Future of US Banking System


On April 21st, we conducted the Financial Stability and Future of Banking Panel at the Madison Avenue building of JPMorgan Chase in New York City. We discussed many controversial topics, such as who is to blame for the current crisis, the effectiveness and implications of government policies and how the banks will have to evolve to survive in this new era where we have thrown the old rule book away. As Finans Network, we are proud to host three preeminent speakers in this panel moderated by Yalman Onaran, Senior
Writer at Bloomberg Magazine. Jayan Dhru, the Head of Global Financial Institutions Group at Standard & Poor’s, Michael Poulos, the Head of North America Financial Services Group at Oliver Wyman, and Richard Christopher Whalen, Managing Director at Institutional Risk Analytics met 120 Finans Network members to analyze the current state of global economy, the stabilization of financial markets, the chaos in regulatory scene and the future of the banking industry
Historical Policies Paved The Way To 2008 Recession
The ongoing financial turmoil has brought reputable financial institutions down to their knees, forced hundred of billions of dollars in write-downs and resulted in several shotgun acquisitions. Policymakers are being forced to put exceptional interventions in place to stop the worsening financial situation. Regulators are debating a rewrite of the governing rules to ensure a sound financial system. 
To understand how the markets arrived at their current state, panelists preferred to analyze the recent history of capital markets. Chris Whalen pointed to the radical changes in the regulatory system after the Great Depression saying, the sudden decrease in the capital requirement for the banks and the final 8% capital/asset ratio paved the way for the problems banks face today. Michael Poulos built on the argument: “After two decades of securitization and the Golden Era of banking in 1993-2003, banks faced significant declines in interest risk profitability and had to expand credit lines” he stated. Jayan Dhru agreed that this movement planted the seeds of today’s economic crises, leading to sub-prime crises. Dhru teasingly quoted “Interest risk wounds, credit risk kills.” He also added how drastically industry belittled and abandoned its own proverbs. Although the dangers of credit risk were often discussed, experts still underestimated the housing bubble, rather naming it a housing soufflé; one that would not burst, but rather unwind slowly.  This forecast, as we all recognize now, turned out completely erroneous. Dhru, talking on behalf of rating agencies, affirmed that they too had expected the profits in the sector to fall, but supposed a much softer landing.
Whose Hefty Shoulders Should Carry The Blame?
Panelist argued that government regulations should have been in place to avoid banks from taking more risk than they could handle. Whalen pointed to the unwise obedience of Milton Friedman policies and mathematical models to create the rules around securitization.
Rating agencies were also criticized for providing Triple-A ratings for the firms who proved to be financially unstable and insolvent on the verge of crisis. Panelists numbered three main assumptions rating agencies used resulting in misleading ratings: 
Relying on history on the magnitude of recent recessions, thus underestimating the aggregate effects of the housing bubble
Being blindsided to the vulnerability of wholesale funding model, not anticipating that short-term funding could disappear overnight
Relying heavily on models to estimate risk, lacking sound historical default studies.
However, Poulos asserted that in free markets, investors, capable of making rational decisions, should not have based their investment decisions exclusively on the ratings provided by these agencies. 
Between banks, regulators, rating agencies and investors, the blame of the market collapse is to be shared.
What Will The Future Unfold For The Street?
In the media, Wall Street is criticized vastly for driving the economy to edge. Two big names in the industry, Lehman Brothers and Bear Stearns burned to the ground, and the two remaining broker dealers, Goldman Sachs and Morgan Stanley became bank holding companies. The TARP package, government orchestrated bailouts and AIG bonuses have raised substantial Main Street anger. We opened the floor to discussion on the road ahead for the firms that were investment  power  houses pre-crisis. 
Except for having to adapt to changing regulatory scene, the banks will have to change their business models significantly in order to create returns. They are expected to settle for lower risk, lower yield products. Panelists think the new industry will resemble traditional retail banking more so than the shadow banking sector that was prospering before the crisis. The most noteworthy enigma is when the confidence will be restored and banks will start lending freely again to provide liquidity without government aid. 
Dhru proposed that going forward, securitization should be controlled closely and originators will need to keep some skin. Keeping the exposure three to six months before selling the product should be a useful way to ask the banks to share the risk of the new product they originate. 
“Consolidation and mergers are also rising in the dawn, given the fall in shares and the necessity to integrate weaker players” Poulos professed. He expressed that, in order create profits, financial institutions should focus on creating value, selling solutions, not products to their clients. 
Creating New Policies: Facing U.S. Treasury’s Limit To Fund
Bush and Obama government drove forceful policies aiming to overcome the crisis and curtail the recession. Interbank loaning, extending funding and equity investment to banks and the sizable stimulus package were all ambitious projects although the effectiveness of some is still subject to debate. 
Whalen suggested that the policy makers should go back to fundamentals and rethink the economic impact of interventions based on Keynesian multiplier versus fiscal policy, both in short and long term. The differences between American and European systems were emphasized and the fixed percentages and fees in many countries such as Denmark were exemplified as successful attempts to create trust in the banking system. The vulnerability of USD was discussed, as well as China’s powerful place in the U.S. economy, as the largest holder of U.S. Treasury bonds. Whalen shared his worries by raising the question “How close are we to treasury’s limit to fund?”
Panelists suggested that the next steps government should take include facing challenging queries such as:
- What is a bank?
- How should the line to capital adequacy be drawn?
- How to police this new market arena?
To Nationalize Or Not To Nationalize: “We have thrown the Rule Book away!”
A question posed by the audience initiated the talk on the “too big to fail” dilemma. The panic in the industry prompted the government to take radical measures and “throw the rule book away” as Whalen articulated. Panelists criticized the federal bailouts stating the TARP package created a system where “Profits are capitalized and losses are socialized.” The return to free markets or the restoration of capitalism, as we experienced it in the recent decades, will be arduous.
Mark To Market Rules
Answering a participant’s question on mark to market accounting, Poulos stated that the rule changes should be explored in depth and added that the current market would look strikingly different if mark to market rules were altered in 1982 or in 1993.
Whalen suggested that firms should be cautious in analyzing the details of balance sheets. He advised to interpret balance sheets using fundamental analysis methods rather than advance software programs.
Onaran’s question ignited the dialogue on the regulatory scene. Established regulatory bodies were not able to halt high-risk activities that triggered the economic crisis.  Whalen offered that a new structure should be build, where regulations should be product-specific. He indicated that regulating the products, not the entities, would help audit and prevent the gaps in the regulatory world. Dhru added that he expects a period of over-regulation and it would be a challenging transition when the regulators need to move out of the banks where they currently hold offices in.  
Panelists agreed that the idea of a combined regular entity is valuable. Charters with differing specialties should be established, but they should all follow the same rules, disclosure standards and safety and soundness guidelines. They also concurred that insurance companies, just like banks, need to present further disclosures.
Comments From The Audience
A networking cocktail, where our members had the opportunity to meet with the speakers and other guests, followed the discussion. Most participants stated that they were astounded at the increasing quality of Finans Network events and were thrilled to be a part of this intriguing discussion. One quoted “I was expecting to see just another debate on the topic, like many fruitless ones we often witness on the media, but Finans Network remarkably surpassed those.” Another member verbalized that she benefited from seeing both sides of the debate, praising the speaker choice representing experts who have experience within banking, regulational institutions, ranking agencies and the U.S. government
.We focus on building a diverse speaker and participant base to present conflicting and corresponding perspectives to provide a strong brainstorming environment for our members in future Finans Network events.
Change is crucial when it comes to financial markets. Let’s hope that the collective learning from Recession 2008 will constitute the building blocks of a strong and sound market place in this new era.
Esra Unluaslan
Director of Media Relations
Finans Network Board 
Disclaimer: The ideas shared in this press release are that of the individuals and do not represent the institutions or the firms they are affiliated with. Finans Network can not be held responsible if investors should consider this report as a factor in making their investment decisions.