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The Public Policy
Breaking Up the Banks Would Be Wrong
A return to Glass-Steagall is no solution to today’s banking problems.
Breaking up the banks and restoring the Glass-Steagall Act to separate commercial banking from investment banking have mass appeal to populists, many in Congress, and to those seeking retribution for the global economic crisis and destruction of capital — and now, to even a handful of bankers, some of whom were original architects or beneficiaries of the financial supermarket model we have today, known as the universal bank.
The idea of breaking up the banks again gained recent attention with the surprising statement by Sandy Weill, former Chairman and CEO of Citigroup Inc., that universal banks should be broken up — to restructure institutions that have become too big to fail and that expose taxpayers. A few other former banking leaders have followed and expressed similar views, evidencing their personal journeys and metamorphoses, citing factors such as incentive structures and higher valuations.
Before hastening to enact new legislation, a phenomenon that often emerges after any crisis or disaster, it should be recognized that breaking up the banks would deny the need for scale and impair U.S. global banking competitiveness, not address so-called too big to fail, and it would not prevent another crisis brought about by unsound lending practices. Further, it does not address industry culture and accountability. While the diversification model of universal banks has been regarded as a benefit, some of the most diversified banking companies in the world suffered most during the crisis, which affected more than one line of business.
Banking is fundamentally a low margin, commodity business: deposits, loans, credit cards, information technology and numerous other banking products are mostly undifferentiated and generic. The obvious exceptions would be private equity, underwriting of debt and equity in inefficient markets, risk principal activity and other proprietary business such as complex derivatives. For most commodity products, banks must compete on the basis of superior relationship execution, an amorphous concept itself, and on reputation or brand.
For a commodity business, internally generated revenue growth may be limited to inflation plus a small premium at best. The ability to manage and reduce operating costs through workflow engineering or new processing technology to achieve economies of scale is critical to achieving target economic returns. In a commodity business, mergers allow fixed costs to be spread over a larger revenue base. To deny American banks global scale is to limit their effectiveness against institutions and countries that do not. Further, the basic industrial, commercial and agricultural businesses and the consumers of Main Street benefit from the strength and liquidity of the U.S. banking system.
Restoration of Glass-Steagall would not prevent the need for government intervention in another meltdown of Wall Street. Lehman Brothers was an investment bank whose demise sparked a global panic in credit and equity markets in September of 2008. Although it will never be known for certain, a rescue of Lehman might have averted that chain reaction. Too big to fail has never been adequately defined and would still prevail, with the need for government rescue of a failing commercial or investment bank. If a banking company with a balance sheet of $1 trillion or more is downsized to half that size, or even 25% of that size, its failure could still incite a domestic run on banks that extends beyond national borders. The key issue is whether a financial institution is deemed by the market and by regulators to be a system bank, a term for which there is no clear cut definition, yet generally refers to one that is so connected to trading counterparties, clearinghouses, corporations, and the general public that its insolvency would bring financial catastrophe to other parties and damage to the nation at large. Ironically, to some analysts, being deemed a system bank evokes confidence and facilitates interbank lending in many countries.
Breaking up the universal banks and returning to Glass-Steagall would have no bearing on the integrity of credit processes in the industry. The quality of mortgage loans — a basic product of commercial banks — was at the heart of the U.S. economic meltdown. Increasingly subprime in nature, those loans made on Main Street when aggregated into Mortgage Backed Securities and Collateralized Debt Obligations contaminated trading desks of the New York investment banks, and from Wall Street found their way into investment portfolios of pension funds and other investors all over the world. An integral part of Dodd-Frank, the Volcker Rule, which among other things prevents proprietary trading, does not affect the quality of asset creation.
Banking is about taking and managing risk: a bank commits capital, takes a risk that its client will not take, or provides financial advice, all for a return. To mitigate undue levels or concentrations of risk, even with oversight by boards of directors and executive management, more effective regulatory scrutiny is required. To achieve this, the regulatory framework comprising the Federal Reserve, Department of the Treasury, Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation, and other federal and state regulatory bodies needs to be vastly simplified.
There is no shortage of regulators. On a given day, there may be dozens of examiners from various agencies at a major financial institution, many of them with permanent offices there. Since regulators have been charged by Dodd-Frank with becoming more cognizant of system risk, it stands to reason that more compensation will be needed to attract the very best regulatory minds — individuals able to challenge the assumptions and trading algorithms of their counterparts, and examine corporate governance at the level of the board of directors.
Before rushing to reinstate a construct that was dismantled by market forces and technology over several decades, the culture and incentives of the industry must first be examined, along with the adequacy of penalties for financial excess and bad judgment. Further, the wisdom of publicly held investment banks needs assessment: when some investment banks were privately held, partners came to work each day putting at risk their personal capital — not the capital of the public.
The question is not how to make banking companies smaller and separate commercial and investment banking, but how to assure the safety and soundness of risk management practices in the financial services industry. If it were to happen, the case to break up the universal banks needs to be made by shareholders, not by Congress or regulators. Shareholders may determine if they are economically better off since the end of Glass-Steagall — as well as the end of laws that once precluded interstate branching and holding company acquisitions, such as the McFadden Act and Douglas Amendment.
About the Author
Frank Schell is a business consultant and former international banking executive. He serves on the Dean’s International Council of the Harris School of Public Policy Studies, University of Chicago, where he is a lecturer, and on the editorial board of the Chicago-based National Strategy Forum, which focuses on national security issues.
Letter to the Editor View all comments (53) | Leave a comment
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aware| 8.22.12 @ 6:31AM
A banker claims shutting down the casino would be bad. There's a surprise. Lehman's collapse didn't "spark" the meltdown, it was a result of the meltdown. Glass-Steagall separated investment banking from deposit banking.
It wouldn't have prevented the crash of risky investments in derivatives but would have contained it to the investment banks and made the sub prime debacle impossible on the scale it achieved.
This article is pure propaganda that flies in the face of the facts. If the banks were sound they wouldn't need bailouts from taxpayers. The scheme is unsustainable without those bailouts, proving my point. Just like alternative energy, the taxpayer bailouts and subsidies are a critical aspect of its sustainability.
The market's verdict on the whole mess was that it was Ponzi shit and worthless. And those behind it deserved to be begging in the gutter(maybe even the writer of this article?) and their institutions should cease to exist. But as the verdict was being carried out the State stepped in and overruled. This is how a fascist crony system works. The next leg down will be far worse and isn't far off.
Oldefarte| 8.22.12 @ 10:20AM
You're full of your usual excrement, UNaware! As I've told you many times previously [but obviously Barry, Joe and the excrement-kicker five won't allow you to consider same], the sub-prime debacle was caused by the Democratic crooks of yesteryear and specifically began with the CRA of 1977 which forced banks to make loans to indigents, and it all flowed donwhill from same. Bankers, the real estate industry, Fannie/Freddie,HUD all got into the act of trying to survive financially and make money from this original CRA governmental interference into private equity matters for their socialistic agenda of giving governmental welfare to their indigent constituents for political vote purposes. Get the excrement out from between your Barry-like earlobes, begin to think and become educated and then tell THE GD TRUTH!!!!!!!!!!
canuckistani| 8.22.12 @ 10:59AM
More revisionism, farte?
The number of bad loans underwritten by Fannie and Freddie pale in comparison to the voodoo derivatives that the newly minted retail/investment banks created after the repeal.
Ask any economist without an axe to grind, there are a few, and they will outline the debacle started by Morgan then picked up by Stearns and Lehman that grew like wildfire through the international exchanges. Goldman (Hank's place) perfected it and found a way to deflect risk onto AIG and the other dupes.
Greenspan knew it and did zero about it. O'Neill knew it, tried to work on it and was punted. Hank was an architect of it and was the wrong guy at the wrong time to address it before it became a catastrophe.
America sues for the moniker of "world leader" on pretty much all fronts. This catastrophe was American conjured, American deployed and it had global implications. Now we want to blame domestic social policy and not the Gekkos on Wall Street?
I call BS. And for you to believe otherwise is tragic.
Oldefarte| 8.22.12 @ 9:55PM
And as I said previously, it all started with the CRA of 1977, and the rest flowed downhill as a reaction/result of same. Do your homework!!!!!
aware| 8.22.12 @ 11:05AM
You know absolutely nothing about this, Olddingleberry. All you know is everything is the Democrats fault. What a stupid bastard you are. Democrats=bad, Republicans=good. That about sums up all you know. Just keep hanging on to that false left/right paradigm like the real rulers want you to. Played like a pawn shop fiddle.
As I've said, I've fired dumbass beancounters like you before.
MK48| 8.22.12 @ 11:51AM
Want to know what happened and who to blame....read The Creature from Jekyll Island by G. Edward Griffin.
I started long before most of you were born and like history it has repeated itself many times.
aware| 8.22.12 @ 12:11PM
You are precisely correct. And I read it in the late '90s. And a couple of times since. It should be required reading, especially for "conservatives". The Birchers are not nuts as they are portrayed.
The Federal Reserve is the cornerstone in the dismantling of America and its subservience into a New World Order.
Oldefarte| 8.22.12 @ 10:21PM
Want required reading, idiot? Try Geller's THE POST AMERICAN PRESIDENT or Klein's THE AMATEUR????????
Oldefarte| 8.22.12 @ 10:35PM
Whats wrong, did some mean ol banker not cover your $5 overdraft at your bank? Maybe one turned down your application of a mobile home mortgage since you were not a minority wanting affirmative action for your AFFORDABLE HOME???????
Oldefarte| 8.22.12 @ 10:18PM
You worthless moron, you couldn't fire your mother, since she'd kick your little insignificant ars if you tried. Anyone who struggles in this pathetic economy thats imploding has to work 24-7 including weekends, and if your BS was halfway true, you would not posses the time or energy required after doing thus to constantly blog all day as you do here. No doubt you're a computer domestic terrorist earning your $20/week political posting salary from the DNC while arguing for THE BLACK JESUS' radical positions on conservative news sites. One thing [only] that you stated is correct however and that is that "everything is the Democrat's [apostrophe added] fault", since they are the hypocritical political whores who selfishly rape taxpayers of their income in order to WEALTH TRANSFER/RE-DISTRIBUTE to their stupid, indigent, worthless, lazy, government-sucking benefits demanding constituents. Instead these blood sucking leeches should be becoming educated in the taxpayer funded free public schools, thereafter working for their own financial living, paying taxes to support the government and the general welfare of society; instead of committing the majority of criminal activity and occupying a majority percentage of prison populations in this country. Democrats are defined by Biden, Obama, Clinton, Carter, Kennedys, Kerry, Pilosi, Reid, Schumer, Conyers, Durbin, Axelrod, Jarrett, Jackson, Sharpton and the like. You just an insignificant little worthless runt of society, sadly!!!!
aware| 8.23.12 @ 6:13AM
Since I post about half the time you do, what does that make you? You really have never encountered anti-State philosophy have you? That explains why you are constantly misidentifying me as a Leftist.
(Notice here with a change in train of thought, we have a new paragraph?)
This used to be a conservative site but now is over run with and parrots NEOconservativism. Neo cons are vile hypocrites who talk conservative talk but walk the Statist walk, hoodwinking simpletons like you.
(New paragraph. Starting to see a pattern?)
The pittance handed to the "underclass" is just to keep them from rioting and to keep you distracted, obviously not difficult. The real "redistribution" is up not down. I don't recall 400 million dollar "bonuses" handed out in the ghetto.
Ask the director of the nursing home if any remedial English classes might be substituted for bingo night. I think it would be more beneficial.
Oldefarte| 8.23.12 @ 1:51PM
What may be "beneficial" to you is perhaps a career advancement from your Mickey D's counter position to possibly one as a meet&greet; representative at WM. You might be able to take your English Lit courses and apply same to your advantage financially [then you wouldn't have to BS people as to your non-existent ability to fire/terminate others]. Oh and DA, as to your "Since I post about half the time you do, what does that make you?", that makes me what you'll never accompolish and that is RETIRED AFTER 35 YEARS OF CORPORATE EMPLOYMENT! [that's why '''''I'''''''have the time to devote to blogging here and elsewhere]. Again, assuming you ARE NOT SO REITRED, then what gives you the right and time to do so, since you're either [1]wasting your employer's time, since you're being PAID A SALARY to perform your employer's duties and not to blog or[2] you're most probably UNEMPLOYED/WITHOUT A JOB which would explain how/why you "I post about half the time you do". Oh and [no new paragraph by intent AH] your "You really have never encountered anti-State philosophy have you?" identifies you as an anarchist/domestic terrorist type, similar to the one now occupying the WH ["anti-State"? Does that equate to the OWS faction possibly or the LGPT crowd that recently defaced CFA's?]!!!!!
DRA2012| 8.24.12 @ 1:02AM
Well, "Aware", you may have fired people before, but that doesn't make you any more correct about the subject. OF's correct when he said it STARTED w/the CRA of 1977, but the real damage was done in 1995 when the Clinton administration directly interfered w/the mortgage market and informed several large banks that they wouldn't be allowed to open additional branches unless they started granting mortgages to sub-prime borrowers. Having political operatives like ACORN and NAACP forcibly occupy the private offices of bank execs didn't help much.
The bankers, knowing that Fannie-Mae and Freddy-Mac would pick up the pieces, did what they were told, and started producing some very inventive ways for people w/no real income and lousy credit histories to sign their names to deeds and mortgage papers. What's the coincidence (not!) that all of these financial papers w/ten year introductory rates started failing ten years later, so that when 2007 rolled round, all of these properties were in foreclosure after twelve months of missed payments?
People don't have sub-prime credit ratings because they are poor - they have them because they don't have good payment histories. The banks never should have been forced to grant the mortgages in the first place.
Derek Leaberry| 8.22.12 @ 11:53AM
You are essentially right. The big banks are part of the corrupt international liberal elite. The goal is to privatize the profit of the elite but socialize the losses. Local economies are to be wrecked so the elite can succeed at the international level.
Ever wonder why the big banks pay off socialistic clods like Chuck Schumer, John Kerry and Barrack Obama? Its because they do the bidding of the big banks.
It is high time for a Jacksonian solution to the big banks. Break them up and send US treasuries to small private banks.
aware| 8.22.12 @ 12:18PM
Well Kennedy signed an executive order to allow government to print money at no interest and by pass the Fed. 5 months later he was dead.
Republicans are just as much in the pocket of the banking elite as Democrats, if not more so. After all, no one wants to star in a Zapruder film.
Derek Leaberry| 8.22.12 @ 1:02PM
I agree that the Republicans are as bad as the Democrats when it comes to fealty to banking interests. They are the right-wing of the international liberal elite.
Oldefarte| 8.22.12 @ 10:28PM
Yeah Da, too bad the Prince of Camelot's Zapruder film didn't include clips of him romping in the WH swimming pool with Fiddle & Faddle etc, or maybe wishing his farewells with his brother and Hollywood pimp to Marilyn, huh? [of course when the corrupt MSM is sucking your joint, nothing like that ever makes the front pages does it????????
Dai Alanye | 8.22.12 @ 11:40PM
I believe it is accurate to say that Oldefarte is one of -- if not the -- most simplistic commenters on the AmSpec site. Almost every post of his adds to the proof, this one being a fine example.
aware| 8.23.12 @ 5:40AM
Entirely accurate. He also doesn't understand the concept of paragraphs and his punctuation keys are always getting stuck.
Oldefarte| 8.23.12 @ 1:56PM
No, AH that's representative of not being a BULLEXCREMENT ARTIST like you and your UNDERAWARE friend below, so as the old saying goes.........STICK IT UNDERAWARE THE SUN DON'T SHINE [and do twist it sideways too]!!!!
WaffenSS| 8.23.12 @ 7:02PM
Good article, well written and to the piont. As soon as the regulations were taken off the twoo seperate banking systems, the ponzi schemes started up, using the subprime structure as a vehicle to fleece whoever got "into" the fray. Same thing happened with the Savings and Loan fleecing of the late eighties orchestrated by Ronnie Raygun and his band of felons. Next came Enron which was nothing more than a warm-up of things to come. Bend over America, the jew and the international banking cartel are getting ready to slip some high protein derevitives in our collective goyum bottom.
MelvinNC| 8.22.12 @ 7:25AM
In a perfect financial world this type of banking model might work. But the banking and investment world at least right now is not perfect.
Crony-Capitalism, Vegas style investments, ill conceived legislation and laws, absolutely no oversight. Inbreeding between those who are supposed to oversee, and those who enter into risky and dangerous investment schemes.
What is right is now wrong, and what is wrong is now right. The American public has completely lost all confidence in this Country's banking and investing sectors. Look at Congressman Chris Dodd, and others receiving sweet heart loan deals form Country Wide, Congress, the Senate, their cronies, aids all have benefited handsomely very, very handsomely from insider trading from failing investments schemes.
The Ethanol mandate won't die, even though prices for food products based on corn are skyrocketing, and politicians who have personally invested heavily will not back off on one liter of Ethanol to put into food production.
I myself used to put allot of faith and respect to the titans of the American Banking System, but after the banking system underhanded dirty tricks in trying to legislate Credit Unions out of existence, so that it could corner the banking market. I then put the banking industry in the same class as trial lawyers. Did that weasel Timmy G. pay his back taxes yet?
Ryan| 8.22.12 @ 8:26AM
Corporatism is a better term, because it prevents the term "capitalism" from being coopted.
JimH| 8.22.12 @ 8:22AM
The banks certainly were not innocent in this, but neither were they fully responsible. Essentially they were responding to unnatural conditions created in the housing market by government. The government was requiring that loans be made to people who in the past would not be considered credit worthy. Interest rates were unnaturally low because of Fed policy. The banks, not being entirely stupid, did not wish to be on the hook for these loans, so they collateralized them and sold them on. They have some culpability at this stage because it looks to have been a deliberate attempt at disguising the risk by packaging the dubious loans with the good. A housing bubble by itself would have been painful but would not have brought the economy to the brink of collapse. Much of the crash was the result of the collapse of the market for the CDOs that represented these loans. Again, if the housing bubble had merely burst these CDOs would have dropped in proportion. But no one knew what was in them so the underlying value could not be assessed. Also, many were playing with these in leveraged trades so the effect of the drop in value was multiplied. You can throw in the lack of mark to market valuation into the mix as well. It should be noted too, that not all banks required government handouts. Some were required to take the money in order to provide cover for those that needed it. The government did not want people to know which banks were on shaky ground.
Ryan| 8.22.12 @ 8:27AM
We keep blaming the CRA, but I believe that the implicit and explicit guarantees of the government behind many of the loans is the real culprit - it's how the corporatists publicized the risks while they raked in the profits.
Sjccoach| 8.22.12 @ 8:53AM
Why you bother publishing argle bargle like this is beyond me. The author is an apologist for a corrupt banking system. He states that banking is a "low margin commodity business". In other words banks don't want to deal with real people. They want to trade phony derivatives and make real money. Funny credit unions can make money in this low margin business. The author is an example of everything that is wrong with big banks. They should be broken up and cut down to size.
Von Mises Jr| 8.22.12 @ 10:12AM
This is further supported by the fact that Corzine got off “Scott Free” after transferring customer funds to MF Global accounts. If the banks can get away with risking customer funds for their own benefit or stealing them when necessary, no deposits in any financial institution are safe.
Ann Barnhardt closed her fund and returned all customer funds telling them to get the hell out of the financial institutions.
And this clown is purporting that we should have more of the same. TAS, where did you find this shill?
JimH| 8.22.12 @ 11:13AM
VM, despite what I posted earlier, I agree that the major banks are too big and gaming the system. The problem though, is absent accurate free market price signals, how do you establish what the size ought to be? Are we advocating a return to TR era trust busting? What are needed are policies and regulatory changes that encourage competition and don’t stifle smaller banks. I can tell you from personal experience that many of the regulations advocated by the administration are effectively useless for reducing risk and serve only to strengthen the larger banks relative to smaller competition as the larger are far better able to absorb the costs of following these wasteful rules.
Von Mises Jr| 8.22.12 @ 3:31PM
You have a handful of banks with deposits in each other's banks and deposits at the Creature from Jekyll Island.
The whole purpose of capitalism is to decentralize everything from planning to "too big to fail" institutions.
This stuff like international trade gets complicated and past my pay grade. But we need people such as Lew Lehrman and John Taylor that are both genius and moral to replace Ben "the Bank" Bernanke and his helicopter, and tax cheat "little Timmy" Geithner.
ata777| 8.22.12 @ 9:44AM
Sorry Frank, no soap. the assets of the five biggest banks are equivalent to about 56 percent of U.S. GDP--now. Prior to the meltdown it was 43 percent.
Not only are they more powerful, but you miss the most painfully obvious point: people at five institutions are far more easily corruptible than people 105 or 1005 institutions.
This is nothing more than a plea to maintain the crony capitalism on steroids corruption that is ruining the nation.
And be sure to let me know when Jon Corzine even has to break a sweat for MF Global's criminal activity.
Maxwell| 8.22.12 @ 9:57AM
ata, don't hold your breath waiting for Jon to do time, blue may not be your color.
Oldefarte| 8.22.12 @ 10:25AM
I agree with Weill's assessment that banks should be downsized, in order for them to become more manageable, profitable and less dangerous to collapsing. The government as stated should not be involved in same, since typically government is inept at performing their own dictated tasks, much less managing/regulating private concerns. Major banks that are now excessive in size are akin to governments, in that they are TOO BIG TO FAIL AND TO MANAGE PROPERLY/EFFICIENTLY. They simply need to be ratcheted down into more managable and workable dimensions!!!!!!!!
aware| 8.22.12 @ 11:55AM
Well genius, who's going to "ratchet them down"? You? Me?
It'll be that "government" that ratcheted them up. In a crony system there can never be half measures, it's all crony, all the time.
The politicians know who owns them. The bankers know, too. But you sure as hell don't.
Oldefarte| 8.23.12 @ 2:03PM
What a truly stupid comment. You obviously don't have a clue as to economic, finance and capitalism. Your 'who's going to "ratchet them down"? You? Me?' is ludicrous, and you've obviously not read articles regarding Weill's commentary previously regarding this subject. I'm not going to waste my time SPLAINING IT TO YA......go research same yourself and hopefully [impossible no doubt] you'll become educated regarding this matter, as to WHO can "ratchet them down" [what a DA]!!!!!!!!!!
MelvinNC| 8.22.12 @ 10:46AM
The banking has absolutely no oversight right now. As I have noted earlier the watchdog of the banking system is screwing fifi.
Somewhere I read during this whole mess that some high placed schmuck within the banking oversight married some bankers daughter.
No argument will wash with this one. MaBell gave the same excuses when it was forced to break up and was stifling innovation because it was the only fat kid on the block.
Once MaBell was broken up innovation burst forth.
Two things need to happen, The banking giants need to be broken up into manageable pieces. Then I don't know to accomplish this next task, but there has to be something that will by law keep government(greedy little weasels looking to make a fast buck) other than oversight out of the banking system.
Cool Hand Luke| 8.22.12 @ 10:52AM
The bigger they get, the more corrupt they become.
I don't think Thomas Jefferson would agree with
your analysis.
Paul A'Barge | 8.22.12 @ 10:55AM
So, this is interesting but the bottom-line is that Schell is wrong. And here's why:
(1) Too Big To Fail is precisely and exactly the equivalent of Gotta-Get-Government-To-Bail-Out. It's just that simple. You can waddle about spouting all the financial details about scale and competitiveness but when a large sector of the American economy has Government-Bail-Out built into its design, you're just asking for trouble
(2) Regarding scale and efficiency and effectiveness, what benefit in international competition does a mega-business have if it's competing in an economic era of financial doom that is spreading across the globe. Especially when that era is caused in large part by the failure of Too-Big-To-Fail entities?
(3) Resiliency planning doesn't posit that organizations must be ready to rumble when times are great. It posits that organizations be ready when times suck. And so when Too-Big-To-Fail hits the global economic downturn, guess whose resiliency planning is pointless? Yep. Too-Big-To-Fail.
Look, unfortunately for Mr Schell and his coterie of Denial-Is-Not-A-River-In-Egypt folks, it doesn't take an economist to understand that chopping up these Too-Big-To-Fail organizations is precisely smart resiliency planning. And yes, Mr Schell. It is precisely and exactly that. Smart.
JD| 8.22.12 @ 11:03AM
The large financial entity that needs breaking up due to its excessive power is the Fed.
roadrunner| 8.22.12 @ 11:19AM
Mr. Schell overlooks an important safeguard to our commercial banking system that was thrown under the bus with the repeal of Glass Steagall - ACTING AS A SURETY FOR THIRD PARTY DEBT.
This simple risk concept was written into the Federal Deposit Insurance Act to prevent Federally insured commercial banks from accepting potentially catastrophic amounts of liability without disclosing such liability on their books and meeting other credit safeguards that was carefully monitored by legions of bank examiners.
If one really looks at the underpinnings of the financial collapse that occurred with home mortgages, it was not only the misbegotten belief that home values would never go down, but that some other entity would make these instuments good if all else failed. That is the concept that failed - that ordinary sound underwriting of home mortgages could be set aside because some third party of perceived financial strength would ride to the rescue if someone down the line didn't do their job.
The repeal of Glass Steagall opened the gates of hell to our commercial banking system.
George S| 8.22.12 @ 3:09PM
It's easy to lay the blame on the repeal of Glass-Steagall when you do not understand that the law was useless when it was repealed and therefore had no impact on the financial crisis.
GS seperated commercial banking from investment banking when it was passed during the Depression. However, over the years banks formed subsidiaries to handle the investment portion and non-banks formed holding companies with securities and insurance. Banks such as National City Bank became CitiCorp to handle depositors and investors; Sears installed banking kiosks on their sales floors setting up holding companies with Dean Witter and Allstate; Traveller's insurance teamed up with Smith-Barney. All of this was going on for decades prior to GS repeal.
So how did the repeal of GS opened the "gates of hell"? Nobody scrambled to to mix and match because they were already mixing and matching. That's why the law was repealed -- it was successfully avoided for decades.
What the law did accomplish was to prevent smaller banks from combining services. Since the bigger banks could form holding companies, they could easily show a volume of business that was not "engaged principally" in underwriting and securities, thus escaping the law and getting a monopoly in the business.
GS would not have stopped the collapse, originating from bad mortgages bundled into securities sold by Fannie whose risks were hidden by government controlled bond rating companies.
roadrunner| 8.22.12 @ 4:40PM
The repeal of GS allowed Citicorp, whose main asset was Citibank, to create Special Investment Vehicles (SIV), whose only purpose was to borrow billions of commercial paper with the real or implied backing of Federally insured Citibank. The proceeds of the CP were used to fund billions of CMOs and was a pure arbitrage scheme using low cost funding from CP to carry higher yielding CMOs which unfortunately for the taxpayers carried billions in credit losses.
In the end the FDIC had to guarantee $400 billion of CMOs so the CP could be made good. The losses contained in the CMOs was sufficient to wipe out the entire deposit insurance fund. None of this would have been legal prior to the repeal of GS.
I rest my case.
George S| 8.22.12 @ 6:25PM
Deposit insurance was part and parcel of GS. If depositors in CitiCorp didn't have their deposits insured, they would have pulled out of the bank back in the late 1980's but the FDIC socialized the risk, enabling the banks to gamble knowing full well they would be bailed out. While GS was in force.
If your bank played fast and loose without deposit insurance, you's cash out immediately. What CitiCorp did with SIV's (aka real estate investment trusts) have been going a decade prior to GS's repeal. Citi Bank, Goldman et al were bailed out before and that's why the housing market mortgage securities didn't concern them too much.
Your case is far from settled.
Ryan| 8.23.12 @ 9:23AM
Is the problem Deposit Insurance or Fannie and Freddie guaranteeing bad loans?
Maybe a combination of both...
JP| 8.22.12 @ 11:22AM
What's the old adage? If you owe a bank $1000 it owns you, but if you owe the bank $1 billion you own the bank.
People forget that one of THE biggest lobbyists for the repeal of Glass-Stengal was none other than Robert Rubin. He had just retired as Treasury Secretary, and he spent the next several months pounding on the doors of Texas Senator Phil Graham to repeal that provision of FDR's New Deal. Graham greased the legislative wheels, and President Clinton signed it into law. A decade later, Graham and not Clinton nor Rubin got the blame.
The banks that are too big to fail will always be an albatross around the neck of our economy. Today, thier main areas of operations are in the Beltway and not Wall St. For it is now the Beltway the holds to key to riches.
There is no reason for an investment bank to manage operations that it cannot possibly control. These institutions run life and casulty insurance, manage dozens of hedge funds, as well as serve as savings and loans, buy government bonds, municipal bonds, and private equity. We saw what happened with MF Global (run by John Corzine) when these institutions go down the tubes. A billion dollars in investor's money (which was not supposed to be co-mingled with its hedge fund operations) vanished into thin air. Last week, in a very quiet announcement, the DOJ said it would not at this time indict Corzine. That's what these bankers want. Thier size gives them immunity from crimes they commit, and losses they engineer.
Cool Hand Luke| 8.22.12 @ 11:42AM
"I sincerely believe that banking institutions are more dangerous to our liberties than standing armies."
Thomas Jefferson
Kingofthenet| 8.22.12 @ 1:09PM
Too big to fail has never been adequately defined?
OK here is MY definition, IF a Bank Failure induces Systematic Risk into the system and can cause a domino effect that can lead to a destruction of the ENTIRE system, it's too Big. This has to be addressed or we are going to have to spend TRILLIONS making sure that these whales live to see another day.
dougm| 8.22.12 @ 7:00PM
Mr. Schell, some good analytics and a couple I perceive to be a bit specious. On the specious side, you state that market forces caused the repeal of Glass-Steagall. That is not true. It was intense lobbying by Weill and was a needed hurdle to consummate the Citi vision including the gulping down of Travelers. That worked out great! Banks being commodity entities should focus on delivering commodities and being efficient, and not foment undue risk on we the taxpayers. Investment banks should never have gone public, as it completely changed their risk taking profile and we the taxpayers bailed them out too. Correspondingly, Commercial banks should not be involved in investment banking for that very reason. Finally, not competing on a global scale as being a downside to bringing back Glass-Steagall is a ridiculous statement. Banks can partner with other banks on very large deals without having to concentrate very large risk onto their balance sheets. If the opportunities are there, the banks will work together to make them happen.
Senator Blutarsky | 8.22.12 @ 7:45PM
dougm - you are confusing the passage of Gramm Leach Bliley with the de facto repeal of Glass-Steagall, which began in earnest in 1990 when JP Morgan became the first US bank in decades to participate in a bond offering. Market forces, in the form of an organic blurring of lines - which perhaps seemed distict in the 1930s - between loans and securities really were more important than Sandy Weill's megalomania.
http://senatorjohnblutarsky.bl.....h-nor.html
Senator Blutarsky | 8.22.12 @ 7:42PM
Breaking up the banks in not a free lunch.
I'm no fan of universal banks, but breaking them up is highly likely to accomplish what advocates hope.
Breaking up the big banks may make political sense. And it may well prove shareholder-friendly, which implies at least some economic benefits. But we should be deeply, deeply skeptical of claims that breaking up the banks would meaningfully reduce the risk of either financial catastrophe or of related pressure for future bailouts.
http://senatorjohnblutarsky.bl.....h-nor.html
cicero| 8.22.12 @ 8:58PM
This article was a hoot. I don't think that anybody who is the least bi tinformed buys this nonsense anymore. Iit may have worked up until the banks paid back TARP ONE so that the bigs could pay themselves their bonuses in 2009. Not anymore. The whole bailout nonsense was only to save the BANKERS from losing their jobs, and not having to put their insurance carriers on notice. It saved them from having to face stockholders suits, and having to cough up their millions, and being drummed out of the industry. The solution to this fiasco is to remove the taxpayer safety net from these greedy bastards. Tfhe market always works. When no one will deposit money in to Citibank, they will have gotten the message. When the R obert Rubins of the world who was paid $15 million a year to lobby Washington are stripped of their ill gotten gains, and sent to jail for the same period of time as any other thief, this nonsense will stop. Until then, expect our bandits of Broadway to continue on their merry way, all the while soothed by the melodies played by the troubadours of the beltway, and their accompaniests in the financial press.
WaffenSS| 8.23.12 @ 7:03PM
Good article, well written and to the piont. As soon as the regulations were taken off the twoo seperate banking systems, the ponzi schemes started up, using the subprime structure as a vehicle to fleece whoever got "into" the fray. Same thing happened with the Savings and Loan fleecing of the late eighties orchestrated by Ronnie Raygun and his band of felons. Next came Enron which was nothing more than a warm-up of things to come. Bend over America, the jew and the international banking cartel are getting ready to slip some high protein derevitives in our collective goyum bottom.
WaffenSS| 8.23.12 @ 7:06PM
If to big to fail is the axiom then the United States is bound to resurrect the Soviet Union and make sure it stays afloat.