I know. This is a cheap way to blog. Sent the first response from a friend posted in this run to a colleague with an opposite view on things. So, here’s his response. “”… dismantling Glass-Stegall Act’s separation of types of banking functions was a really bad idea, and unless we create a new version of it, we are in for more trouble.”
I agree completely. The underlying problem is that bank deposits are currently protected by FDIC. As a result, the depositors don’t pay much attention to what the banks do with the money, giving the bankers a free hand to gamble as they wish; if they win they become rich, and if they lose the government (taxpayers) bail them out. It wasn’t always that way. Jim Grant, a very smart guy with his own newsletter, recounts the story of a bank in San Francisco during the 1840′s. There was no FDIC, and if the bank failed, the owners were personally on the hook for every penny of debt. As a consequence, the bank in question carried a 25% capital cushion (currently we think 8% is OK).
When property prices shot up during the gold rush in 1849, the bank took out an ad in the paper stating that property was in a bubble due to the gold rush, and they would no longer write ANY mortgages for new purchases based on the current valuations. Imagine that happening today! But back to the present.
We need to not allow banks to gamble with taxpayers money, which is what Glass-Stegall was about, and which we need to return to. Hasn’t happened yet.
1. 1% share of GDP is grotesquely large. So what? It’s the natural result of a richer world, in which everyone on average has more money. Are there still problems with fairness for the other 99%? Yes, but generating instant billionaires like the founder of Facebook is a side effect, not a problem. A lot of political discussion revolves around the ‘fairness’ of some people making more than others, but the real issue is C. If we continue to grow world wealth eventually we can C. If someone becomes a trillionaire in the process, so be it.
2. ‘these guys’ is somewhat vague. Some billionaires have had a positive effect on the world, and Warren Buffett is an example of a financial guy doing well for himself and the world. There are a lot of bankers however, who fit the description of parasite.
3. ‘new financial instruments that generate no jobs’ is too broad a description. The futures market, for example, allows a farmer growing corn to lock in a price today, so that he can know how much he will make before he plants, and not be stuck with a horrific loss if the prices drop during harvest season. I would say that futures are useful even though it is possible to speculate on the future price of corn and not grow any of it. Most of the people who made
the news with large gambles on interest rates or credit defaults, for example, are offset by hundreds of others who made similar speculations but were wrong in either their direction or timing. People speculating and making or losing money has been with us for a long time, and isn’t a problem AS LONG AS THEY ARE RISKING THEIR OWN MONEY. The problems start when banks do this risking depositor’s capital.
4. “They did it irresponsibly and brought down the economy.” Well they at least endangered the economy. But again, if they hadn’t been able to do this with money backed by taxpayers, this wouldn’t have been a problem. You can’t get enough scale without a government guarantee behind you.
5. There isn’t anyone to punish. Well maybe legislators and regulators, but they never get punished. There was certainly some fraud in the sub-prime mortgage market, there always is in any ‘hot’ market, but the underlying problem is the ability of financial institutions to take risks and not be responsible financially for the results. Since the current regulations allow this, acting irresponsibly isn’t a crime that someone can be punished for. Note I’m not saying that bankers don’t deserve to be punished for being irresponsible, but by the current regulatory system there isn’t any letter of the law to use against them.
The bank in San Francisco followed a much different path because of the banker’s personal liability. I don’t want to go back to no FDIC, but in exchange for that support banks cannot be allowed to invest their capital in anything but conservative strategies. Figuring out what the
‘conservative strategies’ are is the next big challenge.”