Next blog: Off-Site Loan Review DangersBring Back Glass-Steagall
The past banking crisis (2008 – 2012) saw over 400 banks and thrifts fail, comprising over $690 Billion in assets. Granted, one third of the total assets was attributed to Washington Mutual and others like: Countrywide, FIA Card Services, and a couple of the Merrill Lynch banks are not included as they were “Assisted Transactions”, regardless, the cost to the Deposit Insurance Fund (DIF) was over $73 Billion - per the FDIC as of 12/31/2015.
Let us not forget that the total balance in the insurance fund at the beginning of 2008 was almost $53 Billion and that from the end of 2009 through the second quarter of 2011 the DIF was running a negative balance. However, by the fourth quarter of 2012 the DIF had regained its positive balance at over $25 Billion - per the FDIC’s “Quarterly Banking Profiles”. As of the quarter ending March 31, 2016 - per the FDIC’s “Quarterly Banking Profile” - the fund now stands at $72.6 Billion.
These numbers are not meant to reflect poorly on the FDIC’s resolution division as they can only react to circumstances presented. In fact, this past banking crisis is a testimonial to the great efforts by this department. They have demonstrated a great deal of resourcefulness under very stressful times. No, the FDIC was not the culprit that caused this crisis, it was pure and simple – Greed.
Why is it that when practical constraints (Glass-Steagall) are put in place, eventually greed disguised as rationale purporting to provide more choices supplants them?
Glass-Steagall was put in place to “provide for the safer and more effective use of the assets of banks … and to prevent undue diversion of funds into speculative operations” 1 In essence - keeping a barrier between banks and investment banking. In other words, investment banks couldn’t get their hands on banks’ deposits.
So why and how did the Financial Services Modernization Act of 1999 – commonly known as Gramm-Leach-Bliley break down this barrier? By brokering a deal with a number of the players to create the appearance that the emperor was wearing clothes (a lot of money could be made, regardless of the appearance painted to provide “more options”). Setting the stage - Mega banks already had subsidiaries that were broker/dealers, investment banking, and/or insurance. Further, the fees that can be generated by securitizing mortgages were literally a gold mine and the consolidation of the banking industry was in full swing. For instance, in the early 1980s there were over 18,000 banks and thrifts and by the year 2000 there were just over 10,000. So the ability to get at deposits as a funding source for securitized products was only a natural outcome. But there was this minor problem – an “outdated” not “modern” law called Glass-Steagall.
So why not create another type of organization (The Financial Holding Company as opposed to a Bank Holding Company) that the Federal Reserve could regulate (they got what they needed), the mega banks could get what they wanted (use of insured deposits), and the business community (Wall Street) could get what they wanted – more fees described as “options”? Hence, money and the political powers came together to repeal Glass-Steagall with the Gramm-Leach-Bliley Act of 1999.
In retrospect, the most recent banking crisis has taught us that the Federal Reserve - although charged with monitoring these new behemoths (Financial Holding Companies) - is not able to prevent the cascading fraud that ensued.
A couple of instruments within this whole maze of greed that defies any legitimate business logic are the “no-doc” loan† and the “only interest” loan. Of course they were needed to keep the securitization “gold mine” flowing, even though they were based on fraudulent and over inflated appraisals, mortgage brokers providing false income information, duping the uneducated consumer, and the large rating agencies providing stellar ratings on what has turned out to be junk. Read any of the Congressional Hearings articles of 2010 whereby Congress hauled in the big rating agencies with evidence of pay for ratings shenanigans.
Yes, it is time to repeal Gramm-Leach-Bliley and bring back Glass-Steagall as the first step in breaking up the TBTF banks and reigning in greed. At the very least, insured deposits should be off limits to any type or related investment backed activity.
† Who ever heard of a “no-doc” loan? What rational business person or any person with skin in the game (and therein lies the rub) would ever consider such an inherently fraudulent instrument?
1Banking Act of 1933, commonly called Glass-Steagall, by Julia Maues, Federal Reserve Bank of St. Louis, November 22, 2013