Thursday, April 1, 2010

A Plan For Success? The Case for Better Regulation

How much regulation is too much regulation? And, can regulation hurt American bank holding companies' ability to compete with other banks from around the world? Both of these questions are important questions and deserve an answer. But, I doubt if I can answer these two questions in less than a book, but here is winging it.

The Glass-Steagall Act of the 1930s was a simple, yet smart piece of legislation. Basically, the Act provided that commercial banks and investment banks not be combined under the same roof. The running of a commercial bank has its own unique problems. Every time a Commercial bank makes a loan or enters into a syndicate to make a large commercial loan with other banks, it is placing its deposits at risk. Deposits come in in the form of checking and savings accounts and CDs. Money goes out in loans to individuals and businesses. In the old days, banks borrowed short term money and turned around and loaned it out for longer terms. Now banks take the extra precaution to try and match assets with liabilities under a risk management department. Banks are also more concerned with fee business as this helps the overall earnings per share. Trust departments and the fees they earn contribute to the bank holding company's earnings too.

Investment banks underwrite bonds and equities and put the firm's capital at risk much the same way a bank puts its deposits at risk. The big difference is that investment banks make a market in bonds and equities and carry an inventory that fluctuates in value as the prices for these securities go up and down in the market. At one time, investment banks were not publicly traded corporations and their gains and losses were divided among the principal partners. Today, with these corporations being publicly traded, investors in these investment banks know that they are placing their money at risk. Unfortunately, in the Lehman case, assets were misrepresented in value or even removed (hidden) from the balance sheet altogether.

Trying to regulate a corporation engaged in commercial banking, investment banking and insurance (credit default swaps) is in my opinion nearly impossible to do. For the simple reason that near worthless assets can be bounced around from one location to another and a deception can go on until the house of cards falls under its own weight. Regulating each entity so that there is transparency, accountability and enforcement is a huge responsibility in today's world of financial products.

A financial system that places the whole economy at risk is, in my opinion, bad public policy. The situation, in the future, that we should be trying to protect against, is one where risk takers are not encouraged to place their corporations at great risk thinking that the government can not afford to let them go under, for the simple reason that their financial operations extend into almost every other financial operation in this country and quite possibly around the world. To go with such a system, puts us right back in the position of too big to fail. No one in their right mind wants the Federal Government to be using tax payers' dollars, as well as weakening the value of our currency by inflating our US dollar, by the continual process of bailing out mismanaged financial holding companies. This is not a plan for success.

Stay tuned.

1 comment:

winslow said...

What is so ironic about our present system.....
If investment banks make tons of money, they are deemed to be extremely successful (even if they take extraordinary risk).....but yet when these banks fail and pull down the entire system, (applying the same extraordinary risk) they are discredited with poor money-risk management.

The trouble with this country is that we are so money-hungry, we look the other way when reaching for more dollars to line our here we are now, letting investment banks be backed by the government...and we can't make the simple decision of "No, this is not right"!