Posted on 01/21/2010 7:31:08 AM PST by SalAOR
The causes of the Great Recession of 2008-2010 (and possibly beyond) have been debated and explored in many publications, including on these pages. One of the arguments that I see frequently, even among Conservatives, is that the banking industry collapse was a direct result of the repeal of Glass-Steagall in 1999 by the Republican Congress and signed into law by President Clinton. Today, Obama is expected to announce the creation of a new regulatory scheme that would effectively be Glass-Staegall II. Such a move would be a big mistake, and would do nothing to avert another similar crisis in the future.
Glass-Steagall effectively prevented commercial banks from owning investment banks, and vice-versa. It was enacted in 1933, but it effectively was relaxed in the 1970s through a waiver program which was often granted. The 1999 reversal, which so many point to as being the trigger that caused the crisis, was more of a formality to codify in law what was being done in practice through these waivers. Yet commercial banks owning investment banks, and vice-versa, had absolutely nothing to do with the economic crisis.
(Excerpt) Read more at axisofright.com ...
Meaning that the law was being flaunted by the big shots in the Clinton administration who held board seats at Citi, et al.
Yet commercial banks owning investment banks, and vice-versa, had absolutely nothing to do with the economic crisis.
"Myopic" is about the most charitable characterisation of this ridiculous assertion I can think of. Depository institutions with statutory capital requirements having capital at risk in securities markets is exactly the mechanism which nearly erased every major financial institution in the US and would have done likewise anywhere else there were similar banking capital requirements.
And acknowledging this reality doesn't even touch on the argument of how savings is turned, defacto, into risk capital by allowing savings institutions to put capital at leveraged risk in securities markets.
flaunted >> flouted.
“Yet commercial banks owning investment banks, and vice-versa, had absolutely nothing to do with the economic crisis.”
Don’t piss on me and tell me it is raining.
Furthermore, calling any abomination out of DC "Glass-Steagall II" is to mischaracterize it and brand with a mark of acceptability and sound legislation which it, in almost all certainty, will not deserve.
You are so wrong. The firms that failed were NOT commercial banks that had investment arms, or investment banks that had commercial arms. Rather they were either Commercial banks that made bad loans, or investment banks that traded bad securities. The firms that had both did not fail, in fact they gobbled up the failed firms and helped to save the economy.
Sure, let ‘em run wild. What’s the worst that could happen? (And how much will it cost me to bail them out when it does. Again).
The new regulation regime coming down the pike from DC will be all smoke-and-mirrors / bait-and-switch / red-herring subterfuge. The main purpose will to deflect “anger” away from Congress and the Administration and make a scape goat out of the banks, with the result that the Dums will attempt to heroify themselves. That will be the redux if you boil down everything Robert Gibbs will say over the next 2 months.
I’m not saying banks didn’t screw up - but don’t let Frank’n’Dodd white wash their criminal incompetence by dumping ALL the blame on the banks. Congress is at least equally to blame, and I’ll only allow them to pass as much blame on the banks as those creepy pols are willing to blame themselves. Bunch of @%^@#(^@#U hypocrites!!!!
DON’T LET CONGRESS OFF THE HOOK - WE GOT OUR BOOTS ON THEIR NECKS, LET’S “FLOOOR IT”!!!
That being said, the main problem was that banking became a fee driven business rather than a lending driven business. EVERYONE knew the model changed, but no one - K Street, Wall Street or Main Street - reassessed the risk.
Here are the changes I would make to banking...
1. No “points” on mortgages, and generally reducing the number and amount of transaction fees. Banks should make their money from smart lending over the life of their loans, not windfalls from up-front transaction fees. A 30-year mortgage is a relationship, transactionalizing it is myopic.
2. Minimum down payments - 20%? 15%? 25%? Maybe it depends on amortization term or size or underlying asset? The homeowners need to have skin in the game. If they haven’t been able to save up a down payment, why would anyone think they’d have the financial or moral strength to make the payments down the road?
3. Retention of loan securitizations - any firm putting an MBS/ABS deal together needs to retain a slice of each and every tranche - the IO’s, the PO’s, sub-prime, AAA.
The Federal Government has no business setting these rules. The biggest cause of this problem was government-mandated mortages to high-risk borrowers. That’s what created the vehicles of sub-prime mortages and low down payments. The banking industry was given a false sense of security that Uncle Sam would bail them out - and bail them out he did. The cycle is set up for a repeat, and no amount of new government regulation will fix that. In fact, it will stymie growth and cause our economy to flounder like Japans did in the 1990s.
This author doesn't get it. Banks clearly engaged in risky behavior after the repeal of Glass Steagall and the Fed lowered the reserve requirement to historic lows. It was effectively less than 5% by the time you consider all the funds now exempt from those requirements.
The acceptance of risky behavior was endemic in the banks, in the bank regulators and in the Federal Reserve. The banks were engaging in risky loans backed by worthless insurance from AIG that had moved their offices to the U.K. to escape U.S. regulator scrutiny. The regulators never questioned the validity of the insurance.
That the "too big to fail" institutions got preferential treatment from the Fed's and were allowed to buy up the others for pennies is irrelevant. Allowing these supper huge businesses was never the right course and would have never been allowed if anti-trust regulations were still enforced. Allowing them to buy up the others didn't save the economy, it just makes the economy that much riskier.
One of the reasons that traditional banks failed is that they were competing against banks who didn't care about the future and how much risk they took on. It's a process that left all banks weakened.
It's another form of the outsource to china phenomenon. If you don't outsource, you'll be driven out of business by your competitors who do outsource. And that will happen long before China takes over your stupid competitors.
Same thing with banks. If you don't engage in the risky behavior, you'll lose market share to the risky banks that did because you won't match their returns. And so you'll fail long before the market crashes thanks to the risky bank's behavior.
The banks that own investment banking operations should never, and I do mean never, have FDIC insurance, that makes the taxpayer responsible for their poor business decisions.
Fractional Reserve banking should never be subsidized via a fund that is a liability to taxpayers if they lose money.
Karl Denninger is much more eloquent than I.
Thursday, January 21. 2010
Posted by Karl Denninger in Editorial at 09:56
Mish Misses The Mark (Glass-Steagall)
In a rather interesting article this morning Mish attempts to argue that reinstating Glass-Steagall “wouldn’t have solved anything.”
The idea that Glass-Steagall would have done much, if anything to prevent this crisis is potty. Goldman Sachs, Bear Stearns, and Lehman would all have done what they did. Wells Fargo would have kept its pool of option arms, and the rest of the banks would have followed their lend to securitize model and the regional banks would still be losing their asses on silly commercial real estate deals.
Mish misses the point of Glass-Steagall.
It is not that Glass-Steagall would prevent people from acting fraudulently. It would not have done so.
Indeed, without prosecution of wrong-doing and strong anti-fraud statutes that are not only on the books but are actively enforced against everyone, including the “big society and political class”, THERE IS NO BUSINESS STRUCTURE THAT PREVENTS THE SORT OF BS GAMES WE SAW DURING THE HOUSING BUBBLE.
However, Glass-Steagall’s point is not to prevent fraud.
It is to prevent fraud, when and if it occurs, from bringing down the entire banking system and therefore removing the “you can’t allow us to pay for our crimes in the free market or the world will end” argument from the banksters arsenal of arguments.
I believe it is unethical if not outright fraudulent to front run trades or to trade against advice given to clients. Units that offer advice must be physically separated, not logically separated from units that trade their own accounts. The only sure-fire way to make that happen is to physically breakup the companies.
All of this dark-pool stuff of sniffing out orders and front-running trades has to go as well.
Yep. I agree entirely.
But then Mish makes the “be careful what you wish for” argument:
Everyone wants more small business lending and less risk. Sorry folks, that is physically and logically impossible. Reducing reckless risk, especially risk born by others (taxpayers) is a good idea, but it’s important to understand exactly what that will mean to earnings going forward.
Think of the affect lower share prices and reduced risk taking will have on pension plans and 401Ks. In the long run, less risk is a good thing, and I am in favor of it. I just doubt people are prepared for what it means.
This is a logically-false argument.
We have two options:
We can take our medicine. This means splitting up the commercial banking and investment functions into physically and legally separate firms so that never again will the investment activities of a firm be able to trash the depository function and thus expose the taxpayer to systemic collapse. We can prosecute prior fraud and make clear that any future fraud will also draw an immediate and vigorous criminal and civil fraud statute response. Yes, this will mean the equity market will adjust to actual, not falsely-inflated value on a forward basis and yes, this means we will trade lower - perhaps a lot lower. But it also means the market will be STABLE with prices based on actual earnings and profits, not fraudulent ponzi-style games.
We can continue to pretend that market prices don’t matter, that you can securitize debt and yet end up with more yield in the product securities than existed in the original lending transactions (that is, that people not only work for free but work for a negative amount of money!) and that there will always be a greater sucker upon which to offload whatever we buy. In other words we can continue to do what we’ve done up until now - base our entire capital market structure on an ever-expanding pyramid of fraud and lies. We’ve done this twice in the last ten years and the consequence was two horrific market crashes in a decade’s time, employment capacity utilization back to 1980s levels, a $1.6 trillion deficit as far as the eye can see and a market that has lost half or more of its value - on balance and with account for inflation - over that decade’s time.
If we continue to choose path #2 there is a very real risk that the next crash will be too large for the government to be able to rescue or that the public will not permit another rescue irrespective of the government’s desire to do so. That is, either the buyers of our debt may say “no mas!” or the people may say “screw you!” Indeed it should be assumed at this point that another bailout at any time in the next decade or more will be unable to be mounted, either due to public outrage, creditor revolt or both.
As such choice #2 is literally gambling with the future of the nation - and that, my friends, is a gamble we must not take.
Whether Goldman likes it or not.
The term 'too big to fail' comes to mind. Are you familiar with it?
No, the total amount of mortgages in default when TARP 1 was enacted was $230 billion. For 1/3 of the first TARP, the government could have bought up every mortgage in default.
The problem was much bigger than that. It included the worthless insurance offered by AIG affecting more than just mortgages, the historically low bank reserve rates, the abusive tactics by the credit card industry which had accelerated of late pushing more and more consumers into default, and poor economic decisions in the name of free trade that has allowed our manufacturing and technological base to be decimated.
Not only that, who is going to continue to invest in a market that is shown repeatedly to be corrupt. Eventually market prices are going to reflect an expectation of corruption and that will drive market prices down much further than any regulation will do. Regulation will restore confidence in the markets.
The problems were caused by losses on mortgage holdings. Banks were allowed to hold mortgages before Glass Steagall was repealed.
I reject the term “too big to fail”. The collapse of AIG and Bear Sterns would have been painful. We would likely have ended up in a similar economic situation that we are in now. By bailing out the institutions through TARP, we have created more systemic risk by creating the bailout mentality. Plus, there have been many assessments to say that TARP actually did nothing. Let the free market be the free market, and let the chips fall where they may. No bailouts, regulations to essentially prevent fraud, and no stupid government mandates to provide insurance.
Exactly! Holding all those mortgages. What were they thinking?
The banks were engaging in risky loans backed by worthless insurance from AIG
And buying all those guaranteed securities from Fannie and Freddie.
I challenge anyone here to name for me one institution that failed that would not have failed had Glass-Steagall been in place.
Amen @toddsterpatriot
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