Chairman Bernanke and Secretary Paulson wrongly said they lacked the legal power to save Lehman. Then, they almost immediately turned around and saved other major investment banks — by waving a magic wand and making them bank holding companies, eligible for federal support. But Shakespeare's line applies: "If it were done…, then 'twere well it were done quickly."
Same for money market funds. We should have extended a federal guarantee for customer balances before the Reserve Primary Fund broke the buck rather than after — thereby avoiding astronomical losses to its accountholders from a forced liquidation.
But if we didn't have the prescience to do the right thing before the fund fell, at least we had the good sense to timely restore the normal order of federal disengagement after the crisis. Namely, the U.S. will no longer guarantee money fund balances — and (wonder of all wonders) their asset composition is more tightly limited than before.
Comparable disengagement has not been mandated for the investment banks (with virtually no resemblance to real banks) that were so hastily dubbed bank holding companies.
The reason this contortion is permitted to continue can't be just that a few big investment banks are systemically important. Other mechanisms were established by Dodd-Frank to deal with systemically important entities that are not banks. And no one has (yet) suggested that we turn all these beasts into fictional bank holding companies.
The defining activities of banks are to provide payment services, gather deposits and then lend (and invest in liquid instruments). Most U.S. banks still do exactly that. If they have other activities, these typically do not involve issuing and dealing in securities, and are low risk.
We can debate who promoted the repeal of Glass-Steagall and why — and what good consequences, if any, followed from repeal. We can ask whether anybody could possibly harm the housing industry and homeowners more than securities activities did during the past decade. But all of that is irrelevant now.
The real question is why on earth we would continue to extend programs intended to protect banks and hence their depositors to any entity that substantially engages in inventorying assets for securitization and in issuing and dealing in securities. What could conceivably justify this?
Is it necessary because banks need to rely on income from securities dealings to subsidize their engagement in real banking? Because these activities are counter-cyclical and reduce risk? Or because large banks need added breadth and scale of activity to compete internationally?
Surely it is by now apparent that all of the above "reasons" are self serving nonsense.
There is nothing counter-cyclical about the securities industry, and no assured returns. In a recession, bank earnings go down and investment banking volume and profitability likewise drops.
To be an international securities firm, you have to have international mass. But efforts to internationalize commercial banking have failed repeatedly to engender superior performance. Ask HSBC. U.S. banks are once again cutting back foreign involvements that have proved to be neither synergistic nor remunerative.
With deposit insurance and unique access to Fed support, banks have a franchise that gives them overwhelming dominance of markets ranging from insured deposits to credit cards. They can price these services to earn return—unless pricing is deflected by huge institutions deluded by ephemeral or phony profits from high-risk, non-banking activities.
Asset-backed securities for which banks retain financial responsibility, such as credit card securitizations, constitute a legitimate source of bank funding that has stood the test of time and weathered the recent crisis outstandingly well. On the contrary, buying up, packaging and selling loans with no or little recourse isn't banking. It's an activity to be overseen by securities regulators, subject to additional restrictions when, in the aggregate, it becomes systemically important.
But then, who's going to accumulate and package mortgages?
If buying, packaging and selling pools of mortgages can't attract enough capital to continue to operate at recent levels — without using capital that benefits from access to Fed support — then there should be less of that. If the Government wants to promote mortgage security issuance, then it will once again find occult ways to do so.
So, how do we get our banks back to banking? Legislate a sunset for engagement by bank holding companies in activities other than deposit, lending and payment services, liquidity investments, and specified incidental operations such as stock brokerage and corporate advice that do not involve dealing or buying assets to be packaged and sold. The Volcker Rule and QRM won't get us anywhere near this goal.
Andrew Kahr is a principal in Credit Builders LLC, a financial product development company, and was the founding chief executive of First Deposit, later known as Providian. He can be reached at firstname.lastname@example.org.