It has been almost three years since the onset of the financial downturn as marked by the liquidity crisis suffered by BNP and its depositors in the summer of 2007. By the end of 2008, the five largest U.S. investment banks were either bailed out by the government, bankrupt, or bought by other companies. First was the government-orchestrated acquisition of Bear Sterns by JPMorgan in March 2008. Next, in early September, Fannie Mae and Freddie Mac were placed into conservatorship. Less than nine days later, Merrill Lynch was acquired by Bank of America, and Lehman fell into bankruptcy. Some 72 hours after that, in light of global systemic risk, the Federal Reserve Bank (the “Fed”) rescued AIG and permitted Goldman Sachs and Morgan Stanley to become “banks.” As such, both were eligible to borrow from the Fed, and subject to its regulation. Throughout this period, sizable banks such as Indy-Mac and Washington Mutual (“WaMu”) failed. There were also major financial company bankruptcy cases and government rescues in the auto sector
There are at least three recognizable lessons from this historic financial turbulence. First, there was a gap in the regulatory scheme: subprime and other financial companies fell through the regulatory cracks; exemptions granted to U.S. investment banks in 2004 permitted unacceptably high leverage levels; and the authority of the Fed or Treasury to make loans or take decisive action was insufficient. Second, financial globalism and sophisticated financial products—notably derivatives—presented an “interconnectedness” that made distress difficult for nations and institutions to contain or address. Third, the impact of fair value accounting and the lack of transparency in derivative liability (including negative basis trades and liquidity puts, among others) presented unacceptably high leverage ratios across the board.
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