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Issues That Needs to Be Resolved in The Financial Sector

The financial industry is mainly designed to supply capital into the real economy. They should provide aid wherever it is needed most in the market. It is not supposed to be an end in itself. However, certain flaws in the sector’s structure enabled it to become a powerful entity that is capable of sucking the real economy into oblivious. And because it is prone to fraud, it threatens the nation’s economic stability, even democracy itself. Among the flaws that can be seen includes the following:

It Has Become Too Big

Financial institutions should mainly act as a “middlemen” that enables capital to flow through the markets. Similar to all middlemen, it should be kept as small as possible while accomplishing its goals. If that is not the case, its structure makes it become parasitical. This is exactly what happened. Since the financial sector became larger than what was necessary, it dwarfed the same economy that it is supposed to serve.

It should also be noted that it uses the capital for its own benefit. Whatever amount remains afterwards is misallocated. Financial sector rewards the already-rich while depriving individuals who need credit and additional capital most.

Causes Crisis around the World

Although the current economic crisis generates the most attention to the faults of the financial sector, it is not the first in their list of misdemeanors. As if that’s not enough, big banks are capable of causing devastating failure to the world economy. It has become very unstable while retaining its power. The industry has enough influence to convince Congress that their accounting rules work, though it is merely an attempt to hide their losses.

Contributes to Inequality

The predation of the financial industry has become so bad that it now controls the upper one percent of the country’s income distribution. As a result, income inequality has widened. This can cause massive problems not only to the economy, but to the social welfare of the citizenry as well.

Did Lehman Have To Go to Save Wall Street?

A year ago this weekend, the Lehman Brothers announced their collapse. With hopeful signs being seen in the economy today, many experts reflect, “What was the impact of the Lehman Brother bankruptcy in the global financial industry?” What if the government bailed-out Lehman Brothers the same way it bailed out Bank of America, Citibank, and a host of other institutions?

We all know the events that preceded the announcement of Lehman Brothers on September 15, 2008. Not surprisingly, the stock market tanked that same day, dropping more than 500 points. The American International Group nearly gave and it had to be bailed out with an $85 billion loan from the US government. European banks were tethering on the edge and there were rumors that Morgan Stanley will be next to go. In general, panic is in the air all over the Western banking industries.

Because of these catastrophic results, the Treasury’s and the Fed’s decision not to help the ailing investment bank was seen as many as the single biggest mistake the government committed in the crisis. Looking back now though, many economic experts are suggesting that the Lehman Brother collapse might have been necessary to prevent other big banks from falling.

A visiting scholar at the American Enterprise Institute suggested that “If the Lehman Brothers’ failure had not triggered the panic phase of the cycle, some other institutional failure would have done so.” Indeed, the weakness of the financial industry was revealed immediately following this event.

However, for people who experienced the Lehman Brothers collapse first hand though, any explanations cannot take away their bitterness. Richard Fuld, the former chief executive of the investment bank, noted that Lehman committed the exact same mistake that other firms did – too much leverage, underestimating the risk of over-relying on real estate, and playing down the risks. Yet, other banks in its position were bailed out; Lehman Brothers was the only one to fall.

Big Banks Back to their Bad Ways

After receiving billions in government bailout and being humbled for a few months, it seems that banks are now back to their old bad ways. But probably the most grating result of the previous year’s financial crisis was that credit became harder to get for individual Americans and businesses.

Contrary to popular perception that banks have become too “weak” because of the crisis, they have actually grown, perhaps at the taxpayers’ expense. For example, Wells Fargo & Co got Wachovia Corp., JPMorgan acquired Bear Sterns Cos, and of course the infamous Bank of America, which got Merrill Lynch & Co. Over the short term, these acquisitions might have helped alleviate financial and political pressure. However, with too much power vested in too few banks, problems are bound to occur in the future. In addition, “bigger” isn’t necessarily better for the end-consumers.

It’s simply part of how the market works. If the big banks already have significant market share, they have “less incentive” to offer longer credit terms, lower fees on opening regular accounts, and they won’t offer high savings rate. There is simply no reason for them to do that. Washington’s “too big to fail” theory might have worked backwards.

Average Americans today might already be experiencing these consequences, but they have not yet experienced the full brunt of it. Taxpayers are being treated as if they’re begging for money. And indeed, it seems that way because they don’t have a choice. Banks today are making more money. However, they aren’t really making credit available to those who need it. This tactic prolongs the recession and is bad for everyone.

Will this situation improve in the near future? It isn’t very likely. If anything, it might even become worse. The big banks are still trying to recoup their losses. They are likely to increase credit card fees, bank account fees, and shift their risks using high mortgage rates and lower credit limit to the consumers. The situation looks pretty grim. And the government needs to do something to right its wrongs.

Bondholder’s $3 Billion Rescue Not Enough to Shield CIT

The $3 billion worth of CIT bondholder pledge might not be enough to avoid a CIT failure. According to Renee Dailey, CIT has “indicated they have significant upcoming maturities”. The commercial lender has around $10 billion of debt that’s maturing next year. It also has to deal with dwindling market share, mounting loan defaults, and other problems related to the economy.

CIT just announced its agreement bondholders; the rescue funding is designed to keep the 101-yr-old institution stable enough to avoid bankruptcy. The first $2 billion of the deal is immediately available while the rest will be received in the succeeding 10 days. While these efforts are certainly commendable, it is not nearly enough. Already, the company has said that this is just the first step. It is also asking debt holders to decrease their claims. In addition, there is a bigger restructuring plan on the drawing board.

What Brought CIT on the Brink of Collapse?

The first question in everyone’s mind is, was CIT as irresponsible as some of the country’s largest banks? It would seem that they were more of a victim of adverse economic conditions rather than a perpetrator of it. Over the last eight quarters, this century-old company has had to deal with $3 billion worth of losses from student loan, home mortgage, and commercial defaults.

However, unlike Citibank and company that were deemed “too big to fail”, it would seem that the government thought CIT shouldn’t get second cash infusion. It is fortunate that the group of bondholders stepped in after the government declined CIT their request. The loan extended to the company is said to be backed by a mix of corporate debt, medium-sized company loans, and even aircraft credits. To get this funding, CIT has pledged assets that have a face value of $30 billion.