What’s that, Mitch?
And now for some good news from Washington. The White House is finally listening to Paul Volcker:
Declaring that huge banks had nearly brought down the economy by taking “huge, reckless risks in pursuit of quick profits and massive bonuses,” President Obama on Thursday proposed legislation to limit the scope and size of large financial institutions.
The changes would prohibit bank holding companies from owning, investing, or sponsoring hedge fund or private equity funds and from engaging in proprietary trading — what Mr. Obama called the Volcker Rule, in recognition of the former Federal Reserve chairman, Paul A. Volcker, who has championed the restriction.
Cue the standing ovation from the tea-party right, right? Probably not. But an even nicer sound: the silence of the Grand Old Populists on Capitol Hill.
This truly is good news! I believe that this proposal was crafted by Paul Volcker, and this too is good news; for unlike Summers and Geithner whose independence of Wall Street is questionable, Paul Volcker (along with Elizabeth Warren) is untainted and has a long record of service in the interest of the public. Let us hope that Volcker is in and Summers is out.
People should make sure to click through to the article. The post includes the few sentences in the article that aren’t entirely skeptical of this plan.
This is really a back door way of reinstating Glass-Steagal. It is only a first step and in the end actual reinstatment may be preferable. As to whether the absence of Glass-Steagal constraints had anything to do with the crisis all I can say is that I have spent over forty years at fairly high levels within the financial world, and I don’t think I know a single person with similar experience who has the slightest doubt that it was a major cause of the problems. Certainly had Citi, B of A, Wachovia, and all the other commercial banks been prevented from participating in the CDS and CMO trading, to say nothing of the off-balance sheet leveraging used to finance these and other risky non-banking activities, neither the Treasury nor the Fed would have been quite so compelled to come to their rescue. The real question is whether the Massachusetts debacle has scared Congress enough to take meaningful action.
Thanks, Matthew. Great news. (Surely the Republicans wouldn’t be so fool-hardy as to filibuster such a new law. Would they?)
legislation to limit the scope and size of large financial institutions
By far, the largest financial institutions are the Federal Reserve and the federal government.
For years, folks have been calling for the scope and size of both of them to be limited. But they just keep getting bigger and bigger.
“As to whether the absence of Glass-Steagal constraints had anything to do with the crisis all I can say is that I have spent over forty years at fairly high levels within the financial world, and I don’t think I know a single person with similar experience who has the slightest doubt that it was a major cause of the problems.”
That is interesting. FactCheck.org actually reaches the opposite conclusion (http://www.factcheck.org/elections-2008/who_caused_the_economic_crisis.html), saying, in pertinent part:
“The truth is, however, the Gramm-Leach-Bliley Act had little if anything to do with the current crisis. In fact, economists on both sides of the political spectrum have suggested that the act has probably made the crisis less severe than it might otherwise have been.
Last year the liberal writer Robert Kuttner, in a piece in The American Prospect, argued that “this old-fashioned panic is a child of deregulation.” But even he didn’t lay the blame primarily on Gramm-Leach-Bliley. Instead, he described “serial bouts of financial deregulation” going back to the 1970s. And he laid blame on policies of the Federal Reserve Board under Alan Greenspan, saying “the Fed has become the chief enabler of a dangerously speculative economy.”
What Gramm-Leach-Bliley did was to allow commercial banks to get into investment banking. Commercial banks are the type that accept deposits and make loans such as mortgages; investment banks accept money for investment into stocks and commodities. In 1998, regulators had allowed Citicorp, a commercial bank, to acquire Traveler’s Group, an insurance company that was partly involved in investment banking, to form Citigroup. That was seen as a signal that Glass-Steagall was a dead letter as a practical matter, and Gramm-Leach-Bliley made its repeal formal. But it had little to do with mortgages.
Actually, deregulated banks were not the major culprits in the current debacle. Bank of America, Citigroup, Wells Fargo and J.P. Morgan Chase have weathered the financial crisis in reasonably good shape, while Bear Stearns collapsed and Lehman Brothers has entered bankruptcy, to name but two of the investment banks which had remained independent despite the repeal of Glass-Steagall.
Observers as diverse as former Clinton Treasury official and current Berkeley economist Brad DeLong and George Mason University’s Tyler Cowen, a libertarian, have praised Gramm-Leach-Bliley has having softened the crisis. The deregulation allowed Bank of America and J.P. Morgan Chase to acquire Merrill Lynch and Bear Stearns. And Goldman Sachs and Morgan Stanley have now converted themselves into unified banks to better ride out the storm. That idea is also endorsed by former President Clinton himself…”
Mat
I’m sorry, but you’re just repeating the old deregulation mantra which even Greenspan, its principal advocate, has now repudiated. The people you have referenced-DeLong and Cowen- have so much of their professional reputations tied up in the notion of the “invisable hand” always creating the best outcome that their objectivity is simply non-evistant and their scholarship is a shambles. I think that the lesson of history is absolute! From the 1930′s through the late 1980′s the financial markets functioned efficiently within an environment of strond regulation. As soon as regulation was removed or not fully enforced, greed prevailed and markets fell apart starting with Long Term Capital in the 90′s and ending with the mess we are now saddled with.
Perhaps deregulation could have worked but not in the environment of unmitigated greed that has prevailed since the mid 1980′s. In that respect restoration of the 70% marginal tax rate on incomes over $1.0 million as existed on an inflation adjusted basis prior the 1980′s era tax reforms would probably be even more effective than ramping up regulation. But that is not likely, so increased regulation, of which Obama’s latest proposal is just the beginning, is almost certain to occur. And in my view, that is a good thing.
The Gramm-Leach-Bliley Act was part of a series of deregulatory measures that dismantled the Glass-Steagal Act between the 1970s and 2000 when the Commodities Futures Modernization Act of 2000 was adopted. The Gramm-Leach-Bliley Act allowed for the creation of large financial conglomerates that spanned banking, securities, insurance and other financial services. It did NOT, however, modernize the regulatory structure to deal with such financial conglomerates. That was its big mistake. (It was something of a sin of omission.)
While Congress in the Gramm-Leach-Bliley Act created a new holding company structure for financial conglomerates called a Financial Holding Company (FHC) and subjected FHCs to regulation by the Federal Reserve, it did NOT mandate that all financial conglomerates had to become FHCs. Loopholes in the act allowed AIG, which owned savings and loans, financial derivatives units and other financial subsidies in addition to its insurance subs, to decide to be classified as a Thrift Holding Company and be supervised by the Office of Thrift Supervsion rather than the Federal Reserve.
Similarly, Goldman Sachs, Bear Stearns, and Lehman Brothers owned banks but due to loopholes in the laws were not required to become FHCs or Bank Holding Companies (BHCs), which are also regulated by the Federal Reserve, For about five years after the Gramm-Leach-Bliley Act was passed, these huge financial conglomerates had no regulator overseeing their holding company structure as a whole. When it looked like they might be subject to European regulations as a financial conglomerate, Goldman, Lehman Brothers, Bear Stearns, and a few others went to the SEC to get them to create a new holding company structure, the Consolidated Supervised Entity classification (CSE), so that they could avoid being regulated by the Federal Reserve as a either a FHC or BHC or being subject to European financial conglomerate regulations. The SEC didn’t have much experience imposing prudential regulations on such large financial conglomerates nor was ideologically inclined to do so. As a result, it let them use internal risk models to justify extraordinarily high leverage ratios, which helped them make massive profits when the markets were up but also contributed to the huge financial problems of Bear, Merrill, and Lehman when the markets turned.
As a CSE, Bear, Lehman, Goldman, and Morgan Stanley did not have access to Fed funds in the same manner as a FHC or a BHC did. This is why when Bear and Lehman couldn’t directly access Fed funds when they got into trouble. It is also why Goldman and Morgan Stanley converted to BHC in Sept. 2008 in order to gain access to Fed funds in the wake of Lehman’s collapse.
For over a decade, Goldman, AIG, and other large financial conglomerates benefited greatly from engaging in regulatory arbitrage to pick which regulator it wanted when it is convenient for them. While I am not sure that it is necessary (or politically feasible) to re-introduce and pass a new Glass-Steagall Act, I do think that a regulatory system that eliminated opportunities for such regulatory arbitrage would be preferable.
“I’m sorry, but you’re just repeating the old deregulation mantra which even Greenspan, its principal advocate, has now repudiated. ”
I think you misunderstood the quote from FactCheck.org. The quote was referring to the Glass-Steagall Acts which you mentioned in your previous comment, not “deregulation”. To take your examples, Glass-Steagall would not have applied to Meriwether because he was not a bank holding company and ditto for the 750 or so banks which failed during the S&L Crisis as none of those banks had affiliated investment banking operations. As far as I am aware, the only bank which either recently failed or required TARP funds (versus opportunistically taking them) to which Glass-Steagall would be relevant is Citi. And frankly it is not surprising the fact that diversified banks were far less likely to fail or need TARP funds, precisely because their conduit business allowed them to keep much of the so-called “toxic” assets off the balance sheets.
Regarding regulation, I think the comments accompanying the standing ovation from the tea-party’s newspaper of record says it best:
“…[Y]esterday Mr. Obama introduced his first serious idea into the debate on reforming the financial system. In calling for an end to proprietary trading at firms with a federal safety net, the President showed that he now understands an important principle: Risk-taking in the capital markets is incompatible with a taxpayer guarantee.
…
If we are going to have a Fed and a political class as reckless as we have, then we need a more comprehensive answer to financial risk. Bankruptcy for risk-takers who bet wrong is the best option. Barring that, strict limits on margin and leverage, especially for holders of insured deposits, can be helpful. Mr. Obama’s suggestion yesterday of limits on the size of financial firms—with the limits still to be determined—deserves a hearing but would seem more problematic.
Still, we’re encouraged by yesterday’s announcement. The Democrats appear to finally realize that too-big-to-fail is a problem to be solved, not the foundation of a modern banking system.”
I think these restrictions are a good thing, too. I do share Mr Bogle’s skepticism (it was in the article) as to whether government will actually be able to regulate these large banks, even if it wants to. From 1999 to 2009, I did a lot of CRA-related advocacy. (CRA is short for the Community Reinvestment Act, which requires banks to not only serve high income communities, but to also meet the credit needs of low- and moderate-income borrowers and communities within their footprint).
As part of my work, I would review bank merger applications and CRA evaluations and comment on the strengths and weaknesses of a bank’s CRA performance in NYC’s neighborhoods. My experience is limited to this very narrow niche, but it seems similar to Mr. Ladner’s much broader experiences in the industry.
After Financial Modernization, the big banks’ CRA-related lending, investment and services plummeted. I don’t know the intricacies of it, but I think Gramm-Leach-Bliley contributed at least indirectly to this. We saw the growth of mega-banks that were poorly structured to address credit needs on a community level, and this was coupled with what my banker friends called a “relaxed regulatory environment” . By 2004 we were seeing very concrete retrenchment in CRA activity in NYC at banks like Chase; this retrenchment snowballed in the second half of the decade; by 2009 Chase, for example, had essentially dismantled it CRA programs. Although bank applications can be denied if the institution does not have a satisfactory CRA rating, the regulators now always give banks satisfactory ratings and never deny an application.
There is also a problem of “regulator-shopping”. We have multiple federal regulators and the large banks are able to maneuver so that they are regulated by the most bank-friendly agency. I think “too big to fail ” might also mean “too big tooregulate”, though as Bogle said, we need to try.
I also share Mr. Ladner’s lack of confidence in Geithner. He headed the NY Fed when all of this bad stuff was happening, the NY Fed was a much better regulator under his predecessor, McDonough. So, at the end of the day, I think, yeah, we need stronger laws, but those laws will only be effective if the regulators do their job and actually enforce them.
On a side note, my burning question is: where is NY’s Chuck Schumer on this? Schumer took public credit as the man who worked behind the scenes to save Gramm-Leach-Bliley when its passage was in trouble. Is he still taking credit for that, I wonder?
Two pertinent stories which show the banks need to be regulated. Poor Golman only 16.2 billion will they give in bonuse. And now lobbyists will be calling the shots.
“We have got a million we can spend advertising for you or against you — whichever one you want,’ ” a lobbyist can tell lawmakers, said Lawrence M. Noble, a lawyer at Skadden Arps in Washington and former general counsel of the Federal Election Commission.”
http://www.nytimes.com/2010/01/22/us/politics/22donate.html?ref=todayspaper
Despite a record 2009, the bank announced that it had set aside only $16.2 billion to reward its employees. http://www.nytimes.com/2010/01/22/business/22goldman.html?ref=todayspaper
What effect will the apparent revolt against confirming Bernanke have on the Volker plan? Does Bernanke make that much difference?
http://dealbook.blogs.nytimes.com/2010/01/22/2-democrats-oppose-another-term-for-bernanke/?scp=2&sq=Bernanke&st=cse
Margaret I think that on balance Bernanke has been O.K. He is, above all, an economic historian and appears to have a good understanding of the mistakes of the past.
On the other hand, Bernanke’s policy of administered low interest rates is in part inneffective. It is problematic for the following reasons:
1. the banks have been reporting very high earnings derived from their low cost of money. We know that these earnings are not coming from new lending, rather (I suspect), they are mostly coming from the bank’s pre-existing position as counterparties in their book of interest rate swaps.Thus no economic stimulus is possible from this source because no new money is made available to support business growth, while at the same time the expectation that the banks would improve their capital base by their retention of earnings has been frustrated to the extent that they divert funds into their bonus pools.
2.The cost of the Federal Reserve’s policy of low interest rates falls mainly on savers among whom are the many investors in money market mutual funds. The asset value of such funds is approximately $3.8 trillion. About $2.5 trillion is held by individuals. If the fed policy has depressed short rates by say 200 basis points, then it is apparent that the public is now subsidizing the banking industry’s low cost of funds and thus its profits (and employee bonuses) by about $50 billion per year.This too is counter-productive to the goal of economic stimulus.
Ms. Brown –
Thanks for a very enlightening post about what is a very murky matter to us non-economists.
Can you answer another question for us: how can economics ever be certain of *any* of its explsnations of what happened in the past? I know that the Keynesians hold that the future is essentially unpredictable. It would seem to me that the past must also be unexlpainable, and for the very same reason– an economic system is a functional one with an indefinite past.
Forget about restrictions, changes, etc. Now that the SCOTUS has emasculated the voting public, whatever the Really Big Bux want will be law.
You think otherwise? Dream on. Democracy as we think we had it has taken a severe blow and all of this wishful thinking about a return of a clone of Glass-Stegal, etc. is just that — wishful thinking.
Despair not, Jimmie Mac. The Saints won this evening. Miracles do happen. If we persist:-)