January 22, 2010

The Economist on “Glass-Steagall lite”

Filed under: Uncategorized — ktetaichinh @ 11:58 pm
Tags: ,

January 22, 2010 1:45pm

I thought this concise analysis by The Economist was one of the best things I have read on Obama’s new banking proposals.

Allow me a quibble over nomenclature (ie, the politics). To have this plan referred to as any kind of Glass-Steagall–”lite”, “in the spirit of”, whatever–annoys me because that designation is all about pandering to the view that the repeal of Glass-Steagall caused the crisis. It did not. And this plan (as The Economist’s article explains) does not come close to repealing the repeal. Deposit-taking banks would still be able to act as investment banks for their clients, and policing the boundary between client services and own-account activities will be a mess. (JP Morgan doesn’t even think it will have to divest its hedge fund, for heaven’s sake.) I prefer the Volcker rule. That way, as with the Greenspan put, we would know who to blame later. No matter, better get used to it: the new Glass-Steagall, Glass-Steagall lite, son of Glass-Steagall.

Branding aside, The Economist piece gives an excellent even-handed appraisal of the idea and its likely results. There are things to be said for the proposal: it’s just that none of them has anything to do with the crisis we have just witnessed. For me, these are still the key points:

[Once Goldman] is cut loose from banking restrictions, and from Fed funding, would it not continue to enjoy implicit state backing? Would it really be allowed to fail if it blew up? Officials argue that other reforms, such as central clearing for derivatives, will make it easier to let such firms die. Convincing markets of that will be difficult.

I’d say so.

Enforcement could be tricky, too. Regulators will struggle to differentiate between proprietary trades and those for clients (someone is on the other side of every trade) or hedging. Getting it wrong would be counter-productive: preventing banks from hedging their risks would make them less stable.

Moreover, the plan is unlikely to help much in solving the too-big-to-fail problem. Even shorn of prop-trading, the biggest firms will still be huge (though also less prone to the conflicts of interest that come with the ability to trade against clients). As for the new limits on non-deposit funding, officials admit that these are designed to prevent further growth rather than to force firms to shrink.

They may, in any case, be pointed at the wrong target. Curbing the use of deposits in “casino” banking is an understandable impulse, but some of the worst blow-ups of the crisis involved firms that were not deposit-takers, such as American International Group and Lehman Brothers. And much of the losses stemmed not from trading but from straightforward bad lending (think of Washington Mutual, Wachovia and HBOS).

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