulders, the government stopped releasing data on the so-called "M3" measure of the money supply in 2006. Since then, independent organizations have gone to great lengths to come up with their own M3 estimates.
These estimates indicate a sharp increase in the money supply. Since the government's decision to stop publishing M3 data, the rate at which the money supply has grown has tripled at times. It increased by up to 17 percent last year alone. By comparison, the money supply in Europe grew by only 6 percent in the same time period.
This put the Fed in the business of creating money, money that ended up in the over-inflated US real estate market. In short, the Fed was partly to blame for the crisis it is fighting today.
Invitation to Excess
Much of the blame is centered on Alan Greenspan, the man who chaired the Fed for more than 18 years. He was the first economic celebrity, a living legend who, in 1975, became the first economist to be featured on the cover of Newsweek.
Greenspan became the face of a new era, one in which the economy liberated itself from government regulation. Greenspan even managed to convince then-President Bill Clinton to eliminate the key law protecting savers and small businesses, the Glass-Steagall Act, which was intended to separate commercial banks and investment banks, thereby preventing excessive consolidation in the industry. In doing away with Glass-Steagall, Greenspan effectively tore down the wall between commercial and investment banks, accelerating the fateful consolidation of banks that led to the crisis.
Greenspan's low-interest rate policy was a key factor in the development of the financial crisis, because the most important price in every market economy is the price of money. The interest rates set by central banks determine whether money is expensive, cheap or even free for borrowers.
Greenspan made low interest rates his trademark. He reduced the Federal Reserve's key rate from 8 percent in 1990 to 3.5 percent in 2001, and when terrorists brought down the World Trade Center in New York on Sept. 11, 2001, he lowered the key rate again, until it eventually reached 1 percent in 2003.
Given an inflation rate of between 2 and 3 percent, this meant that banks could essentially borrow money for nothing. It was an invitation to party, and lenders didn't wait to be asked twice. Even the Wall Street Journal called it "stimulatory overkill."
Revenge of the Ninja
From then on, banks began issuing a new form of mortgage, the "Ninja loan," with the word "Ninja" standing for "no income, no job, no assets." From 2001 to 2006, subprime loans as a percentage of all loans grew from 5.4 to 20 percent.
One year after Greenspan's replacement in 2006 by Ben Bernanke, the real estate market began to collapse. One of the biggest bubbles in US history burst. With it collapsed the legacy of an era that many to this day are loath to criticize.
To combat the crisis, Bernanke is continuing the same low-interest rate policy his predecessor promoted in the boom years. And because this is not enough, the government is issuing trillions in treasury bonds. And because there are not enough buyers for all of these bonds, the Fed is buying up its own securities. This makes it one of the fastest-growing companies in the United States, having increased its total assets by an astonishing 144 percent in 2008.
To date, German Chancellor Angela Merkel has been the only world leader with the temerity to challenge the sacrosanct US policy. In a speech in Berlin, she criticized Washington's loose monetary policy and its massive purchases of its own treasury bonds, noting that this amounts to nothing less than simply switching on a money-printing machine.
The chancellor recommended a return to an "independent central bank policy" and a "policy of reason," saying that she viewed the Fed's policies "with great skepticism."
Bernanke coolly rebuffed the criticism from Berlin, saying he "respectfully" disagreed with Merkel's opinions and that he was "comfortable" with the action the Fed had taken.
Demanding an Exit Strategy
But the debate will now be held in Pittsburgh, as well, although naturally the Fed will not be mentioned by name. Germany, France and Britain have agreed to demand an "exit strategy" from the Americans.
Europe wants to know when the United States intends to stop driving up its debt to ludicrous levels. And Europe also wants to know when the Fed plans to curb the flood of dollars. Indeed, Washington's crisis fighters are on the verge of becoming a systemic risk themselves.
The German chancellor is about to receive support from Hollywood, where director Oliver Stone plans to film "Wall Street 2," starring Michael Douglas once again. This time, however, Stone plans to focus on the Fed in his film. The banks are important, he said last week while touring locations for the film, but the Fed is the "bulwark of the system."
The Party Continues
Meanwhile, the bankers and traders who are the focus of Stone's film and the Pittsburgh conference have returned to normalcy -- their normalcy. The party on Wall Street continues. In 2008, the bonus pool of US banks was so full that it seemed as if nothing at all had happened.
Nine of the biggest bonus-payers spent more than $32 billion on their supposed top performers, while at the same time collecting government bailout funds. For the general public, this is an outrage, but investment bankers see it as a "smart" move.
In a minor concession, Goldman Sachs CEO Lloyd Blankfein has asked his bankers to at least keep their spending habits discreet. But whether they have followed his advice is another matter.
At a recent event called "Fashion meets Finance" -- an opportunity for beautiful fashion models to meet wealthy bankers -- there was a long line at the door of the Nikki Beach club in midtown Manhattan. According to the invitation, the post-crisis panic had led -- horror of horrors -- to "a two-year blip in the system where a hot fashion girl might commit to a pharmaceutical salesman." But fortunately, the invitation continued, those days are gone, and "women of fashion" can take solace in the fact that "it will only be a couple more years until you can quit your job and become a tennis mom."
Back in Gear
Former Lehman banker Lawrence McDonald is already looking forward to the annual get-together with his former coworkers -- and to telling them about his proposal for reform, of which he is proud.
He believes that there should be more bonus payments, not fewer. "You have to pay the people in the government regulatory agencies some incentives too," he says, "so that good people take those jobs."
Until now, says McDonald, most of the government's watchdogs have been making only a little more than about $100,000 a year. "We used to laugh about this in the trading room," he says. "These people have to deal with some bankers making $5 million a year."
McDonald smiles at his own observation. His world is back in gear. Wall Street is big on forgetting.
BEAT BALZLI, SEBASTIAN BORGER, WOLFGANG HÖBEL, MARC HUJER, CHRISTOPH PAULY, WOLFGANG REUTER, MATTHIAS SCHEPP, GREGOR PETER SCHMITZ, GABOR STEINGART