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WASHINGTON — Former Citigroup chairman Sandy Weill's call to reinstate Glass-Stegall has sparked a growing countermovement among those that argue restoring the Depression-era law would not make the system safer.
The naysayers are hoping to outmaneuver policy heavyweights like Tom Hoenig, a director at the Federal Deposit Insurance Corp. and former president of the Federal Reserve Bank of Kansas City, who say separating commercial from investment banking is the only way to prevent another financial crisis.
The list of skeptics includes former bank executives and regulators from both political parties, including Richard Kovacevich, the former chairman and chief executive of Wells Fargo, Steven Rattner, former counselor to Treasury Secretary Timothy Geithner, and Rob Nichols, a former Treasury official in the Bush administration and now president of the Financial Services Forum.
"Glass-Steagall never solved any real problems," said Wayne Abernathy, the head of financial institutions policy and regulatory affairs at the American Bankers Association. "I haven't found anyone at all that has been coherent in outlining [the argument]. It's all been mystical. It will make the world better. It will make things less risky. They've never really hooked up cause and effect. The riskiest thing that a bank does … is loan money to somebody."
The allure of Glass-Stegall, the 1933 law that banned commercial banks from owning investment banks, has become so prominent that a recent episode of HBO's The Newsroom said its repeal was the cause of the 2008 financial crisis.
But many current and former industry and regulatory officials take issue with that idea, saying the crisis and the 400-plus bank failures that resulted had nothing to do with the mix of commercial and investment banking.
They point to Bear Stearns, Lehman Brothers and Merrill Lynch as proof, as all three investment firms were at the center of the crisis, but were not owned by commercial banks at the time (Bear was eventually bought by JPMorgan Chase, while Merrill was purchased by Bank of America). Had Glass-Stegall been in effect in 2008, they argue, Bear, Lehman and Merrill would still have collapsed. Nor would the law have prevented the fall of insurance giant AIG or real estate investment trust New Century Financial.
The primary cause of the crisis, they say, is the proliferation of exotic mortgage products that were securitized and sold off across the market. Nothing in Glass-Steagall would have prevented such loans from being originated, sold and securitized.
"Roughly 20 financial institutions were the major perpetrators of the recent financial crisis and the resulting great recession, primarily through the origination, securitization and distribution of exotic subprime mortgages with toxic features such as negative amortization and teaser rates, with stated incomes and reduced documentation," William M Isaac, a former chairman of the Federal Deposit Insurance Corp., and Kovacevich wrote in an editorial in the American Banker.
To be sure, Steven Pearlstein, a columnist for The Washington Post, notes that investment bank activities in the U.S. created a shadow banking system outside of regulators' jurisdiction, which helped encourage sloppy lending practices.
Still, Pearlstein is unconvinced Glass-Steagall would have stopped the crisis.
When I was a statistician for American Banker in the 80s, banks found themselves competing with investment banks for the then much coveted MBA graduate. They thought themselves at a disadvantage because banking back then was staid and boring. Core earnings didn't explode, Money Center banks had to be content with ROA of 9% and ROE of 11.
Then Asset-Backed Securities began to take off and banks went into the market enthusiastically, with mortgage- and credit-card-backed debt. It didn't take long for the market to collapse with a flood of garbage MBS from First Boston. The market was a lot smaller then, but the industry hasn't learned very much.
Back then, issuers took back the securities and properly repackaged them. The top mortgages were of course gobbled up, but the industry discovered something else. Even the high risk securities went quickly. In some cases, even faster than the top rated MBS. As long as investors knew what they were getting, they were willing to take the risk.
There were other wild and un-wise antics during those days just before the end of Glass Steagall. The hostile takeover craze, brokered deposits, etc. All of it only emphasized the difference between commercial and consumer banking and investment banking. This only happened 30 years ago, yet all of it has already been forgotten.
The traditionally commercial/investment banks (JPMorgan Chase, Citi, BofA) have about half their RW (risk-weighted) assets as loans. But look at Goldman and Morgan Stanley. The ones whose trading-intensive business the Fed protects make few real loans. The ratio that illustrates that is the percentage of RW loans and leases to RW assets. Also look at the derivatives percentages. Wells is pretty much a huge, traditional bank. No doubt big into mortgage servicing and not without sin. But not a big trading institution. Does few derivatives compared to the others at the top. (Risk-weighted assets seemed a better way to compare assets. Of course, with the Fed's support of the biggest banks credit ratings, the risk-weights for them are totally distorted. They are the walking dead, on Federal life support. The Morgan Stanley downgrade was an interesting move towards reality.)
When you look at Goldman's few assets comprising the loans and leases, it's not a large amount of C&I, for example. Big into sovereigns, RMBS. They don't make loans.
The seperation of investment banks should happen again - put Wall Street back together again and do not call them bankers they are gamblers who lost with the backing of elected officals who cannot look in the mirror- require that the Treasurer of the USA be a fiduciary banker and stop falling into the diversionary tactics to do nothing and continues to hide its head in the sand.