Thursday, January 14, 2010

Another brilliant idea from the D.C. pitchfork brigade

The Nobel Prize-winning geniuses on Capitol Hill have come up with another bi-partisan scheme to improve our financial system. They--Sens. John McCain (R) and Maria Cantwell (D)-- want to restore Glass-Steagall and prohibit banks from being in the securities industry and vice versa. 

Please recall that the standalone investment bank was invented by Senator Carter Glass(D-Va) in 1934. Thus the US became unique in the world by placing its capital market into the hands of Wall Street broker/dealers who were supposed to intermediate billions in capital flows with no core funding, minimal capital and no lender of last resort. This prescription for disaster finally bore fruit  in the fall of 2008, when the standalone investment bank model finally died a well-deserved death

When Lehman failed, there was a funding run on the remaining investment banks (Goldman, Morgan Stanley, Merrill). Although they had plenty of good collateral, the money markets were closed tight. No one wanted their name. This impelled them to merge with or convert to bank holding companies in order to come under the Fed's umbrella (and, ultimately, to develop sources of bank-like core funding, God willing).

If we are lucky, a silver stake has been driven for good into the heart of the wholesale-funded investment banking model.  If, by some horrifying circumstance,  the Glass-Steagall Act were to be  restored by the Senate's  Know-Nothing caucus, the government will mandate the resurrection of these misshapen creatures (a financial version of The Night of the Living Dead), and the US will inevitably face another wave of failures and bailouts. 

Citi will disgorge Salomon/SmithBarney, BofA will  gift us with Merrill, and JPM will rebirth Bear Stearns. And what, dare one ask, will happen to Goldman and Morgan Stanley when they are pushed out of the Fed's nest to fend for themselves? Are they expected to self-liquidate before or after they pay their penalty taxes?

This whole idea would fall under the "unthinkable" category if we didn't have the pitchfork crowd in Washington today. Are we truly condemned to relive bad history every 75 years? 

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