Banking is the Easiest Business in the World
So how is it that bankers manage to screw it up so badly time after time after time?
[Before I begin, let me thank all of you who have subscribed to see my postings here. These have been sporadic. I have a number of other irons in the fire and am aggressively pursuing a longer plan. Still, I am honored you have chosen to read my thoughts on world affairs and my rants on the idiocies I see in the political arena.]
[And before you peruse the latest of the latter, I recommend you review my Substack article written 3 days before Putin’s ill-advised invasion of Ukraine. While most of the rest of the intelligence community was in agreement that the “mighty Russian military” would quickly destroy Ukraine, I was pretty much alone in saying Russia could never subdue Ukraine, even to predicting Finland’s accession to NATO before Finland considered it. …Now, on to my political rant!]
How Easy is the Banking Business ?
Borrow short, lend long.
Ensure that the spread between the money you borrow (mostly from consumer or business depositors) and the money you lend those who need funds (consumer and business loans, car loans, mortgage funding etc.) is wide enough to pay all expenses and make a profit.
That's it!
Of course, a bank must pay enough to those from whom it borrows (depositors) to keep their monies in their bank. This means they must be competitive in what they pay. As rates rise, depositors may become restless and decide to take their money and go somewhere else unless the bank pays competitive rates.
However, bankers are fortunate that most people are pretty darn lethargic when it comes to moving their money around like some hotshot traders. The bank’s job is to give them enough of a return without onerous charges for anything beyond keeping their money safe. As long as depositors believe their money is safe from stupidity or cupidity, they are unlikely to up and move for an extra 10 basis points (one-tenth of 1%.)
On the lending side of the ledger, the bank must be scrupulous in selecting borrowers that pose the least risk of defaulting, declaring bankruptcy, skipping town or becoming so seriously behind in their payments that the bank now has these non-performing loans on their balance sheet.
At its most basic, that is all banking is. So how is it that bankers manage to screw it up so badly time after time after time? I believe the answer lies in human ego and human greed -- and wrong-headed regulation.
The Slippery Slope of Continued Deregulation
Between 1929 and 1933, more than *4,000* U. S. banks closed. Millions of people who thought their money was “money in the bank” were impoverished overnight.
As a result of this catastrophe, Congress passed the Banking Act of 1933, more commonly known as the Glass-Steagall Act. It was enacted to curtail the reckless underwriting of listed and unlisted securities and overly risky loans in search of massive returns that never materialized.
This legislation answered the need for a “Chinese Wall” between banking backed by deposits & deposit insurance and intelligent loan-making profits --versus the underwriting and trading in securities for the "bank's" in-house trading accounts.
Under Glass-Steagall, a "commercial bank" (those that accept customer deposits) was specifically prohibited from also acting as "investment banks" engaged in underwriting and selling securities. Congress further extended the Glass-Steagall Act in 1956 with the passage of the Bank Holding Company Act, which barred commercial banks *and the companies that own them* from engaging in non-banking activities like insurance, new company underwriting and touting stocks. (Congress especially thought banks should be walled off from the risks in underwriting insurance. This comes into play later with the straw that broke the camel’s back…)
All this created the most stable banking system in the world.
The brilliance behind Glass-Steagall was that the entire financial system would not catch fire from a different part of the system. Banking regulators’ sole function was to ensure the stability of commercial banks by monitoring the level and use of funds and the soundness of a bank’s lending standards.
Humpty Dumpty Has a Great Fall
The big banks as well as the Federal Reserve, the bank of bankers (whose depositors are effectively the American taxpayer without whom the Fed has no funding) behaved responsibly during this initial period. What came next, however, is a travesty of greed and stupidity foisted upon the American people.
Over the next few decades, the Fed, comprised of bankers, effectively gutted Glass-Steagall.
In 1987, the Fed’s Board of Governors voted 3-2 to “reinterpret” what Congress intended. The Fed unilaterally, without legislative input, decided to allow commercial banks to derive up to 5 percent of their gross revenue from dealing in certain types of securities, including commercial paper and municipal bonds.
Fed Chair Paul Volcker was one of the 2 dissenters on the board. I do not believe it was a coincidence that he was replaced that year by Alan Greenspan, a “true believer” for deregulation of the banking industry.
In 1989, the Fed unilaterally added debt and equity securities. It also raised the cap on such activiteis from 5 percent to 10 percent of gross revenue. In 1991, Congress rejected a bill to repeal the Glass-Steagall firewall. But the Greenspan Fed kept at it.
In 1996, the Fed gutted the law yet again. This time they allowed banks to derive up to *25 percent* of their revenue from investment banking activities. It should have been predictable that by 1998 all 25 of the largest U. S. banks, operated investment banking subsidiaries.
Remember, during this entire time Glass-Steagall was not repealed. The law was just ignored by the Federal Reserve and other federal agencies which answered only to the executive branch of government.
Then, in 1998, came the final nail in the coffin of this legislation that for decades had made America the leading light of responsible banking in the world.
In that year, Citicorp and Travelers (which was big into investment banking and insurance) arbitrarily announced that they would merge, removing the last brick that prevented go-go banking.
Why was this direct violation of Glass-Steagall, a law still on the books, not challenged? It was seen as just “so yesterday” in the coming age of digital banking. After all, we were entering a new millennium. Why keep outdated ideas that stood between billions in profits just because those ideas protected investors and depositors?
Travelers CEO Sandy Weill figured he and his banking industry cohorts could spend enough on lobbying and campaign contributions to kill Glass-Steagall.
Why was he so confident? He had, before announcing the merger, called Alan Greenspan, Robert Rubin, (then Treasury Secretary) and President Bill Clinton. All three basically said, “Sure, Sandy, why not?” (Rubin was rewarded with a seat on the Citi board when he left office. I can’t speak to the other two.)
When Congress took up their obligatory rubber stamp, they were told that if Glass-Steagall were not ditched, it would force Citi to sell off large parts of its business. Instead of saying "So what? Citi created the problem; it should be theirs to solve," $300 million in campaign contributions followed and Congress agreed with Citi/Travelers that "these days" market forces alone would ensure a level playing field. What followed was the predictable carnage of...
The "Financial" (Banking!) Crisis – 2007-2009
By removing any impediment for the huge firms to basically buy their way into monitoring themselves, the nation faced the realization that we could no longer put Humpty together again. The federal government had overridden any state protections, and now allowed mega-monster banks to create mortgage tranche swaps, over-the-counter derivatives , credit default swaps, or whatever else they chose.
[A brief personal interjection: My last job before leaving Charles Schwab in 1991 to found Stanford Wealth Management was as Senior VP of Fixed Income. A sales team from Bear Stearns cajoled my boss into having my team analyze BS's derivative products. I consider it a great departure gift to Chuck and the rest of the firm that I booted these carnies out of my office.
[I asked the most basic questions about insurance, safety, reliability, crossover risk, leverage, default risk, etc. – and they could not answer a single question. They awkwardly produced a 6-hour VHS tape and said, “If you still don’t understand it after seeing this, we can fly one of our analysts out.” I replied, “I understand it. Clearly, you do not.” I was kind enough to wait until they were gone to toss the video into my special circular file. Bear Stearns is gone, but many remain – all of whom you and I bailed out with our dollars.]
Bring Back "The Wall" in a Form that Recognizes Today’s Changes
Changes like SPACs, shadow banks, crypto and more.
Forget all this jibber-jabber about Modern Monetary Theory and the benefits of agglomeration. If you want to be a bank, hire bankers. If you want to be a brokerage firm, hire brokers. But draw the line between them and do not allow it to be crossed.
Dodd-Frank is the updated version, you say? Not a chance. It is a pale imitation of banking regulation.
Was SVB a bank? Yes, by the current squishy, all-encompassing term currently being used. But accepting unlisted and often virtually untradable securities in the midst of a bear market, as collateral for loans, defies even Wall Street cupidity and stupidity.
Was Signature Bank a bank? Yes, by the current squishy, all-encompassing term currently being used. But Signature Bank’s crypto exposure and SVB’s acceptance of unlisted stock as collateral for loans sealed their fate.
Indeed, another banking “enhancement” in Modern Monetary Theory sped these banks’ demise. All you need to transfer your funds via wire is a cell phone and a password.
If we cannot find the courage to bring back an updated Glass-Steagall, then I would propose a checklist. Every “bank” must state and be responsible to depositors, under penalty of perjury and jail time, rather simple questions like “Is part of your capital base in crypto?” “Do you have unmarketable securities in your capital portfolio?” “Do you have assets that will take longer to sell than the speed of a telephone wire transfer?” Etc.
I see on the horizon a reduction in the number of US banks, with many depositors going from small and potentially weaker firms to larger and more closely scrutinized banks. I don't want to imply that big banks are safer banks, merely that they are audited most thoroughly and most closely monitored by the Fed and the FDIC (Federal Deposit Insurance Corp.)
According to the FDIC, the country with the second greatest number of banking institutions in the world is the UK, with London having been a banking center for centuries. Luxembourg, Switzerland, Singapore, and Hong Kong have numerous banks as well, not that far behind the UK. Which country has the most banks? The USA — with more than 4,000! If 2,000 of them merged with others or were acquired, we would still have more than enough banks from which to choose.
I believe a shakeout is likely. I hold out the hope, forlorn that it might be, that the US Congress will do something besides one side rubber-stamping whatever the incumbent president wants and the other side opposing anything the incumbent president wants. Ther US president is not the maker of laws! Though, of late, regulators of all stripes have done what Congress has failed to do. These non-elected bureaucrats have changed entirely the direction of what Congress oiriginally intended. The wholesale gutting of Glass Steagall is just one example.
Congress is the nation’s legislator. Their job is to make the laws. The executive branch is charged with carrying out those laws, and the highest court of the judicial branch is there to interpret the laws and the actions of all actors to ensure they are in keeping with the supreme law of the land, the United States Constitution.
It would be refreshing to see Congress legislate a new wall between banking and the current spate of “banks” that also function as go-go trading desks of firms that bring new companies public, that provide insurance and credit cards and have become the Borg of finance. JP Morgan, Morgan Stanley, B of A, Citi et al should make a choice of what they want to be when they grow up and divest the rest.
They will not do it on their own. Theirs is a profit motive. But what motive do the unelected bureaucrats who are daily undoing the “intent of Congress” have? They have their own agend and it is to please the president in office, who either directly or by their choice of cabinet members, selected these bureaucrats.
The watering down, then destruction of Glass Steagall is but one example. When you next vote for someone running for Congress, make sure they have the three essential qualifications every Congress person needs but it seems few to possess these days:
A brain that functions independently of the amount of money a lobbying firm is willing to dispense.
A spine that allows them to stand up to power that is wrongly used.
A moral compass that reminds them daily that their first responsibility is to the American people.
© 2023 JL Shaefer
That was wonderful. I’m going to pass this in, as I totally agree with you. Especially the three characteristics any elected official should posses before being eligible to hold an office. Love, Angel (Baratta) Harrold