Too Big to Succeed
By Philip Bowring
Op-Ed Contributor
November 10, 2009
HONG KONG — This
week is the 10th anniversary of the signing by President Clinton of
legislation abolishing the Glass-Steagall act, which, since 1933, had
kept a wall between commercial banking and investment banking and
insurance. That Depression-era law stemmed from the role that
speculative investment banking had played in the failure of many
commercial banks, which in turn wrought havoc on the U.S. economy.
The abolition,
passed by a large majority in Congress, was strongly supported not only
by the big names on Wall Street but by the then Treasury secretary,
Lawrence Summers, and his immediate predecessor Robert Rubin, a star of
Goldman Sachs. Glass-Steagall was, it was argued, outmoded and a
barrier to innovation and competition. I was then in a minority in
worrying about the return of huge financial consortiums. But events
suggest that the essential wisdom of Glass-Steagall remains intact.
Separation of powers and functions should be as important to the
finance sector as to the U.S. Constitution.
By the 1990s,
Glass-Steagall was certainly out of date, having been bypassed by
financial sector developments, astute lawyers and compliant officials.
However, the principle enshrined in it — that finance should be
compartmentalized to prevent problems in one sector from wreaking havoc
on the whole industry — remains valid. Today, even those who most
strongly supported abolition are having second thoughts. They include
John Reed, former chairman and chief executive of Citigroup and the man
primarily responsible for turning Citibank, a world leader in
commercial banking, into a conglomerate with investment banking,
insurance and broking interests. Mr. Reed recently noted the wisdom of
compartmentalized ship design: “If you have a leak the leak doesn’t
spread and sink the vessel.”
Since 1999 there
have been three financial sector crises that in different ways have
shown the dangers of financial arrangements with internal conflicts of
interest, a tendency to cross-sector infections, and emergence of the
“too big to fail” mentality that has cost American taxpayers billions
in bailouts.
The end of
Glass-Steagall coincided with the last surge of the tech stock frenzy,
which peaked in early 2000. The economic damage done by that boom and
bust was relatively modest as it was mostly not financed by debt. But
it showed how failure to keep financial activities in their proper
compartments led to conflicts of interest that helped drive prices to
absurd levels and made gigantic profits for intermediaries at the
expense of the public.
Investment banks
and stockbrokers tailored their research not to the needs of public
investors but to maximizing profit from their primary share issue
business. They had a close relationship with a mutual fund industry,
which focused on short-term returns and over-rewarded managers
accordingly. They also fostered a stock options culture among corporate
executives aimed at maximizing short-term share performance to enable
them to cash-in quickly.
Since the tech
stock crash there has been some strengthening of the walls between
investment bank and broker research, and increased competition in the
mutual fund industry. But “compliance departments,” which are supposed
to keep investment banks honest, are often staffed by the meek and
bureaucratic.
Nor did the tech
stock crash resolve another conflict of interest in an increasingly
concentrated financial services industry. The Enron collapse in October
2001 underlined both the zeal of investment banks to create opaque
structures to hide debt and the willingness of some auditors, seduced
by high fees, consultancy contracts and golf course friendships, to
sign off on dubious accounts. The consequent collapse of Enron’s
auditor, Arthur Andersen, may have led to some improvement in
standards. But it further reduced the number of big name auditors and
strengthened the cartel tendencies of an industry that exists to serve
the interests of outside investors and creditors, not management.
Over the past 18
months the whole world has suffered from financial sector abuse that
was only possible because a few institutions combined several of the
roles of commercial banks, primary dealers, derivatives traders, bond
underwriters, fund managers, insurers, merger specialists etc. Now an
even tinier group of top firms still make most of their profits from
“trading,” a euphemism not just for commissions on trades in which they
are intermediaries but trades on their own account that can often only
be profitable at the expense of clients of another part of their
business.
Foreigners who look
to the United States for financial leadership need no reminding that
international icons like Citigroup, Merrill Lynch and A.I.G. have been
brought to their knees. For decades these icons had done much to
facilitate the development of global trade and cross-border investment
and spread best practices in banking, brokering and insurance. But when
they tried to combine all these specialties they became not just “too
big to fail” but too big to succeed.
The Glass-Steagall
principles should form a basis for discussion by G-20 ministers who
were again last weekend getting nowhere in their promised efforts to
improve the stability and transparency of global finance.
| 
