Yesterday, the stock market slid precariously with dire warning about the impediments to profitability we can expect if Obama's limitations on risk-taking by "too big to fail" banks are enacted. Let's take a look.
I. The Big Conglom-ocom
Bank in the 1980's, the savings and loan industry, which specialized in mortgage lending and savings accounts, was badly damaged during a period when the rate they could pay for deposit accounts was deregulated, and mortgage rates were not. Paying extraordinarily high unregulated rates for deposits and charging low regulated mortgage rates was, as 747 failed institutions found, a flawed business plan. Through corrective regulations that addressed these problems, the difference between commercial banks and so-called thrift institutions was blurred, and banks increased their mortgage lending as thrifts began opening checking accounts.
In the late 1990's, the Clinton administration, under the advice of Robert Rubin (soon to be Citibank CEO) and others, repealed the Glass Steagall Act, which had separated investment bankers (those who invest in capital markets and raise money with investors) from commercial bankers (those who lend to businesses and raise money with insured deposits). As a result, after the turn of the century, JP Morgan was presented with an intriguing study from its newly-graduated MBA Quantitative Analysts, concluding that, at no time in recent history had the entire US mortgage market ever experienced a downward price correction.
Concluding that, based on this study, that mortgages could be packaged and sold as high grade investments, since payments on a diverse geographic basis be reliable even as there may be regional problems, investment bankers entered the mortgage business. Relying on the "general rise in housing value" premise, they relaxed their lending standards, forcing commercial bankers to either compete on those relaxed terms or lose their business.
We all know the end of this story.
II. All Banks Under One Roof
Just as the savings and loan mortgage lenders became virtually indistinguishable from commercial bankers, now investment bankers were becoming more like commercial bankers, and vice versa. As the recent crisis progressed, nearly every investment bank ducked under a commercial banking charter, received Troubled Asset Relief Program money, and again, as you know, many have repaid that money, returned to profitability and began paying bonuses equivalent to those in 2008.
III. TARP, TLGP, FDIC (and Other Four Letter Words)
What you may not know is that, as a benefit of acquiring a commercial banking charter, these investment bankers have benefited from another four lettered program - TLGP, or the FDIC Temporary Liquidity Guarantee Program.
Unlike TARP, a preferred stock investment to encourage bank lending through increasing capital, TLGP is more of an ultra-cheap bond program. Here's how it works.
If, for instance, Goldman Sachs wanted to raise money by issuing bonds (loans) to capital investors, it would have to pay a competitive market rate for those borrowings. Bond buyers, a notoriously skittish sort who prefer being repaid, demanded 7.5% for the 10-year $2 billion debt it raised in January last year. Under the TLGP program, however, Goldman raised money for just 2%, with a 1% fee.
For 4% less than market rate, Goldman borrowed from the FDIC and has acknowledged it can do more "at pretty attractive rates."
IV. Glass Steagall Anyone?
TARP and TLGP were designed to encourage banks to increase lending. Goldman's CFO has said, however, that it has "virtually no direct exposure to the consumer."
So, banks' allegations that Obama's requirement that banks who utilize FDIC insurance for their depositors in order to lend to commercial enterprises must not operate proprietary trading desks, hedge funds, etc., will derail the economic recovery is straddling the fence. Using the government to insure high risk endeavors is clearly inappropriate.
Here is the question Obama poses. Do you want to operate as a commercial bank or an investment bank?
Getting the benefit of FDIC insurance and cheap borrowings used to NOT lend to consumers is a bad deal for consumers and a good deal for banks.
He's right on this one.
I welcome discourse from anyone who disagrees.