Wednesday, May 16, 2012

Bringing Back Glass-Steagall

One of the problems in communicating in the United States is that while we all speak English, the words we use have definitions that we each hold that may be as different as everyone's finger print! When I write about money, banking and monetary policy, I use words we all can read, but do we all understand them in the same way? Everyone, I think, wants a money and banking system that works. Yes, works for everyone, and leaves no one short changed. The Glass-Steagall Act from the 1930s did just that. And, it has been my opinion for several years, I have been writing this blog MONEYTHOUGHTS since February 2008, that in order to make our banking system work for all of us, we need to separate the function of commercial banking from the function of investment banking. And, for good measure, insurance companies should not be owned by either commercial banks or investment banks. Yes, I know commercial banking is more exciting if it has an investment banking division. Exciting in so far as the investment banking division can trade, do swaps and put together all kinds of derivatives to play the market. Yes, I said play the market. Commercial banking is far less exciting as hedging for a commercial bank can simply be done by matching assets against liabilities under the risk management department with a senior investment officer of the commercial bank. Commercial banks make loans and one thing that a commercial bank has to do is to make sure they have not loaned long term and borrowed short term. When interest rates go up the commercial bank will find themselves in a bit of a problem if they haven't matched their loans (the loan's maturity) with certificates of deposit (with similar maturities). I know this is far less exciting then creating a derivative that looks like a salad from every continent on earth, and then betting the ranch that your assumptions were valid before you ran that salad threw your mathematical model. I have no problem with an investment bank trading and creating derivatives, so long as they are using their own money, or their shareholders' money. Yes, I know this means that commercial banks will have slower earnings growth and that they will get a corresponding Price/Earnings ratio that will be commensurate with that slower less exciting growth. But, that is the price we all pay for having a commercial banking system that can not bring our domestic economy to its knees. I am sure my explanation could have been explained better by Paul Volcker or Professor Krugman, but since they have never contacted me about being a guest writer for my blog, I guess you will have to get by with me. I can assure you that I know what I am talking about. This money and banking stuff is not rocket science or brain surgery. Believe when I say, you don't have to be a genius to understand this stuff. Yes, derivatives can be made very complex, but just because they are complex does not mean that they are right. For example, take the derivatives JP Morgan Chase bet on recently, they were, I can assure you were very complex, having been run through some very complex mathematical models, yet their assumptions were mostly likely wrong. Because, if their assumptions had been correct, they would not be losing $2 billion dollars!

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