Financial terrorism II: Where do we land?
For all of you who read Financial terrorism: US taxpayers bail out Wall Street Criminals, welcome to Financial terrorism II, the sequel, soon to be playing at commercial banks and investment banks in your neighborhood. First of all, how could I fail to mention in FT 1 that to pay for this $700-800 billion-plus bailout, Treasury Secretary Paulson heartily recommended raising the national debt limit from $8.965 trillion to $11.3 trillion, see the second paragraph of this New York Times story.
But I suppose as a counterbalance to this breathtaking amount of national debt, Paulson and the Fed wanted to seem prudent and the Times announced yesterday Goldman and Morgan Shift Marks End of Era in Finance.
There are two huge, theoretical pieces of news here. One that Goldman Sachs and Morgan Stanley, the last of the red-hot independent investment banks on Wall Street, will morph into bank holding companies and be subject to greater regulation, which will mark the end of the big time buyer/spenders era. Second, it brings Wall Street back to those not-so-golden days of yesteryear, during the Great Depression, when Congress passed the Glass-Steagall Act, to separate the functions of commercial and investment banks and to expect transparency from both.
Free Marketers will hold up their crosses or favorite religious icons to ward off the fact that bank holding companies have far more stringent regulations and supervision from a variety of government agencies, as opposed to just the Securities and Exchange Commission (SEC). Now the former investment bank powerhouses spending and losing OPM (other people’s money) like water, will behave more like commercial banks, with more transparency, disclosure, and more capital reserves and less risk-taking.
Companies like Morgan Stanley and Goldman Sachs had a decades-long party taking big bets, too often utilizing large amounts of debt to pump up their profits. All this with little outside oversight, like pigs in a poke. They were the Geckoes of Wall Street, rounding up the industry’s juiciest businesses, delivering the splashiest deals, and touting mergers, stock offerings, restructurings to companies and governments around the globe.
But their irresponsible behavior helped sink their Titanic. Boom, the iceberg of reality hit. Investors lost confidence. They didn’t like the way the boyz placed their bets in the recent credit boom, especially when they moved in on shady securities whose risks nobody could quite fathom. People started pulling out their money. The Dow headed to the depths. These banks listed and some sank. Yet, even in return for agreeing to more regulation, these companies will have “access to the full array of Federal reserve lending facilities,” which still makes me shudder. It will provide them with liquidity so they won’t end up like Lehman Brothers, buried in the bankruptcy graveyard. What excesses will they provide?
The new restrictions could include the Fed stepping in to regulate hedge funds at last, the largest of which look pretty much like Goldman and Morgan Stanley. The new bank holding companies will have to shed their resistance to regulation. Commercial banks have rules on how much money they can borrow and the kinds of business they can be in. The Goldman lobby, which spent years pushing away close supervision, will have to find other jobs.
The bank holding companies will have to cut what they can borrow in relation to their capital, like a commercial bank has to maintain a reasonable fraction of their deposits, not a buck for every $22 in assets like Goldman, or a buck for every $30 in assets like Morgan Stanley. More like a buck for less than $11 in assets like Bank of America, a commercial bank, the bank that has okayed buying Merrill Lynch for $50 billion. Bear Sterns went up in smoke in a fire sale to JP Morgan, an investment bank.
Supposedly, it will take time for Goldman and Morgan to morph into fully regulated banks because they can’t cut down the amount they borrow now compared to their assets. The Fed and SEC have sent the doctors in to examine the investment banks, which have supposedly made themselves available for X-rays. Good luck. They want to build up their retail deposit business and to “expand over time.” Goldman chairman, Lloyd Blankfein, said it “will be regarded as an even more secure institution with an exceptionally clean balance sheet and a greater diversity of funding sources.”
John Mack, chairman and chief exec of Morgan said “This new bank holding structure will ensure that Morgan Stanley is in the strongest possible position -- with the stability and flexibility to seize opportunities in the rapidly changing financial marketplace.” Actually, of late, Morgan has been deep into talks with China to boost its capital, as if China weren’t pumping enough money (something over a trillion dollars) into the US government. Morgan Stanley was also, as of my last piece, thinking of merging with Wachovia.
More about the Glass-Steagall Act
This act grew out of the loose supervision of the SEC during the 1920s that led to the crash of 1929. Sound familiar? This act separated investment and commercial banking activities. At that time, commercial bank involvement in stock market investment was considered overzealous and was considered the main cause of the crash. Commercial banks were not only investing their assets, but also buying new issues for resale to the public. They became greedy and took on unnecessarily large risk, hoping for bigger rewards. Banking became sloppy and its objectives unclear. Unsound loans were given to companies in which the banks invested in, and their clients would be advised to invest in the same stocks. This was a deadly conflict of interest, not unlike what we recently saw with stock and bond ratings often being provided by financial institutions that were selling them.
Senator Carter Glass, one of the co-sponsors of the Glass-Steagall Act, a former Treasury secretary and co-sponsor of the US Federal Reserve System, was the main force behind the Glass-Steagall Act. Steagall was a House of Representatives member, and chairman of the House Banking and Currency Committee. Steagall supported the act with Glass, after an amendment was added to permit bank deposit insurance, the Federal Deposit Insurance Corporation (FDIC), a godsend.
Another firewall added to separate commercial and investment banks was in 1956. It prevented financial conglomerates from getting involved in the insurance sector. Underwriting insurance, Congress agreed, was not a good practice for banking. So, the Bank Holding Company Act further divided financial activities between the two areas, again a good notion.
Unfortunately, in November of 1999, Senator Phil Gramm (R-Texas) and Representative James Leach (R-Iowa) finally got Clinton, after a majority vote of Congress against the act, to get rid of it. And free-market Phil, unlike Punxsutawney Phil, became an unlikely predictor of the financial storms this would bring.
As Wikipedia reports, “The banking industry had been seeking the repeal of Glass-Steagall since at least the 1980s. In 1987, the Congressional Research Service prepared a report which explored the case for preserving Glass-Steagall and the case against preserving the act.
“The repeal enabled commercial lenders such as Citigroup, the largest U.S. bank, to underwrite and trade instruments such as mortgage-backed securities and collateralized debt obligations and establish so-called structured investment vehicles, or SIVs, that bought those securities. Citigroup played a major part in the repeal. Then called Citicorp, the company merged with Travelers Insurance Company the year before using loopholes in Glass-Steagall that allowed for temporary exemptions. With lobbying led by Roger Levy, the ‘finance, insurance and real estate industries together are regularly the largest campaign contributors and biggest spenders on lobbying of all business sectors [in 1999]. They laid out more than $200 million for lobbying in 1998, according to the Center for Responsive Politics’ . . . These industries succeeded in their two decades long effort to repeal the act.”
This opened the doorway to the financial disaster we have been living. In fact, in the last 20 years, we have the savings and loan disaster, thanks to pumping and dumping junk bonds into the 1989 market, which created Black Tuesday; then add to that the dot.com bubble, pumping up the value of literally unknown dot.com companies to inflate the economy with a false prosperity. This was just like the spread of collateralized (junk) debt paper, much of it from predatory lending, to grease the housing bubble into oblivion and cause a nearly world economic collapse due to the loss of liquidity.
What do we learn from this?
The notion of the taxpayer picking up this third tab of $700 billion, as well as hiking the national debt to $11.2 trillion, is something not to be pushed through blindly at warp speed in the dead of night. That hiked debt will be serviced and paid for from tax money, our Treasury money. The US Treasury will be responsible for that tab, as it was with the savings and loan debacle’s tab of some $300 billion plus, the dot.com debacle that plunged the market into financial disaster, and led to this last Ponzi scheme, with the $700 billion tab.
Congress should not continue the cycle of adding huge debt to huge debt. For once, let the guilty parties take the rap for their mistakes. Otherwise, we will keep them in business to come up with another scheme to fleece the public. They should be allowed to fail -- fail big -- to learn a lesson that we the taxpayers are not their Big Daddy.
If Congress had only stopped to examine Bush’s lack of real evidence to attack Iraq and plunge us into that war debt, roughly the same as this subprime debt, we would not have those trillions of debt added to our national debt. Someone needs to say no, enough is enough. And let the chips falls where they may.
Enabling the market’s addiction to unregulated, unbounded profits is not the answer to creating a healthy economy. Retooling to meet the green challenge of new sustainable energy technologies is certainly one way to go. But it will never be if we cave on the subprime debt. All that we do is connected. This includes paying for Social Security, Medicare, education, and other human-based needs. Why would the free marketers, who tried so hard to privatize (destroy) Social Security now want to literally nationalize the stock market. Now, let them stand on their own two privatized feet, or fall.
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