Thursday, October 22, 2009

More Regulatory Pressure To Separate Commercial & Investment Banking

Way back in 1996, my friend B predicted that, going forward, US banks would become increasingly like utilities, with core lending and deposit-taking functions eventually separated from riskier investment banking. The former would become federally-insured activities, with lending subject to fairly rigorous standards in order to qualify for federal guarantees.

Otherwise, he noted, the few, large deposit-taking banks would subsidize risky investment banking with insured deposits and a "too big to fail" condition that would only lead to increasingly riskier trading and underwriting activities.

This week, Mervyn King, Governor of the Bank of England, and Paul Volcker, former US Fed chairman, once again called for separation of investment and commercial banking. For pretty much the same reasons B prophesied over a decade ago.

Both central bankers identified the increasingly risky behavior of commercial banks which have bulked up proprietary trading and underwriting activities.

Yet, one only has to look at this week's mortgage loan delinquencies at Wells Fargo to see that my old Chase Manhattan boss, Gerry Weiss, was prescient when he observed that money center banks didn't need to enter investment banking to lose money. They could do that in their regular businesses through the usual abandonment of credit standards in pursuit of market share as various product/markets exhibited strong growth in demand.

Is a return to an era of a Glass-Steagall type of separation of investment and commercial banking possible?

If the current administration and Congress have their way, quite possibly.

Given the quick return to risky trading activities at Chase this past quarter, it's clear that the combination of the two types of banking is going to once again, in time, lead to risk-based profits for shareholders and compensation for employees, while heavy losses will once again tax the FDIC and result in federal rescues.

Just a few days ago, on Tuesday, Columbia finance professor Charles Calomiris authored another flawed editorial in the Wall Street Journal, on the subject of universal banks combining investment and commercial banking. The last one one which I posted, here, was exactly a year ago.

Because Calomiris' piece was so long, and contains a number of fallacies, I'll touch on it in a subsequent post.

But, for me, King and Volcker represent far more objective, reasoned positions on the subject of separating riskier banking activities from those of insured deposit-taking institutions.

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