Just half a year ago, the Treasury was rushing to rescue a gaggle of distressed banks with taxpayers' money. Now we read of enormous trading profits at J.P. Morgan Chase and Goldman Sachs and 5,000 people getting $1 million or more in bonuses and one extraordinary oil trader at another bank getting paid $100 million.
Americans are understandably startled to see gigantic profits reported by the same organizations that were at the center of that "perfect storm" we call the global financial crisis and are asking, Why? How can this be? It's hard to comprehend, let alone justify, a W-2 over $50 million or $100 million.
The obvious answer: the trading opportunity of a lifetime. Anxious pension funds, SWFs, central banks, and other institutional investors with intense desires to change their portfolios needed dealers with the guts and ability to take major market risks. With Lehman Brothers and Bear Stearns gone, and Merrill Lynch, Citibank, and others hurting, and Morgan Stanley and CSFB choosing to be cautious, dealer competition was unusually low.
Sure, Goldman Sachs and J.P. Morgan Chase made huge profits. Thank goodness they were taking the risks and making the markets that earned those profits. Without their work, the market panic would have cut deeper into our economy and lasted longer - and we'd all be worse off today - much worse off.
Serious observers will divide the real issues into four areas: our social-political system; our overall economic system; our financial markets; and large market participants. Each was at fault. We were all at fault.
Our social political system was at fault. Liberal politicians wanted more Americans to have access to mortgage credit. Conservatives wanted less regulation. Strange bedfellows, they combined to change mortgage lending in ways that combined to create toxicity. Similar political combinations blocked regulation of most derivatives even as derivatives rose to greater trading value than the cash markets.
Our economic system was at fault. Removing Glass-Steagall encouraged commercial banks to jump into securities dealing, a world that has always required different kinds of people with different kinds of incentives and different kinds of controls and management. Regulators and credit-rating agencies failed us with unrealistic "insurance" and "AAA" packages of mortgages were sold worldwide as our financial system emphasized current profits and ignored long-term consequences.
Our financial markets were at fault for accepting credit ratings that, in retrospect, were absurdly optimistic because they were based on data from years of only favorable experience. The SEC unwisely authorized dealers to increase their financial leverage significantly and did not respond adequately to the influx of hedge funds, high-speed trading, the internet, computer models, or derivatives.
Specific participants were at fault -- letting Lehman Brothers fail rather than engineering a feasible take-over; letting major banks get over-leveraged and lose internal control "while the music played"; taking spectacular CEO bonuses based on reported "profits" that were unreal; or not supervising overseas subsidiaries when they reported spectacular phantom "earnings."
Careful study will also find in J.P. Morgan Chase and Goldman Sachs two remarkable organizations of highly motivated and talented people who took themselves to leadership the old fashioned way: They earned it by working intensively within the financial system produced by our socio-political system. We have no public interest in changing their striving and creativity.
As we make changes -- and change is sorely needed -- let's be careful to protect the amazing creativity and dynamism of the financial engine of global growth for the billions of people whose lives will be effected. While creative global finance helped bring two billion people out of poverty in a single generation - the greatest economic success in history -- the changes went too far and the consequences became hugely destructive.
Recent moves by Goldman Sachs, J.P. Morgan Chase, and others to base financial incentives on longer-term results with future "claw-backs" or shifting even more to stock ownership are steps in the right direction. So are Fed regulation, hedge fund reporting, and derivatives regulation. We still have a long way to go and many things to do.
Let's also be sure to install guardrails to protect us all from the extremes we so persistently underestimate - fat tails and black swans. Castigating specific firms with imaginative, but irresponsible insults is not helpful. Nor is it helpful to throw giant cash payouts in the faces of politicians or a public still suffering from the crisis. Indignation is no substitute for careful thought.