The Key To Banking Reform—-Hog-Tie The Fed
………Most importantly, Super Glass-Steagall would also hog-tie the Fed by ending discretionary interest rate pegging and the entire gamut of FOMC market interventions and securities price falsification.
The latter point, in fact, is the sine qua non of true banking reform. As we demonstrated in Chapter 4, our debt saturated economy——with $64 trillion of credit market debt outstanding representing an unsustainable leverage ratio of 3.5X national income—does not require artificially priced credit to rejuvenate growth and prosperity.
Nor is there any point whatsoever in perpetuating ZIRP and the Fed’s long-standing and destructive regime of financial repression. The major consequence of 90 months on the zero bound has been a massive transfer of income—upwards of $250 billion per year—-to the banking system from the hides of savers and depositors.
The relevance here is that BAC and most of the other giant financial conglomerates would be insolvent without these arbitrary transfers.
Given BAC’s $1.2 trillion deposit base, in fact, the Fed’s financial repression probably reduced its funding costs by at least $30 billion last year compared to a free market pricing environment.
Needless to say, that wholly unwarranted and economically wasteful subsidy amounts to more than double the $14.6 billion of net income BAC posted in the most recent 12 months, and is more than 8X the size of its dividend distributions.
And, no, in the face of free market interest rates, BAC and other banks would not have automatically made up the difference via higher yields on its loans and assets.
The fact is, BAC’s loan book today is smaller than it was on the eve of the crisis because as we demonstrated in Chapter 6, US households and businesses have reached a condition of “peak debt”.
Accordingly, in a free market the current central bank driven deformation of pricing would be unwound. Interest rates on savings would rise more than yields on borrowings because demand for market rate debt—-as opposed to Fed subsidized rates—–would fall sharply.
Stated differently, BAC and most other giant banks are solvent only because the lion’s share of their earnings have been indirectly manufactured by the monetary central planners in the Eccles Building.
Yet no matter how interest rates and profit spreads might ultimately shake out on the free market, one thing is certain. To wit, there is not a snowball’s chance in the hot place that BAC could have earned the $75 billion in dividends and share repurchases it made over the last decade. Not even close.
So what real banking reform would do is strip the giant banks like BAC, Citi, JPM, Wells Fargo, and the next tier as well, of the deposit cost subsidies which accrue from Fed financial repression, as well as their access to the discount window and FDIC insurance. .
By the same token, once the mega banks were stripped of these state conferred privileges and subventions, they would be free to operate any financial business they wished. And they would be free to employ whatever balance sheet arrangements their at-risk depositors, bond investors and equity holders would permit.
The banking behemoths keep demanding less government interference and regulation. Well, Super-Glass/Steagall would provide the free market they claim to desire.
Getting from here to there requires one more super-Glass-Steagall feature. The nation’s handful of megabanks have operated so long in the corrupt world of bailouts and state conferred moral hazard that they are inherently unstable and prone to the errors and abuses for which BAC and C are the poster boys.
Moreover, none of them would have gotten to their current size without the serial M&A campaigns and roll-ups that were enabled by the current rotten banking regime. Giant, multi-trillion banking conglomerates would not arise in a free market because there are simply no demonstrated economies of scale in banking beyond a few hundred billion in balance sheet footings, at most.
So cap their size at 1% of GDP or about $200 billion during the transition period when they are being weaned from their state crutches, subsidies and privileges and finding their sea-legs in the free market.
At the end of the day, cesspools like BAC and C need to be completely drained. And the only way to get them out on the free market where this could actually be accomplished is through the enactment of the kind of Super Glass-Steagall described below.
Super Glass-Steagall—-A Model For Sweeping Change
As indicated, Super Glass-Steagall would consign today’s handful of giant financial services conglomerates to the arena of pure free enterprise where they would live or die at the hands of competition and their value to customers. There would be no bailouts of alleged Too-Big-To-Fail institutions because this proposed enactment would strip the statute books of every vestige of authority to rescue banks with assets greater than $200 billion (<1% of GDP).
To remove any doubt, it would also impose multi-million fines and jail time on top officers of the Federal Reserve and U.S. Treasury if they tried to circumvent any of the new Super Glass-Steagall restrictions. So doing, it would reassure the American public that the larcenous crony capitalism of the last two decades has been abolished and that the ability of the racketeers of K-Street to corrupt the halls of government has been drastically curtailed.
In order to further purge the hoary myth of “systemic importance” and “financial contagion” from the Washington excuse bag, banks with more than $200 billion in assets would be denied access to the Fed’s discount window. Likewise, they would be ineligible to have their deposits backed by FDIC insurance.
Accordingly, the failure of a behemoth like Citigroup would not threaten to bankrupt FDIC as it did during the 2008 crisis. Even more crucially, the giant banking conglomerates would not become a pretext for the power-hungry bureaucrats at the Fed to yell “contagion!” during a time of financial dislocation, thereby giving themselves an excuse to bailout their Wall Street wards.
That’s because under a new Super Glass-Steagall type regime most banks below the $200 billion threshold would drastically limit their counter-party risk exposure to the dozen or so Too-Big-To-Insure banks in the US.
Today giants like JPMorgan, Bank of America, Citi, Well Fargo and the other usual suspects including the charted banks of Goldman and Morgan Stanley are viewed as privileged wards of the state. But without the implicit backing of Uncle Sam, smaller banks would be forced to put a market based risk discount on their exposures to such free market behemoths.
This would leave approximately 6,000 commercial banks and thrifts below the size threshold to offer FDIC insurance to all currently covered depositors. There could be no demagogic claim that ordinary citizens were being consigned to potential financial ruin.
So the argument that blue haired widows and financially uninformed wage workers need the protection of universal deposit insurance just doesn’t cut it. They could still obtain FDIC coverage on their deposits and savings, but only at what would be thousands of “narrow” banks engaged solely in the business of deposit taking and lending.
At the same time, the public could be assured that taxpayers were not unwittingly underwriting Citigroup’s $53 trillion of derivative exposures or the $51 trillion at Goldman and JPM. Likewise, the risky multi-trillion trading books of the big banks would be sequestered in a pure free market arena.
Finally, to insure that the Fed’s discount window and deposit insurance was not abused even by smaller banks, the 6,000 remaining Federally privileged institutions would also be prohibited from engaging in trading, underwriting, investment banking, private equity, hedge funds, derivatives and other activities outside of deposit taking and lending.
The overwhelming share of midsize and community banks do not participate in these activities today, anyway. But if their customers demanded such services in the future, and they wished to remain in competition with the big free market banks under Super Glass-Steagall, they would have to spin-off such activities to separate, independent companies—– just as did the big wall street banks after the original Glass-Steagall was passed in 1934.
In short, these latter inherently risky economic functions would be performed on the free market by at-risk banks and financial services companies. The latter could never get too big to fail or to manage because the market would stop them first; or, after the fact, they would be disciplined by the fail-safe institution of bankruptcy.
No taxpayer would ever be put in harms’ way by trades like those of the London Whale.
Today’s Banks Are Wards Of The State, Not Free Market Enterprises
Besides, severing the big bank’s pipeline to the Federal bailout trough and putting the big Wall Street banks back on a free market based level playing field is the right thing to do. Today’s multi-trillion banks are simply not free enterprise institutions entitled to be let alone.
Instead, as we have shown, they are wards of the state dependent upon its subsidies, safety nets, regulatory protections and legal privileges. Consequently, they have gotten far larger, more risky and dangerous to society than could ever happen in an honest, disciplined market.
Foremost among these artificial props is the Fed’s discount window. The latter provides cheap, unlimited funding at a moment’s notice with no questions asked. The purpose is to insure banking system liquidity and stability and to thwart contagion, but it also nullifies the essential bank management discipline and prudence that comes from fear of depositor flight.
Likewise, FDIC insurance essentially shields banks’ balance sheets and asset management practices from depositor scrutiny. Whatever its merits in behalf of the little guy, there is no doubt that deposit insurance is a fount of moral hazard and excess risk-taking in the bonus-driven executive suits.
Indeed, the function of maturity transformation—–borrowing short and lending long—-which is the essence of fractional reserve banking is inherently risky and unstable. Once upon a time the state attempted to limit banks’ propensity for excesses by permitting injured depositors to bring suit against stockholders for double their original investment. That tended to concentrate the minds of bank boards and stock owning executives.
The opposite incentives prevail in today’s bailout regime. Under current legal and regulatory arrangements shareholders and boards face no liability at all—let alone double liability—-for mismanagement and imprudent risk taking.
Instead, insolvent or failing institutions are apt to be bailed-out; and even if share prices are permitted to plunge, boards and executives are likely to be given new stock options struck at the post-collapse price. That happened in every big bank in America after the 2008 meltdown.
Likewise, prior to the establishment of the Fed and its bailout windows, the big New York money center banks were required to remain super liquid by holding cash reserves equal to 20% or more of despots. In that regard, the post-Keynesian history books have been stripped of the fact that even at the peak of the infamous banking crisis on the eve of FDRs inauguration in March 1933 none of the big New York City banks had lines at their teller windows or were in any way illiquid or insolvent.
By contrast, one of Greenspan’s most deleterious actions was to essentially reduce cash reserve requirements to zero. Owing to the release of such immobilized assets and the costs of carrying them, of course, banks became more profitable.
Yet the ultimate cost of keeping the banking system liquid was not eliminated; it was just transferred to public institutions including the Fed, FDIC and eventually the US Treasury via TARP.
Two Decades Of Bank Merger Mania Made It Worse
All of these violations of free market discipline have had a cumulative historical effect that’s no longer tolerable. And these distortions, disincentives and moral hazards were immensely compounded by two decades of monstrous bank merger roll-ups that resulted in incomprehensible and unmanageable financial services conglomerates like Citigroup and BAC.
Indeed, the worst excrescence of that trend—-the merger of Travelers and Citibank—–happened only after the old Glass-Steagall was repealed in 1999.
Once these unnatural and inherently unstable multi-trillion financial services conglomerates came into existence after the turn of the century, the subsequent regulatory acquiescence in the 30:1 leverage ratios achieved by the Wall Street brokers, including the vast investment banking operations inside Citigroup, Bank of America and JPMorgan, only added insult to injury. So did the regulatory lapse which enabled Citigroup and others to establish trillion dollar off-balance sheet SIVs during the run-up to the financial crisis.
Indeed, as we indicated above, the Citigroup style of rogue financial behemoths should have been put out of their misery by the FDIC when they failed in 2008. But their screaming insolvency—–including that of Goldman, Morgan Stanley, Bank of America and others—- was covered up by multi-trillion bailouts from the Fed’s alphabet soup of liquidity infusions and TARP.
Indeed, Washington’s desperate thrashing around in the bailout arena resulted in the worst of all worlds. The problem caused by too-big-to-manage government enabled financial conglomerates was made far bigger by Washington sanctioned and directed mega-mergers. These included the shotgun marriage of Bank of America and Merrill Lynch, the Federally subsidized takeovers of Bear Stearns and Washington Mutual by JPMorgan and the rescue of Wachovia by Wells Fargo.
These mergers were outright madness. As shown in the chart below, we now have five Federally subsidized and underwritten behemoths that control $7 trillion of assets and nearly 50% of the banking market. And these figures do not include Goldman Sachs and Morgan Stanley, which also have bank charters, and would add another $1.7 trillion of assets and bring the concentration level to upwards of 60%.
By contrast, before the age of Bubble Finance really got underway in 1990, the combined balance sheet footings of the five largest US banks were only $400 billion or barely 5% of today’s level; and their collective market share was just 10%.
Again, this is not about bigness per se or anti-trust populism, but about dangerous financial conglomerates that would not even exist without the dispensations of government, and would not persist if they did not hire half of the K-street lobby complex to protect their privileges.
At the end of the day, the destructive form of central banking carried out by the Fed, ECB, BOJ and other major central banks need to be eliminated entirely. But in the interim, bringing the worst excesses of Wall Street to heel under a Super Glass-Steagall regime would go a long way toward preventing another financial meltdown like that of September 2008.
And that gets us to the 2016 campaign. By embracing this kind of Super Glass-Steagall Donald Trump would consolidate his base in the flyover zones and reel in some of the Bernie Sanders throng, too.
The latter will never forgive Clinton for her Goldman Sachs speech whoring. And that’s to say nothing of her full-throated support for the 2008 bank bailouts and the Fed’s subsequent giant gifts of QE and ZIRP to the Wall Street gamblers
To be sure, the big Wall Street banks will whine that they face unfair competition from giant foreign banks which are protected, subsidized and privileged by their governments. But there is a simple answer to that strawman argument.
If the free market does not reward giant financial conglomerates for the risk/reward equations buried in their derivative books or opaque holdings of junk bonds, OTC bilateral trades or the maturity mismatches in their funding accounts, then they do not add to efficient economic production or wealth creation.
Foreign socialist governments are more than welcome to bear the losses, even as their crony capitalist banksters scalp the windfall profits.