Wall Street Gamblers’ Insurance Courtesy of Uncle Sam
Your tax dollars still provide FDIC insurance to banks that have the best deal a gambler ever dreamed of. When they take big risks and win, they win big. When they take big risks and lose, they can count on both the FDIC safety net and, in a worst-case scenario, a too-big-to-fail government bailout.
The 2011 Financial Crisis Inquiry Commission report made it clear that high-risk investments by financial firms were at the heart of the financial meltdown: “We conclude dramatic failures of corporate governance and risk managementat many systemically important financial institutions were a key cause of this crisis…Too many of these institutions acted recklessly, taking on too much risk, with too little capital, and with toomuch dependence on short-term funding. In many respects, this reflected a fundamental change in these institutions, particularly the large investment banks and bank holding companies, which focused their activities increasingly on risky trading activities that produced hefty profits. They took on enormous exposures in acquiring and supporting subprime lenders and creating, packaging, repackaging, and selling trillions of dollars in mortgage-related securities, including synthetic financial products. Like Icarus, they never feared flying ever closer to the sun…
“Many of these institutions grew aggressively through poorly executed acquisitionand integration strategies that made effective management more challenging. The CEO of Citigroup C +0.29% told the Commission that a $40 billion position in highly rated mortgage securities would ‘not in any way have excited my attention,’ and the co-head of Citigroup’s investment bank said he spent ‘a small fraction of one percent” of his time on those securities. In this instance, too big to fail meant too big to manage. Financial institutions and credit rating agencies embraced mathematical models as reliable predictors of risks, replacing judgment in too many instances. Too often, risk management became risk justification.”
The “fundamental change in these institutions” cited by the report was, of course, the result of the repeal of Glass-Steagall in 1999. Since its enactment in 1933 to correct the abuses that led to the stock market crash of 1929 and the Great Depression, Glass-Steagall had separated commercial banks, insured by the FDIC but severely restricted in investment scope, from investment banks that were not FDIC-insured and were free to make high-risk investments.
“When we eliminated the separation of investment banking from commercial banking,” FDIC Vice Chairman Tom Hoenig said recently, “we expanded the safety net to broker-dealer activities, trading activities and so forth. These activities do not need government protection to function effectively. However, the expanded safety net gave covered firms an advantage, encouraged them to take on higher risk, to leverage up and to acquire and bring broker-dealers inside the net.”
If any one person was responsible for the repeal of Glass-Steagall, it was Sandy Weill, who as the head of Travelers Insurance in the 1990s wanted to merge with Citicorp. He and Citicorp CEO John Reed made the deal in 1998, but the repeal of Glass-Steagall was necessary to make the merger work. They convinced President Bill Clinton, Treasury Secretary Robert Rubin and a large majority of Congress, and in 1999 Glass-Steagall was repealed.
It took less than ten years for all of the resulting “dramatic failures of corporate governance and risk management” described by the FCIC to lead to the financial meltdown. In fact, with the development of more esoteric financial products than investment bankers of the Glass-Steagall era could have ever imagined, taking higher and higher risks became the norm in our megabanks.
I thought reinstating Glass-Steagall in some updated form was a no-brainer back in 2009, when I co-sponsored a bill to do that with John McCain (R-AZ) and Maria Cantwell (D-WA). It was rather immediately clear there was not sufficient support for the bill to pass. Politics is the art of the possible, so an alternative approach was necessary. In January 2010, President Obama announced that he was “proposing a simple and common-sense reform, which we’re calling the ‘Volcker Rule’– after this tall guy behind me. Banks will no longer be allowed to own, invest, or sponsor hedge funds, private equity funds, or proprietary trading operations for their own profit, unrelated to serving their customers. If financial firms want to trade for profit, that’s something they’re free to do. Indeed, doing so—responsibly–is a good thing for the markets and the economy. But these firms should not be allowed to run these hedge funds and private equities funds while running a bank backed by the American people.”
By the time Dodd-Frank was finally passed seven months later, the Volcker rule had already been watered down. In true Dodd-Frank style, it was then sent to the Fed, FDIC, SEC and CFTC to work out the details. Never forget—that’s where the devil is. For the past three years, the regulators have conducted roundtables and received thousands of comment letters. Lots of talk, as usual, and still no action.
The Volcker Rule is a kind of poster child for the worst failure of Dodd-Frank—not dealing with the causes of the meltdown in the bill, but kicking solutions down to the regulators. Wall Street banks have the resources to bombard the regulators with their positions on any potential rule. This was demonstrated in a study done by Kim Krawiec of Duke Law School on lobbying activity involving the four agencies responsible for formulating the Volcker rule. She found that, between July 26, 2010 and July 7, 2011, 93.6 percent of the meetings with commissioners and staff were with financial institutions, law firms representing financial institutions, or financial institution trade associations, lobbyists, or policy advisors. Only 3.2 percent represented labor or public interest groups; another 3.2 percent were with Senators Levin, Merkley and their staffs.
Curiously, while the regulatory agencies have done little but listen to Wall Street lobbyists these past three years, some old Wall Street hands have been having something of an epiphany. “What we should probably do is go and split up investment banking from banking,” Sandy Weill said last year; “have banks be deposit takers, have banks make commercial loans and real estate loans, have banks do something that’s not going to risk the taxpayer dollars, something that’s not too big to fail.”
His old partner, John Reed, agreed in a letter to the editor of The New York Times. “As another older banker and one who has experienced both the pre- and post-Glass-Steagall world,” he wrote, “I would agree with Paul A.Volcker (and also Mervyn King, governor of the Bank of England) that some kind of separation between institutions that deal primarily in the capital markets and those involved in more traditional deposit-taking and working-capital finance makes sense.”
Live and learn, right? It’s just too bad we had to live through the financial meltdown before they got things right.
Perhaps the ultimate irony is what three leading Wall Streetbank analysts recently wrote about the likely outcome if the megabanks like Citigroup, Bank of America and JPMorgan Chase were broken up. All agree that the value of the parts would be greater than the whole. CLSA analyst Mike Mayo wrote, “Almost every investor that we speak with indicates that a breakup would be bullish for the stocks.”
A few days ago, Senator Elizabeth Warren (D-MA) joined up with Senators McCain and Cantwell and added Senator Angus King (I-ME) to reintroduce our bill to bring back Glass-Steagall. I like Senator Warren’s down-to-earth reasoning: “It will take a lot of tools to get rid of too-big-to-fail, but one of them ought to be that if you want to do high-stakes gambling, good on you, but you do not get access to people’s checking accounts and savings accounts.”
Of course the bill doesn’t stand a chance in the current Congress, but I am convinced it is just a matter of time before we go back to a Glass-Steagall-like solution. It really is the only way to guarantee that FDIC-insured banks don’t engage in risky investments. The only question is how much damage will be done before we do it.
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