Blame Bank Deregulation/Blame the Repeal of the Glass-Steagall Act

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[EJ]

Re: Blame Bank Deregulation/Blame the Repeal of the Glass-Steagall Act

Until the repeal of the Glass-Steagall Act, banking regulation prohibited banks with federally insured deposits from operating brokerage subsidiaries.

In December 1986, the Federal Reserve Board, which has regulatory jurisdiction over banking, reinterpreted Section 20 of the Glass-Steagall Act, which bars commercial banks from being "engaged principally" in securities business, deciding that banks can only have up to 5% of gross revenues from investment banking business. The Fed board then permitted Bankers Trust, a commercial bank, to engage in certain CP transactions. In the Bankers Trust decision, the board concluded that the phrase "engaged principally" in Section 20 allows banks to do a small amount of underwriting, so long as it does not become a large portion of revenue.

In the spring of 1987, the Federal Reserve Board voted 3-2 in favor of easing regulations under Glass-Steagall Act, overriding the opposition of then-chairman Paul Volcker. The vote legalized as policy proposals from Citicorp, JPMorgan and Bankers Trust to allow banks to handle several underwriting businesses, including commercial paper, municipal revenue bonds, and mortgage-backed securities.

since then, the history of finance capitalism has been the triumph of the security industry's aggressive culture of risk over the banking industry's prudent culture of security.

In March 1987, the Fed approved an application by Chase Manhattan to engage in underwriting commercial paper. While the board remained sensitive to concerns about mixing commercial banking and underwriting, it reinterpreted the original congressional intent by focusing on the words "principally engaged" to allow for some securities activities for banks. The Fed also indicated that it would raise the limit from 5% to 10% of gross revenues at some point in the future to increase competition and market efficiency.

In January 1989, the Fed board approved a joint application by JPMorgan, Chase Manhattan, Bankers Trust, and Citicorp to expand the Glass-Steagall loophole to include dealing in debt and equity securities in addition to municipal securities and commercial paper. This marked a large expansion of the activities considered permissible under Section 20, because the revenue limit for underwriting business was still at 5%. Later in 1989, the board issued an order raising the limit to 10% of revenues, referring to the April 1987 order for its rationale.
In 1990, JPMorgan became the first bank to receive permission from the US Federal Reserve to underwrite securities, so long as its underwriting business does not exceed the 10% revenue limit. .

In December 1996, with the vocal public support of chairman Alan Greenspan, the Federal Reserve board issued a precedent-shattering decision permitting bank holding companies to own investment bank affiliates with up to 25% of their business in securities underwriting, up from 10%. This expansion of the loophole initially created by the Fed's 1987 reinterpretation of Section 20 of Glass-Steagall in effect rendered the act obsolete, in view of explosive growth of banking. Virtually any bank holding company wanting to engage in securities business would be able to stay under the 25% limit on revenue, since banks are much larger institutions as compared with security firms.

In August 1997, the Fed further eliminated many restrictions imposed on "Section 20 subsidiaries" by the 1987 and 1989 orders. The board stated that the risks of underwriting had proved to be "manageable" and allowed banks the right to acquire securities firms outright. After the merger announcement on April 6, 1998, Weill immediately launched a lobbying and public relations campaign for the repeal of Glass-Steagall and passage of new financial services legislation known as the Financial Services Modernization Act of 1999. "Modernization" was a euphemism for total deregulation for the brave new world of financial globalization.

As the final push for new legislation heated up around election time, lobbyists raised the issue of financial modernization with a fresh round of political fundraising. Indeed, in the 1998 mid-term election, the finance, insurance, and real-estate industries, known as the FIRE sector, built a bonfire of more than $200 million on lobbying and more than $150 million in political donations. Campaign contributions were targeted to members of congressional banking committees and other committees with direct jurisdiction over financial-services legislation.

After 12 attempts in 25 years, Congress finally repealed Glass-Steagall, rewarding financial companies for more than 20 years and $300 million worth of lobbying efforts. Supporters hailed the change as the long-overdue demise of a Depression-era relic. Opponents saw it as the root of a future depression.

the repeal of Glass-Steagall would pave the way to the emergence of the non-bank financial system,

Henry C. K. Liu


In retrospect, the banks should have been subject to mopre intense, not less, regulation. In reorganizing our financial insittutions the first requirement is to recongnize that the competitive freedoms of the mercantile marketplace cannnot be applied to the institutions that create our money, or protect our savings. More than 75 years ago this wisdom was recognized by the inauguration of the FDIC (Banking Act of 1933), and many other changes in our banking structure. Deregulating financial institutions to the extent that they have been deregulated, combined with the governments' guarantee of the liabilities of these institutions (too big to fail), was an invitation to fianancial disaster.

http://henryckliu.com/page13.html

Greenspan was instrumental in getting Glass-Seagall repealed. As a free-market ideologue, he was the right man for the job as a hired gun of FIRE Economy leadership to get Glass-Seagall out of the way of a new source of profits from sales of unregulated financial products. He then fought for and won for the Fed the role of banking system regulator, then again–consistent with his "free-market" hired gun modus operandi– proceeded to abdicate the responsibility.

[flow5]

Re: Blame Bank Deregulation/Blame the Repeal of the Glass-Steagall Act

The problem is that all unregulated markets eventually self-destruct. Weak competitors are naturally forced off the market, leading to monopolies that are the result of market failure of competition. Yet regulation cannot cure the problem preemptively because remedial regulation only makes sense after disasters, never before

Henry C K Liu http://henryckliu.com/page139.html

Remedial regualtion only makes sense after disasters, never beforre

This is of course an accusation, and an attempt, by the non-professionals to preempt the field. Liu is not an economist and his claim is total nonsense. Virtually all economic vacillations were predictable in theory as well as predicted in practice.

[Spartacus]

Re: Blame Bank Deregulation/Blame the Repeal of the Glass-Steagall Act

While I agree, I also think anyone else in the same position would have done the same.

Nasser Saber says "Speculative Capital (SC) changes the laws to favor itself" (something like that - maybe he wrote "SC greases it own gears")

and he gives lots of examples - foreign exchange restrictions lifted in Greece, Spain and various Asian coutries (as recently as a few months ago in Malaysia, wasn't it?) When certain companies with lots of speculative capital wanted to do something that was illegal under the old regulations.

Once the supply of money becomes large enough and concentrated enough this kind of thing is pretty much guaranteed, isn't it?

Greenspan was instrumental in getting Glass-Seagall repealed. As a free-market ideologue, he was the right man for the job as a hired gun of FIRE Economy leadership to get Glass-Seagall out of the way of a new source of

[flow5]

Re: Blame Bank Deregulation/Blame the Repeal of the Glass-Steagall Act

SANTA MONICA, Calif. (MarketWatch) -- Time was when banks and brokerages were separate entities, banned from uniting for fear of conflicts of interest, a financial meltdown, a monopoly on the markets, all of these things.


In 1999, the law banning brokerages and banks from marrying one another -- the Glass-Steagall Act of 1933 -- was lifted, and voila, the financial supermarket has grown to be the places we know as Citigroup, UBS, Deutsche Bank, et al.
But now that banks seemingly have stumbled over their bad mortgages, it's worth asking whether the fallout would be wreaking so much havoc on the rest of the financial markets had Glass-Steagall been kept in place.
Diversity has always been the pathway to lowering risk. And Glass-Steagall kept diversity in place by separating the financial powers that be: banks and brokerages.
Glass-Steagall was passed by Congress to prohibit banks from owning full-service brokerage firms and vice versa so investment banking activities, such as underwriting corporate or municipal securities, couldn't be called into question and also to insulate bank depositors from the risks of a stock market collapse such as the one that precipitated the Great Depression.
But as banks increasingly encroached upon the securities business by offering discount trades and mutual funds, the securities industry cried foul. So in that telling year of 1999, the prohibition ended and financial giants swooped in. Citigroup led the way and others followed. We saw Smith Barney, Salomon Brothers, PaineWebber and lots of other well-known brokerage brands gobbled up.
At brokerage firms there are supposed to be Chinese walls that separate investment banking from trading and research activities. These separations are supposed to prevent dealmakers from pressuring their colleague analysts to give better results to clients, all in the name of increasing their mutual bottom line.
Well, we saw how well these walls held up during the heyday of the dot-com era when ridiculously high estimates were placed on corporations that happened to be underwritten by the same firm that was also trading its securities. When these walls were placed within their new bank homes, cracks appeared and -- it looks ever so apparent -- ignored.
No one really questioned the new fad of collateralizing bank mortgage debt into different types of financial instruments and selling them through a different arm of the same institution. They are now.
Enforcing separation
I'm not saying that Glass-Steagall would have made a difference to the evolution of the collateralized debt obligations. But it might have helped identify and isolated the damage.
When banks are being scrutinized and subject to due diligence by third-party securities analysts more questions are raised than when the scrutiny is by people who share the same cafeteria. Besides, fees, deals and the like would all be subject to salesmanship, which means people would be hammering prices and questioning things much more to increase their own profit -- not working together to increase their shared bonus pool.
Glass-Steagall would have at least provided what the first of its names portends: transparency. And that is best accomplished when outsiders are peering in. When every one is on the inside looking out, they have the same view. That isn't good because then you can't see things coming (or falling) and everyone is subject to the roof caving in.
Congress is now investigating the subprime mortgage debacle. Lawmakers are looking at tightening lending rules, holding secondary debt buyers responsible for abusive practices and, on a positive note, even bailing out some homeowners.
These are Band-Aid measures, however, that won't patch what's broken: the system of conflicts that arise when sellers, salesmen and evaluators are all on the same team.
Glass-Steagall forced separation. Something like it, where conflicts and losses can be mitigated, should be considered again.