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Break Up The Banks

Wanna have some fun?  I have an idea about how to “save” the banking industry.  Through mergers and acquisitions, the banking cartel grew to become infallible.  Dave Shafer pins the tipping point of this crisis to the repeal of The Glass-Steagall Act of 1933.  I’m not so certain he’s incorrect.

The intention of The Glass-Steagall Act of 1933 was to avoid this:

Commercial banks were accused of being too speculative in the pre-Depression era, not only because they were investing their assets but also because they were buying new issues for resale to the public. Thus, banks became greedy, taking on huge risks in the hope of even bigger rewards. Banking itself became sloppy and objectives became blurred. Unsound loans were issued to companies in which the bank had invested, and clients would be encouraged to invest in those same stocks

Do the 1920’s sound like this decade? As Dave Shafer points out,  the Gramm-Leach-Bliley Act of 1999 ENCOURAGED  the financial behemoths  explaining  “economies of scale” as the primary reason for the repeal of Glass-Steagall.  While financial institutions with strong technology infrastructures can reduce the cost of banking processing functions, the GLB act of 1999 discouraged what Greg Swann calls “flinty banking practices” and encouraged rampant speculation, this time in risky home loans rather than new stock issues.

We were so interested in free online banking that we fed the growing gorilla until he bloated to 1600 pounds. Today, we’re shocked that he busted out of the cage and is chewing up the zookeepers and zoo patrons.

Let me try an analogy for those less interested in economic history .  You once had neighborhood grocery stores.  Certainly, economies of scale favor the supermarket approach.  Distribution costs drop which lower retail food prices.  As those supermarkets vertically integrate, they branch out into ownership of trucking companies, slaughterhouses and farms.  Prices keep dropping and everybody is happy. A chicken in every pot becomes two and all praise is given to the phrase “economies of scale”

Then, a company like Starbucks comes around and the demand for coffee, on a retail level, skyrockets.  Supermarket companies, now owning the commodities suppliers, focus the lion’s share of their efforts on coffee bean farming rather than milk production.  One day, consumers realize that massive caffeine consumption is unhealthy and curb their Starbucks-a-day habit; they return to the practice of drinking milk.

…but there ain’t no milk, just coffee.  Really cheap coffee.  Crashing market prices coffee.  Coffee that costs a nickel a cup.  In fact, supermarkets have so much coffee that the supermarket companies hire lobbyists, to encourage the FDA to  stop telling mothers that caffeiine stunts growth, and start telling mothers that whole milk makes for fat kids.

Am I reducing this to the ridiculous?   Of course I am.

Wanna solve the banking crisis?  Break ’em up.  Reinstate Glass-Steagall, stop taking interstate deposits, and limit loan origination to market areas or regions. Securities firms can still package those loans to provide liquidity but an irrevocable loan guarantee, on the originating lender, will serve as a deterrent to poor lending practices. I hypothesized that the problem wasn’t in the failure of the securitized mortgage process, it was its instantaneous success.  That instantaneous success led to the systemetized approach to real estate lending rather than the local approach that is needed for sustainability.  Dan Green’s thoughts on a real estate data inspired that hypothesis.

“Break ’em up !” I say.  Citigroup can become the First National City Bank.  Bank of America can become Bank of California (or North Carolina).  Wells Fargo the Fargo National Bank, etc, etc.  If we spend that $700 billion on an auction process for the break-up of the oligopoly, we may just get banks to lend money to worthy borrowers, again.

Sound nuts?  Look down at your cell phone.  Do you think you’d have that marvel of technology if Ma Bell was still in charge?

12 comments

12 Comments so far

  1. Caleb Mardini September 23rd, 2008 4:47 pm

    Interesting analogy with milk and coffee Brian.

    Here’s a quote from 1999 at Glass-Steagall’s End:

    “[W]what we are creating now is a group of institutions which are too big to fail. Not only are they going to be big banks, but they are going to be big everything, because they are going to be in securities and insurance, in issuance of stocks and bonds and underwriting, and they are also going to be in banks. And under this legislation, the whole of the regulatory structure is so obfuscated and so confused that liability in one area is going to fall over into liability in the next. Taxpayers are going to be called upon to cure the failures we are creating tonight, and it is going to cost a lot of money, and it is coming. Just be prepared for those events.”

    Representative Dingell (D-Michigan)

  2. Brian Brady September 23rd, 2008 4:59 pm

    @Caleb- ugh (shaking a bowed head, side to side)

  3. David Shafer September 23rd, 2008 6:00 pm

    Wow Dingell got it right! Amazing…..

    But you know I question the too big to fail thinking with the exception of Fannie and Freddie….
    I think we shall see a constant barrage of folks lining up for this gravy train….

  4. Thomas Johnson September 23rd, 2008 6:13 pm

    I call Wall Streeters the white shoe boys. The white shoe boys figured out that if they got rid of Glass Steagall, they could consolidate into the behemoths we see today, at no small personal enrichment to themselves. After the .com bust in the 90’s, they couldn’t find enough suckers to buy their equities.
    There was also a small political problem with everybody losing big chunks of their 401k accounts. Boomers with no retirement vote. The equities well of cash to churn was gone.

    Another problem restraining the white shoe boys was Reg T
    http://www.sec.gov/investor/pubs/margin.htm
    the treasury required that investors had to put up 50% in order to play.

    With mortgages, they were able to get the margin requirements reduced to nothing with zero down payments. Wow! Now all they had to do was get the rating agencies to call the mortgage bonds AAA so they could peddle the resulting mortgage backed bonds off on widows, orphans and Norwegian townships and they could bonus themselves to fantastic wealth by churning the housing stock of America. Of course, since Americans only move every 5 years or so, the white shoe boys began to run out of credit worthy suckers. We had sold everybody a house! So the white shoe boys did what they always do. They poured cash into the coffers of the elected officials and had them write the regulations they needed under the guise of “home ownership for all!”. Then something happened. The wheels fell off, but not until the white shoe boys had their guy(#1 Goldman Sachs white shoe boy Paulson) at the helm of the Treasury department.

    We now see Paulson’s proposal: an $800 Billion bailout of the white shoe boys on top of the Fannie/Freddie nationalization. Paulson wails that if we don’t do this the financial system will freeze and his buddies might have to downgrade from Maybachs and Bentleys.

  5. Tom Vanderwell September 23rd, 2008 8:45 pm

    David,

    “Dingell got it right – amazing…”

    You know the saying, even a broken watch is right twice a day…..

    Tom

  6. Sean Purcell September 23rd, 2008 10:13 pm

    Brian,

    Great ideas. Would localized banks help prevent some of the problems we see now? I’d like to think so, but recent history tells us otherwise. Even your analogy throws doubt:

    Caffiene (even in very small doses) is bad for you. Milk does make you fat (that is its sole purpose). You nailed it: what we really have is marketing and/or some jumble of gov’t letters (FDA, the Fed, you pick ’em) leading the average consumer from one poison to another. This is the natural result of an entire generation believing they are not responsible for their actions or the results of their decisions.

    Hey look, little Johnny got a medal for participating; and Susan sued that restaurant because she was too incompetent to handle hot coffee; and Bill & Mary are hopping mad that the government has not protected them from themselves in their retirement planning. Is it any surprise that Joe homeowner figured he deserved whatever house he wanted, affordability or long term financial health be damned!

    Don’t worry, Starbucks has a huge cup of caffiene and sugar ready for you. Pour some milk in it and wait for the bail out to fix everything. Our only responsibility is to stay in line and follow closely the lemming in front of us.
    Say, is that a cliff up ahead…

  7. Bob in San Diego September 23rd, 2008 11:07 pm

    Nice idea, but it aint gonna happen.

    Warren Buffett is staking $5b on Goldman Sachs. Goldman Sachs wants IndyMac’s banking assets. So now we have Buffett getting another banking entity via Goldman Sachs – the same guy who owns a chunk of Wells.

  8. Michael Cook September 24th, 2008 7:04 am

    Brian,

    I am surprised that you dont think we have enough banks right now. There are enough major player to keep competition going. I have to agree with Sean above, its more about incentive alignment then scale. I like your accoutability point above with the loan guarantee, that will certainly help. At the end of the day though, there were rules in place, they just werent followed. Make guidelines requirements and this problem goes away completely. Unfortunately poor lending standards is not the only problem, but at least that one seems easy to tackle.

  9. Smithers September 24th, 2008 11:03 am

    “This is the natural result of an entire generation believing they are not responsible for their actions or the results of their decisions.”

    Dead-on, Sean.

    We all expect “bail-outs” if anything bad or “unfair” happens to us. Even if we bring it on ourselves, does not matter. Gimme a bail-out. A do-over. Also, I expect to get all of the goodies that someone more successful than me gets.

    (Good job, boomers).

  10. Chris the Implementer September 24th, 2008 12:15 pm

    Brian

    That is one of the best explanations I have heard to date and I think the relatability factor with your analogy is ideal. I am constructing my own blog on this, but heck… I am just gonna point back to you and save myself the agony!

    Chris

  11. JDallas September 25th, 2008 8:00 am

    Speaking of breaking up banks, I heard that the reason BofA is buying up these financial companies is because they want to be so big, that Uncle Sam will have to bail them out should they get into trouble. Isn’t that the most Machiavellian thing you’ve heard of in a long time !

  12. Paul Francis, CRS March 7th, 2009 9:08 pm

    Thomas Johnson’s comment was spot on..

    http://www.opensecrets.org/news/2009/02/tarp-recipients-paid-out-114-m.html

    “Never waste a Good Crisis”

    Marketing at it’s finest…