Mod Note (Andy): This post is a reprint from the November 12th edition of Jared's Daily Dirtnap Newsletter. If you'd like to read more, WSO readers qualify for a $100 discount to his Daily Dirtnap daily market newsletter...just email [email protected] and mention "WSO Monkey Discount". You can follow Jared on twitter at @dailydirtnap..
Even if you could split apart investment and commercial banks, I’m not sure you’d want to. And I’m pretty sure you can’t. You can’t put that genie back in the bottle.
I think there are two major fallacies on this issue:
- Publicly traded banks have moral hazard
- Investment banks “gamble” with depositors’ money.
Lots of people like to talk about the “agency problem” and they observe that back in the old old days of Lehman Brothers and its cousins, when it was Bobby Lehman running the show, it was a private partnership, and people didn’t do stupid stuff because the partners were on the hook. Maybe. And people make the argument that when shareholders are on the hook, the managers behave differently. Maybe. But probably not, because the managers are often big shareholders, so it would be suicidal to intentionally do things that would imperil the firm. For sure, management sometimes does things that unintentionally imperil the firm, but this idea that bank CEOs nuked their companies just for cheap thrills is kind of dumb, because they were personally ruined in the process.
The second point is also interesting. Traditional services of an investment generally consist of underwriting securities. For sure, that is riskier than lending, but honestly, not by much. Lending is pretty risky. It is the capital markets activities that are much riskier, and even then, it depends how you do it. This phenomenon of the 80s- 00s where banks were the big liquidity providers is a little bit of an aberration. For years, the risk was much more spread out. Should banks be liquidity providers? Obviously, yes, as we are finding out now. The question is to what extent.
I remember in my Investment Banking class in business school, we had a guest speaker, the erstwhile CEO of Volpe Brown Whelan, was it Tom Volpe? Volpe was fresh off of selling his firm to Prudential. Volpe hands out a tombstone ad for a bond deal in the 80s. What do you notice about this ad, he asks.
All the banks on it were gone!
They literally no longer existed. There were two that were still around, and one of them was Lehman Brothers Kuhn Loeb.
Then Volpe says: “In ten years, all of our current banks will be gone.”
He didn’t have any knowledge that we would have the financial crisis. He knew that this was the natural order of things, that banks would take too much risk and blow themselves up, and new banks would take their place. So what we experienced in 2008 wasn’t any different than what had been happening for years--just on a much bigger scale.
We always think that we are unique, that these things have never happened before. There is nothing new under the sun.
Volpe sold his boutique investment bank for $150 million. He owned some fraction of that, an amount of money that almost seems quaint nowadays. He went on to do sovereign wealth fund stuff.
Will bringing back Glass-Steagall prevent another crisis 50 years from now? No. Will making all investment banks private partnerships? No.
If you abolished capitalism, you might prevent another crisis, but then it would just be terrible all the time. In markets, people make mistakes. It is human nature. It is easy to do the Monday morning quarterback thing. How could you have not known?
I am entitled to say that, because I was sending out Bloombergs about the housing market at the time. How could you not know?
Lots of people didn’t. And sometimes people did, but kept doing what they were doing anyway, because of competitive pressures (that line about dancing while the music’s playing), which are a feature of capitalism.
In general, human beings will succeed in preventing the exact same thing from happening twice. But a variation of it will happen. Who knows, maybe 50 years from now there will be a bubble in convertible bonds. Or munis. It will be something.
I saw the housing bubble, but I try not to be too hard on people who didn’t. Look—I didn’t get that gold was a bubble, and I’m supposedly smart. It happens.
This isn't the least bit convincing. That 'genie' was put into the bottle once before. Why not now?
Referring to the "agency" problem, Wall Street CEOs obviously didn't "nuke their banks for cheap thrills" but they went from having to be "long-term greedy" and having personal liability to having shares in companies with very diffuse ownership bases they were barely accountable to and for which the next earnings number was all that matter. If that doesn't seem like a dangerous proposition, I don't know what is.
Investment banks don't "gamble" with investor money, they leverage up their balance sheets to fund their various businesses. And leveraging up money from a diffuse and mostly unsophisticated investor/depositor base is vert different from doing it with a partnership's equity.
And the problem of moral hazard is very really when these are FDIC protected deposits and you mix investment banking (in the large IBD+S&T+merchant banking sense) with the commercial lending the economy depends on.
Of course there will be another major crisis in the 50-60 years. But a big part of the reason the financial system was so resilient after 1929-1933 was precisely the Glass-Steagall act. Its repeal had a major exacerbating influence on the financial crisis and need for bank bailouts.
Just because a crisis is inevitable doesn't mean we should cling to the stuff that heightens its likelihood and severity.
No one seriously believes that ending 'universal banking' would have any net positive impact on macroeconomic cyclicality/volatility. It's a throw away line. A slogan that's particularly expedient for the liberal politician and his/her know-nothing base.
That said, there is a problem with the current structure of banks. Specifically, there is no synergy between commercial baking on the one hand and investment banking (all functions) and IM on the other. Commercial banks are essentially relics of proto-capitalism. Soon there will be apps that entirely eliminate the role of commercial banks as financial intermediaries. They provide little value in this function and regulation puts a significant strain on an already failing industry.
Capital requirements, flat yield curves, draining organic deposits, "consumer protection" litigation risk and all other forms of traditional banking risk (maturity, inflation, counter-party, etc) makes traditional baking fruitless. I could go on but the key is that banks as we know it don't exist out of practicality. They exist, at this point, out of convention - tradition. This is how we conceptualize banking but soon it will all change.
Soon when you want a loan, you will log on to your loan app. It will pull your credit score, your income and other market inputs (LIBOR, inflation, etc) and a loan will directly flow into your cloud account. No teller, no lines, no overdraft fees, nothing.
Glass-Steagall Making a Comeback? (Originally Posted: 12/18/2009)
Looks like the reinstatement of the Glass-Steagall Act is gaining some momentum, which might spell trouble for the way big banks operate these days. Two bills were introduced in Congress this week that would bring back the act that forbade investment banks from entering insurance or retail banking. The Senate bill was introduced by former Republican presidential candidate John McCain and Democrat Maria Cantwell.
Obviously, the response from Wall Street isn't favorable. The banks didn't pay over $200 million to lobbyists this year just to have to go back to playing by the rules.
.
What I mean by that is that these bills have very little likelihood of passage. The banking lobby is way too powerful and well-funded.
In the off chance that it passed, however, the large banks would be broken up and things would go back to the way they were 10 years ago. In other words, retail banking would probably feel little to no impact because that business model is essentially unchanged, but the investment banking side would be disrupted and have to return to more traditional profit centers.
It would be a major step towards eliminating "too big too fail." This ought to be an interesting time to find out who is totally and completely owned by the banking lobby. Kudos to McCain for doing this.
We'll see how this passes. Once the punch bowl returns, people will forget about bringing back Glass-Steagall.
no chance this passes, but interesting...if anyone hasn't noticed JPM and the banks with access to the discount window will turn into a monopoly of sorts soon; this needs to be busted in some way...would be great for companies to actually receive financial advisory again, versus having a credit agreement jammed down their throats in order to get charged additional M&A advisory fees...
i don't know i think it has a better chance than you may think. There is an awful lot of animosity towards bankers right now.
Think about the big banks that failed last years-- the ones that had a commercial bank unit survived (JPM, C) while the pure investment banks either failed (BSC, LEH, MER) or had near-death bank runs (MS, GS, in September/October '08)
Breaking up the universal banks won't fix the problem.. at all. I'm all for effective regulations that help preventing future catastrophes, but bringing back Glass-Steagall itself is just stupid.
Let's hope they've put the $200 million lobby dollars to good use.
This is an old post but it looks like the issue is being brought up again. I wouldn't be surprised if there was an even more aggressive version of Glass-Steagall - separating commercial/investment banking AND/OR limiting size / giving a regulator the ability to take over and wind down
If you look more closely to the events that have occurred in the last two days, senators are now afraid to do things that may rattle the markets even more, top analysts are suspecting that the Broader Sovereign Debt Crisis and lack of ECB's quick agility has shut down some parts of financial regulation including the audit of the fed, separating derivative trades, and most importantly the Volcker Rule (shadow of the glass-steagall).
Reinstate Glass-Steagall (Originally Posted: 09/22/2009)
The upcoming G-20 meeting in Pittsburgh has me a little worried. If we are to believe the hype, it would appear that our world leaders are salivating at the thought of limiting bankers' pay in a bid to tame the unruly mob and pass off the blame for the financial crisis to the simplistic notion that the whole thing was caused by people who got paid too much.
Having weathered several seasons of our financial discontent myself, I started wondering if there was one event, one watershed moment, that precipitated the current crisis. There were several obvious candidates.
1) Congress injecting the Community Reinvestment Act with steroids during the Clinton administration 2) The Long Term Capital Management debacle that opened many of our eyes (though clearly too few in the long run) to the dangers of derivatives exposure 3) Deregulation of the sort that creates incentives for bad behavior
Focusing on number 3, I remembered the repeal of the Glass-Steagall Act in 1999. I had recently retired from trading and bought an insurance agency with some of my money. I always figured insurance to be a nice stable business, free from the emotional and financial peaks and valleys that are a daily component of trading. Boy was I wrong.
I'd no sooner got the hang of running an insurance agency when one of my carriers flew me out to their headquarters for a major meeting. The CEO was positively giddy. Glass-Steagall had been repealed, and this major insurance company had just been authorized to enter the mortgage business.
This made no sense to me, as these guys were one of the top health insurers in the nation. What did they know about the mortgage business? Well, they knew the re-finance market was starting to heat up in mid-2000, and they'd be damned if they were going to miss the boat.
The company started paying my agents $500 for every loan application they submitted, whether the application got approved or not. It doesn't take a rocket surgeon to figure out that this business model is unsustainable over the long term.
I don't even have to tell you what happened to the company. You already know. But I can't help wondering what might have been if insurance companies were forced to remain in the insurance business, and banks were forced to remain in the banking business, and investment houses were forced to remain in the investment business.
Maybe instead of agreeing to new legislation and pay curbs and what not at the G-20 meeting, our leaders should discuss a common sense return to the regulations that worked over the past 70 years.
Do investment banks produce crude oil? No. So why do Goldman Sachs and others have a bona fide hedger exemption from margin requirements? That's just stupid and invites price manipulation. Likewise, what business do banks have selling insurance? And vice versa?
A reinstatement of the Glass-Steagall Act won't solve all our problems. But it would be a hell of a good start.
what great advice can jp morgan give to a ceo on a merger when it is salivating over commitment fees on lending...the incentive schemes are too screwed up...
Gasparino Talks Glass-Steagall, Dimon, Volcker (Originally Posted: 11/17/2009)
Gasparino calls Glass-Steagall "common sense" and opines that Jamie Dimon's hotline to the Prez might be what's keeping the regulation from making a comeback...
It's no coincidence that less than 10 years after the repeal of Glass Steagall, 3 of the largest investment banks (Bear, Lehman, Merrill) collapsed and/or got swallowed by commercial banking conglomerates. The Government/Fed is heavily connected with the large banks (Citi, Bofa, JPM) and want to consolidate the industry into the hands of the few.
The government is also trying to take over the healthcare industry which makes up over 15% of GDP. I hope the Senate doesn't pass that bill...
The 21st Century Glass-Steagall? (Originally Posted: 07/11/2013)
According to WSJ, a bill was announced today that will begin to re-separate commercial and investment banking. The bill was written by a group including both Elizabeth Warren and John McCain.
Any thoughts on how this will affect those already working in investment banking and those in future recruiting cycles (if it does actually become law)?
Here is the link: http://online.wsj.com/article/SB100014241278873244252045785999005196167…
This bill isn't law. It was just proposed. I doubt it goes anywhere. Elizabeth Warren is a demagogue that does nothing but introduce feel-good legislation.
Thanks, good catch. I edited the original post.
No way this gets passed, thankfully.
Anyone know where to read good arguments for and against this?
Wouldn't this mean deposits could still be used to fund mortgages/loans made by the commercial banking side, investments that could also fail just as a derivative in the investment bank could? Why are mortgages or business loans less risky? Anyone know which side of the banks the bad mortgages were housed prior and during the recession (not a rhetorical question; I'm not sure of the answer and it's obviously relevant here)?
Also, I was under the impression that deposits were ring-fenced from the investment bank except for a period during 2008 when they suspended the rules. So then doesn't that make it irrelevant anyway? Or is the argument that IBD has an implicit backing from the deposits in that, in the event of a crisis, the government might lift the ring fence to help bail out the failing assets so that IBD gets implicit free insurance through FDIC?
Dealbreaker had an article on this. Made the same sort of points you did. This woman seems to have absolutely no clue.
But I believe that the mortgages were all over the place. Some in the IBs waiting to get securitized, and other still sitting on the books at the retail banks/S&Ls. Someone, correct me if I'm wrong though.
nailed it
Retail banks that made NINJA loans are just as much to blame for that whole shit show.
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