Big banks are having a torrid time of it these days. First there was the financial crisis, for which most people blamed them, and now a spate of scandals that has cast the industry in an even worse light — an achievement that few would have thought possible a year ago.
Indeed, the stink is now so bad that some people are calling for the re-introduction of Glass-Steagall, a post-Depression set of rules that erected a strict (and simple) divide between Main Street and Wall Street banks, or something similar. And our readers agree — in our web poll last week, three-quarters of them said it is time for commercial and investment banks to be separated again.
That is hardly surprising given the worst excesses of the pre-crisis period. Many practices that have come to light in its wake seem to be precisely the type of behaviour that Carter Glass and Henry Steagall had hoped to banish to history.
But history had different plans. The wall formally came down in 1999, but the reality is that very few bankers working today have experienced the full-fat version of Glass-Steagall, which until the 1970s had prevented deposit-taking institutions from having anything to do with securities markets.
By the 1980s, years of lobbying had withered the rule to such an extent that it was already dead, at least in effect. The creation of “nonbank banks”, bank holding companies, securities subsidiaries and a raft of other exemptions meant that Fed chairman Alan Greenspan and Treasury secretary Robert Rubin were absolutely right to describe the remaining regulation as “obsolete” in 1995.
The rule became so watered down that it even permitted the merger of Citicorp and Salomon Smith Barney, one of the biggest securities firms in the US at the time. Far from opening the floodgates, the official repeal in 1999 was only needed to complete the merger with Travelers, the insurance company that owned Salomon. (Travelers was sold a few years later, as it happened, but its presence lingers in the unhappy-looking umbrella motif in Citi’s logo.)
In practice, Wall Street had been moving in on Main Street, and vice versa, long before then. In his 2005 book, Traders Guns & Money, Satyajit Das recalled a conversation with a German banker who resented the arrival of hotshot investment bankers.
“‘It will end badly,’ he muttered. ‘It is an Anglo-Saxon thing. The investment bankers make a lot of money. They rape and pillage our clients. Then they move. They always do. Then we will go back to real banking. Lending money.’”
The crossover between commercial and investment banks introduced both sides to risks they were unfamiliar with — commercial bankers traditionally understood credit risk, while investment bankers traditionally understood market risk. But the competition from commercial banks forced investment bankers to expand their loan books as a way to coerce clients to do deals with them.
The resulting cross-selling often involved credit derivatives, a product created by the new generation of one-stop-shops, offering the reward of big margins and even bigger balance sheet benefits — and ultimately fulfilled the German banker’s prophecy.
Even Sandy Weill, the former Citi chief executive who played such a big role in bringing an end to Glass-Steagall, recently confessed to a dramatic change of heart.
“What we should probably do is go and split up investment banking from banking, have banks be deposit takers, have banks make commercial loans and real estate loans, have banks do something that’s not going to risk the taxpayer dollars, that’s not too big to fail,” he said on CNBC’s Squawk Box.
Still, not everyone connects the dots from the demise of Glass-Steagall to the financial crisis. Mitt Romney’s pick for running mate, Paul Ryan, is among them. He pins the blame on the Fed’s loose monetary policy and the actions of Fannie Mae and Freddie Mac, and is in favour of further deregulation, which is of course like music to the ears of Wall Street bankers.
Even if Barack Obama is returned to the White House, his administration would find it hard to put the genie back in the bottle, assuming it wanted to, not least because lobbying power is one of the biggest economies of scale that financial conglomerates benefit from. And, after the forced acquisitions of the crisis, the banks are even bigger today than in 2007.
Much as our readers would prefer to see the banks separated once again, the reality is that a return to strict separation is probably too ambitious a project for even a committed reformer. The banks are not only too big to fail, but also too big to break up.
