Why Are We Having Nonstop Financial Crises?

Issuing a sell opinion on a bank stock is usually a short route to oblivion for a banking analyst.  Mike Mayo is one banking analyst who did issue sell opinions on banks yet managed to survive.  In his new book, “Exile on Wall Street”, banking analyst Mike Mayo provides an insider’s view on why the financial system has spiraled out of control, leading to a series of nonstop financial crises.

Excerpts from Why Wall Street Can’t Handle The Truth provide a convincing argument that the financial system is still basically corrupt, operating against the interests of the general public and beyond the control of regulators.

courtesy goglocalmag.com

Over the years, I have pointed out certain problems in the banking sector—things like excessive risk, outsized compensation for bankers, more aggressive lending—and as a result been yelled at, conspicuously ignored, threatened with legal action and mocked by banking executives, all with the intent of persuading me to soften my stance.

Looking inside the world of finance—with its pressures to conform and stay quiet—may offer some insight into why so many others have fudged. And it may offer some answers as to how crisis after crisis has hit the economy over the past decade, taking the markets by surprise, despite what should have been plentiful warning signs.

Five years after the interstate banking law of 1994, which allowed banks to operate across state lines, the easy gains from consolidation were over. When banks couldn’t maintain their growth momentum through mergers and cost cuts, they took the next logical step—they made more consumer loans. Logic dictated that this meant the quality of those loans would probably decrease, and, in turn, create a greater risk that some of them would result in losses. At the same time, executive pay was soaring, aided by stock options, which can encourage executives to take on greater risk.

To fix the banking sector, should we rely more on government regulation and oversight or let the market figure it out? Tougher rules or more capitalism? Right now, we have the worst of both worlds. We have a purportedly capitalistic system with a lot of rules that are not strictly enforced, and when things go wrong, the government steps in to protect banks from the market consequences of their own worst decisions. To me, that’s not capitalism.

Moreover, the real problem with regulation is that it often doesn’t work very well, in part because it’s always considering problems in the rearview mirror. The financial system today is almost dizzyingly complex and moving at light speed, and new rules tend to address fairly precise things, like banning specific types of securities or deals.

The more effective solution would come from letting market forces work. That doesn’t mean no rules at all—a banking system like the Wild West, with blood on the floor and consumers being routinely swindled. We need a cultural, perhaps generational, change that compels companies to better apply accounting rules based on economic substance versus surface presentation.

Even in 2011, some banks were woefully deficient in detailing the amount of their securities and loans that are vulnerable to the ravages of the European financial crisis. The solution is to increase transparency and let outsiders see what’s really going on.

What we need is a better version of capitalism. That version starts with accounting: Let banks operate with a lot of latitude, but make sure outsiders can see the numbers (the real numbers). It also includes bankruptcy: Let those who stand to gain from the risks they take—lenders, borrowers and bank executives—also remain accountable for mistakes.

Mike Mayo makes many good suggestions for reforming the banks and financial system.  Unfortunately, despite the continuous financial crisis since 2008, fundamental reform of the financial system has seen zero progress.  The biggest banks have gotten bigger, the risks of failure still fall on the taxpayer, and the politicians and Federal Reserve still serve the too big to fail banks.


  1. Ban KKiller says

    It doesn’t take much to understand that the big banks are totally corrupt. Mr. Mayo is very brave to point out the obvious…banks are exposed to MASSIVE liabilities with their ownership of “derivatives”. These are toxic products because of the way they were put together and sold. Everyone involved said “why worry if it doesn’t perform, I won’t be here!” Imagine all those “bankers” and “Wall Streeters” that said that with their products that they were selling to each other. Now they have run out of suckers! Time still to short bank stocks.

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