Retribution or Crash Prevention, Which Is It?

 Let us examine the motivation for bank reform. Are we trying to satisfy a desire to penalize the bad behavior of various leaders during the last few years? Or, are we aiming to build a system that will avoid similar catastrophes in the future? If it is the latter, it is important to not overplay the desire to tie-up the industry from performing its vital functions to satisfy a desire for retribution. That can only be done in the courts.

There are several important reasons to worry about the changes being suggested at the last minute for the Congressional reform negotiations. If the work comes up short of achieving meaningful reform, a great opportunity is missed. If the motivation is to make the culprits pay it is unlikely that existing laws will do any more than penalize the most blatant, however we could also be saddled with rules that inhibit much of what aims our system at meeting the economic needs of a modern society.

How the system failed

First, examine the underlying causes:

1. Rampant greed at all levels of the mortgage banking process,
2. Unqualified buyers,
3. Loan brokers and others who gamed the system,
4. Regulators blinded by the silly notion that markets cure all problems,
5. Wall Street firms that bankrolled and created unsustainable leverage,
6. Co-conspirators such as Moody’s and Standard & Poors, accountants and lawyers – in other words just about everyone who had anything to do with the unregulated mortgage business.

 

Second and very important, Congress and their money feeders encouraged Fannie Mae and Freddy Mac to abandon sane underwriting rules while growing beyond any reasonable scope.  The misdirected belief that by feeding the “American Dream” of homeownership it would be possible to keep themselves in office and sustain an endless euphoria from a pseudo economy rather one that produced goods that would put America back into the worldwide competition for products and services.

Understanding the Volcker Rule

Now lets look at the changes that would essentially dilute the “Volcker Rule”. In simple terms his recommendations put banks out of the business of speculating in financial markets for their own account as well as from operating hedge funds and private equity firms. The overall goal is to have commercial banks stick to their knitting, namely attracting deposit accounts and making business loans along with associated consumer banking services and sources of reasonable fees. For this, the charter would continue to have access to FDIC insurance and to the Fed’s discount window. 

His goal is to clearly distinguish between the kinds of financial services offered by commercial banks versus investment banks and insurance companies. It would not place a restriction on size of the enterprises, but along with expanded risk based capital accounts would put the banks on a more solid footing.  Unfortunately, the dynamic of finance has shifted the game away from purely conventional banking services. The “shadow” banks have made inroads into the preserve of commercial banking over the last twenty-five years to the point where the banks have had to hold their commercial customer base by moving into other businesses. Well, maybe banking isn’t the go-go business that it became. Our early training in the business was one that taught the good lessons of credit and in gaining balanced liquidity. Investment banking on the other hand is encouraged to find creative solution to financial needs, but at their own risk and those who seek to play their games. Remove their commercial bank charters and any warranties and services that imply access to the system and preserve of real (commercial) banks.

Span of control and scope of knowledge

Is it so bad to have banks own subsidiary businesses that do not create added direct risk to the parent? In the case of a Citibank we’d say that its diversity and span of activity created an unmanageable entity. Even truly smart people such as Robert Rubin could not get a grip on its diversity. This is often the case as management capabilities are stretched beyond anyone’s comprehension and particularly that of governing boards of directors. Further, the failure of one arm of the business can often mean a shadow cast upon all other parts – failed money funds that “broke the buck” for example. 

Where from here?

There are some good signs of real reform, however, we hope that the final product of the legislation will restore the reliability of good business practices and control in the banking industry. In our work during the 1990’s throughout the former Soviet Union as we taught banking and helped to establish systems modeled after the U.S., we were proud to represent our industry. However, we now can look back with some shame for how in just ten years ours became a colossal failure as all of the good rules were buried by a breed of regulators and vicious money schemes that sold out the ideals of most Americans.

However disappointed we are in the performance of many bankers and trusted money managers, we do not want to saddle the banking industry with punitive restrictions to simply satisfy a desire for retribution. It is important to restore a clear distinction between commercial banking and investment banking like that which existed during the time of the Glass-Steagall domain.  The Volcker Rule is paramount to thoughtfully achieving this end.

RL/BN

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