Throughout history, walls have been a source of fascination and controversy.
Nearly everyone knows about Joshua and the tumbling, crumbling walls of Jericho. Then there’s the stone and timber fortification built by the Roman emperor Hadrian. It cut an 80-mile swath across the British Isle dividing Druid England from Scotland.
Patriarchs of ancient Jerusalem constructed mammoth walls to protect inhabitants from the invading hoards. Today, only the Western Wall of the Great Temple remains, a holy shrine to Jews the world over.
Construction of the Wànlǐ Chángchéng or The Great Wall was begun in the 5th century B.C. Finished during the reign of the legendary Ming Dynasty, this ornate buttress is one of few human structures that can be identified from outer space.
Modern times have seen the erection of other controversial walls, none more so than the monstrosity built by the old Soviet Union dividing East from West Berlin. Who could forget President John Kennedy proclaiming from the Brandenburg Gate Ich bin ein Berliner (“I am a ‘Berliner’”) or President Ronald Reagan uttering the immortal ,“Mr. Gobachev, tear down this wall.”
Another wall of immense dispute has recently come into focus. It’s the wall between investment banks and commercial depositor banks.
Exponential Growth of Mergers
In 1999, Congress passed the Gramm-Leach-Bliley Act, allowing retail banks (which accept deposits and issue personal loans), investment banks (which trade securities and manage corporate acquisitions), and insurers to merge. Subsequently, the pace of bank mergers accelerated, creating gigantic one-stop financial shops. When these banks teetered on the brink last year, the federal government, fearing that their collapse would cause an economic cataclysm, was forced to bail them out. The 1999 law overturned the Depression-era Glass-Steagall Act whose wisdom had long divided the two banking worlds.
Even in the1930s, lawmakers realized that retail banks and investment banks have fundamentally different functions; thus, different appetites for risk.
Retail banks are low-risk ventures. Their deposits are insured by the FDIC. Investment banking is more lucrative but involves greater risk. When these two businesses are placed under the same roof, the result is a potentially toxic conflict of interest.
As we have now learned, conglomerate banks that are considered too big to fail are also often too big for executives to manage effectively. In all likelihood, most bank CEOs did not want to take on ruinous amounts of risk that caused their downfall. But the shear scale of their operations hindered their judgment and oversight.
Citigroup is a case in point. After the bank’s historic merger with Travelers, Citigroup was heralded as a “financial supermarket.” Today, this stumbling financial behemoth has been exposed as a bloated, mismanaged basket case that is being forced to sell off assets just to survive.
Recently, during a panel hosted by Vanity Fair and Bloomberg News, Morgan Stanley’s CEO John Mack said his firm welcomed greater regulatory oversight because “we cannot control ourselves.” Like investment banking giant Goldman Sachs, last year Mack’s firm opted to become a regulated bank holding company.
Referring to the presence of regulators roaming the halls of Morgan’s New York headquarters 24/7 watching its every move, Mack said, “I love it!”
Similar to its arch-rival Goldman Sachs, Morgan Stanley also had 10 billion other reasons why it welcomed its conversion to regulated status. It not only gave the bank instant access to federal bailout monies, but also to unlimited funds from the Discount Window at the Federal Reserve Bank.
As the President and the Congress attempt to tackle a long-term strategy for dealing with financial institutions too big to fail, a growing segment of economists, politicians and taxpayer advocates is urging resurrection of the wall that once separated investment banks from retail commercial banks.
No Need to Change, They Say
CEOs of megabanks like Morgan Stanley believe they have the best of both worlds. Consequently, the last thing they want is a return to the bad old days when the two banking realms were kept separate.
You can’t blame them.
Under the current regime, banks like Morgan Stanley have unfettered access to cheap money, to a government that appears willing to take any measures to keep them afloat, and to bamboozled regulators who are unable to keep pace with the rate at which the banks introduce new and potentially riskier financial products.
Is it any wonder these mega-banks are more profitable than ever?
In a dramatic change of heart, last month Alan Greenspan argued that institutions deemed too big to fail operate under an implicit subsidy from the government, since all would likely be rescued in a future financial emergency. Greenspan went on to say the system allows these banks to borrow more cheaply than their competitors and to gain an even greater market share.
Today, four conglomerate banks (JPMorgan, Citigroup, Wells Fargo and Bank of America) hold 39 percent of all domestic deposits. To any sober observer, this is too many eggs in one basket. It is too risky to our entire financial system.
As a practical matter, the President and the Congress cannot come up with a foolproof formula to measure and monitor the systemic risk posed by financial institutions that are judged too big to fail. In reality, if the division between investment banking and commercial banking remains blurred, lawmakers desperate to protect the system from future collapse will have little choice other than what already has been done before, bail them out.
Mr. Obama, rebuild that wall.
John Cohn is a senior partner in the Globe West Financial Group based in West Los Angeles. He may be contacted at www.globewestfinancial.com
