G-20 to weigh global banking oversight

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By Patrice Hill

One of the biggest questions to be resolved in the Group of 20 summit is what to do about the giant global banks like Lehman Brothers and Citigroup that are the main players in the world financial crisis.

Governments exerted little if any control in the past decade as Wall Street titans and European mega-banks created risky, little-understood securities out of instruments like subprime mortgages and sold them all over the world. Yet when their gambles on the securities went bad and the banks got themselves into financial trouble, they were deemed too big to fail and taxpayers were forced to bail them out.

Some European countries, including France and Italy, would like to clamp down tightly on the banks and severely limit their activities, while Britain has proposed to create a "college of regulators" from each country a bank operates in to supervise each bank.

The United States has taken no stance on the issue. The Bush administration is opposed to any strong, regulatory approach and mostly wants to tinker with the existing loose system of controls, while President-elect Barack Obama and Democrats in Congress favor more regulation but lack a unified strategy.

See related story:Group of 20 to take spotlight amid crisis

While a decision on what to do is not likely at this weekend's G-20 summit, analysts expect that global banks will face much stiffer government controls next year either as national regulators crack down or as the G-20 develops a consensus to take action.

Meredith Whitney, an Oppenheimer & Co analyst, expects governments to force banks to significantly reduce risky activities. She noted that already is occurring on Wall Street, where once high-flying investment firms like Merrill Lynch, Goldman Sachs and Morgan Stanley have turned themselves into regulated banks that are required to follow more conservative practices.

"Banks that all of a sudden thought that they had kryptonite powers have to come back to earth," she told a Reuters conference, and the result will be a transformation of the way Wall Street and global banks do business.

Some banking powerhouses already have paid a steep price for their mistakes. Bear Stearns & Co., the firm that had the most extensive mortgage operations on Wall Street, was forced into a takeover by J.P. Morgan in March by the Federal Reserve. Washington Mutual and Wachovia Corp., two major banks that were loaded down with toxic mortgage portfolios, also were absorbed by other banks in marriages arranged by federal authorities. Some big European banks have met with similar fates or been taken over by regulators.

Lehman Brothers paid the ultimate price as its pleas for assistance were rebuffed in mid-September and it was forced to file for bankruptcy, creating a tidal wave of defaults on more than $200 billion of debt that is still reverberating through global credit markets.

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The shock wave caused by the Lehman defaults was so great that it prompted dramatic action by regulators around the world to inject trillions of dollars into stricken credit markets and set up massive bailout programs for banks that were suddenly choking from the sudden credit drought.

The ugly aftermath of the Lehman bankruptcy prompted much criticism of the Treasury's and Fed's decision not to rescue the Wall Street firm, and is cited by regulators from Hong Kong to Paris as a reason such global banks must be more tightly regulated in the future.

The Treasury and Fed say their limited regulatory powers left them with no choice but to let Lehman fail. But Fed Chairman Ben S. Bernanke seemed to concede recently that the bankruptcy created monumental problems when he told a conference that the United States has a "too big to fail problem."

Ironically, the numerous mega-mergers between banks that the Fed and Treasury have hastily arranged this year to stave off messy bankruptcies or taxpayer-financed bank closings have only added to the problem by creating even bigger banks whose failure would be even more destructive to the financial system.

"We need major process changes, major infrastructure changes, major regulatory changes. There's no question about that," said Robert Kapito, president of the BlackRock investment firm. He said that overhauling regulation of banks will be at "the top of the agenda" for Mr. Obama and Congress next year.

"The industry, right across the board from sophisticated Wall Street firms that created the trusts and the [collateralized debt obligations], down to the intermediaries that made the loans, and in many cases borrowers' irresponsibility, will require more regulation," said Denis Salamone, chief operating officer of Hudson City Bancorp Inc., adding that regulators may even go too far in an overreaction to abuses.

"It's deserved if it goes overboard a little bit," he said.