From Medicine to McKinsey to Main St

Break up the banks says former Treasury Sec. Paul Volcker.  We heard outrage against bankers and their excesses during the financial crisis, as we heard that business as usual would crash the country.  Following that time, we’ve seen a return to paper profitability by the big banks…but with a focus on trading operations over the loans and credit lines that lubricate the real economy down on Main St.

Which raises the question…what was the point of savings the banks if they weren’t going to provide this critical role for the economy?  And by allowing the institutions that had grown through excess live, we’ve choked out the opportunities for those who were prudent and waiting for tougher times.

The banks are there to serve the public,” Mr. Volcker said, “and that is what they should concentrate on. These other activities create conflicts of interest. They create risks, and if you try to control the risks with supervision, that just creates friction and difficulties” and ultimately fails.

The only viable solution, in the Volcker view, is to break up the giants. JPMorgan Chasewould have to give up the trading operations acquired from Bear Stearns. Bank of America and Merrill Lynch would go back to being separate companies. Goldman Sachs could no longer be a bank holding company. It’s a tall order, and to achieve it Congress would have to enact a modern-day version of the 1933 Glass-Steagall Act, which mandated separation.

Glass-Steagall was watered down over the years and finally revoked in 1999. In the Volcker resurrection, commercial banks would take deposits, manage the nation’s payments system, make standard loans and even trade securities for their customers — just not for themselves. The government, in return, would rescue banks that fail.

On the other side of the wall, investment houses would be free to buy and sell securities for their own accounts, borrowing to leverage these trades and thus multiplying the profits, and the risks.

Being separated from banks, the investment houses would no longer have access to federally insured deposits to finance this trading. If one failed, the government would supervise an orderly liquidation. None would be too big to fail — a designation that could arise for a handful of institutions under the administration’s proposal.

I think this idea brings us back to a more sustainable future.  If something’s too big to fail, its too big to exist…evolution’s pre-requisite is the failure of the biggest institutions to better adapted institutions.  This also addresses the fundamental problem of the finance industry…taking risks with OPM (Other People’s Money).  When investment banks were partnerships, they took risks with the invested capital of the partnership.  When investment banks are public corporations, bankers are taking risks where they gain the upside and the stockholder eats the downside…in my mind this leads to one inevitable outcome, which we’re suffering through today.

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