By Matthew Benjamin and Christine Harper
March 10 (Bloomberg) -- A decade after Wall Street killed off the Glass-Steagall Act that separated commercial banks from securities firms, its ghost has returned to haunt the financial industry.
Comments by Paul Volcker, the former Federal Reserve chief advising President Barack Obama, and Federal Deposit Insurance Corp. Chairman Sheila Bair in the past week suggest it will become more costly for banks to remain in some of the areas they were let into with Glass-Steagall’s 1999 repeal, analysts said.
“The capital-market rules are going to change,” Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York, said in a Bloomberg Television interview. For firms that remain banks, “it’s going to be much more difficult to trade in the illiquid parts of the market” beyond government and corporate bonds, and to borrow to finance investments, he said.
Hedge funds will increasingly take over business in riskier areas such as emerging-market and distressed securities, predicted Hintz, who served as chief financial officer of Lehman Brothers Holdings Inc. from 1996 to 1998.
By removing the barrier between everyday banking such as lending and deposit-taking and riskier areas such as derivatives trading, Glass-Steagall’s 1999 repeal helped create the current crisis, according to some policy makers and politicians.
‘Never’ Again
“You can’t break the bank and lose everyone’s” pension investments “without expecting a real food fight with respect to laying blame and trying to fix the financial system so this never happens again,” said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York.
Volcker called for a “two-tier” financial system that would limit risk-taking by the most systemically important firms, at a conference in New York March 6. Bair said in an interview with CBS that aired March 8 that Congress should curtail the size of the biggest banks.
Fed Chairman Ben S. Bernanke today said the central bank has already stepped up surveillance of the systemically important firms, and that such companies require “especially close oversight.” He spoke at the Council on Foreign Relations in Washington.
Many on Wall Street are now resigned to jettisoning some sources of revenue and paring back others in order to comply with a new regulatory regime. How that regime will look around the world is set to be discussed when finance ministers and central bankers from the Group of 20 nations meet this week near London before an April 2 summit of leaders.
Morgan Stanley
“Some of the businesses that we’ve been in in the past are going to be curtailed,” Morgan Stanley Chief Executive Officer John Mack said on Feb. 23.
Obama has told his aides to work with Congress on shaping proposals for regulatory changes within weeks.
Obama himself has decried the way Glass-Steagall was undone, saying it left a regulatory vacuum that contributed to the current crisis.
“A regulatory structure set up for banks in the 1930s needed to change,” then-candidate Obama said in a March 27, 2008, speech at New York City’s Cooper Union. “But by the time the Glass-Steagall Act was repealed in 1999, the $300 million lobbying effort that drove deregulation was more about facilitating mergers than creating an efficient regulatory framework.”
Obama referred to a campaign by companies such as Citigroup Inc., Merrill Lynch & Co. and Aetna Inc. in the late 1990s to overturn the law. Its demise allowed banks, insurance companies and securities firms to integrate and compete with one another.
Citigroup’s Birth
Citicorp, a commercial bank, and insurance company Travelers Group Inc. announced a merger in 1998 that needed Glass- Steagall’s repeal to become legal. The combined entity became Citigroup.
As commercial banks sought to compete with investment banks, they took bigger trading risks and created off-balance-sheet financing vehicles to help reduce the capital they needed to hold to protect against loan losses. Investment banks became more aggressive in lending to companies and increased their own borrowing to buy securities or real estate.
Phil Gramm, a Republican senator from Texas who co-authored the Gramm-Leach-Bliley Act that repealed many key provisions of Glass-Steagall, later went to work for UBS AG, the Swiss bank whose foray into investment banking contributed to an 88 percent drop in its shares since June 2007. Robert Rubin, a Clinton administration Treasury secretary who advocated Glass-Steagall’s repeal, went on to work for Citigroup, which lost $27.7 billion in 2008 and has needed $45 billion in government funds to remain solvent.
Questioning the ‘Threshold’
“Taxpayers rightfully should ask that, if an institution has become so large that there is no alternative except for the taxpayers to provide support, should we allow so many institutions to exceed that kind of threshold,” FDIC’s Bair said March 8 on the CBS News program “60 Minutes.”
The financial conglomerates enabled by the lifting of Glass- Steagall restrictions are “unmanageable,” Volcker said in January. Traditional commercial banking shouldn’t be combined with “very risky capital market activities,” he said.
Some argue that Glass-Steagall’s repeal is not to blame for the current financial crisis.
“There’s nothing any of these groups did that they couldn’t do before,” said Jim Leach, a former Republican congressman from Iowa who helped engineer the law’s undoing. Rather, the fault lies with “the greatest regulatory breakdown in history, on the part of the Fed, the Treasury and the Securities and Exchange Commission,” said Leach, now a professor at Princeton University’s Woodrow Wilson School.
Return to Washington
Several officials who supported the 1933 law’s repeal have returned to positions of power in Washington in the current administration. Most prominent among them is Lawrence Summers, Obama’s top economic adviser, who succeeded Rubin as Treasury secretary in the Clinton administration. Timothy Geithner, who now serves as Treasury secretary, was undersecretary for international affairs under Rubin and Summers.
Advocates of reinstalling barriers between investment and commercial banking “will run into a little bit of opposition from the same people who fought so hard for the death of Glass- Steagall,” Alan “Ace” Greenberg, the former Bear Stearns Cos. chief executive officer said on Bloomberg Television March 9.
To contact the reporter on this story: Matthew Benjamin in Washington at Mbenjamin2@bloomberg.net; Christine Harper in New York at charper@bloomberg.net.
Last Updated: March 10, 2009 09:45 EDT
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