Submitted by Edward Harrison of Credit Writedowns.
Last week, I followed up Yves Smith’s excellent post on “Why Big Capital Markets Players Are Unmanageable” with “More on why big capital markets players are unmanageable.” I would like to extend the discussion beyond the U.S. border into a look at how the universal banking model abroad encroached on the U.S. banking system and created a response that made the repeal of Glass-Steagall an inevitability. I begin this post with the end of the Bretton Woods system and the beginning of deregulation. These event internationalised finance in way that made universal banking a desirable business model in the U.S. and ended Glass-Steagall.
I should note up front that I am not a market pundit that thinks the repeal of Glass-Steagall was a catalyst for the credit bubble and crash. Nor do I think regulatory reform should bring Glass-Steagall back as Paul Volcker seems to argue. Hopefully, this post will help explain why.
In July 1944, major nations met in Bretton Woods, New Hampshire to discuss reforms to the international monetary system. What came out of this conference was a system that had the U.S. dollar at its core with the dollar linked to Gold at a value of $35 an ounce. The system was stable only to the degree that the U.S. dollar maintained its value at this level. However, the U.S. started to inflate from the word go, with this inflation taking on greater measure in the 1960s under the”guns and butter” policy of Lyndon Johnson.
The French, under the charge of the sometimes anti-American leader Charles de Gaulle, were the first to balk at the inflation and they started to convert their U.S. dollar holdings to gold. Other nations followed. This led to the closing of the gold window in 1971, which was the formal recognition that the U.S. dollar was a depreciated currency due to money printing of the U.S. government.
Post Bretton Woods changes in American finance
After Bretton Woods ended, inflation soared globally, leading to disintermediation of the traditional banking system. Money market funds and the Eurodollar market came into existence immediately. Other forms of disintermediation for commercial banks followed including the development of the high yield bond market and securitization to name two. The market for oil and currencies took off as the removal of gold backing from the international monetary system introduced volatility into those markets. The net effect of these changes was a reduction in profits in traditional banking in America and a internationalization of the U.S. financial system.
In large part because of these changes, a focus on deregulation was seen as a fix. In academia, the laissez-faire movement had become dominant, with professors like Milton Friedman leading the way. Now, their ideas were moving into markets beginning with the deregulation of brokerage commissions in 1975 and the creative destruction this created. Over the short-term, deregulation was a killer for broker-dealers, upending the brokerage industry, decimating profits at many brokerages and leading to the rise of discount brokerages like Charles Schwab. This also allowed commissions to be low enough for middle class Americans to start participating in the markets and can thus be seen as a democratization of the markets.
But, overall the 1970s were unkind to the finance industry in America. Commercial banks were disintermediated. Broker-dealers were wiped out and large portions of the financial system moved offshore. The result was that American finance increasingly went abroad in search of profits.
The U.K. is next for major changes
Meanwhile the deregulation movement was gathering steam. The U.K. was considered the sick man of Europe in the 1970s and deregulation was seen as a fix. Eventually this led to changes in Britain that were similar to the changes in the U.S., the most significant of which was Big Bang in 1986 when fixed commissions were abolished. As in the U.S., the stockjobbers and stockbrokers were pummelled by deregulation and many went out of business. In my view, this marked the beginning of the global Universal banking model. Here’s why?
The U.K. became a beach head for U.S. banks searching for profit abroad after the collapse of oil prices and the Latin America crisis in the early 1980s. This disintermediated traditional commercial bank lending in western Europe and reduced profits significantly for banks there. The U.K., as part of the European Union since 1973 and the locus of the Eurodollar market, also became the beach head for European universal banks now expanding internationally, in their own effort to increase profits. All of the major U.K. merchant banks were eventually gobbled up – most by foreign universal banks. Remember Barclays de Zoete Wedd, ING Barings, Dresdner Kleinwort Benson, SBC Warburg, Deutsche Moran Grenfell? Only one of these takeovers involved a U.K. domestic bank. In effect, the U.K. was becoming a de facto Universal banking market.
Back in America: New Competition
By the late 1980s and the 1990s, the deregulated atmosphere in the U.S. meant that commercial banks were seeing an erosion of margins in their traditional lines of business. They reached abroad and were burned (see article on ratings downgrades from 1988). So, they successfully lobbied to increase their ability to participate in investment banking (see 1987 NY Times article) and trading (not without problems: Bankers Trust was the most aggressive and trading irregularities were noted as far back as 1988).
By the 1990s, the now internationalised European universal banks were on the prowl in America too (I am ignoring Japan because its banks were forced into retreat during the lost decade). We saw Credit Suisse acquire First Boston, SBC acquire Dillon Read, and Deutsche Bank acquire Banker Trust. Now, we were seeing international universal bank behemoths that had huge balance sheets and huge investment banking and trading operations in America. The American companies felt at a disadvantage because of Glass-Steagall. And, in truth, they were. So, at this point, Glass-Steagall’s repeal was inevitable because the climate in banking had changed. It was much more international and much more of a universal banking model.
Nevertheless, there was ample reason for alarm because deregulation and lack of oversight make for a dangerous combination. Had America moved to a universal banking model with strict oversight like one sees in Canada, perhaps many of the problems of the credit bubble could have been avoided. But, oversight was lax and the regulatory controls that even the Federal Reserve was granted over the mortgage market in 1994 were never used to stop excess in that market. All of this was predicted in 1999. Below is an excerpt from a New York Times story that ran after Glass-Steagall was repealed.Note how many of the lawmakers cited are the same ones in power today.
In the House debate, Mr. Leach said, ”This is a historic day. The landscape for delivery of financial services will now surely shift.”
But consumer groups and civil rights advocates criticized the legislation for being a sop to the nation’s biggest financial institutions. They say that it fails to protect the privacy interests of consumers and community lending standards for the disadvantaged and that it will create more problems than it solves.
The opponents of the measure gloomily predicted that by unshackling banks and enabling them to move more freely into new kinds of financial activities, the new law could lead to an economic crisis down the road when the marketplace is no longer growing briskly.
”I think we will look back in 10 years’ time and say we should not have done this but we did because we forgot the lessons of the past, and that that which is true in the 1930’s is true in 2010,” said Senator Byron L. Dorgan, Democrat of North Dakota. ”I wasn’t around during the 1930’s or the debate over Glass-Steagall. But I was here in the early 1980’s when it was decided to allow the expansion of savings and loans. We have now decided in the name of modernization to forget the lessons of the past, of safety and of soundness.”
Senator Paul Wellstone, Democrat of Minnesota, said that Congress had ”seemed determined to unlearn the lessons from our past mistakes.”
”Scores of banks failed in the Great Depression as a result of unsound banking practices, and their failure only deepened the crisis,” Mr. Wellstone said. ”Glass-Steagall was intended to protect our financial system by insulating commercial banking from other forms of risk. It was one of several stabilizers designed to keep a similar tragedy from recurring. Now Congress is about to repeal that economic stabilizer without putting any comparable safeguard in its place.”
Supporters of the legislation rejected those arguments. They responded that historians and economists have concluded that the Glass-Steagall Act was not the correct response to the banking crisis because it was the failure of the Federal Reserve in carrying out monetary policy, not speculation in the stock market, that caused the collapse of 11,000 banks. If anything, the supporters said, the new law will give financial companies the ability to diversify and therefore reduce their risks. The new law, they said, will also give regulators new tools to supervise shaky institutions.
”The concerns that we will have a meltdown like 1929 are dramatically overblown,” said Senator Bob Kerrey, Democrat of Nebraska.
Clearly Bob Kerrey was wrong and Paul Wellstone was right.
Post-Internet Bubble makes universal banking model complete
Just after this legislation was passed at the peak of the Tech Bubble, the bubble burst. I would argue that the bursting of the bubble was instrumental in completing the transformation in the U.S. to a universal banking model. If you think back to the mid-1990s, there were scores of boutique investment banks concentrating on the technology sector. The ‘Four Horsemen’ of Alex.Brown, Montgomery Securities, Hambrecht and Quist, and Robertson Stephens were the principal actors. When the tech bubble burst, all of them disappeared, gobbled up by large commercial banks.
In effect, the disappearance of the Four Horsemen marked the end of the old Glass-Steagall model. It was only a matter of time before the likes of Morgan Stanley and Goldman Sachs were forced into the universal banking model.
U.S. Banking: Worse after the crisis than before
With the disaster at Lehman Brothers and Bear Stearns, the transformation became complete because Merrill was gobbled up by Bank of America and Goldman and Morgan became banks. Now, I failed to mention that another step commercial banks took to defend the economics of their business was to merge (list of large mergers here on Wikipedia). This, coupled with relaxation of interstate banking laws, has made the U.S. banking system very concentrated. Add in FDIC-enabled takeovers of WaMu and Wachovia and six too big to fail institutions control the roost: Citigroup, JPMorgan Chase, Wells Fargo, Bank of America, Goldman Sachs and Morgan Stanley.
So, ironically, the U.S. banking system is much more prone to systemic risk today than it was a year ago or a decade ago. Moreover, these institutions still have an enormous amount of so-called toxic assets on their balance sheet hidden in Level Three assets (see post “Level Three Assets: banks are hiding the ball on credit writedowns”). These assets have not been written down to reflect present market values. And, many more writedowns from commercial real estate and credit cards, leveraged loans and high yield bonds remain to be taken.
My conclusion, therefore, is that the likely technical recovery toward the end of this year or the beginning of 2010 is a fake recovery. Much underlying systemic weakness remains. Moreover, the U.S. banking system post-crisis is more concentrated and more vulnerable than ever before. Will bringing back Glass-Steagall solve this? No. This post demonstrates that there are forces in the global marketplace that make Glass-Steagall a relic of the 1930s. Nevertheless, a move away from the self-regulatory nonsense of the last generation is warranted. Enforcement of existing regulations, regulation of OTC derivatives and the shadow banking system are all important steps that need to be taken. However, above all, I am most concerned with the concentrated risk in our financial system. I see no other way to reduce this concentration than to break up too big to fail institutions. If you do see another way please feel free to comment.
Edward, thanks for the post. One additional insight from the regulatory perspective: much larger institution are harder to regulate, as in many cases the difficulty of regulation rises exponentially with the size of the institution.
With a small company focused on one or two lines of business, only the regulations pertaining to those lines of business need to be examined. But with larger institutions in multiple lines of business, not only the lines of business, but their interactions with each other have to be examined.
With a small bank, only the expected areas of interest need to be examined: capital requirements, lending standards, etc. But with a universal bank, lending needs to be checked against securitization, which needs to be checked against analysis, which needs to be checked against insider trading, which needs to be checked against proprietary trading, etc., etc. The result is a regulatory maze that requires scores of regulators to review, and which can never be reviewed thoroughly enough.
Too big to fail is also too big to regulate. And unfortunately, the savviest players know that, and know that they can work in the gray areas of the regulatory structure, confident that they'll never get caught or, at worst, get caught but have to pay a penalty far lower than the benefits. All that points to the same conclusion: the sizes of institutions have to come down to manageable levels.
While there's some points to your history, I'd say its pretty industry standard view of what happened, especially over the last three decades.
One thing is the banks played a role in opening up the S&L industry so they could get their grimy paws all over that. Check out Greider's analysis in "Who Will Tell the People?"
Also, you drop profitability and "internationalization" in there as reasons.
1)Getting money from money is much of the time profitable, the size of the profits is the issue. Everyone hates to see other people make more than themselves, especially Wall Street and the banks. Its ok to regulate certain aspects of the financial system to low profits and if people aren't happy with that, they can get into another business.
2)Internationalization, it was the corporations that created this system. It's not some a priori force of nature. There's ability to protect things from forces deemed harmful. You write this very much how the narrative has been the last three decades. The mega-corporations were behind the whole corporate globalization process and they kept using it for reasons that things had to change, while they were the force behind the whole process. So, when you say internationalization as a cause, its not, it is a process we allowed to be created.
Finally, Glass Steagall was not a relic. It's greatest importance and that of many of the regulations of the era were to separate the money supply and sectors, so that if there was a problem in one area, it didnt instantly spread across the whole system. Again, it's ok if your going to lend money to certain areas of the economy, its not tremendously profitable, just enough, that keeps things stable. Like I said if you want bigger profits go somewhere else.
This is why all the talk from Obama et al is not getting to the point. You don't need a systemic regulator, you need rules and regulations that don't allow bubbles, we had them for fifty years and they worked well, sure some can always be updated, but there's a lot of wisdom from what they did in the 30s we could relearn. I'm not a neo-New Dealer.
The financial sector needs to be caged back up, it needs to be shrunk by at least half.
Enjoy your writing.
I dunno, if we break up our TBTF institutions and other players do not it seems like we have just made it easier for foreign TBTF banks to buy up now digestible sized American banks (probably just in time for the next crisis). It seems like that would make responding a crisis even more buggered than it is now.
My take on what is now happening is this: the crisis has benefited TBTF institutions by consolidating power. Therefore, they are willing to accept the changes proposed by Obama which do not address their size and dominance in exchange for being allowed to continue in their present form.
The result is that regulatory reform will be a failure and large banks will continue business as usual. Concentrating on a return to Glass-Steagall does not have enough political support in Washington. That's simply not going to happen even if Obama suggested it.
Therefore, if we want any change, it would have to be in reducing the risk posed by TBTF institutions. And since I have little faith in macro-prudential regulations due to how poorly regulators have operated, trying to create a systemic risk regulator just is not going to do it.
Well, I don't see any forces here except political ones. The kind of determinism that says, for example, "Glass-Steagal has been negated by the forces of history and therefore cannot be brought back" is really just trying to pretend a certain political order is a law of nature or a metaphysical verity.
In this case, it's the financialization of the global economy which is assumed to be the Hegelian Absolute, when in fact we don't need to have any such thing, and can politically decide to be rid of it (and we'd be better off for it).
In fact, globalization itself has seen its high point and now starts its ebb. Oil depletion will enforce this, and from there the inability of financialized
civilization to resurrect exponential debt, which is in turn necessary for growth.
That's why the banks are hoarding and not lending. They know the debt party is over, and any further lending is throwing good looted money after bad.
And that in turn is why we don't need the big banks at all anymore, let alone in this Rube Goldberg form.
I suggest that we "break up" "too big to fail" institutions by allowing them to fail. "Too big to fail" is a political problem, rather than an economic problem.
Imposing new "regulations" in an oligarchical system is completely fruitless, because the corrupt lawmakers and regulators involved will ensure that the "regulations" benefit the oligarchy at the expense of other market participants.
This is exactly how we ended up with "too big to fail" institutions to begin with. These institutions became "too big to fail" not as a result of free markets and capitalism, but rather special subsidies, tax breaks, bailouts, institution-specific exemptions from regulatory requirements, and other political favors. Not to mention the ability to violate securities law with impunity (due to regulatory capture), while instigating selective enforcement of securities laws against competitors. Without these factors, these institutions would have been "broken up" a long time ago. By failing!
Am I making my point clear? The problem we have in this country is not too many regulations, too few regulations, socialism, or capitalism, but rather a corrupt oligarchy that has captured our government (a la Russia). This is the problem that must be addressed before all others. Until then, all other attempts to "fix" our system are doomed to failure.
I disagree w Dr. Harrison and agree w Joe Costello that Glass-Steagall is a relic of a bygone era. The point of Glass-Steagall is that brokerages were trading on the good name of the then-prudent banks to sell people stocks and bonds. This goes on today. It impresses people to this day and especially up to 2007 that the great Bank of America says that XYZ Corp is a "buy".
In addition, the finances of depository banks and that of brokerages should be separate.
One borrows short and lends long and makes them subject to runs.
The other is either a middleman or an underwriter- – neither is subject to runs and neither is critical to the day to day functioning of society and thus needs no special rules/support.
I have to differ a wee bit with your history.
Citibank had universal banking aspirations since the early 1980s. Ditto JP Morgan, BT was keen since the late 1970s to get into investment banking, but didn't think having consumer deposits was a plus and famously sold their branch network
And by "universal banking" most people meant the euorbanks, like DeutscheBank, which even as of the 1970s had been permitted for more than a century to own unlimited stakes in industrial companies and underwrite and trade securities. So this was a long standing model, not a new model. The Germans and Swiss just were not very good at the investment banking part, sine their securities markets were not as deep and developed as the US.
Also, the US bank acquisitions of UK brokers post 1986 were notably unsuccessful. The view among investment bank prior to this exercise, and it appeared to confirm their prejudices, is that commercial banks would screw up any securities industry deal by imposing new, inappropriate management systems on the staff, leading them to quit. The first kind of investment banking deal I recall succeeding was the Swiss Bank Corporation acquisition of O'Connor & Associates, a derivatives trading firm. I was very much surprised they kept the people and were successful at skill transfer. They had a JV in 1992 and did the full acquisition in 1993. If anyone knows of any earlier deals that could be deemed successful, I'd be interesting in knowing about them.
And Glass Steagall was shot full of holes by the time it was formally repealed in 1998. The main practical impact was allowing the Citi-Travellers merger to proceed. Look, I had Citi as a client in the 1980s and as of 1986, they had bought and sold an industrial company, meaning not as an M&A advisor (that was perfectly kosher) but moving it through their balance sheet. This appeared to be one of those typical Citi "let's do it because we can" sort of the way engineers take apart and reassemble washing machines for fun. Any regulator would have been horrified. And the real waivers took place in the later 1980s and 1990s.
The big deal for the commercial banks was the rise of derivatives. New product, the highest tech, they got in on the ground floor, and balance sheet strength was important in that business.
Good comments. I would agree there are some caveats to the brief history one could make i.e. BT or JPM's desire to enter I-banking and Citi's global universal banking aspirations.
Glass-Steagall's repeal was inevitable, because it was shot full of holes by then. I agree 100%.
My focus here, however is that international pressure created an atmosphere where universal banking in the U.S. was desirable for the big banks. Even though the European banks were clumsy and poor managers (I was at Morgan Grenfell when became subsumed into Deutsche Bank so I know from personal history) and were wasting lots of capital, they still made banks in America have to react. Just as Morgan Stanley felt it had to react to Merrill's retail franchise.
The likes of Goldman, JPM, and Morgan Stanley were getting their clocks cleaned in Europe by the Universal banks. In the U.S., UBS and SBC and Deutsche were laughed at in the 1990s. But in the last decade, they were making inroads in all the businesses – even advisory.
Was it derivatives? Yes, in part. But, it was also the huge balance sheets, the ability to do bridge financing, to syndicate loans, etc etc. And, it ws the ability to poach talent as well: Deutsche Bank's global markets operation has been run by Ex-Merrill people for over a decade. Anshu Jain is on the board of directors there now. That's huge in Germany.
As for Glass-Steagall, again, I do no think one could categorically say its repeal led to the crisis. Bringing it back is no panacea and I don't think it's possible given the international nature of finance.
I fully expect Goldman and Morgan Stanley to be universal banks as well in due course.
I simply do not agree with your reading of motivations.
BT lobbied the REAGAN administration for, and got, Rule 415, as of 1983, the first real chink in Glass Steagall (shelf registration of new securities issues, main implication that banks could now distribute without underwriting. Effects different than BT envisioned. Did not do much of anything for banks in the corporate bond business, but did a lot to weaken relationship between IBanks and corps).
McKinsey as of the mid 1980s was doing TONS of studies for major commercial banks on their investment banking strategy, even Japanese banks. They all saw the very high IBank ROEs and wanted a piece. This was defensive only as far as they were also losing market share to IBs via disintermediation, that is, the rise of securitization. We had tons of crap at McKinsey showing banks why this was inevitable. Markets were much more geographic then, US banks saw Europe as a separate market, as an opportunity. Their version of your history would be "it was harder to penetrate some businesses than we had expected."
Thus, I don't know what you mean about "getting clocks cleaned". The Euro banks had long dominated Eurobond trading and dealing, but that was a really crappy, low margin business. The US banks were making good headway in M&A, which was far more high margin. albeit often on the backs of US LBO firm deals.
No one except a nut did bridge loans to win M&A (and anyone, unless he is a VERY seasoned, savvy deal-doer, who picks his M&A advisor based on his lending ability also needs his head examined). That is a peak of cycle phenomenon that always leads to tears. A bad bridge loan (Ohio Matress, aka "Burning Bed" nearly killed First Boston at the end of the 1980s LBO wave, and forced its JV partner, Credit Suisse, to buy it out. I know the guy from the FB side who was running that deal, the Swiss were NOT happy to take on FB. Pretty much all the end of cycle LBO deals from then delivered huge losses (everyone forgets that the banks in the early 1990s had huge LBO losses; GE Capital had a major unit working out its own deals). The damage to banks was much more extensive than the "S&L crisis" banner put over that era. And now we have a re-run with CLOs.
Similarly, CLOs in this cycle were a sign the banks had lost discipline. Linkage of the two products is always a sign things are going to blow up.
Morgan Stanley was an exception re retail securities and I recall the logic among analysts at the time. Was not seen as a competitive threat, was seen as a more predictable profit stream (as in increasingly going to asset management model) and hence would produce higher valuations. Again, you see it as defensive, I don't see it that way at all. No other big IBs made that move. PaineWebber went to UBS, I don't recall any US interest on that deal All the regional securities brokers (Wheat First, McDonald & Company) were also ripe for the picking. No one went after them.
Morgan Grenfell had always had a good advisory business that would now be seen as boutique due to its limited geographic footprint, so that was an existing franchise.
The universal banks did give the US banks a big basis for making their case, but frankly, the biggest thing in their favor was Greenspan.
Agree with Ed that any successor to Glass-Steagall would have to apply globally now. Imagining how the politics would work for that is quite a stretch though.
Yves, you've reminded me, Burning Bed was another nail in the coffin for Glass-Steagall. IIRC (worth checking) the CS takeover was considered to be a breach of G-S but the Fed chairman, one Alan Greenspan, deemed that the systemic risk of having FB go under outweighed other considerations. Looking back it's amazing how slow they were to actually get on and repeal it.
Ed, not sure if it was the universality of the Eurobanks that led to slow progress in Europe for the Americans. Wasn't it just hard to get those businesses going?
On what we Brits call the continent, there is a durable aversion to "Anglo-Saxon" finance. French, German, Dutch and Swiss clients always had credible locals that did business the way *they* wanted to.
In the more accommodating UK, it was the builders rather than the buyers amongst the American entrants post Big Bang who made it, and again that just does take time.
I don't think the Eurobanks were a credible threat to US banks *in the US*, in much the same way as the Americans didn't do so well in Germany, etc. That may not be the way it looked at the time to the Americans, but OTOH bigging up 'unfettered foreign competition' hits all sort of handy political buttons if you are a US bank that wants to be 'universal'.
Admittedly UBS did eventually hit the big time, but not really in the way they wanted, as it turned out. They had taken some risks!
It's worth noting that the IBs were riding high until chopped down in 2008. The survivors' taste for universality is quite recent. Would they have turned into banks if they hadn't needed the Fed window? Not sure.
Ed & Yves,
I was on BT's branch divestiture team in the early 80's. And I advised the BT team that developed the first non-currency asset backed derivative—commercial paper backed by letters of credit, tying together both sides of the BS to reduce rate volatility risk. Before BT, I covered Wall Street banking as a Senior Banking Industry Manager for The Service Bureau (computer timesharing, which was pervasively used by all the money centers, especially for money market applications, bond bidding and statistical models to reset prime weekly).
I can honestly say, most of the top money center banks back then were keenly interested in repealing Glass-Steagall, especially the wholesale banks, BT and JPM.
Ed, disintermediation was a key factor in this interest. Rate regulation until the Monetary Control Act of 1980 capped the interest rates all US banks could charge for loans, while inflation meant they had to pay double digit rates to attract deposits. Everyone was seeking different models to better control balance sheet portfolios. For all intents and purposes, the loan/deposit model was already dying. But, I don't recall much concern about competition with European banks—other than offshore regulation changes had recently opened to door to new international FX trading desks. Bond issuance for banks was still confined to municipals until Glass-Steagall repeal.
Yves, you are right that legislative changes won in the early 80's had far different consequences than imagined. Used to managing by portfolio arbitrage, I don't think the banks fully understood what the shift to an IB model would mean capital-wise. I left BT at the end of 1983—it was ideas about derivatives that brought me in and a difference of opinion about the future of derivative usage that led to my leaving. So, it was just as the LBO craze was gaining momentum. I'm not surprised though that, one thing leading to another, derivative creation and usage exploded. It may have been the only avenue open to banks, given the restrictions of regulation then.
We need a new global banking structure that's regulated globally. I agree with Ed. I'm not comfortable with the current degree of banking concentration worldwide or the degrees of freedom to conduct business off the books either. However, re-enacting Glass-Steagall won't solve these problems.
Like many who have commented before me, something needs to be done and done fast, but I'm at a loss to say what it should be.
Thanks for the nice discussion of possibilities though and keep it up.
Thanks for adding your voice. And it is a great discussion. A lot of food for thought. I expect Yves and I will have some links tomorrow on the same topic.
By the way, I had a back channel e-mail exchange a with Yves and I do think she and I agree far more than it may seem at first blush. When we get a chance to 'harmonize' I will add my two cents on why her last comments were good and where I agree.
I think we all understand that the Glass-Steagall act of 1935 was not the same as what was repealed in 1999. But the principle which underlay it of separating investment activities from commercial banking and insurance is. This is what many of us are talking about when we invoke Glass-Steagall. It would have kept many of the TBTF entities, like Citigroup, from existing or have prevented others, like AIG from ever getting involved in the CDSs that did it in. Even major villains in the meltdown like Goldman would have been constrained because there would likely have been no housing bubble or the securitized flows from it for Goldman to profit from and which eventually brought the financial system to its knees. Nor would Goldman have access to the creditlines it does now to fuel its ongoing speculations.
Glass-Steagall is far from the only reform needed for the financial industry, but it is an important one and remains an excellent barometer of how serious or not the Obama Administration is about real regulation. That it isn't even on the table says everything about how unserious Obama and his economic team are about reform. If they can't even address Glass-Steagall, there is no way they will ever move to break up institutions TBTF.
Hugh, Joe Costello and DoctoRx, I have great respect for the view that Glass-Steagall was worthy and helped to keep things in check. So while I make a different argument here, I understand why it existed – to keep systemic risk in check.
As for Yves earlier comments, having pinged her, I think we agree on most of the core issues. (As much as I like to stir the pot, I wouldn't like to post unless content alien to her way of thinking)
In particular, BT (and JPM and Citi) were lobbying for a long time to move into Ibanking). They wanted the ROE as Yves said and given their declining ROE, they had huge reason to want in.
Yves says "This was defensive only as far as they were also losing market share to IBs via disintermediation, that is, the rise of securitization."
Agreed. And don't forget high yield bonds and leveraged loans too.
Yves also said "Thus, I don't know what you mean about "getting clocks cleaned". The Euro banks had long dominated Eurobond trading and dealing, but that was a really crappy, low margin business."
She says: "The US banks were making good headway in M&A, which was far more high margin. albeit often on the backs of US LBO firm deals."
Yss, Yes, Yes. Europeans clocks were getting cleaned in a big way here. This gave them incentive to move into the U.S. in my opinion.
As far as getting balance sheet and retail brokerage access, that was a big part of the tech bubble because of telecom and technology. Yves told me she saw the retail brokerage talk as a bit of a fad of the mid to late 1990s. I would agree and it went away post-tech bubble.
But, in the end, I come full circle to my main point of disagreement i.e. Glass-Steagall. As Kathleen has said, all of Europe and Canada have the universal banking model and they all have a huge presence in the U.S. markets. It seems unworkable to bring back Glass-Steagall in that environment, even if it had political viability – unless this is arranged on global basis and that is not going to happen.
To the degree the TBTF institutions need to be held in check, reducing their size and increasing oversight are more preferable ways of dealing with the situation given this constraint, IMO.
By the way, I would still argue that strong oversight and applying the existing regulatory laws is more important than Glass-Steagall.
Since glass stegal aint coming back anytime soon, how about a corporate tax on the lines of a progressive income tax. The more assets you have on the balance sheet, the higher tax rate you fall into. A certain percentage of the tax goes into a systemic risk fund. Obviously, the bigger guys pay more tax and more likely to make use of the funds when they blow so it evens out.
this will prevent banks from exploding their balance sheets. however, if a bank is smart and has better revenue streams, they aren't unfairly penalized.
in fact this model should apply to all multinational companies with the tax revenues shared between the nations they operate (obviously easier said than done).
this so called tax on size will ensure that companies (not just banks) grow too big and get power beyond what they should.
Nassim Taleb proposes that basic banking functions- e.g. check clearing etc. be nationalized. I can live with these being regulated utilities a la electric companies. But I think he's on to something important. IMO basic depository and financial functions are far too important to be performed by stock-touting companies, bond promoters and general speculative-markets companies.
The "gambling" should occur among private individuals and companies on whatever scale they wish, just so it isn't mixed up with depository functions. These companies such as Citi have deliberately gamed the system so that the bank holding companies that FDR despised get bailed out as a whole when the only public purpose is to prevent bank runs.
Thus I continue to respectfully disagree w Dr. Harrison and believe that the Glass Steagall principle, esp. as modified and clarified by Taleb, is valuable.
The argument that foreign financial companies are here in the US and are "universal" confuses me. When they are here in the world's biggest financial market, they will play by our rules. They won't take their chips and go home! They will split up into 2 or more entities as required as peaceably as JPMorgan did after Glass Steagall was passed. Am not sure what I'm missing in that argument. . .
While I understand why many are behind the concept of reinstating Glass-Steagall, keep this in mind. BT was done in by derivatives in the early 90's. The scandal forced them to sell themselves to Deutsche Bank in order to salvage anything of worth.
This was before the repeal the of Glass-Steagall.
My point is that Glass-Steagall didn't prevent the potential ravages of derivative risk gone awry.
Another thing to consider is from whence come the flow of fees these days. In other words, follow the money. The largest banks have been operating from a fee-based model since the 70's. The risks inherent in these flows is what any new regulation must address.
No regulation is perfect. It must be dynamic, meaning it must be revised over time.
Glass-Steagall had already failed to work before it was repealed. The failure was that it was not replaced with new or revised regulations that worked better. Any society, including that of world banking today, does not function well without rules.