Tuesday, June 21, 2016


FLG has been busy and was clearing out a backlog of blog reading.   He was surprised to find a Tweetstorm on Glass-Steagall by Josh Brown.    FLG likes John Brown and is sorta shocked by his take on Glass-Steagall and the financial crisis.

FLG won't rehash his own Glass-Steagall argument in full again, but here are the two main points:

1) It wasn't the big universal banks that went under during the financial crisis; it was Bear Stearns and Lehman Brothers, both risky investment banks.   Bear got bought by whom?  JP Morgan, one of those horrible universal banks made possible by Gramm-Leach-Bliley (GLB), aka the Repeal of Glass-Steagall.   Lehman was allowed to fail.  Who was next Wall Street domino likely to fail after Lehman?  Merrill Lynch.   What happened to Merrill?  It got bought by Bank of America, another horrible universal bank made possible by GLB.

So, GLB actually helped stabilize the system during the crisis.

2) Financial innovation has blurred what were previously very clear financial lines.   Derivatives, so often described as inherently risky, can be cheap, effective tool to reduce risk.   Interest rate swap, to provide one example, allow a bank to manage the interest rate exposure of its loan book quickly and cheaply.   Should we force commercial banks to manage their loan portfolio using a more expensive and slower method to manage the risk because the instrument that is cheaper and faster is perceived as inherently more dangerous?  If we don't ban their use of derivatives entirely, then it's a question of risk management, which, let's be honest, the regulators suck at micro-managing.  So, we are left with fortress balance sheets and leverage ratios.  Not Glass-Steagall's return.

As long-time readers are aware, FLG believes it's the lifting of restrictions on interstate banking, like the Interstate Banking and Branching Efficiency Act of 1994, that were the real problem.   State borders, while political borders without much financial or economic rationale, helped contain the scope and size of banks albeit sub-optimally.  Hence, any particular failure was probably not going to take down the entire system.   Although, the Fed and FDIC didn't risk it with Continental Illinois.


The Ancient said...

Did you notice that Jay Cost's Twitter feed (sic) recently featured several posts about Bray Hammond's book?

I haven't read Cost's new book, but I suppose it must all come from there.

FLG said...

I hadn't seen that. The presidential campaign has made me sick, so I've been staying away from political blogs.

Although, until right this second, I hadn't really seen the parallels between Trump and Jackson on finance. Tone and foreign policy, sure, it was obvious. guess I'd always thought that since Trump was in New York and I specifically remember him calling Goldman Sachs a 'great company' on the first season of The Apprentice, Kwame Jackson, the guy who came in second, worked there, that he wasn't a Jacksonian financial guy. But just right now, I remembered this passage by Walter Russell Mead:

"The fourth pillar in the Jacksonian honor code struck Mrs. Trollope and others as more dishonorable than honorable, yet it persists nevertheless. Let us call it financial esprit. While the Jacksonian believes in hard work, he or she also believes that credit is a right and that money, especially borrowed money, is less a sacred trust than a means for self-discovery and expression. Although previous generations lacked the faculties for consumer credit that Americans enjoy at the end of the twentieth century, many Americans have always assumed that they have a right to spend money on their appearance, on purchases that affirm their status. The strict Jacksonian code of honor does not enjoin what others see as financial probity. What it demands, rather, is a daring and entrepreneurial spirit. Credit is seen less as an obligation than as an opportunity. Jacksonians have always supported loose monetary policy and looser bankruptcy laws."

Donald Trump might just be the highest form of Jacksonian financial esprit.

Sorry, had nothing to do with your question.

George Pal said...

Should we force commercial banks to manage their loan portfolio using a more...

No, we should force them to own their losses, or jump out the highest window.

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