Newsflash folks: This isn’t Market Capitalism, it’s Monopoly

I entered the world of commercial banking the same year that the Monetary Control Act of 1980 (MCA) got passed and signed by Jimmy Carter.  President Jimmy Carter was responsible for the first onslaught of deregulation of all kinds of industries which is important to think about.  It was a Democratic President that pulled the first card from the laws that were put into place to stop the banking crises that had plagued our country in the early years of capitalism.  I should also remind you that the country was founded on a system of economics called mercantilism.  Capitalism didn’t come into being until the early-to-mid-19th-century. (Note to Rick Perry: The US Revolutionary war was not in the 16th or  17th century.) We had series of financial crises in  the 1840s and then in 1870s .  The first one was in 1792 and a politician/financier caused it. 

We didn’t call them recessions bank then.  We called them Panics and they were sourced in banking and nascent financial markets.  They were the result of excessive speculation and/or some Bernie-Madoff-like figure and scheme.  In 1792, the panic was set off by William Duer who used his appointment to the US Treasury by Alexander Hamilton to use insider information in a similar way to Hedge Fund Manager Raj Rajaratnam who was just sentenced to 11 years in jail yesterday.  This is a very old story and really dates back to the birth of capitalism as we know it.

Hamilton was pretty appalled by Duer’s speculative activities.  He wrote this at the time.

“Tis time, there must be a line of separation between honest Men & knaves, between respectable Stockholders and dealers in the funds, and mere unprincipled Gamblers.”

If you start typing Financial Panic into Google, you’ll start seeing a huge number of dates pop up.  From 1792 down to the present time, most of these panics have been clearly rooted in that same problem: speculative bubbles and banking malfeasance.

There’s a clear difference between the good old fashioned community banking that gave me my first job out of my masters program and what we have today.   Much of it is due to that first card pulled from the bottom of the financial market card house by Jimmy Carter in 1980.  You can read about the law at FRB Boston.  There were a lot of responsibilities placed on the FED for oversight at the time but the banks got a lot of benefits including increased access to borrowing money from the FED.  When I was working in Nebraska,  a bank was allowed one branch and a main office. There were restrictions on how far away the branch could be.  I worked for a small bank with a branch across the street at a big shopping center.   That local law was pulled down shortly thereafter because the banks wanted to branch every where into communities they did not know.  There are very few community banks left in the country where your banker knows if you’ll be good for your loan or not based on years of knowing you.

Most small and regional banks have been gobbled up by the top 4 or 5 financial institutions. The majority of financial assets sit in a handful of institutions.  That’s called monopoly, folks.  Monopolies require regulation, not free reign.  That’s basic classical economic theory and has nothing to do with Keynes and politics.  Any microeconomics 101 students should be able to explain why.  They are incredibly inefficient. We say they are not Pareto Efficient, which means some very specific things.  They overprice their products.  They restrict access to these products. They earn profits above and beyond what they should because the revenue far exceeds the productivity of the factors used to produce the service. They create a deadweight loss which is bad for every corner of the economy except for the monopolist.

We have gone from a system where lending risk is personalized and spread around a number of institutions to a situation where it’s all concentrated and automated in the hands of a few big banks. They also can invest in a lot of specious assets.  The banks continued to seek complete interstate banking and eventually got it. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 gave them exactly what they wanted.  It also allowed bank holding companies to do things that they had previously been disallowed like hold subsidiaries that offered speculative investments.  Interestingly enough, it is much easier to become a bank holding company than it is to become a bank.  Many investment banks became bank holding companies to access borrowing through the Fed Window in 2008 when they had gambled away a good deal of their own capital.

This law was signed by Democratic President Bill Clinton. That’s only the commercial banking side.  The so-called shadow banking industry got freed to speculate at will and be closely aligned with banks and their guaranteed deposit when the Gramm-Leach-Bliley Act  (GLBA) was signed by President William Clinton in 1999.  It repealed huge sections of the Glass Steagall Act that were put into place during the Great Depression to deal with all those financial panics that finally led up to the 1929 Bank Run.  If you’re unemployed and you’ve seen your housing equity and your retirement funds depleted, I’d suggest going to Phil Gramm’s house with placards and rotten eggs.  He’s the one mover and shaker that brought all this on to our heads and a symbolic tar and feathering would make me feel good, frankly. (Here’s an academic site with some brief notes on a Mishkin textbook on the history of the repeal of important banking laws for your reference.)

So, it goes with out saying that the minute these things were put into play from 1980 forward, it was only a matter of time before we started to repeating panics and would eventually get another Great Depression.  The panics started in the 1980s. I’d moved out of commercial banking and into the S&L business right before our first panic came.  When S&L’s started giving market rates of interest on their liabilities, they had to start giving new mortgage loans out at exorbitant prices.  My first one–in 1982–was for around 17%.  I got the banker discount which brought it down to 12%.  The problem was that all the liabilities were repricing to market and all the assets (loans) were still stuck at those 1950-1960 home loan interest rates of about 5%.  My dad was barely paying 4% because the bank he used also was funding his floor plan (that’s the cars he had on his inventory sheet as a new car dealer).  His floor plan interest was through the roof in those days because the usury laws had been suspended.  It was in the 20% levels just like credit card debt was at the time.  The commercial banks were seeing incredibly high prime rates of interest and the Savings and Loans were hemorrhaging money.  This is a problem of term mismatch when you rely on arbitrage profits, but I’ll avoid the lecture on that one!  The S&L crisis should’ve been the first cautionary tale from that Monetary Control Act.  I have some pretty wild stories from those days including the Treasurer that I worked for using GNMA futures to day trade to try to up our cash balances.  Illegal yes!  That’s if you’re caught! However, we were the least of the FSLIC’s problems at the time and he got away with it!

The second cautionary tale came with a  Long Term Capital Management that lost tons of money after the Russian Financial Crisis in 1998. That didn’t stop the GLBA at all however.  There was an earlier canary too.  That was Franklin Savings and Loan.  There’s actually a more recent example of the same.  That would be Granite Funds. LTCM made convergence trades that required huge sums of money and enormous leverage to be profitable.  They were eventually bailed out and wound down at a huge cost.  There is absolutely something wrong when we repeatedly have huge organizations collapse because of margin calls.   I point back up to the quote from Alexander Hamilton who got it the first time out.  We still haven’t learned the lessons from any of this because we’re ready and primed for the next financial crisis with European Sovereign Debt too.  The speculators are pulling the same tricks and we’re suffering from the same results.

So, the deal is that after about 100 years of horrible problems, we put a box around the speculators called Glass Steagall.  There is a new box proposed called the Volcker Rule.  The banks are kicking and screaming about even the smallest regulations to stick them back into their boxes.  We cannot afford to repeatedly coddle an industry that systematically creates huge social and economic costs on a regular basis when set free to do as it will. The Volcker Rule–in its current form–is pretty mild.  It’s no where near what ex Fed Chairman Paul Volcker originally offered but it’s a step in the right direction.  That’s why it’s first on my list of demands for OCCUPY activists.

Fitch Ratings on Friday said it sees potential for a delay in the adoption of a newly proposed rule barring banks from trading for their own profits, due to industry opposition that could lead to a political fight.

Banks’ opposition “will likely fuel a lengthy debate in Washington regarding the ultimate scope and precise implementation” of the Volcker Rule, Fitch said in a report released four days after federal banking regulators proposed the rules.

“There is a real possibility that controversy surrounding the proposal could delay the precise definition of restricted trading, particularly in a presidential election year when partisan debate over financial regulation will be intense,” Fitch said.

The rule, named after former Federal Reserve Chairman Paul Volcker, was required under the financial overhaul that became law last year. The rule would bar banks from trading for their own profit instead of on their clients’ behalf. Banks must hold investments for more than 60 days, and bank managers must make sure employees comply with restrictions.

The day after banking regulators and the Federal Reserve backed the rule, the Securities and Exchange Commission voted 4-0 to send the proposal out for public comment. The public has until Jan. 13 to comment on a rule that’s expected to take effect by July after a final vote by all the regulators. Banks would have until July 2014 to comply.

The industry has said that the proposal would put them at a disadvantage to banks in other countries.

Let me reiterate something I’ve said earlier.  The Scandinavian countries learned from their last disastrous banking crisis in the early 1990s and put their banks back into the box.  This was roughly the same time of our own S&L crisis and came from speculative bubbles.  They all come from speculative bubbles, excess risk taking, and extremely immoral behavior on the part of many bankers/brokers because the extraordinary profits that can be extracted on the ride up are incredible. The Canadians never let them out so they’ve basically been sitting pretty well during this last crisis.  None of these countries had the problems that we and other countries have had since then.  The Volcker Rule is the least we could do to start down the path to sanity.

I want to end this post by pointing out a new voice in the blogging community called Reformed Broker.  His real name is Joshua Brown.  He has written a Dear Wall Street letter that’s worth a read.  He now feels like I felt after living through the S&L crisis and then watching the insanity repeat with LTCM and the others in the late 1990s.  All this fol de rol tanked my 403(B) retirement account as badly as this last bit of craziness has tanked it again. Only this time I am 10 years closer to retirement. Oh, and this time they got my home equity in the process and my job.  The S&L crisis got my job and killed my ability to sell my house.  It also caused incredible damage to my father’s small business.  He sold it at a huge loss just to get out from under the stress that was killing him.  I’ve just about had it now with this nonsense, the bankers, and the politicians that enable them.  As I’ve said it’s been going on for some time and they need to be put back into the box.

I’m going way beyond fair use here, Josh but I wanted your voice to be read by our readers.  Please take this as a compliment and not a copy right violation!

In 2008, the American people were told that if they didn’t bail out the banks, there way of life would never be the same. In no uncertain terms, our leaders told us anything short of saving these insolvent banks would result in a depression to the American public. We had to do it!

At our darkest hour we gave these banks every single thing they asked for. We allowed investment banks to borrow money at zero percent interest rate, directly from the Fed. We gave them taxpayer cash right onto their balance sheets. We allowed them to suspend account rules and pretend that the toxic sludge they were carrying was worth 100 cents on the dollar. Anything to stave off insolvency. We left thousands of executives in place at these firms. Nobody went to jail, not a single perp walk. I can’t even think of a single example of someone being fired. People resigned with full benefits and pensions, as though it were a job well done.

The American taxpayer kicked in over a trillion dollars to help make all of this happen. But the banks didn’t hold up their end of the bargain. The banks didn’t seize this opportunity, this second chance to re-enter society as a constructive agent of commerce. Instead, they went back to business as usual. With $20 billion in bonuses paid during 2009. Another $20 billion in bonuses paid in 2010. And they did this with the profits they earned from zero percent interest rates that actually acted as a tax on the rest of the economy.

Instead of coming back and working with this economy to get back on its feet, they hired lobbyists by the dozen to fight tooth and nail against any efforts whatsoever to bring common sense regulation to the financial industry. Instead of coming back and working with the people, they hired an army of robosigners to process millions of foreclosures. In many cases, without even having the proper paperwork to evict the homeowners. Instead, the banks announced layoffs in the tens of thousands, so that executives at the top of the pile could maintain their outrageous levels of compensation.

We bailed out Wall Street to avoid Depression, but three years later, millions of Americans are in a living hell. This is why they’re enraged, this why they’re assembling, this is why they hate you. Why for the first time in 50 years, the people are coming out in the streets and they’re saying, “Enough.”

And one more time, let’s hear from Alexander Hamilton because it bears repeating!!!

“‘Tis time, there must be a line of separation between honest Men & knaves, between respectable Stockholders and dealers in the funds, and mere unprincipled Gamblers.”

I’ve added a link to Josh’s blog so you can go sample his writing any time you want.  He’s also on twitter as @ReformedBroker.  Okay, this is a little long, and a little like one of my lectures for financial institutions, but I thought you might appreciate how this thing came down and what needs to be done.  Like I said, we need to put them back into a box.  If they are to be free from the chance of bankruptcy, able to access US tax dollars at zero cost, and are still able to create Financial Panics by bad lending and investment practices we have no other chance.  This will repeat ad infinitum and will cost us our personal and national treasures.