On The Hot Seat

Learning from Wall Street’s failures

(Michele Mcdonald for The Boston Globe)
By Beth Healy
Globe Staff / June 27, 2010

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Mark Williams,

author, ‘Uncontrolled Risk’

Mark Williams, a former Federal Reserve examiner who teaches finance at Boston University, recently authored the book “Uncontrolled Risk: Lessons of Lehman Brothers and How Systemic Risk Can Still Bring Down the World Financial System.’’ He spoke with Globe reporter Beth Healy about the book and the financial crisis, as Congress tries to overhaul the laws governing banks and Wall Street.

In your book, you examine the downfall of Lehman Brothers. Do you see this mainly as a work of history, or are the there lessons for the future in Lehman’s fate? I wanted to look at the themes around asset bubbles, and those themes continue to come through. We’ve had both a real estate bubble and an asset bubble. The decade of 2000 was quite an interesting one for learning about excess. I think there are a lot of lessons here for the future.

How, in sum, did Lehman, one of Wall Street’s big names before the crash, wander into such serious trouble?

It was as if the ship got into a sort of narrow, dangerous area where it couldn’t get itself out. It was really a series of small events. Lehman sticks its toe in the real estate market and eventually moves into subprime in the late 1990s, early 2000s. Things looked pretty good. Lehman came in and bought real estate assets for cheap. Then, making profits makes you want to stretch it out further. By 2008, the capital structure wasn’t adequate to support the level of risk.

Congress is trying to wrap up the financial overhaul bill. Does this legislation address the root causes of the 2008 crisis?

The answer is no. One of the key root causes was excessive lending. There’s no piece of legislation that actually sets a higher credit standard on banks. The Fed has had a really disappointing record in protecting consumers. And yet we’re throwing them greater responsibility, and they haven’t earned it. I really don’t think the Fed is up to the task yet.

Do new regulations stand any chance of staving off another crisis?

I think it would be naive for us to say that an asset bubble won’t happen again, and that banks themselves cannot be caught up in another one. It will happen. But we can reduce the chances of another one occurring. It should be crafted with the understanding that these things do occur — it’s part of capitalism.

Don’t regulations tend to look in the rearview mirror, attacking yesterday’s problems instead of tomorrow’s?

The regulators need to anticipate. The excesses of the future will be different. What will be consistent is risk will be taken to make profits. And the government needs to anticipate those risks.

What do you mean?

The Fed needs to start rating banks on whether their compensation schemes are aggressive. We know that compensation itself motivates behavior. So if regulators are going to be proactive, that’s what they really need to look at.

Isn’t it a little late for Congress to go after Wall Street now that the financial crisis is in the past?

Look at BP and the environmental disaster. Regulators need to regulate. We saw that with the Fed. These banks took risk over time, not overnight. And yet the Federal Reserve Bank examiners — and I can speak to that group because I used to be one — they were very slow to understand that growing risk trend, not only its impact on our US banking system, but also how that could affect the global financial markets.

Is the debt crisis unfolding in Europe essentially Part B of the US crisis?

I think it’s a continuation. In this case, instead of a company’s excess, it was a country that’s overdosed on debt. It’s a discipline that wasn’t put in place. Lehman taught us how fragile our global financial system is. And a small country like Greece — its potential implosion has such a rippling affect globally. That just goes to show we need more stewardship and more global oversight . . . we’ve learned the banks just have this ability to shoot themselves in the foot. We have to protect them against themselves.

How do you do that? I think with the Volker rule [and another measure proposed by Senator Blanche Lincoln, requiring banks to raise more capital to continue trading derivatives], they are trying to protect banks against themselves. If you’re going to take big risks, you need a big capital position.