Preventing Another Banking Crisis

The New York Times today has an article about Goldman Sachs. It's been getting a lot of press recently. The Times reports that it's business at usual at Goldman. That leads some to worry, because they feel that lavish bonuses and "risky" practices that promote short-term profit might cause another crisis. I have some issues with that logic.

Let's start with bonuses. I have already expressed some concern that they continue to be so large, in spite of the crisis. But they didn't cause the crisis. They just didn't. Let's say that every bank on Wall Street took every penny of bonus money paid out for 2005, 2006 and 2007 and put it in their treasuries instead for capital cushion. According to two articles I tracked down, the grand total of all Wall Street bonuses for these three years combined was $83.4 billion. Now realize that includes all bonuses on Wall Street, not just those of the big American banks that received bailout money. It includes places like Barclays, Deutsche Bank, Credit Suisse, etc. It also includes boutique banks that didn't need a bailout. That means the big bailout bank portion was smaller than this $83.4 billion.

Let's compare that with the money that was used to bail out these banks. Combining Citigroup, Bank of America, JP Morgan, Goldman Sachs and Morgan Stanley, you get $140 billion. That far exceeds the bonuses paid. So we can officially stop blaming bonuses for causing the crisis.

However, it might further be argued that bonuses encouraged short-term profit, risky behavior, etc. That might be true, but Wall Street has always worked that way, and it had always been fine. The reason it was different now was because these banks were so highly leveraged. Then the music stopped. Once they lost their ability to turnover their debt, bad things happened.

But this isn't a problem with all risky behavior -- it's a problem with leverage. If these banks weren't so highly leveraged, then they would have had more cushion and not been on the brink of failure. So if anything, regulatory reform should require less leverage. Incidentally, less leverage would result in less profit, which would also lead to smaller bonuses.

I say this because I don't think that any amount of regulation is going to successfully discourage Wall Street -- especially traders -- from shunning short-term profit. If there's a profit to be made, then banks are going to seek it. The graver concern, I think, is insuring that, if something goes wrong, you don't have to bail them out. One obvious option would be to break up the banks, so that if they fail, you don't really care from a systemic risk standpoint. But another option would be to require them to have less leverage.