Monday, June 21, 2010

The Desire To Return To Glass-Steagall Still Not Explained

I was listening to MarketPlace on Friday and heard Heidi Moore say (jump to the 9:30 mark or so), "All we really want to do is bring back the old Glass-Steagall Act that separated risk taking in banks...derivatives and swaps and all that...from commercial banking, where banks lend out to companies and people."

Really? That's all we want to do? Then why aren't we simply doing that? Must be because all the evil banks are lobbying too hard and effectively to prevent what everybody knows is the right thing to do.

FLG, as you probably guess, thinks this is simplistic bullshit that misunderstands what's going on. The banking world has changed because of technology and financial inventions. We now have financial products that are hybrids between the previous financial sectors. Let's take one example of why we wouldn't want the bright line described above:
Commercial banks lend to companies and people. Let's say the bank decides that it has too much of its loan book in fixed interest rates. Well, it can use an interest rate swap to cheaply and easily turn those loans, for all intents and purposes, into flexible rate loans. Sure, the commercial bank could sell or swap the actual loans, but that means that the a) need to find a bank willing to buy fixed rate loans, then b) have them look over the loan book that they want to swap or sell. This takes time. On the other hand, they could buy swaps almost immediately and at relatively low cost.

Moreover, Glass-Steagall helped in the crisis because it allowed commercial banks to buy the troubled investment banks. The risky investment banks were the ones who were going down and we didn't let them. Well, we did let one go and it almost brought everything down.

All told, FLG hasn't seen anybody make a compelling case that reinstating Glass-Steagall 1) is desirable or 2) would solve the problem of systematic risk. The issue is leverage. Not derivatives or investment versus commercial banking. And again anybody who says anything other than the issue is leverage is either misinformed, dumb, or has a political agenda.

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