I would like to recommend two more articles on the growing move to greater regulation. Both appeared this Saturday morning. The first by John Authers, “Politicians look to enter another Faustian pact,” appeared in the Financial Times (http://www.ft.com/cms/s/0/b1379f2a-07bf-11df-915f-00144feabdc0.html). The second by Jason Zweig, “Will New Rules Tame the Wall Street Tiger?” appeared in the Wall Street Journal (http://online.wsj.com/article/SB20001424052748703822404575019423049886674.html#mod=todays_us_section_b).
Both articles discuss the unfolding drama in Washington, D. C. concerning the direction events are taking and both authors make some suggestion as to the direction regulation should take.
The important take-away from each article, however, is that politicians often enact laws, rules, and regulations that either miss the point or provide impediments to competition that banks and other financial institutions spend millions of dollars to get around, eventually succeeding.
Zweig argues in his piece that “the bad behavior on Wall Street in the 1920s wasn’t really caused by the blurring of commercial and investment banking”. The bad behavior he lists include “collusion among firms to jack up prices, sweetheart deals for favored clients, shoddy due diligence, too little disclosure of risk, too much trading on borrowed money, betting that securities would go down while telling the public they would go up.”
However, Zweig presents the argument that “there is a strain in the American psyche that has always worried about concentration of financial power.” Drawing upon this populist concern, Senator Carter Glass and Representative Henry Steagall were able to pass legislation fondly remembered as the Banking Act of 1933.
[Disclosure: I was born in the state of Missouri, formally a Unit Banking state, and my grandfather was a Missouri banker. My hand was photographed in the check copying machine in the latter part of the 1940s. Missouri bankers were paranoid about the “concentration of financial power!"]
Zweig’s conclusion is that “the Obama proposals are politically shrewd, because they tap into the same populist anger that motivated the Glass-Steagall legislation in 1933.”
Authers also compares the present time with that of the 1930s. He prefaces his discussion of the 1930s by stating that “Tighter regulation involves a Faustian bargain, of accepting greater stability in return for limiting ‘upside’, or potential growth.” The Glass-Steagall Act, the Faustian bargain, “worked” as “Bank runs, endemic for decades before the 1930s, disappeared in the US after this package of reforms. Growth in both markets and the economy was relatively stable.”
“Over the years, financial ingenuity and regulatory changes found a way around most of the repressive 1930s rules.” By 1998, there was basically nothing left and the rules were finally buried.
“The White House’s proposal on Thursday can loosely be called an attempt to apply the spirit of Glass-Steagall for the new era.”
The end result of the process will be up to Congress.
And what hope do we have?
Authers’ conclusion: “It is not clear that as a deliberative body it (the Congress) is capable of making a coherent decision.”
“It looks as though US and European political institutions are about to go through much the same test that they failed in the autumn of 2008. It is the risk that they fail again that worries the market.”
See my position on this point: “Bracing for the New Banking Regulations” (http://seekingalpha.com/article/183203-bracing-for-new-banking-regulations).