Toward Universal Banking

Barry Eichengreen pointe this out to me yesterday, and I could have blogged it first if I had been smart.

Justin Fox:

Aren't you sort of glad Congress repealed Glass-Steagall?: Was deregulation a factor in bringing us to our financial system to its current teetering state? Yeah, sure. But the deregulatory decision most often cited by lefty (and not so lefty) observers--the 1999 repeal of the Depression-era Glass Steagall Act that had separated depositary banking from investment banking--is actually looking pretty good this Monday morning. Without Glass-Steagall repeal, Bank of America wouldn't be able to buy Merrill Lynch, the only bit of arguably positive news to come out of this crazy weekend. And more generally, it is looking like investment banks that don't have big consumer banking franchises aren't up to the challenge of surviving modern-day financial crises. Of the five big independent investment banks that existed six months ago, only two survive.

Now it is true is that we failed to replace the archaic Glass-Steagall rules with a sensible, modernized regulatory structure. But don't worry, we'll be getting to that soon enough!

Comments

[Rob]

Yes nothing screams smart like allowing a financial institution deemed too big to fail to be bought by another financial institution making it even bigger.

[andrew]

Hold on, isn't the problem that Bank of America (or some institution like it) had to buy Merrill Lynch in the first place? This argument only works if the failure of Merrill Lynch is unrelated to Glass-Steagall repeal. This is not convincing evidence for that argument.

[Justin Fox]

And what evidence, convincing or otherwise, is there that the failure (sic) of Merrill Lynch is related to Glass-Steagall repeal?

[Ken Houghton]

WHAT andrew SAID. (/shouting)

That's like successfully arguing for orphan's rights for the proverbial kid who killed his parents.

[Adrian]

Andrew, how would Glass-Steagall repeal be responsible for Merrill's failure? Merrill didn't have a depositary affiliate. More generally you don't need co-ownership of banks and broker-dealers to generate Big Shitpile. Merrill itself produced a whole lot of MBS CDOs, using mortgages other people originated.

To add to Fox's point, without Glass-Steagall repeal you don't have depositary parents to fund broker-dealer subsidiaries, which the Fed just allowed to help shore up the broker-dealers. (Whether that's a good idea is another question.)

[jon]

Justin: Don't try and use your discreet argument about Glass-Steagall as a proxy argument to try and tell us that deregulation had nothing to do with this. You dismissed that in your column quick so that you could come to the conclusion you reach: which is that deregulation (no Glass-Steagall) is good.

This happened for the same reason most busts happen: people get the idea the market is never going to go down so collateral and/or reserve requirements are loosened in the name of the "free market"... and then it goes down.

Anyway, you're paid to be clever—how contretemps you are!—and your argument is clever, but it's basically nonsense. Shifting the burden of proof does nothing to prove your conclusions. Furthermore, how do you know that someone (the Fed maybe who is bailing out AIG) wouldn't have done the same for Bear or Merrill? You don't.

Since you assumed the truth of that proposition to reach your conclusion, you engaged in the fallacy of question begging. In other words, Glass-Steagall is good and created the only entities capable of being the White Knight, therefore Glass-Steagall is good.

qed.

Thus defeated, your argument does not hinge on whether GS led to the fall of Merrill or not. That question is independent of the point you are trying to make.

[andrew]

"And what evidence, convincing or otherwise, is there that the failure (sic) of Merrill Lynch is related to Glass-Steagall repeal?"

I didn't argue either way. I was just making the limited point that the fact that the repeal allowed one institution to buy another in response to the crisis does not say anything about the causes of that crisis.

And yes, I realized just after posting that Merrill Lynch didn't actually fail and that was a mistake to refer to it that way. Thanks for that (sic).

[Julio Huato]

This reminds me of the ambulance that ran over the biker. Wasn't he lucky they happened to pass by?

[Barry]

"And more generally, it is looking like investment banks that don't have big consumer banking franchises aren't up to the challenge of surviving modern-day financial crises."

The only way I can read this statement as making sense is that it in essaence says 'isn't it great that failing financial institutions can loot their depositors money to cover their loses?'.

[Barry]

Jim Henley's comments:
http://highclearing.com/index.php/archives/2008/09/19/8711

[radish]

With all due respect, isn't it a bit early to conclude that BofA buying Merrill Lynch is an "arguably positive" development?

The dodgy assumption here is that even if Merrill Lynch turned out to be a money pit for BofA, it wouldn't affect BofA's depositors. How safe is that assumption exactly? Why should we believe that what remains of the regulatory firewall supposedly protecting depositors from their bank's investment liabilities is going to hold up, when both balance sheets are owned by the same entity and the government is obviously desperate to look the other way? Come to think of it, why should we believe that BofA -- or anyone else -- has correctly assessed Merrill Lynch's exposure in the first place? Or Countrywide's for that matter ;-)

AFAICT the market value of Merrill Lynch's holdings is still a big honking mystery.

[Walt French]

While we're on the subject of economic history, let's look at some ancient history -- 1913 -- when the Congress, tired of multiple bank panics, established the Fed. Since then, it has had monopoly control over printing money (and my great-great-grandfather's picture on a 19th century banknote is a cherished curiousity).

Although the Fed's track record is far from perfect, the 20th century has been marked by much less turmoil than the 19th, even though we were far less inter-connected and "contagion" meant nothing about banking.

Maybe we could consider how we transitioned from a hugely successful convenience and efficiency, as well as the ultimate protection of capital that we gained from having Uncle Sam as Risk Manager and Traffic Cop.

Instead, we have a rabble of banks, iBanks, insurers and whatnots, each careering around in pursuit of Profit. But it's not just bumper-car fun; these businesses pay nothing for the externality of risking "the system." Rather, they profit more in failouts the more they levered up their risks.

Why did we expect that the Shadow Banking System, totally unregulated, would not be more risky than the pre-Fed "system" of private banks?