QUESTIONS FOR THE BIG BANKERS / THE NEW YORK TIMES OP EDITORIAL ( RECOMMENDED READING )

January 13, 2010

Op-Ed Contributors

Questions for the Big Bankers

Today, the Financial Crisis Inquiry Commission, which Congress established last year to investigate the causes of the financial crisis, is scheduled to question the heads of four big banks — Lloyd Blankfein of Goldman Sachs, Jamie Dimon of JPMorgan Chase, John Mack of Morgan Stanley and Brian Moynihan of Bank of America. The Op-Ed editors asked eight financial experts to pose questions they would like to hear the bankers answer.

1. Bankers are dealers in money. The Federal Reserve is a creator of money — since the crisis began in August 2007, it has conjured up $1.1 trillion. Given the ease with which these dollars are materialized on a computer screen, how can they be worth anything?

2. The Federal Reserve’s setting of its benchmark federal funds rate at nearly 1 percent in 2003 to 2004 was a primary cause of the housing and mortgage debacle. Yet, in an attempt to nurse the economy back to health, the Fed has set that rate at nearly zero percent. So what’s the next bubble, and how do you intend to profit by it?

3. For Mr. Blankfein: In capitalism, profits are no sin, yet Goldman Sachs keeps making excuses for its success in 2009. If you earned the money honestly, what are you apologizing for? And if you didn’t earn it honestly, how did you do it?

— JAMES GRANT, the editor of Grant’s Interest Rate Observer and the author, most recently, of “Mr. Market Miscalculates”

•

1. It still isn’t clear precisely how mortgage-related losses in the financial sector grew to be many times greater than the actual losses on the mortgages themselves. What role did synthetic collateralized debt obligations — a Wall Street invention that uses credit default swaps to mimic the payments from mortgages — play in multiplying the losses? Is there any way in which a synthetic debt obligation adds value to the real economy?

2. Goldman Sachs and other Wall Street firms argue that the clients to whom they sold mortgage-related securities were sophisticated investors who fully understood the risks. Goldman has said this was also the case when its clients bought the very same mortgage securities that Goldman, on its own behalf, was betting would default. Did these clients indeed understand all the gory details?

3. At the height of the panic in the fall of 2008, Wall Street firms blamed short-sellers for trying to destroy them. What short positions did Wall Street firms have in one another’s shares, and were they also betting against each other using credit default swaps?

— BETHANY McLEAN, a contributing editor for Vanity Fair, who is co-writing a book about the financial crisis with Joe Nocera of The Times
•

1. Without the Troubled Asset Relief Program, Wall Street banks would not have survived the shock to the financial system that occurred in September 2008. Nor would they have subsequently accrued large profits and bonus pools in 2009. Shouldn’t a substantial share of those bonus pools be sequestered on bank balance sheets for several years to increase the banks’ capital levels and shield taxpayers against another bailout?

2. All deposits insured by the Federal Deposit Insurance Corporation that were held by Wall Street financial conglomerates should have been insulated in separate bank subsidiaries that were prohibited from trading, holding derivative securities and investing in risky assets like equities or bonds with less than a AAA rating. Wouldn’t such safeguards have reduced excess banker risk-taking, thereby reducing the need for taxpayer bailouts?

3. Wall Street turbocharged the subprime mortgage boom from 2002 to 2006 by providing billions in cheap warehouse loans to non-bank lenders that otherwise had virtually no capital or financing. Had the Federal Reserve kept short-term interest rates at a more normal 4 percent to 5 percent, rather than pushing them down to 1 percent, would this not have greatly curtailed the reckless growth of subprime loans?

— DAVID STOCKMAN, a director of the Office of Management and Budget under President Ronald Reagan

•

1. One result of the Pecora commission, the Depression equivalent of this investigation, was the Glass-Steagall Act, which kept investment banking separate from commercial banking until the act was repealed in 1999. Many experts now believe that divide should be reinstated. Yet commercial banks like Washington Mutual lost a lot of money during the crisis without having any investment banking activities, and pure investment banks like Bear Stearns and Lehman Brothers collapsed without being deposit-taking institutions. This suggests that the problem does not lie with mingling commercial and investment banking. Are you in favor of the return of Glass-Steagall, and why?

2. Many people argue that the financial industry now accounts for far too much of the gross domestic product and that it is unproductive, indeed counterproductive, to devote so much of the nation’s resources to simply moving money around rather than making things. Why has this shift occurred and what, if anything, can the government do about it?

3. Over the last 20 years, the world of finance has been irrevocably transformed: individuals have moved their money from savings accounts into money market funds, and institutional investors now keep their cash in the repo market, where Treasury securities are borrowed and lent, rather than as deposits in commercial banks. As a result, before the crisis, half of the credit provided in the United States was being channeled outside the commercial banking system. What regulatory changes do we need to ensure that our current financial system is as stable as the traditional banking system that served us so well from 1936 to 1996?

— LIAQUAT AHAMED, the author of “Lords of Finance: The Bankers Who Broke the World”

•

1. Describe in detail the three worst investments your bank made in 2007 and 2008 — that is, those transactions on which you lost the most money. How much did the bank lose in each case?

2. What was the total compensation of each manager or executive supervising those three transactions — including yourself — in 2007 and 2008?

3. Are those executives still with your bank? What investments do they supervise today? How much will they be paid for 2009, including their bonuses?

— SIMON JOHNSON, a professor at the M.I.T. Sloan School of Management and a senior fellow at the Peterson Institute for International Economics

•

Some of your firms received payouts on credit-default swap contracts with American International Group. Most of those guarantees resulted from hedging supposedly safe investments (they had AAA ratings, after all) with A.I.G. or other insurers. This hedging allowed traders to book “profits” that had not yet been earned — profits that would be counted in calculating their bonuses.

However, this insurance was likely to fail, as your risk managers surely knew. It involved so-called wrong-way risk: the guarantor (A.I.G.) was certain to be damaged by the same event (the housing market collapse) that would lead you to seek payment on the insurance. The insurance was effective only because the government stepped in, theoretically on the taxpayers’ behalf, and made payments for A.I.G., an otherwise bankrupt firm. Since employees’ bonuses, and ultimately yours, were based on these fraudulent profits, my questions are these:

1. How much profit did your firm record for bonus purposes on these trades that ultimately delivered huge losses? How much of those bogus profits were paid out in bonuses?

2. Have you made any effort to recover the bonuses? If not, why not?

— YVES SMITH, the head of Aurora Advisors, a management consulting firm, and the author of the blog Naked Capitalism and the forthcoming book “Econned: How Unenlightened Self-Interest Undermined Democracy and Corrupted Capitalism”

•

1. Why did Wall Street continue to package and sell as securities so many mortgages of questionable value and underwriting standards even as the housing market started to collapse?

2. Why were Wall Street traders and other moneymen permitted to make bets — through the use of so-called credit-default swaps — on the long-term value of securities they didn’t even own? (This is akin to everyone in your neighborhood being allowed to buy fire insurance on your house. Since the only way that bet can pay off is if your house burns down, it shouldn’t be any surprise when that is exactly what happens.)

3. Why aren’t bankers and traders required to have more skin in the game — that is, more of their own salary at risk — and not just a marginal part of one year’s bonus? (In the old days, when investment banks were private partnerships, a partner’s entire net worth was on the line, every day.)

— WILLIAM D. COHAN, a former Wall Street banker and the author of “House of Cards: A Tale of Hubris and Wretched Excess on Wall Street,” who writes a regular column on business at nytimes.com/opinion

•

1. How did you use the bailout money, and to what extent did it result in more lending or higher bonuses for your employees than you otherwise would have provided?

2. What, if any, changes do you contemplate making to your pay programs for executives and other high-level employees in light of recent events and related public concerns?

3. What have you done to modify your risk management and oversight structures to reduce the possibility that the problems of 2008 and 2009 will occur again?

— DAVID M. WALKER, the president and chief executive of the Peter G. Peterson Foundation and the comptroller general of the United States from 1998 to 2008

Copyright 2010 The New York Times Company