Tuesday, December 8, 2009

Poor Misunderstood Bankers

Bankers, commercial bankers specifically, are a poor misunderstood lot. They are so different from their cousins the investment bankers, who are a totally different breed of cat. Bankers in the early days of this country were not a well liked group either, because I would say, they are such a misunderstood group.

Banks in the early days of this country started up with a few dollars in gold or silver, or even copper as a reserve against the paper money, bank notes, that they issued. In the early days, there was no central bank such as the Federal Reserve Bank. Banking had very little if any regulations. People that accepted bank notes on any given bank were saying that they had confidence in the people that ran that bank. They also felt that if they presented those bank notes for gold, that the bank would meet their demand because the bank would have gold on deposit in the bank's vault. But, like all things human, some banks issued more bank notes than they had gold on hand to back up. A loss of confidence in a bank could mean a run on the bank and if everyone demanded gold for their bank notes, well you can see what would happen.

Now let us jump forward about 200 years to the present. The banking system in the United States consists of a central bank, the Fed, and several National and State chartered banks. The situation in 2007-08 when the Fed came to the rescue of the commercial banks prevented what might have become a run on the banks. But, what would have that meant in 2007? If everyone went to their bank to withdraw cash money, bills, so they knew they had their money in their hands, the banking system would almost certainly collapse, in my opinion. Banking and confidence go hand in hand.

The Fed did not have much of a choice in 2007. The first order of business was to prevent a run on the banks and maintain the confidence of the people, and hope that they would leave their money, in the form of savings and demand deposits (your checking account) in the banks.

So, is it any wonder that the banks would be the first to be made whole and the rest of us to lag behind in the present recession. I have nothing wrong with this scenario, except, all the banks that were "saved" were not commercial banks. With the end of the Glass-Steagall Act in 1999, banks were permitted to enter other businesses like securities brokerage and insurance. Goldman Sachs and Morgan Stanley became banks so they could keep their heads above water in 2007. The Fed permitted this and now we have banks that are not banks, but they can borrow at the Fed's window. The ability to borrow at the Fed's window means you are a commercial bank.

I realize I have run a lot of history into a very few words, but I hope you get my drift. Helping commercial banks from going under to stabilize the economy and prevent a run on the banks is understandable. But, the misuse of the word bank in the present era, I do not go along with, and it still leaves this country and our economy at risk. Unfortunately, our Congress does not have a clue about all this, and so, we are headed down the same road again.

Stay tuned.


Summer Smith said...

Okay, Moneythoughts -- for you, this is Finance 101 or Banking 101, but for those us who do all our banking electronically, some of the distinctions between "commercial" bank and "investment" bank are off our radar.

Are you telling us that the investment "banks" are allowed to call themselves "banks" just so they can "borrow at the Fed's window?" And, that they function the same as "commercial" banks, (i.e., Fidelity offers credit cards, checking accounts, etc.), except that they are allowed to make more money gambling on Wall Street?

I guess my question would be, why don't all the "banks" morph into "investment banks?" Feels to me like the investment "banks" get to operate on a broader scale with less regulation. Is that what you're saying in your last paragraph?

Thanks in advance for your kind indulgence of my questions.


LceeL said...

Driving down the same road? Well ... They fixed the road, right? No more potholes? Smooth sailing from now on? Right? Are we there yet?

moneythoughts said...

First, Fidelity is not a bank. Fidelity is an investment management company. Fidelity offers mutual funds and if you are as big as an institutional client, they will manage a separate fund for you.

Commercial banks, traditionally, were either State or National Charters, and took in deposits for both savings and checking accounts. With these deposits they could then lend money for people to buy cars, homes and make business loans.

Investment banks, traditionally, were partnerships that used partners' capital to trade stocks and bonds and participate in the new issues of stock and bond offerings called underwriting or IPOs, initial public oferings. They would form groups with other investment bankers called syndicates and buy an issue and then sell it to the public. They would then perhaps make a market in that stock or bond issue and trade it in the secondary market.

Investment banks moved into managing money for large clients and institutions as money management became very profitable. Then, with the removal of the Glass-Steagall Act in 1999, investment banks could enter into owning other businesses and commercial banks could buy insurance companies and securities brokerage.

Goldman Sachs and Morgan Stanley became commercial banks, in 2007, so that they could borrow money from the Fed, as only commercial banks can borrow funds from the Fed.

Running a commercial banking operation out the front door and a casino operation out the back door doesn't lend itself to good banking practices in my opinion. But, what do I know? I don't even have a lobbyist in Washington.

Summer Smith said...

Thanks for your explanation, Moneythoughts. It helps me put some of the pieces together!



Julie Schuler said...

I don't know if there will ever be a traditional "run on the banks" again, do you? Most people use digital blips instead of actual money, and since they seemingly come from nowhere, and also go to nowhere there doesn't seem to be the worry that they will not be there. It's all become so ephemeral.