Outlook: A No-Account Industry

Wall Street Has Shown Little Responsibility Recently; Bear Stearns Bail-Out Won't Change That

"Once upon a time on Wall Street, in the days when investment banks were small private partnerships, a simple but ingenious idea kept bankers and traders accountable for their actions: the collective-liability clauses in their partnership agreements. A mistaken trade here or bad advice there, and all the partners suffered. ... Accountability has been absent from Wall Street for too long. Unless we restore it to the equation -- amid all the other proposals for fixing the capital markets now being bandied at both ends of Pennsylvania Avenue -- the chances are high that the cycle of boom and bust will keep churning."

Former investigative journalist and J.P. Morgan Chase managing director William D. Cohan, author of "Last of the Tycoons: The Secret History of Lazard Frères & Co.," was online Monday, April 7 at 1 p.m. ET to discuss his Outlook article explaining how using taxpayer money to save Bear Stearns only will lead to future collapses.

The transcript follows.

Archive: Transcripts of discussions with Outlook article authors

____________________

Virginia: Is Bear Stearns an investment company? Why didn't the others collapse too?

William D. Cohan: Yes Bear Stearns is an investment banking company. Others didn't fail for many reasons, but in the end Bear did not have sufficient capital to withstand a run on the bank.

_______________________

Olney, Md.: Bill, if you were appointed to be the Financial Czar to straighten this country out of the mess its in, what would be your first three steps to get us back on the right track?

William D. Cohan: Well first I would change the Wall Street incentive system to make people more accountable for their actions. If all goes well they can still make a lot of money but we have to change the incentives from a revenue driven model to one with more accountability. Then I get the boards of directors out of the pockets of the CEOs and get Wall Street out of the pockets of the leading politicians that are supposed to oversee them ... for starters.

_______________________

Suffolk, Va.: Good morning. During the senate hearings, why did none of the senators asking the questions demand to know why the executives get paid enormous sums of money to screw up? The old adage you have to pay market rates to attract top talent makes me sick -- I'll take the CEO job at Bear Stearns for 5 percent of what the last guy earned, and I certainly can do no worse. Even a trained chimp could have done a better job at risk management -- the chimp knows when he's out of bananas.

William D. Cohan: Couldn't agree with you more. There is simply no accountability. No one seems to want to ask these very obvious questions and I am afraid it gets back to the cozy relationship that exists and has always existed between Wall Street and Washington.

_______________________

Kona, Hawaii: I can't understand why lenders would provide a loan without documentation for a $400,000 house or more. Go to the Chevrolet dealer and you couldn't buy a $15,000 vehicle without proof of ability to meet payments. Obviously our lenders were able to understand that a family making $30,000 hardly was able to make a $1,500-a-month payment for a house, with an increase to $3,000-a-month payments in 12 months.

There are many lenders guilty of terrible crimes. Why won't our Justice Department prosecute them? Obviously the Bush administration is guilty of this and they should be prosecuted. Where is the American justice system? This, along with the terrible foreign policy to prosecute a war in Iraq, is the worst American disaster since the Great Depression. The Republicans must be removed from the White House and the Congress. That is why Obama is so popular.

William D. Cohan: I think you are on to something here. We will know more in November, obviously.

_______________________

Aspen, Colo.: How is it possible a financial firm could have overstated the value of their holdings to their stock holders by so much that the stock would lose 93 percent of its value, and yet not have committed fraud?

William D. Cohan: Well it comes down to that the book value of Bear Stearns was an accounting number -- which is a judgment at a point in time and is backward looking. This was truly a run on the bank. Bear had $17 billion one day and $2 billion the next because their hedge fund clients took their money out first and asked questions later. The government is looking into the question of fraud related to bear's hedge funds that collapsed last summer.

_______________________

Washington: What is your view of Lazard's role in the Bear Stearns debacle? I understand that they were both an advisor to the Bear board, as well as providers of two fairness opinions to that same board. Lazard came under fire for the latter, because they provided an opinion saying that $2 per share was appropriate eight days before saying that a quintupled offer of $10 per share was also "fair." Was Lazard conflicted? Should they be accountable for the fairness opinion they provided?

William D. Cohan: Excellent questions. Lazard was a hired to provide the Bear board an insurance policy. If the $2 a share number was fair then obviously Bear was facing bankruptcy as was described at the hearings on Thursday. And if $2 was fair then $10 was obviously fair. I think Lazard had the easiest job of all here and I am told got paid very well ... probably way way to well as usual.

_______________________

New York: Though I agree with most of your article, I do wonder how you manage to claim that the taxpayers somehow have bailed out Bear Stearns. Even if all of the $29 billion that the Federal Reserve assumed turns out to be bad (highly unlikely), there is still not a single tax dollar that was lost here. This was not a bailout -- this was a liquidation.

William D. Cohan: Well the taxpayers -- you and I -- are on the hook for that $29 billion. The Fed took our money and bought $30 billion of Bear's assets. The first $1 billion of losses will be covered by J.P. Morgan and then the rest of the losses will come right out of that $29 billion that you and I coughed up. Now neither the Fed nor the Treasury believe money will be lost but only time will tell. Who knows? But we are on the hook for that money.

_______________________

Woodbridge, Va.: How is it that Bear managed to survive the events of the past 85-plus years, but now needs saving from itself? Aren't banks and other such institutions supposed to be conservative? We had to prove to the bank 20 different ways that we could afford to pay back the mortgage loan we were asking for; these subprimers should have been subjected to no less scrutiny.

William D. Cohan: Excellent question and this is what I am going to answer in my book. Not to be coy but I am just not sure yet what happened. They did a damn good job of things for 85 years and then beginning sometime last year, things went to heck in a hand basket.

_______________________

Washington: So, in a year when banks are taking huge losses and write-downs, why are investment bankers still getting huge bonuses, even if down from last year? If the banks are taking losses, there should be no bonuses. Don't reward this irresponsible behavior by unregulated banks!

William D. Cohan: I couldn't agree with you more and that is exactly what my article was about. There is simply no accountability for these Wall Street bankers, no matter what they argue to the contrary.

_______________________

Arlington, Va.: Mr. Cohan: Thank you for your interesting and informative article. Do you see anything in Secretary Paulson's proposed reorganization of the financial regulatory agencies that will provide the accountability necessary, or are they just rearranging the deck chairs?

William D. Cohan: I am no expert -- yet -- on Paulson's blueprint -- 250 pages -- but my guess is that more is happening already through the Fed putting its people in all of these banks for the first time than what will come out of the Paulson plan. It is pretty clear the fed demanded that Lehman raise capital, and they did! So for a while there will be a very close watch, and then who knows...

_______________________

Los Angeles: A blot on U.S. capitalism is that Bear Stearns's chairman can receive $61 million after leading the company to its demise, billions in shareholder losses and a government-backed bailout. Formerly, Republicans championed limited government regulations (perhaps because regulated company officials make large political contributions). But Bush killed that Republican brand with regulatory expansion, like the Patriot Act that reduced civil liberties. Now Bushies want to expand regulation of financial markets. You think these new regulations would have exposed Elliot Spitzer's hooker use sooner than Patriot Act Suspicious Activity Reports?

In any event, new regulations should include barring federal employees who regulate banks, brokerages and hedge funds from working for regulated companies until a reasonable period has expired, say three to five years (helps avoid conflicts of interest, like the one that occurred in the in 2002-2003 Boeing-Pentagon scandal); allowing purchasers of a stock that experiences dramatic decline in stock price within 60-90 days of purchase (e.g. Bear Stearns going from more than $100 to $2 since December 2007) to reverse the transaction if the purchase decision was based on fraudulent or grossly inaccurate accounting information the company reported; and finally, ruling that if grossly inaccurate or fraudulent information is discovered, bonuses paid to company and brokerage officials based on such information should be subject to recovery by regulators or shareholders to benefit the company and/or shareholders.

William D. Cohan: Well said all. You are obviously very thoughtful.

_______________________

Chicago: I can understand why Bear's enormous portfolio of illiquid mortgage-backed securities was not taken into account when J.P. Morgan offered their initial $2 per share, but why wasn't the Bear Stearns building, which some say is worth $1 billion, taken into account? Does the new $10 per share offer take the building into account?

William D. Cohan: It was always part of the equation. J.P. Morgan had all the leverage, all the cards in the negotiation so even to consider the deal they demanded the building -- worth 1.5 billion -- for 1.1 billion. nice work if you can get it. Bear obviously was essentially bankrupt after Friday, it could not meet its debts as they came do, and without a serious capital infusion all bets were off. J.P. Morgan took advantage of this perfect storm, as anyone would I bet.

_______________________

McLean, Va.: I think the housing and credit bubbles have proven that the "invisible hand" of the free market never misses an opportunity to give the middle finger to the notion of the greater good. Recent history has shown that market forces will take advantage of every opportunity to privatize any gain, but socialize any risk. I think that the axiom "too big to fail" should have a corollary: If it's too big to fail, then it's too big to go without close regulation.

William D. Cohan: Can't disagree with a word of this. And that was I think the Fed's point on the moral hazard issue. Make it hurt for the shareholders and I guess management but they will all be fine you can count on that.

_______________________

Seattle: It's been posed many times by columnists, but were Wall Street and Main Street ever connected? If so, when did they separate, and how did that separation contribute to the lack of accountability going on now?

William D. Cohan: Well there is the obvious link that Wall Street sells what's on Main Street right? Target, Wal-Mart, Boeing etc. ... they are selling stocks and bonds that represent the credit and the hopes and dreams of Main Street. Still, Wall Street is very insular, completely disconnected from main street and the pay is insane and completely off the charts and out of whack with reality.

_______________________

Lanham, Md.: What I don't understand is how the Treasury Secretary's plan takes power from the SEC and gives more power to the Federal Reserve. Who does Paulson work for, the banks or the citizens? By taking power from the SEC, there will be even less ability to prosecute wrongdoing on Wall Street, while the Fed will be doing what it is already -- nothing. At what point did the bad guys start to run our country?

William D. Cohan: In truth I am not sure the SEC has ever been the best cop of Wall Street ... Secretary Cox said a few days before Bear failed that the firm had enough capital, so this is tough. The Justice Department needs to step up here big time. I think the scrutiny will be huge for the next year or so, heightened by these recent events but can it be sustained as Wall Street starts lining the pockets again. Fix the incentives for bankers/traders and perhaps things will change.

_______________________

Virginia: Even if the investment banks hadn't gone public, hasn't the limited liability corporation LLC form of business organization removed liability from partnerships in all industries, not just those in Wall Street? Shouldn't at least some of the investment banks' lack of accountability be laid at the door of New York state authorities, particularly the New York attorney general's office?

I can't think of any executive at a top-bracket investment bank who ever has been indicted for anything. Despite a lot of posturing by Spitzer and Cuomo, a lot of the recent scandals --research, trading, mortgage securities -- took place on their watch. Seems like most of the perpetrators get off with a slap on the wrist and a fine that readily is accepted as the cost of doing business.

William D. Cohan: The question is, was the behavior criminal, or just bad judgment. There was an awful lot of poor judgment across Wall Street. But was it criminal? Was Bush's decision to send us to war in Iraq criminal or poor judgment?

_______________________

Long Island, N.Y.: Why is congress allocating $300 million to "mortgage counselors"? From the research I have done, this money is funneled into groups like ACORN and the National Council of La Raza, which blur the line between partisan politics and their other activities. ACORN steered many low-income people into these dangerous loans -- advertising 100-percent-financing, no-income-check, no-tax-return loans. Why have the same groups who put people in the mess "counsel" them out? Aren't the taxpayers being ripped off?

William D. Cohan: This one I cannot answer, my apologies.

_______________________

pneogy : Quite right -- the compensation schemes on Wall Street encourage insane risk-taking because managers and traders get the lion's share of rewards in bull markets while shareholders bear the brunt of losses in market downturns. The same incongruity also encourages investment banks to leverage their assets absurdly highly. This is a prescription for disaster, as we know now.

William D. Cohan: Absolutely right -- those bonuses are long gone before it hits the fan. Why not hold more of it back until we know for sure?

_______________________

artg: The bailout was necessary, as we don't want to have a run on all the banks like in 1929. We are not out of the woods yet with only one bailout, as there maybe others. The big question is what the new regulations are going to cover to protect our financial system. They will not occur in the Bush administration, but in the next one. Will the new regulations protect us, or will the financial system go under when the next problem occurs? A fix is needed and I hope it happens. Otherwise don't put you money in a bank -- or for that matter in money -- but other assets like gold. There is too much printed money.

William D. Cohan: You are correct, time will tell. But this was a serious wake-up call.

_______________________

William D. Cohan: Thank you everybody. You can watch me on CNBC at 2:05 p.m. talking some more about all this.

_______________________

Editor's Note: washingtonpost.com moderators retain editorial control over Discussions and choose the most relevant questions for guests and hosts; guests and hosts can decline to answer questions. washingtonpost.com is not responsible for any content posted by third parties.