Hindsight tends to impose order on disorder, to hammer the misshapen contours of chaos into smoother, more intelligible narratives - particularly after a crisis. Even as time sharpens our understanding, it can dull the memory of how that anxiety and dislocation actually felt.
I was reminded of this recently after Goldman Sachs Group Inc., that gilded bastion of Wall Street, emerged from the muck of the Great Recession with a staggering quarterly profit of $3.44-billion (all figures U.S.). The firm also revealed - with what seemed a touch of embarrassment - that it had set aside $11.3-billion for bonuses during the first half of 2009.
And little wonder. Ordinary Americans have been fulminating over excessive banker compensation, since they are the ones who have bankrolled the sector's recovery and essentially indulged its recklessness.
Goldman received $10-billion in bailout money from Washington nine months earlier, but the firm paid it back by the spring, and was now free to do more or less what it liked. The firm's traders were feasting on volatile stock markets and a growing appetite for corporate debt. And, of course, several of Goldman's long-time rivals were enfeebled or extinct, giving it more command of the playing field - and of lucrative fees.
All of this went some way in terms of explaining Goldman's reversal of fortune. But the results made a lot less sense considering the collective panic that erupted last fall in the days and weeks following the collapse of the investment firm Lehman Brothers.
Tuesday will mark the one-year anniversary of Lehman's demise, an event so calamitous that some have taken to calling it 9/15. Though Wall Street's meltdown began with the unravelling of the subprime mortgage market in the summer of 2007, through the dissolution of Bear Stearns and countless hedge funds, the Lehman bankruptcy was undoubtedly the crucible.
This wasn't just the failure of a once-venerable brokerage house. It was an indictment of lax risk-management practices within the financial industry, of pliant credit-rating agencies, of limp regulators and of indifferent lawmakers. More broadly, it was an indictment of market fundamentalism, and it didn't take long before the necrologists were out in force, etching the epitaph for American-style capitalism.
Outraged politicians were quick to offer assurances, as they threw hundreds of billions of dollars at the problem, that when the wreckage was cleaned up, there would be a new financial architecture - one in which rules were enforced, bonuses were reined in and exotic financial products were subject to stiff scrutiny.
Yet Goldman's stellar results implied a different reality. Here was a bank taking on more risk, churning out a gaudy profit and indicating it was on track to pay out more compensation per employee than at any other time in its history. Others were following quickly in its footsteps. The question, one year after the old Wall Street went into cardiac arrest, is: What has changed? Have we learned anything?
A maelstrom unleashed
I remember eating a late lunch last Sept. 17. It was a warm Wednesday afternoon, and I was sitting with a banker on the patio of a bistro, both of us struggling to divine the implication of Lehman's disappearance two days earlier.
In just 48 hours, some version of hell had broken loose. Merrill Lynch was forced to sell itself to Bank of America in order to avert almost-certain bankruptcy. American International Group Inc., one of the world's biggest insurers, began to list badly, and Washington seized control of the company through an $85-billion emergency lifeline.
Meanwhile, distrustful banks refused to lend to one another, fearful that someone in their midst could prove to be the next Lehman.
While we were chewing over what this meant, and making feeble attempts to gauge how far this credit crunch would ripple throughout the system, I received a pair of e-mail alerts. Within seconds, the banker's phone was also buzzing: Morgan Stanley, the No.2 U.S. securities firm, was under fierce attack, and its stock had fallen 23 per cent. There were now rumours it might seek to merge with Wachovia, a troubled North Carolina bank. Even Goldman, the closest thing to unassailable in the pantheon of blue-chip banks, was getting clobbered.
The idea that these twin pillars of Wall Street might crumble, and possibly take the nerve centre of the American financial system along with them, cast the crisis in a much darker perspective. Investors had lost faith in everyone. For the first time since the subprime crisis began, nobody was safe.
Bob Kelly, the Canadian-born chief executive officer of Bank of New York Mellon, recalls surveying the tumult of that week and shuddering: "I could imagine any large financial institution in the world disappearing."
Mr. Kelly was part of a group of high-ranking bank CEOs who held emergency meetings with the Treasury Department and the U.S. Federal Reserve on the weekend before Lehman expired. He acknowledges now that even though people knew the situation was dire, they had no idea the sort of damage that would be wreaked by the decision to let the firm fail.
"In hindsight, that was a mistake - it shouldn't have been allowed to collapse," he says. "What people never realized at the instant Lehman disappeared is how it would create a very rapid, global, funding crisis, of the most severe nature anyone would have seen in their career. Within days, we walked right to the edge of a global depression - and it was breathtakingly bad."
The day after that lunch, word leaked out that the government was readying a $700-billion bailout fund, which would later become known as the Troubled Asset Relief Program, or TARP.
And by Sunday, fearful bankers at Goldman and Morgan Stanley received permission to convert themselves into bank holding companies, a move that made it easier for them to borrow money, but at the same time required them to retain more capital as a buffer against potential losses.
Technically, they ceased to exist as investment banks, while the other three of the Big Five independent firms - Lehman, Merrill and Bear Stearns - had already disappeared. The Wall Street Journal, in a lengthy piece cataloguing the fallout, proclaimed it "The Weekend Wall Street Died." At least it felt that way.
Too fatal to fail
The devastation wrought by the Lehman failure instigated the biggest government intervention in the history of financial markets, and set the stage for similar incursions into the struggling automotive sector.
Over the next several months, both the George W. Bush and Barack Obama administrations made it clear that they would not let another massive institution fail. They injected hundreds of billions of dollars into the country's largest banks, from the weakest, such as Citigroup, to the strongest, such as Goldman Sachs. Meanwhile, they continued to pour more resources into mortgage giants Fannie Mae and Freddie Mac and the ailing insurer AIG.
This was triage, plain and simple. The first priority was to save the patient, however reckless his actions. The discipline would come afterward.
Yet a year later, that discipline doesn't appear very evident. By propping up the banks through loans and guarantees (rather than allowing them to fail, like Lehman, or effectively nationalizing them and breaking them up), the government has created a quandary: If banks know that size determines whether they will get bailed out, there is a built-in incentive to get bigger. And that makes it unlikely that Washington can ever let one fail without endangering the entire system.
"I think the bigger problem is that they've exacerbated the moral hazard," says Ken Rogoff, an economist at Harvard. "[Lawmakers]have shown they're not prepared to let large or even medium-sized institutions fail. That basically sets up the system to reflate to an even larger level."
True, the banking sector is operating with less leverage than it used to, meaning that it is making bets with smaller amounts of borrowed money. But that is only natural, considering some firms were borrowing $25 or $30 for every dollar of their own that they were deploying. And though Goldman and Morgan Stanley have to keep more capital on hand now that they are bank holding companies, they are still assuming enough trading risk to generate handsome profits.
And there is evidence that as banks and their clients are getting stronger, they are regaining a taste for the kind of esoteric financial products, known as derivatives, that proved to be a dangerous black box in the recent crisis.
The Obama administration, along with several other countries, has attempted to curtail excessive risk-taking by clamping down on the compensation policies that induce bankers to make ill-considered gambles. But the actions Congress has taken are both watered-down and difficult to enforce - particularly for companies such as Goldman, J.P. Morgan, Morgan Stanley and others that have paid back their loans and dispensed with government shackles.
Just take a look at last year. Even with the industry on the verge of imploding, and racking up billions of dollars in losses, nine of the largest banks still managed to dish out more than $1-million in compensation to each of 4,793 employees. And the CEOs at the 20 banks that received the most government aid received an average of $13.8-million apiece in total payouts in 2008, despite laying off 160,000 workers, according to a study this month by the Institute for Policy Studies.
European leaders have been much more vehement in pressing for tougher regulations on risk and pay, fearing that the rebound in markets could diminish the appetite for reform - and, by extension, court a repeat of history. Already, the top five U.S. banks have earned more than $23-billion in profit in the first half of this year.
"The abatement of financial tensions has led some financial institutions to imagine they can return to the same modes of action prevalent before the crisis," British Prime Minister Gordon Brown, French President Nicolas Sarkozy and German Chancellor Angela Merkel warned in a letter to their peers this month.
Despite commitments among Group of 20 members to strengthen capital standards and deal with compensation, reform efforts in the United States have been fitful. Attempts to improve regulation, including measures that would create a consumer-protection agency and allow the Fed to oversee banks, have stalled in Congress amid partisan bickering and disagreements over who should shoulder the blame for the crisis. Most alarmingly, the issue itself has been all but elbowed off the stage in recent weeks amid public debate over the future of health care.
"There were commitments made last fall, and I don't think they've been honoured," says James Galbraith, a professor of government at the University of Texas and author of The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too . "I think there's every reason for people to be frustrated. What change have they got?"
Of particular frustration is the diverging fortunes of Wall Street and Main Street: The banking sector is beginning to heal even though unemployment continues to rage and the housing market remains in tatters.
That has left policy-makers in a tricky spot. They have tipped their hands that they are willing to rush in and save any player that might pose a grave risk to the wider system, yet there have been no efforts to remake the system so that it is not vulnerable to problems at a single bank. Washington also wants to see the banking industry regain health as soon as possible so that it can recoup hundreds of billions of dollars in loans and guarantees of toxic mortgage assets and so that banks can begin loosening access to credit for businesses and consumers.
The question is, how does one implement new reforms without choking an economic recovery? And how do you moderate the pace of Wall Street's rebound without tempting a return to the cowboy theatrics - and the cheap credit - of the years before the crisis.
"I'd like to think we've had some very good learnings from this, and it's going to lead to higher capital standards, higher liquidity standards and changes in the regulatory system both here and internationally," says Mr. Kelly, from Bank of New York Mellon. "I think there will be some positive things that come out of this. But shame on us if we don't use everything we've learned to prevent the next downturn."
Mr. Obama is expected to voice similar sentiments in New York on Monday, when the White House says he will outline the progress of bailout efforts and urge other countries to work together to prevent a failure of this magnitude "from ever happening again."
Their success may ultimately rest less on how they envision the future than on their collective ability to inhabit the past.
Sinclair Stewart returns this week from his New York posting to become The Globe and Mail's national editor.