Friday, January 15, 2010

Two Interesting WSJ Pieces On Financial Sector Regulation

Wednesday's Wall Street Journal editorial page featured the regular matched editorials by Holman Jenkins, Jr., and uber-liberal Frank Thomas.

While Jenkins wrote a thoughtful, insightful piece, as usual, what was surprising was Thomas' unexpectedly reasonable call for a return of Glass-Steagall.

I found Jenkins' editorial refreshingly candid on why it's Congress that "doesn't get it" about some bankers' compensation, and not the other way around.

He bluntly observed that taxpayers made money, via the Fed, on the assets whose depressed values got so many investment and commercial banks into trouble. That the Fed had record profits of $52B in 2009. A fact about which the administration and the Fed are being rather, well, quiet.

As Jenkins points out, like it or not, traders and investment bankers are highly mobile, so when they add value, they will either be paid commensurately, or leave for another outfit. And let's also be candid about who would do a better job devising admittedly imperfect compensation schemes- government or management? It's going to be management, because they have a vested interest in keeping their talent.

Meanwhile, the usually-ludicrous Thomas actually argued for something sensible. Something my friend B and I have been discussing for over a year. Call it a return of Glass-Steagall, or simply prohibiting any financial institution which enjoys the benefit any government support or insurance scheme, e.g., FDIC, Fed window access, etc., from engaging in: proprietary trading, securities underwriting or any other non-plain-vanilla lending.

Thomas is right to note that Bill Clinton's solemn intonation in 1999 about Glass-Steagall was completely wrong,

"worked pretty well for the industrial economy....But the world is very different."
Granted, as usual, Thomas wrongly blames a general rush to deregulation.

In this case, it was actually the concerted efforts of some stupid commercial banking CEOs who largely failed to understand, or deliberately ignored, that allowing more, and less-capable capacity into proprietary trading and general securities underwriting would cause disastrous systemic consequences for both businesses.

There are ways in which you could allow wholly-owned, separate subsidiaries of commercial banks to do these businesses, but the key would always be two-fold: no leverage, and no government backstops, insurance or aid of any kind, should the riskier units go down. Their failure would have to be fully absorbed by the units' equity, with no debt left unpaid.

It's simpler, of course, to simply forbid insured, government-assisted financial entities from those businesses. But it really is time to restore a functional equivalent of Glass-Steagall.

More than any current regulatory so-called reform afoot in Congress, this one act would do more to minimize the consequences of the inevitable future systemic financial disasters than any other suggestion in circulation today.

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