By Lauren Otis, Staff Writer
Lauren OtisStaff Writer
PLAINSBORO — A complex variety of cultural and institutional factors has made the banking financial crisis the intractable mess it is with little hope for a quick solution unless sweeping changes to the way banks conduct business and are managed are instituted, said Anthony Terracciano, a longtime banking executive and chairman of student loan provider Sallie Mae.
Banks, legislators and the media go forward with the wrong model for problem analysis and problem solving, always fixing the last problem rather than anticipating the next, despite the fact that in recent decades “each solution to one problem becomes the seeds to the next problem,” Mr. Terracciano said in a luncheon address organized by the Princeton Regional Chamber of Congress at the Princeton Marriott Hotel and Conference Center.
”I wish Congress was right — stupidity, fraud and greed — if it was that simple, we’d have this solved in about 12 months, but it’s not that simple,” said Mr. Terracciano, who spent 23 years at Chase Manhattan Bank, rising to vice chairman, and has been president of First Union Corp. (now Wachovia), CEO of First Fidelity Bank and president and chief operating officer of Mellon Bank.
The problem comes from applying what he called the “Othello model” to the financial system’s problems: “You have a lot of good people, you have one bad guy, you find him, you kill him, you move on,” Mr. Terracciano said.
Instead, the financial world’s downfall is more along the lines of the “Oedipus model,” Mr. Terracciano said, with “a lot of well-intentioned people” doing a variety of things, but “the sum total of all their actions is the exact opposite of what any of them wanted.”
”We don’t live in an Othello world; we live in an Oedipus world,” he said.
In addition to the backward-looking nature of problem analysis and solutions, “most of our damage protection is front-ended,” Mr. Terracciano said.
Banking executives would receive a front-end analysis of the risks of a certain financial instrument or investment and approve it, but have no way of continually monitoring risk given “the degree after you approve it, somebody is going to change it a little bit,” he said.
Mr. Terracciano cited the cases of derivatives and syndicated investments.
”Now it has become a bad word. There is absolutely nothing wrong with derivatives if you use them appropriately,” such as to hedge a risk that already exists, he said. “Where you get in trouble is you have a genius who uses them to create a whole new risk position.”
Syndication is also not an inherently bad practice, Mr. Terracciano said. However, “unlink an asset from the quality control related to that asset, you will get in trouble,” he said. “The problem we are having right now is a function, to a large extent, that there was no linkage between syndication and quality control at the front end.”
With pressure to keep growing in boom times and not enough return from holding individual mortgages to do so, lending institutions turned ever more to securitizing the investments, becoming “a commercial bank with a hedge fund wrapped around it,” he said.
Even nomenclature contributed to the meltdown, Mr. Terracciano said.
”You’ve all heard of ‘no doc’ mortgages, which means no documentation, which means I have no idea what the hell I’m doing, but they didn’t call them stupid mortgages, they called them no doc,” he said. “Whenever the word and the underlying reality are not the same you create risk for a financial institution,” he said.
He said he couldn’t fully fault senior management of banks and mortgage companies for not being fully aware of looming problems in their investment and loan portfolios, but “what I can’t excuse them for is the design of some of those products.”
Mr. Terracciano said he believed it will take “a very, very long time to get out of this because we have to go through two stages not one,” first a stabilization of the financial markets, then a return of confidence in the securitization market.
”The market realizes that there was an uncoupling of origination and quality control and will not believe that there is a coupling again for a long time,” he said.
”The financial system of 2009, 2010, 2011, can’t look like the financial system we had in 1980,” he said, or systemic problems again will reappear in four or five years.
Fundamental understanding by senior executives of some of the complex investments their banks took positions in was lacking, Mr. Terracciano said.
As opposed to the old banking model where experience and seniority conferred greater lending authority, with complex derivatives and other investment instruments, the investment is originated by “the most junior person in the approval chain, and so you finally get to the decision-maker and he says, ‘what the hell are you talking about?’” he said.
”Seniority in the organizational chain doesn’t give you the same risk containment as it did 10 to 15 years ago,” he said.
Mr. Terracciano related a story where he sat next to Federal Reserve Chairman Alan Greenspan at a dinner.
”He said to me ‘I don’t know how you guys sleep at night,’” Mr. Terracciano said.
He said Mr. Greenspan told him, “I spent two hours this afternoon trying to understand a derivatives transaction that crossed my desk. After two hours, I gave up. Tony, I was a math major. How do you do it?”
Mr. Terracciano said he responded that if he didn’t understand the transaction as presented, he wouldn’t approve it.
The technical nature of the investments banks took on also meant nonbankers sitting on bank boards of directors often were over-reliant on the bank’s CEO for assurances investments were safe.
Accounting rules, which “defy common sense,” also contributed to the bank meltdown, Mr. Terracciano said. In a good economy, when they are making a lot of money, banks are not allowed to increase their loan loss reserves in anticipation of a downturn, but are required to when times are bad and their business is bad, he said.
Accounting, SEC and tax guidelines are structured in the belief that boosting reserves in good times will tempt banks to misuse those funds or pay them out to shareholders, Mr. Terracciano said.
”That’s a fundamental problem,” he said. “It just violates common sense. You should allow banks to increase loan loss reserves when they are doing well, then watch them like hawks to make sure they don’t peel it out to increase a quarterly earnings result.”
Mr. Terracciano said regulators were not to blame, noting, “I’ve never seen a regulator make a bad loan. The problem is there are not enough of them and not enough is invested in their training to keep them current.”
He added, “The rating agencies are reactionary, and I think that’s a big problem. They are half a cycle behind. I fault the rating agencies that didn’t do their homework. There was a fundamental failure of mission.”

