Jamie Dimon, CEO of Chase Bank, has been contrite – calling the actions that led to the bank’s $2 billion loss “sloppy” and “stupid” and adding that “You always make mistakes”. And therein lies the rub. When a badly managed company makes mistakes it goes out of business, the shareholders lose their equity, the bond holders a percentage of their money and the employees their jobs. But when a bank like Chase gets in trouble, the taxpayers end up on the hook.
The financial industry argues that regulation stifles business and has economic costs. But that argument doesn’t survive scrutiny. Financial crises are as old as the Republic – with ‘panics’ in 1792, 1796, 1819, 1837, 1857, 1873, 1884, 1890, 1893, 1896, 1901, 1907, 1910, 1929 – all with little to no bank regulation.
In the depth of the Great Depression the Banking Act of 1933 was passed, dividing commercial banks from investment banks (Glass-Seagal Act) and creating the FDIC – giving the tax payer a vested interest in the health of the banking industry.
The string of financial panics caused by bank failure stopped and banking became a staid but solidly profitable business – making money by direct loans to business and individuals.
It was the collapse of the savings and loan business in 1989 that illuminated changes being made in the banking industry. There were no shortage of causes for the S&L collapse, but two factors were paramount. A real estate collapse badly devalued the investments held by S&Ls (sound familiar?) and two bills reducing regulations on S&Ls were enacted: the 1980 Depository Institutions Deregulation and Monetary Control Act allowed S&Ls to invest in financial instruments which many didn’t understand (again familiar?) and the 1982 Garn–St. Germain Depository Institutions Act of 1982 which allowed S&Ls to offer adjustable rate mortgages.
Garn-St. Germain was ironically described as: “An Act to revitalize the housing industry by strengthening the financial stability of home mortgage lending institutions and ensuring the availability of home mortgage loans.”
Traditional banks as well were under a lighter regulatory hand, especially after the 1999 Gramm-Leach-Bliley Act repealed the part of Glass-Seagal Act that separated investment and commercial banks.
As regulation was sliced away, the financial industry was creating ever more exotic investment instruments (derivatives), which lay beyond the reach of remaining regulation. They had a champion in Allan Greenspan, who fought as early as 1997 to keep derivatives unregulated. By 2003 Warren Buffet had a more realistic estimate of derivatives, calling them “Financial weapons of mass destruction”. Banks were no longer satisfied with steady profit, but were driven by a pathological need to make money no matter what. Bankers were acting like drunks at a Las Vegas Black-jack table.
The fragility of the financial system was disguised by a housing bubble, driven by lenders who could bundle their loans and sell them as “mortgage backed securities”. With the lenders selling the risk they had little incentive to vet borrowers – creating ‘liar loans’.
That wouldn’t have made any difference if there were no buyers for these new securities. But the returns were too seductive and complex legal entities – “Structured Investment Vehicles” – allowed hugely over-leveraged banks to move assets and liabilities ‘off-balance’ and hide their true exposure to risk.
Everyone knows what happened when the housing bubble burst. But unlike the drunk in Las Vegas who wakes with a hangover and empty pockets, the financial industry knew the government would make them whole. “Too big to fail” forced the government to provide TARP money, finally costing the taxpayer $32 billion.
Dimon and all the other bankers have to understand that, if the taxpayer is in jeopardy, the taxpayer has the right to protect himself with regulation, and if the banks continue to “make mistakes” they need to be broken up into smaller units, so they are never again too big to fail.