Bankers and Goldfish – Run in Schools and get Tanked

The Legislative Race to Prevent Dumb and Dumber from Creating the  Next Financial Meltdown

Now that health care reform had passed, the most contentious issue (not to suggest that all issues are not contentious) facing the President and Congress is how to best tighten or implement new regulations for financial institutions.

The objective of the legislation is prevent another meltdown of financial institutions – especially banks – as occurred in late 2008 and 2009. The big question is how to prevent institutions that are “too big to fail” from failing, and how to pay for the cost of clean up when they do fail?

As usual, commercial banks are at the center of concern. Surprisingly both Democrats and Republicans are in agreement that the real challenge for the legislation is trying to craft regulations that can deal effectively with the banker’s penchant for dim-witted, greedy, incompetent and herd-mentality thinking. As one sage was fond of saying, “I have had goldfish smarter than most bankers.”

A quick review of every national financial crisis suffered by the country during the past 235 years will show that the acts of banks were the spark that set the crisis in motion. The very first act of Franklin Roosevelt when he became president at the depth of The Great Depression in 1933 was to close all the banks in the country. That seems logical since the best way to fight a fire at a gas station is to first turn off the gas.

Paul Volcker, the 82-year-old former chairman of the Federal Reserve (1979-1987) who is himself a former banker, knows that bankers cannot be trusted on their own. In a Wall Street Journal article (New Life for ‘the Volcker Rule,’ May 1, 2010), Volcker proposes that the legislation prohibit banks from doing anything other than what they have a chance to do well, which is “taking deposits and making loans.” He is okay with the government helping banks that get in trouble doing “basic banking,” (which he knows some will) but for banks that go beyond core banking, they should be allowed to fail. As Volcker said to bankers who argue they should be allowed to do more than banking, “We’ll give you a nice coffin and an easy cushion . . . but you’re not going to be saved.”

Even some bankers know they are not smart enough to be left on their own. Some of the more perceptive bankers know they are like alcoholics who cannot control their own actions, so they beg others to keep them away from alcohol (as in “Stop me before I kill again.”)

Just as Ulysses had himself bound to the mast so that he would not follow the seductive song of the sirens, former Citicorp CEO John Reed has indicated that banks should be bound to only be banks, lest they follow the sirens of investment greed and avarice. He said allowing banks to combine investment activities with commercial banking is disastrous because investment people “overwhelmed the traditional culture at the bank.” (This, of course, is an admission that investment people are smarter than bankers.) The WSJ article also noted that current Citicorp CEO Vikram Pandit sent a letter to President Obama in which he wrote, “I believe banks should be banks serving clients. I believe banks should not speculate with their capital.”

Although the current legislation is being couched in terms of “consumer protection,” the real – if unstated goal – is not so much aimed at how to protect us from the bankers, but how to protect the bankers from themselves. History is replete with examples of how, if left to their own devices, bankers will muck it up, not only for themselves, but for all of us.

Each and every time America recovered from a financial crisis an effort has made been to implement new legislation designed to prevent the banks from causing another crisis. For the most part, this legislation worked. That is, until it was later eroded or repealed and banks were allowed to go merrily along on their self-destructive ways. Every time the regulation of banks has been eased, another financial crisis soon befell the country, thanks to the bankers.

The latest – and probably best example – of this regulatory approach after a financial crisis is the Banking Act of 1933 (Glass-Steagall) passed by Congress at the behest of Roosevelt. The key elements of Glass-Steagall were fairly mundane. The law limited the banks to only being banks – banning investment and insurance activities – and limited the size that banks could grow to by prohibiting bank holding companies from owing other financial companies. In essence, the bankers were put in a nice little goldfish tank that limited the trouble they could get into. And it worked. From its passage in 1933 until it was repealed in 1999, very few banks failed and those that did had no material impact of the national economy.

Then, in 1999, the Glass-Steagall Act was repealed by the Gramm-Leach-Bailey Act. That bit of legislative handiwork, the so-called Financial Modernization Act, let the bankers out of their little fish tanks. Like timid feeders in the lagoon, they were suddenly free to school together and feast on targets in the big financial ocean. It took less than a decade of their feeding frenzy to become the major cause for mucking up the entire financial system. Despite the fact that bankers were allowed to rip-off consumers to the tune of billions and billions of dollars in outrageous fees and usury-type interest rates on credit cards, it was not enough to overcome the losses for their mistakes in investments and sub-prime loans. They had to be bailed out again.

When will we learn our lesson with these clowns?

While both Republicans and Democrats agree that new regulations are needed, there is a fundamental difference in their approach to the problem. And of course, banks are spending millions and millions of dollars (mostly to influence Republicans) in a massive lobbying effort to water down or even eliminate new regulations.

The Democrats are taking the approach of prohibiting certain actions of banks, i.e. derivative type investments and forcing the banks to divest – or at least separate – their riskiest activities from traditional banking. The Republicans basically favor allowing banks to continue all of their activities – even the most risky – but with more transparency so we can see exactly what they are doing. The idea is to be able to take quick action if things get out of hand. For me, that is akin to trying to cure an alcoholic by allowing him to drink in front of you, rather than alone.

And the Moral of the Story . . .

If time and again someone indicates a proclivity to harm themselves and to you, it seems the best course of action is to take away the instruments they use to do harm. If you have someone who does a reasonably good job as a bus driver, do you then allow him – even though he has not talent or training – to fly an airliner? (His reasoning being allowed to do it is that busses and airplanes are just forms of transportation.) Would you think it would be okay to allow the bus driver to fly a plane, just so long as you rode along so you knew what he was doing?

The moral of this story is that once and for all we should put these bankers where they belong. We should put them in a goldfish tank where we can watch and be entertained by them as the swim around and around together doing their thing, but not being able to do any damage – except to themselves.

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