"We are here today to repeal Glass-Steagall because we have learned that government is not the answer. We have learned that freedom and competition are the answers. We have learned that we promote economic growth and we promote stability by having competition and freedom."
-- Former Sen. Phil Gramm, on passing the Gramm-Leach-Bliley Act in 1999
"Without a system of wise restraints, gross immorality and extreme craziness will happen in markets. They need to be dampened. Sin and folly needs to be stepped on."
-- Charlie Munger, 2009
One of these guys nailed it. After a decade characterized by no growth, comic instability, and too-big-to-fail-ness leading to the opposite of economic freedom, I'll let you guess which one.
But will yesterday's proposed overhauls -- touted by some as a return to the Glass-Steagall days -- sufficiently stomp on sin and folly? There's a lot of good, and a bit of, eh, so-so, that could come from changes. Here's what's on the table:
- Proprietary trading at commercial banks will be banned. Banks are banks, trading is trading. No more intermingling of the two.
- Banks can't own hedge funds or private equity vehicles. Period.
- The size of banks will be limited.
Details of how any of this will work are nonexistent. But here are a few pros and cons of the broad proposals.
Why propriety trading -- trading on behalf of shareholders, rather than clients -- was ever allowed with bank capital (much of which is explicitly backed by taxpayers via the FDIC) defies explanation. There's no logic to it. There are no societal benefits to it. It's a direct subsidy from taxpayers to banks and their employees. End of story.
Limiting the size of banks is a no-brainer. As my colleague Ilan Moscovitz and I argued, there are few sensible benefits and countless dangers in being huge. Bad decisions of any bank should lead to a failure where no one is affected except that bank's shareholders. To go further, leverage, not just size, needs to be addressed.
In short, the new rules seek to level the playing field and simplify banks. To make them easier to understand. Less like black boxes. More like utilities. That's exactly how commercial banking should be.
The original Glass-Steagall regulation segregated commercial banking and the entire investment banking umbrella. But the proposed regulation only goes after one small sliver: proprietary trading. All other investment banking duties -- market-making, underwriting, advising -- are still fair game.
Now, you'd be hard-pressed to come up with an example of proprietary trading in itself being a cause of the meltdown. It's grossly unfair to use taxpayer-subsidized money to trade with, yes, but it's a stretch to say that banning proprietary trading at commercial banks would have prevented much of anything over the past two years. Prop trading didn't break the system. Bad loans and leverage broke the system.
Ending prop trading will mainly affect Citigroup (NYSE: C ) , Bank of America (NYSE: BAC ) , and JPMorgan Chase (NYSE: JPM ) , and to a lesser extent Goldman Sachs (NYSE: GS ) and Morgan Stanley (NYSE: MS ) .
That might seem backward, but here's the thing: Goldman and Morgan Stanley aren't really banks. They don't accept significant retail deposits like Wells Fargo (NYSE: WFC ) and US Bancorp (NYSE: USB ) do. Goldman and Morgan are banks insofar as they were allowed to become bank holding companies in late 2008 to avoid collapse.
With the proposed rules, it seems they could (and probably would) just forfeit these bank holding charters and carry on as unprotected trading vehicles. This, though, would inject more risk into the financial system. We'd be right back to September 2008, with investment banks susceptible to bank runs, and without access to the Federal Reserve when the brown stuff hits the fan.
Goldman and Morgan Stanley being given the benefits of real banks is unfair and unreasonable. Yes, yes, yes. But it's no doubt safer than letting them run around unfettered. We need to ban systemically risky behavior, not simply segregate it.
By themselves, the proposed changes also wouldn't have prevented:
- The capital-structure flaws of Bear Stearns and Lehman Brothers.
- AIG, at all.
- Fannie Mae or Freddie Mac.
- Commercial banks making bad loans.
So I'm happy these changes are being proposed. I'll cross my fingers and pray they get passed. But don't assume that they represent a cure-all. This is simply one step in what needs to be a broad, encompassing overhaul.
Will it fix the financial system? Absolutely not. But it's a step in the right direction.
What do you think about the proposed regulations? Share your thoughts in the comments section below.