Now we’re begging: Will someone PLEASE bring back Glass-Steagall? The Glass-Steagall Act was, of course, the legislation passed in the early 1930s in response to a certain banking crisis that led to a particular Great Depression. Among other things, the Act erected a “Chinese wall” between a financial institution’s investment banking and merchant banking functions. In less complicated terms, the law forced banks to separate any business it was transacting on behalf of clients from the speculative moves it made with its own money. For the layman: banks can’t make dumb bets with clients’ money.
Sort of makes sense, doesn’t it?
Well apparently it seemed a bit stingy for President Clinton and the Republicans in Congress in 1999. We have Senator Phil Gramm and Representative Jim Leach to thank for that one. Here’s the problem: The heads of big banks have this terrible habit of thinking that they’re the smartest guys in the room. Anyone who doesn’t believe that need only watch Ben Bernanke talk for more than 30 seconds. Actually, let’s refine that a bit. The problem isn’t that banking executives think they’re savants, the real problem is that they aren’t.
In the modern financial age, a lot of very highly paid guys with impressive titles who look at way too many numbers and think they make sense have concocted some very complex “hedging” strategies for “managing risk.” They think they understand the crafty derivatives they’ve invented – which are completely unregulated and totally opaque – and all the counterparty risk involved. They don’t, and therein lies the rub.
Mark Twain once said “It’s not what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”
Truth be told, what bankers are doing wouldn’t be so bad if they were the only ones who suffered from their own idiocy. Enter Congressmen Gramm, Leach, President Clinton, then President Bush (II), hammerin’ Hank Paulson, and Bernanke. It's not just that banks are using complicated models that they don’t understand to speculate on securities they think they comprehend but don’t, they’re now doing it with client money. Starting to get the picture?
The end of October brought with it a new addition to the top 10 biggest bankruptcies of all-time when MF Global went belly-up under the incredible leadership of ex-Goldman chief and New Jersey governor Jon Corzine. Yes, MF Global has been the subject of a good deal of headlines lately, but bear with us for a moment while we take a closer look and apply it to a growing -- and scary – trend.
First, MF Global went bust in just about 3 days, making it the most recent victim in a string of failed financial firms that dates all the way back to Long-Term Capital Management in the late ‘90s. Of course, LTCM failed in just weeks as a result of the East Asian and Russian financial crises. Tack onto that list Bear Stearns, which failed in a weekend, as did Lehman Brothers, along with a number of highly leveraged hedge funds. What we find is that, when it comes to banks and other financial institutions, there is rarely a slow decline. The bets they make are way too big and have way too much leverage. In other words, things are fine until they’re not. The line between the two is very fine, with success on one side and insolvency on the other. Again, that’s not the only problem -- these companies are gambling with their clients’ money. When MF Global went bust, federal regulators found that hundreds of millions of client dollars had gone missing.
Unfortunately, many of these big banks learned their lesson in 2008, but it was the wrong lesson. What they learned is that no matter the dumb decisions they made, US taxpayers would make them whole. Ah, but how right Mark Twain was about what gets people in trouble! As we watch the trouble in Europe intensify and crappy derivatives floating to the surface of big bank balance sheets, we’re waiting for one or more of the big institutions to circle the drain. Those banks better be praying that if things go bad, they do so before January, 2013. Given the rhetoric of our presidential hopefuls, it’s a near-certainty that whoever is in the White House next won’t be helping to structure any bank bailouts. In fact, it’s not even certain that banks could get any help today if things went south. God help them if they end up asking for a bailout package that requires Congressional approval. Forget such a bill being DOA in the Senate, no spending bill will even be considered in the Boehner/Republican-led House – nor should it be.
Banks today desperately need to learn a different lesson from the one they learned in 2008. It’s time they learned to do business in a smart and responsible way, or go broke. Americans would certainly help press the issue by urging Congress to reenact the Glass-Steagall Act. It kept the problems we now face at bay for roughly 7 decades and would go a long way in helping clean up banks.