[R-G] Glass-Steagall’s Specter Returns to Haunt Wall Stree

[Anthony Fenton]

http://www.bloomberg.com/apps/news?pid=20601087&sid=ad_KRWTbPsJw&refer=home

Glass-Steagall’s Specter Returns to Haunt Wall Street (Update2)

By Matthew Benjamin and Christine Harper

March 10 (Bloomberg) -- A decade after Wall Street killed off the  
Glass-Steagall Act that separated commercial banks from securities  
firms, its ghost has returned to haunt the financial industry.

Comments by Paul Volcker, the former Federal Reserve chief advising  
President Barack Obama, and Federal Deposit Insurance Corp. Chairman  
Sheila Bair in the past week suggest it will become more costly for  
banks to remain in some of the areas they were let into with Glass- 
Steagall’s 1999 repeal, analysts said.

“The capital-market rules are going to change,” Brad Hintz, an analyst  
at Sanford C. Bernstein & Co. in New York, said in a Bloomberg  
Television interview. For firms that remain banks, “it’s going to be  
much more difficult to trade in the illiquid parts of the market”  
beyond government and corporate bonds, and to borrow to finance  
investments, he said.

Hedge funds will increasingly take over business in riskier areas such  
as emerging-market and distressed securities, predicted Hintz, who  
served as chief financial officer of Lehman Brothers Holdings Inc.  
from 1996 to 1998.

By removing the barrier between everyday banking such as lending and  
deposit-taking and riskier areas such as derivatives trading, Glass- 
Steagall’s 1999 repeal helped create the current crisis, according to  
some policy makers and politicians.

‘Never’ Again

“You can’t break the bank and lose everyone’s” pension investments  
“without expecting a real food fight with respect to laying blame and  
trying to fix the financial system so this never happens again,” said  
Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi  
UFJ Ltd. in New York.

Volcker called for a “two-tier” financial system that would limit risk- 
taking by the most systemically important firms, at a conference in  
New York March 6. Bair said in an interview with CBS that aired March  
8 that Congress should curtail the size of the biggest banks.

Fed Chairman Ben S. Bernanke today said the central bank has already  
stepped up surveillance of the systemically important firms, and that  
such companies require “especially close oversight.” He spoke at the  
Council on Foreign Relations in Washington.

Many on Wall Street are now resigned to jettisoning some sources of  
revenue and paring back others in order to comply with a new  
regulatory regime. How that regime will look around the world is set  
to be discussed when finance ministers and central bankers from the  
Group of 20 nations meet this week near London before an April 2  
summit of leaders.

Morgan Stanley

“Some of the businesses that we’ve been in in the past are going to be  
curtailed,” Morgan Stanley Chief Executive Officer John Mack said on  
Feb. 23.

Obama has told his aides to work with Congress on shaping proposals  
for regulatory changes within weeks.

Obama himself has decried the way Glass-Steagall was undone, saying it  
left a regulatory vacuum that contributed to the current crisis.

“A regulatory structure set up for banks in the 1930s needed to  
change,” then-candidate Obama said in a March 27, 2008, speech at New  
York City’s Cooper Union. “But by the time the Glass-Steagall Act was  
repealed in 1999, the $300 million lobbying effort that drove  
deregulation was more about facilitating mergers than creating an  
efficient regulatory framework.”

Obama referred to a campaign by companies such as Citigroup Inc.,  
Merrill Lynch & Co. and Aetna Inc. in the late 1990s to overturn the  
law. Its demise allowed banks, insurance companies and securities  
firms to integrate and compete with one another.

Citigroup’s Birth

Citicorp, a commercial bank, and insurance company Travelers Group  
Inc. announced a merger in 1998 that needed Glass- Steagall’s repeal  
to become legal. The combined entity became Citigroup.

As commercial banks sought to compete with investment banks, they took  
bigger trading risks and created off-balance-sheet financing vehicles  
to help reduce the capital they needed to hold to protect against loan  
losses. Investment banks became more aggressive in lending to  
companies and increased their own borrowing to buy securities or real  
estate.

Phil Gramm, a Republican senator from Texas who co-authored the Gramm- 
Leach-Bliley Act that repealed many key provisions of Glass-Steagall,  
later went to work for UBS AG, the Swiss bank whose foray into  
investment banking contributed to an 88 percent drop in its shares  
since June 2007. Robert Rubin, a Clinton administration Treasury  
secretary who advocated Glass-Steagall’s repeal, went on to work for  
Citigroup, which lost $27.7 billion in 2008 and has needed $45 billion  
in government funds to remain solvent.

Questioning the ‘Threshold’

“Taxpayers rightfully should ask that, if an institution has become so  
large that there is no alternative except for the taxpayers to provide  
support, should we allow so many institutions to exceed that kind of  
threshold,” FDIC’s Bair said March 8 on the CBS News program “60  
Minutes.”

The financial conglomerates enabled by the lifting of Glass- Steagall  
restrictions are “unmanageable,” Volcker said in January. Traditional  
commercial banking shouldn’t be combined with “very risky capital  
market activities,” he said.

Some argue that Glass-Steagall’s repeal is not to blame for the  
current financial crisis.

“There’s nothing any of these groups did that they couldn’t do  
before,” said Jim Leach, a former Republican congressman from Iowa who  
helped engineer the law’s undoing. Rather, the fault lies with “the  
greatest regulatory breakdown in history, on the part of the Fed, the  
Treasury and the Securities and Exchange Commission,” said Leach, now  
a professor at Princeton University’s Woodrow Wilson School.

Return to Washington

Several officials who supported the 1933 law’s repeal have returned to  
positions of power in Washington in the current administration. Most  
prominent among them is Lawrence Summers, Obama’s top economic  
adviser, who succeeded Rubin as Treasury secretary in the Clinton  
administration. Timothy Geithner, who now serves as Treasury  
secretary, was undersecretary for international affairs under Rubin  
and Summers.

Advocates of reinstalling barriers between investment and commercial  
banking “will run into a little bit of opposition from the same people  
who fought so hard for the death of Glass- Steagall,” Alan “Ace”  
Greenberg, the former Bear Stearns Cos. chief executive officer said  
on Bloomberg Television March 9.

To contact the reporter on this story: Matthew Benjamin in Washington  
at Mbenjamin2 at bloomberg.net; Christine Harper in New York at charper at bloomberg.net 
.
Last Updated: March 10, 2009 09:45 EDT