Ezra Klein has the news today that Larry Summers, who has long been considered as a possible replacement for Ben Bernanke, is now the front runner for Fed chair. Klein says that through his recent conversations with people close to the nomination process he’s learned that both President Obama and the financial markets seem to like Larry Summers, and that these conversations have convinced Klein that Summers is on the path to becoming Bernanke’s replacement.
We strongly oppose Summers, and so as soon as we read the news from Klein we set out to write a post explaining why he shouldn’t be Fed chair.
In the process of pulling together sources for this post, we came across the piece “Three reasons why Larry Summers should not be the next Fed chaiman” by Matthew Phillips at Quartz, and we realized that each point we planned on making was perfectly detailed by Phillips already.
Here are the three reasons:
1. He was a big part of the Clinton-era deregulatory push that led up to the financial crisis
2. He was especially wrong about derivatives
3. He was hostile to warnings about the financial crisis
The truth is, while Larry Summers has some amazing credentials (he was a tenured Harvard professor at 28! he’s won academic accolades!), he clearly thinks he’s a big deal, and he makes enormous bets (mostly with other people’s money) because of it. He has been consistently wrong on matters of monumental importance (see what he said about derivatives, for details), and now he wants to head what may be the most important economic position in the world.
This administration would be foolish to let it happen, and we strongly hope it doesn’t.
In our last post we talked about a new proposal to restore the Glass-Steagall Act of 1933, an act that separated commercial banking from investment banking.
It’s a proposition that has plenty of critics, many of whom say that Glass-Steagall wouldn’t have prevented the last crisis (see here, here, and here). In response, we’ve listed three reasons (numbers 4, 5, and 6 below) showing that the repeal of Glass-Steagall did in fact play a role in the crisis and that people should therefore support restoring it. Here’s the list:
1. It Will Break Up Chase, Bank of America, and Citi
By international accounting standards, these three banks are the biggest in world. They are also the prime examples of banks that have enormous combined commercial and investment enterprises. What this means is that these banks are increasingly unwieldy, and in the words of former FDIC chair Sheila Bair they’re simply “too big to manage.”
In a Bloomberg video and in an article in the Financial Times, University of Chicago economist Luigi Zingales argues that restoring Glass-Steagall will fracture Wall Street’s lobbying power. He says, “Under the old regime, commercial banks, investment banks and insurance companies had different agendas, so their lobbying efforts tended to offset one another. But after the restrictions ended, the interests of all the major players were aligned.” It’s no wonder, then, that Wall Street’s power in Washington has increased in recent years.
3. Glass-Steagall Is Simple
Separating commercial banking activity from investment banking activity is a simple way to keep banks smaller. This simplicity is reflected in the bill itself: The original Glass-Steagall Act was 37 pages, for instance, while the 2010 Dodd-Frank Act will potentially reach 30,000 pages of rules.
Of course, simplicity in itself isn’t reason enough to support a bill, but it’s a reason that shouldn’t be overlooked. After all, the global economy gets exponentially more complex each year, and so it’s imperative to compensate that complexity with simple regulations—not lots of red tape and loopholes. “The simpler a rule is,” Luigi Zingales says, “the fewer provisions there are and the less it costs to enforce them. The simpler it is, the easier it is for voters to understand and voice their opinions accordingly. Finally, the simpler it is, the more difficult it is for someone with vested interests to get away with distorting some obscure facet.”
We need a few simple laws on Wall Street. Glass-Steagall is one such law.
4. It Would Have Prevented AIG’s Major Role In the Financial Crisis
In his testimony to the Financial Crisis Inquiry Commission, Former Superintendent Eric Dinallo argued that AIG wouldn’t have been so laden with risk if they hadn’t been able to function like a hedge fund. He says that the repeal of Glass-Steagall, “permitted AIG to operate an effectively unregulated hedge fund with grossly insufficient reserves to back up its promises. Had AIG Financial Products been a stand alone company, it is unlikely that its counterparties would have been willing to do business with it because its commitments would never have carried a triple-A credit rating.”
5. Citi Wouldn’t Have Been Run By Someone Who Didn’t Understand Commercial Banking
Vikram Pandit (pictured above) hadn’t ever worked as a commercial banker before becoming CEO of Citi in 2007. As Sheila Bair once said, Pandit “wouldn’t have known how to underwrite a loan if his life depended on it.” His lack of experience with commercial banking was problematic during the crisis because Citi was the sickest of all banks that received bailout money—requiring $472.6 billion in cash and guarantees. Pandit would have never been in charge of such a large commercial banking enterprise if Glass-Steagall hadn’t been repealed. Instead, he would have stuck with what he knew: investment banking.
6. Investment Banks Wouldn’t Have Faced as Much Competitive Pressure During the 2000s
Lehman Brothers CEO Dick Fuld, saying he wanted to rip out the heart of people betting against him.
The man in the picture above is Dick Fuld, the CEO of Lehman Brothers, an investment bank that went bankrupt in the crisis. Fuld was insanely competitive, as we saw in A Colossal Failure of Common Senseas well as this internal video, where Fuld shows his disdain for people betting against Lehman by saying, “I want to reach in, rip out their heart, and eat it before they die.” (Yikes.) Fuld desperately wanted to be a top dog on Wall Street, and the repeal of Glass-Steagall made that much, much more difficult because it created the sudden influx of big competition from commercial banks. Fuld’s blindly competitive spirit led him to overextend Lehman and eventually go bankrupt.
Of course, the repeal of Glass-Steagall didn’t in itself cause Fuld to overextend, but it’s clear that Lehman and other investment banks like Bear Stearns wouldn’t have faced nearly so much competitive pressure if commercial banks like Citi hadn’t suddenly entered the investment banking scene after 1999.
This report from Public Citizen (pdf) reveals more about why “The absence of Glass-Steagall … was intrinsic to Lehman’s collapse,” showing that Lehman itself admitted they were feeling intense pressure in 2005 from the repeal of Glass-Steagall.
7. Plenty of Smart People Support Restoring Glass-Steagall
Here’s a list of people in the video above who support Glass-Steagall:
0:07 - Bill Moyers (PBS) and Matt Taibbi (Rolling Stone discuss how little has changed since 2008). 0:27 - Robert Reich (fmr Labor Sec) explains why we need to break up the biggest banks 0:47 - Sandy Weill (CEO, Citigroup) explains why he wants the banks to be broken up 1:04 - Byron Dorgan gives the successful history of breaking up the banks. 1:32 - James Rickards lists the folks who allowed the banks to get big again. 1:41 - James Komansky (fmr CEO, Merril Lynch) regrets his decision to allow banks to get big again. 1:57 - Luigi Zingales (economist, Univ. of Chicago) on the danger of consolidated banks. 2:13 - Sheila Bair (fmr FDIC Chair) on why she would like to see the banks broken back up. 2:30 - Joseph Stiglitz (Nobel laureate, Columbia economist) on why we don’t have ordinary capitalism when banks are so big. 2:40 - Nouriel Roubini (NYU economist) “if institutions are too big to fail, they are too big.” 2:54 - Simon Johnson (MIT economist) 3:18 - Neil Barofsky (TARP inspector) explains exactly what needs to happen. 3:41 - Elizabeth Warren 4:00 - Bernie Sanders 4:17 - Ted Kaufman
*You can see more from MIT economist Simon Johnson in his articles “Five Facts About the New Glass-Steagall,” where he says that Glass-Steagall would be good for small banks, and in “Remember Citigroup,” where he says that the repeal of Glass-Steagall was directly responsible for Citi’s problems in the crisis. You can also see more from University of Chicago economist Luigi Zingales in his article “Why I Was Won Over By Glass-Steagall,” where he explains why he was initially resistant to the law, and why he now supports it.
In addition to the sixteen people shown in the video above, here are some more quotes from others who want to restore the law:
Barry Ritholtz, chief executive of FusionIQ, an asset management and research firm: “For about 70 years, Glass-Steagall managed to keep the riskier, more damaging part of Wall Street away from what should be the boring, straightforward side of finance. It was the height of stupidity repealing Glass-Steagall.”
Arthur Levitt, former Wall Street regulator: “Clearly, I regret my support of doing away with Glass Steagall.”
John Reed, former Citi CEO: “As another older banker and one who has experienced both the pre- and post-Glass Steagall world, I would agree with Paul A. Volcker (and also Mervyn King, governor of the Bank of England) that some kind of separation between institutions that deal primarily in the capital markets and those involved in more traditional deposit-taking and working-capital finance makes sense. This, in conjunction with more demanding capital requirements, would go a long way toward building a more robust financial sector.”
Thomas Hoenig, FDIC director: “When you mix commercial banking and high-risk broker-dealer activities, you increase the risk overall and as a result you invite new problems.”
Dean Baker, economist for the Center for Economic Policy and Research: “I think there are a lot of ways to make [the big banks] less powerful, less politically powerful, less economically powerful. Glass-Steagall, again I’d like to see that sort of separation.”
Andrew Haldane, Executive director of the Bank of England, calls Glass-Steagall “perhaps the single most important piece of financial legislation of the 20th century.”
Conclusion
Restoring Glass-Steagall won’t guarantee prevention of future financial crises, just as it (alone) wouldn’t have prevented the last one. However, restoring Glass-Steagall is a simple way to reduce the size of Wall Street banks, and its repeal certainly did play a part in the last crisis. Its for those reasons, as well as the others listed above, that the law should be restored.
We’ll conclude with this passage from Simon Johnson’s article “Remember Citigroup,” which argues that the New Glass-Steagall law should be a complement to other propositions to fix banking. We strongly agree with this notion:
The point of the New Glass-Steagall Act is to complement other measures in place or under consideration, including much higher capital requirements (both in the Brown-Vitter proposed legislation and in the new regulatory cap on leverage now under consideration), the Volcker Rule, and efforts to bring greater transparency to derivatives.
These measures are not substitutes for each other – they are complements. Each would be more effective if the others are also implemented properly.
Nothing can completely remove the risk of future financial crisis. Anyone who promises this is offering up illusions and deception.
But, like it or not, public policy shapes incentives in the financial system. We can have a safer financial system that works better for the broader economy – as we had after the reforms of the 1930s. Or we can have a system in which a few relatively large firms are encouraged to follow the model of Citigroup and to become ever more careless and on a grander scale.
Also see our last post on the new Glass-Steagall Act.
At today’s Senate Banking Committee hearing, Elizabeth Warren introduced the 21st Century Glass-Steagall Act of 2013, co-sponsored by Senators McCain, Cantwell, and King. This new bill mirrors the original 1933 Glass-Steagall Act, which separated traditional banking activity (like checking and lending) from the riskier activity investment banking (like derivatives).
The original law was repealed in 1999 by the Gramm-Leach-Bliley Act, though Glass-Steagall had been eroding for years leading up to that point. Gramm-Leach-Bliley, along with several laws passed during that era, allowed the big banks to transform into megabanks, creating “too big to fail.”
To illustrate, the chart below shows that from 1935 to 1990 the three biggest banks averaged around 10% of total bank assets, but by 2009 they suddenly had over 40%.
This new bill from Senator Warren will reverse this trend and make the banks smaller. After all, the three biggest banks (Chase, Bank of America, and Citi) are all bloated conglomerate banks that have enormous traditional and investment subsidiaries, so these banks wouldn’t be able to continue as they’re currently instituted under the new Glass-Steagall Act. Instead these megabanks would be broken up into much smaller firms.
What’s more, the new Glass-Steagall Act will make it so banks cannot gamble with derivatives using depositor’s money, as they do today. Currently, depositors at banks like Chase, Bank of America, or Citi implicitly use their money to help these banks make amplified bets that have the potential to cause another global meltdown. Reintroducing Glass-Steagall will make it so depositor’s money cannot be used for the derivatives market. This would be a major step toward restoring sanity to Wall Street.
For more on why it’s important to restore Glass-Steagall, see this compilation video that shows expert after expert calling to restore it:
Perhaps one of the best quotes from the video is from University of Chicago economist Luigi Zingales who says the strength of Glass-Steagall was its simplicity. The new bill from Warren shares that strength. It’s a mere 30 pages (compare that to the 30,000 pages of rules that will come out of Dodd-Frank).
Joris Luyendijk, journalist on the investment banking beat
Joris Luyendijk, a journalist for the Guardian, has been running a banking blog since summer 2011. As part of the project, he’s interviewed over 70 people in the financial sector.
Before he started interviewing financiers, he knew almost nothing about the industry (hence all the interviews, so he could learn firsthand about what was happening). He initially assumed he would discover that the situation wasn’t really as bad as some people made it out to be, but the interviews convinced otherwise. He realized it really is that bad.
Here’s a key quote from Luyendijk as he compares his long-term study of investment banking to his prior long-term study of Muslims. The contrasted journeys here are very telling. He says,
Before studying bankers I spent many years researching Islam and Muslims. I set out with images in my mind of angry bearded men burning American flags, but as the years went by I became more and more optimistic: beyond the frightening rhetoric and sensationalist television footage, ordinary Muslim people go about their day like all other human beings. The problem of radical Islam is smaller and more containable than Islamophobes believe.
With bankers I have experienced an opposite trajectory. I started with the reassuring images in my mind of well-dressed bankers and their lobbyists; surely at some basic level these people knew what they were doing? But after two years I feel myself becoming deeply pessimistic and genuinely terrified. This system is highly dysfunctional, deeply entrenched, and enormously abusive, both to its own workers and the society it operates in. The problem really is exactly as bad as the “banker bashers” believe.
This trajectory mirrors our own on this site. As we continue to research more and more about the financial sector we only become more unsettled. It’s clearer to us than ever that the underlying problems in the finance industry have not been fixed yet, and that unless they’re fixed soon we’ll experience another meltdown of sorts with all that it entails (more job losses, more retirement money gone, more housing problems). This is something the public shouldn’t ignore.
Thankfully, there are solutions to this problem. In fact, Luyendijk’s proposed solutions mirror the exact ones we’ve made on this blog, which gives us hope that people who’ve studied this issue are discovering what to do to fix it.
Luyendijk calls for “smaller banks, … simpler financial products, and much higher capital requirements” and we called for the same things when we say we should break up the banks, reform derivatives, and raise equity levels. These are three relatively simple reforms that would go a long way to making the financial system much safer and ending too big to fail. Plus, each citizen has the power to change banks and support local lenders.
We recommend reading Luyendijk’s interviews, which include gems like an executive coach saying, “Finance is an amoral world, bordering on the immoral,” a former rating agency worker saying, “we don’t seem to have learned from the crisis. It’s back to business as usual,” and a risk consultant saying, “My sense is that a lot of people in finance hate what they do. There’s no passion. But they are trapped by the money.”
Note: We haven’t been posting as much recently because we’ve been creating an ebook that will explain exactly why too big has failed. It’ll be an awesome exposé of Wall Street. Look for a release by the end of July. In the meantime we’ve found a few crazy bank stories we want to share.
Tim Geithner’s Kickbacks
The Financial Times has the news: Tim Geithner has made $400,000 in speaking fees since he left his role as Treasury Secretary—$200,000 of which came from a single speech he gave at Deutsche Bank.
In 2009, Deutsche Bank received nearly $12 billion from AIG after AIG was bailed out by the US taxpayer, with Geithner adamantly insisting that AIG receive 100 cents on the dollar (i.e. no haircut). So $200,000 was the least Deutsche Bank could do for Geithner, right?
It seems to us that Wall Street uses speaking fees as a loophole to pay public servants back for their “service” when they leave office. We’ve seen the same thing happen with Alan Greenspan and Larry Summers, and it’s a horrible precedent. If public servants know they can join the 1% simply by giving a speech or two after they leave office, then they’re bound to privilege certain citizens (the ones with the money) more than others.
It’s not public service if the public isn’t served.
Bank of America’s Twitter Bot
In a hilarious post from blogger Eksith Rodrigo you can see Bank of America’s Twitter bot giving automated responses to protestors complaining about the bank. The conversation was initiated when Twitter user @darthmarkh posted a picture of his chalk protest. After that, @BofA_Help unwittingly (we mean literally: no wits) joined the conversation. See the interchange at Eksith’s blog, or below:
Bank of America’s Foreclosure Fiasco
The last story we want to share is about the Mata family, who lived in the same home for 10 years before they were hit by the Great Recession. Since then they applied for loan modifications from Bank of America repeatedly, but were given the run around. The article talks about Gisele Mata’s experience (who is the mother in the family):
Every time Gisele would reapply for a loan, she would get a new single point of contact (SPOC). She would receive letters from different people inside the bank with contradictory information, some from an old SPOC saying she was denied a modification (without explanation), others from a new SPOC saying that her paperwork was in the underwriting process. This matches what Bank of America whistle-blowers have stated, that customer service representatives would facilitate delay by claiming that applications were “under review,” when they weren’t.
Gisele talks about how these events led her to protest Wall Street banks. Hopefully they lead more people like her to do the same. Otherwise these banks will continue to treat customers like cogs in a system and give preference to people like Tim Geithner.
