Background: G-S, passed in 1933, was designed to separate commercial banking, which provided savings and loans, from investment banking, which traded stocks. Imagine that you enter a bank with your paycheck, and you tell the clerk that you want to save your money in order to buy a house. He takes your money and then he quickly arranges a meeting between you and a stock broker. Take his proposal or not, the bank has your money which it can use to finance its own stock trading.
The 1929 market crash was in part due to unsustainably low interest rates, which in turn generated low broker call rates, which in turn created low margin rates, or high leverage, which allowed the banks and their clients to freely speculate in the markets.
G-S fulfilled its remit, and between 1933 and 2008 there were no systemic bank crises.
The problems of 2008 originate in the Reagan administration's deregulation of the S&L industry in 1982. Now instead of paying a depositor 2% and then charging him 5% for mortgages or consumer loans, the S&L's were allowed to use their depositor's money to invest in speculative projects. The result was the S&L debacle of the late 80's.
Eventually G-S was abolished in 1999 by the Gramm-Leach-Bliley Act, which allowed banks to use high street depositor’s money to simply play the markets. Sound familiar?
Also, banks were allowed construct Collateralized Debt Obligations, which in many cases were simply bundles of sub-prime mortgages - in other words, repackaged junk. These CDO’s were often given A2 to AAA ratings by the rating agencies, who, coincidentally, were being paid to rate the CDO’s by their customers, the banks. With investment grade ratings, the CDO’s were able to be sold to pension funds.
The CDO’s were then hedged with insurance policies known as Credit Default Swaps.
CDO’s, by the way, were unregulated do to intense lobbying by the financial services industry, spearheaded by Hank Paulson of Goldman Sachs. Paulson also spearheaded an increase in leverage to finance these products. (Leverage is the amount that a bank can borrow based on capital reserves in order to finance dealings.) Industry wide, leverage rose from single digits upwards to 30 to 1. (The ‘1’ being the amount of capital on reserve.)
As we all know, in 2008, the market for CDO’s fell like a house of cards, with no firm having the reserves needed to compensate for systemic loan defaults in the sub-prime housing market . Nor were the firms guaranteeing the Credit Default Swaps able to fund their liabilities.
In the end, the tax payer had to fork over $700 billion to bail out the financial services industry. That's appx. $2,300 for every man, woman, and child. Call it corporate welfare.
(For an excellent documentary on the 2008 crisis, view the DVD ‘Inside Job’, by Charles Ferguson.)
In 2010, a new law, the Dodd-Frank Act, was passed, which among other regulations, restricted the bank proprietary trading activities. It included the Volker Rule which prohibits banks from using high street depositors’ money in order to speculate. It also created new regulations to protect consumers. But it also created a costly internal drain on banks’ balance sheets: compliance procedures and staff.
Here’s a personal example. I’ve been lecturing at banks and hedge funds for many years. I have most often been paid on the day or within two weeks. However, it took two and a half months to be paid for my last lecture. I asked my contact at the bank (yes, a bank), ‘What’s holding up my payment?’ He replied, ‘Compliance.’
And as we in London well know, many of the dealing rooms here have been gutted. So if there’s no dealing and no risk taking, what is there to comply about?
By reading my intro above you may think that I’m against the banks speculating in stocks, bonds, commodities, and fx. Not so, I just think that banks should fund these activities from net earnings, after expenses and dividends are paid. I say permit the banks to have separate hedge fund units, with fire walls in place.
But if Dodd-Frank is holding us back - as some people claim - we could, as men of integrity, simply admit our mistakes: Repeal D-F and reinstate Glass Steagall, After all, it worked for 75 years didn't it? Fat chance.
By the way, Mr. Frank was on the radio here two weeks ago. He was not opposed to a revision of D-F, but maintained that many of its components are essential. Look forward to his testimony during congressional hearings.
Meanwhile, the financial markets will be anxious to know more of Trump’s proposals, and then how they play out.
By the way
The SPX poked its nose above 2300 to 2316. It could be testing the waters, or it could be doing a head fake. One of my trader's rules is Don't Chase the Trend. Wait for a Retracement before getting in,
Now let’s lighten up.
In a fit of madness, I recently looked for contract work on efinancialcareers. Here are titles for a few sought after jobs:
Option Trader. Req: Minimum 2 years of experience. (What? It takes up to 5 years to become a successful options trader.)
Director, Risk and Capital. Requirement: Knowledge of BCBS-IOSCO (Read: justifiable credentials with no, practical experience.)
Night Shift Swaps Trader. (Read: able to fall asleep at the desk.)
[We are amused.]
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