Nostalgia for Glass Steagall

Boy, is sentiment changing. The latest indicator: an article in MarketWatch bemoaning the demise of Glass Steagall, the law enacted in 1933 that separated commercial banking from investment banking.

The article by Thomas Kostigen gets the history wrong. It makes it sound as if the repeal of Glass Steagall in 1999 was a watershed event. In fact, by then, it was irrelevant. Banks had gotten enough waivers of various sorts to enable them to compete effectively on investment banks’ turf. For example, well before 1999, Swiss Bank Corporation, which was later acquired by UBS in 1998, had purchased derivatives trading firm O’Connor & Associates, UK merchant bank S.G. Warburgs, and US investment bank Dillon Read.

To illustrate, this part of the article is a wee bit scary:

But as banks increasingly encroached upon the securities business by offering discount trades and mutual funds, the securities industry cried foul. So in that telling year of 1999, the prohibition ended and financial giants swooped in. Citigroup led the way and others followed. We saw Smith Barney, Salomon Brothers, PaineWebber and lots of other well-known brokerage brands gobbled up.

This passes for journalism? Travelers Group bought Smith Barney (by acquiring Primerica) in 1993 and Salomon Brothers in 1997. Citigroup and Travelers merged in 1998, the year before Glass Steagall bit the dust.

It gets better:

At brokerage firms there are supposed to be Chinese walls that separate investment banking from trading and research activities. These separations are supposed to prevent dealmakers from pressuring their colleague analysts to give better results to clients, all in the name of increasing their mutual bottom line.

Well, we saw how well these walls held up during the heyday of the dot-com era when ridiculously high estimates were placed on corporations that happened to be underwritten by the same firm that was also trading its securities. When these walls were placed within their new bank homes, cracks appeared and — it looks ever so apparent — ignored.

Umm, there was nothing, nada, in Glass Steagall that said you couldn’t have trading and underwriting under the same roof. That was the norm in the securities industry for the large players from the early-mid 1980s onward.

But despite the lack of industry knowledge, Kostigen isn’t completely off base when he suggests the industry has gotten too cozy and insular:

When banks are being scrutinized and subject to due diligence by third-party securities analysts more questions are raised than when the scrutiny is by people who share the same cafeteria. Besides, fees, deals and the like would all be subject to salesmanship, which means people would be hammering prices and questioning things much more to increase their own profit — not working together to increase their shared bonus pool.

Glass-Steagall would have at least provided what the first of its names portends: transparency. And that is best accomplished when outsiders are peering in. When every one is on the inside looking out, they have the same view. That isn’t good because then you can’t see things coming (or falling) and everyone is subject to the roof caving in.

Congress is now investigating the subprime mortgage debacle. Lawmakers are looking at tightening lending rules, holding secondary debt buyers responsible for abusive practices and, on a positive note, even bailing out some homeowners.

These are Band-Aid measures, however, that won’t patch what’s broken: the system of conflicts that arise when sellers, salesmen and evaluators are all on the same team.

Glass-Steagall forced separation. Something like it, where conflicts and losses can be mitigated, should be considered again.

The romanticizing of regulation is a noteworthy development, a warning that leasing and collaring the securities industry will be popular. Lobbyists take heed.

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