A little more on 21st Century Glass-Steagall

A little extra reaction from yesterday’s announcement.

First, back in October Deputy Director of the National Economic Council Diana Farrell famously told NPR:

We have created them [our biggest banks], and we’re sort of past that point, and I think that in some sense, the genie’s out of the bottle and what we need to do is to manage them and to oversee them, as opposed to hark back to a time that we’re unlikely to ever come back to or want to come back to.

It appears that after Tuesday’s election in Massachusetts the White House is going to go and find a bigger bottle. That quote always unsettled me, particularly the phrasing of “manage them and oversee them” instead of “regulate them”, and the dismissal of those who are worried about the concentration of, and power exerted by, structures of the financial industry. Is the narrative changing?

I wonder if there will be a crackup in Obama’s team over this. I’ve blogged before about the conspicuousness of Volcker missing from decisions, and I assume that this is a move away from the “genie’s out of the bottle” approach to the financial sector. Reuter’s seems to near a story of Geithner going rogue, see this PBS interview too.

Other Pieces

The most obvious critique of the bill is that it is necessary but not sufficient for financial reform. Yes. 100% true. But good pieces of financial reform strengthen each other: they make each other more capable of being done, and regulators being capable makes reform more credible, reducing moral hazard.

Other pieces of reform need to move with this in order to make it work. If you take the hedge fund inside a commercial bank and break it out, you still have this floating piece of risk-making out there, just like Bear Stearns, AIG, etc. So it is incredibly important that regulators will have the proper tools to wind down these institutions, including resolution authority to do FDIC-like takeovers with clearly defined rules and procedures, and clearinghouses or exchanges for derivatives, so derivatives can be properly capitalized and the information about holdings will circulate and cause less panic. It’s all works together, and what this bill will do is keep commercial banks in large part fenced off from hedge funds that may implode, which makes resolution authority more credible and effective.

We have heard less from the administration about these two pieces, and how crucial they are. They are wonky, detailed, and headache inducing to think about (though we try our best here at explanation), but they are important.


Tim Carney, the author of Obamanomics, who is always on the lookout for when a regulation really becomes a subsidy for big business, doesn’t see a there there for this regulation. The problem is that the current system of keeping prop trading within banks, especially large ones, is already is a gigantic subsidy.

One problem with the way hedge funds work in theory – that they are highly informed arbitrageurs who use high leverage to keep markets efficient – is that there are limits of arbitrage. That’s a fancy math way of saying “the market can stay irrational longer than you can stay solvent.” If you are making a highly leveraged bets that two bonds will converge in price, but if they diverge further before they converge, you could be wiped out. That’s what happened to Long Term Capital Management, and it’s a problem for hedge funds.

One way to get around it would be if you had a safety net that provided you liquidity via the taxpayer, say from the Federal Reserve discount window. This window is a system designed to keep commercial banks solvent through bank runs; it can obviously be co-opted to keep hedge funds solvent if the market moves away from you become it comes back. That’s a gigantic advantage for the largest and most connected firms. Removing it creates a more even playing field.

(Another way it is beneficial is that, to simplify, many hedge fund strategies are so saturated that one firm exiting the strategy can set off a run in the price that forces everyone to exit. See “What Happened to the Quants in August 2007?” by Andrew Lo for an example. Someone with deep pockets, especially taxpayer provided deep pockets, can potentially make some killings unfairly by manipulating this, ie – by introducing systematic risk into the system, forcing margin calls on their non-subsidized competition and cleaning up in the process. I’m still uncertain about this in practice, but it’s something to worry about.)

And we aren’t even talking that much about the conflict-of-interest that is in play here, where large connected firms can trade ahead of their clients, which sucks for their clients, but also ahead of their smaller competition. This is hard to find, and forcing it off the table is the easiest solution.

End Game

Economics of Contempt has some thoughts about the 21st Century Glass-Steagall, as well as a critique of exchange-based derivatives reform I wrote about previously (which I’ll respond to soon), and you should check them out. This is important:

Some people will claim that it’s impossible to distinguish between market-making trades and propietary trades, but that argument is completely baseless. The banks themselves already distinguish between their market-making trades and their proprietary trades, as there’s a whole different set of rules for proprietary versus market-making trades. So don’t be fooled by that argument.

Remember that, because everyone is going to try to bring that up. As far as I understand it, market-making is not effected by this. And getting regulators involved at this level will have them with a closer eye on the books of the banks they are regulating. EoC also offers:

In any event, I don’t even know why I took the time to write about this, because there’s zero chance the proposals Obama announced today will ever be law…I like how some people think Obama’s proposals represent a fundamental turning point on financial reform, because….well, clearly this is their first rodeo.

This is my first rodeo, but as I’ve stated before, I view financial reform as a long project, perhaps even generational, and not a 2010 project. And here’s the thing for everyone at this rodeo – I highly doubt a financial reform bill is going to pass the broken Senate this year with the filibuster in place. Frank’s bill, even after it was watered down to meet every request of the blue dogs, barely made it out of the House. Not a single Republican voted for it.

When it came to regulating derivatives, an issue that should worry you if you followed the FCIC hearings as every person thought it was necessary, only one Republican voted to get it out of committee. One! For what is one of the most important pieces that needs to move. Will the Senate be any easier?! No. Are there any Republicans in front of this bill championing it on? None that I can see, and after the Brown win I expect them to hold the ball more tightly, and double down on rhetoric of the evil CRA and the moral hazard of having FDIC-insured checking accounts.

The smart move is not to turn financial reform into a compromised, counterproductive mess just so it too can be killed last minute, but make a principled stand for what real reform would look like, a marker for those who are with reform, and go from there.

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5 Responses to A little more on 21st Century Glass-Steagall

  1. Sandrew says:

    Wait. Who’s invoked moral hazard vis-a-vis FDIC deposit insurance? I mean, OK, it’s true (insofar as moral hazard and any form of insurance are inseparable). But nobody’s seriously attacking the FDIC, are they?

  2. Pingback: Weekend Reading/Viewing Laundry List (10/22/10) « Chasing Fat Tails

  3. clarence swinney says:

    1981 turned S&L to WaLl Street
    Corporations- Jobs lost

    1999–Turn local bank deposits to Wall Street Gamblers

    Freak Market went Freaking Wild.

    Krugman-Phillips-Stiglitz screamed screamed–looked like fools to gamblers

    Coke Head Kudlow – Oh! Free Market They know best
    Steve Fiorbes –Do not rock our boat.
    Neil Kapuko–Let us roll we know bestl




  4. clarence swinney says:

    GDP–rose from 6300 to 11,600
    NATIONAL INCOME-5,000 to 8,000 Billion–took 20 years to grow 2500B before Clinton
    JOBS CREATED–over 22 million–record by far
    AVERAGE WEEKLY HOURS WORKED–never hit 35.0–hit that  mark 4 times in 80’s
    UNEMPLOYMENT–from 7.2% down down down to 3.9%
    WELFARE TO WORK—11,533,710 on federal roll in 1996 and 3,880,321 in 2007.
    MINIMUM WAGE–$4.25 to $5.15
    MINORITIES–did exceedingly well
    HOME OWNERSHIP–hit all time high
    DEFICIT–290 Billion to whoopee a SURPLUS
    DEBT—-+28%—300% increase over prior12 years
    FEDERAL SPENDING–+28%—80% under Reagan- who da true conservative?
    DOW JONES AVERAGE–3,500 to 11,800  all it’s history to get to 3500 and Clinton zooms it
    NASDAQ–700 to 5,000—all of it’s history to get to 700 and Clinton zooms it
    VALUES INDEXES– almost all bad went down–good went up in zoom zoom zoom
    FOREIGN AFFAIRS–Peace on Earth good will toward each other—Mark of a true Christian–what has Bush done to Peace on Earth?
    POPULARITY—highest poll ratings  in history during peacetime in  AFRICA, ASIA AND EUROPE even 98.5% in Moscow–left office with highest gallup rating since it was started in 1920’s.
    STAND UP FOR JUSTICE–evil conservatives spent $110,000,000 on hearings and investigations and caught— ONE— very evil man who took a few plane rides to events.
    BOW YOUR HEADS–Thank you God for sending us a man of Bill Clinton’s character, intelligence, knowledge of governance, ability to face up to crises without whimpering and a great leader of the world.

  5. clarence swinney says:




    Love to Spend & Borrow
    Hate to pay your way
    Praise two presidents who, over 12 years, had an average GDP growth of 2.6%.
    Love gutless Marine and Admiral who pled the Fifth to avoid conviction for crimes.
    Love 137 who were charged with crimes over 8 years of plunder the treasury.


    # 1–Debt Creation—equivalent of 600 years worth in 12 years.
    # 1–Deficit Creation—400 years worth in 8 years
    # 1–Lowest GDP Growth, over a 12 years period, since WWII.
    # 1–In number of times (258) a President and Admiral testified under oath “I don’t remember”.
    # 1–Bank Failures—President smiling and chanting “No Pain –No Gain”.
    # 1–Personal Bankruptcies -President smiling and chanting “No Pain-No Gain”
    # 1–Business Bankruptcies-President smiling and chanting “No Pain-No Gain”
    # 1–Farm Foreclosures
    # 1–Looting of S & Ls after a President said –“Folks, I think we just hit the jackpot.” The Vaults are unguarded come and get it. They did. 140 Billion charge to taxpayers.
    # 1–Total bankruptcies
    # 1–Stagnating median incomes
    # 1–60% Tax Cut to Rich
    # 1–In having a President with Alzheimer’s. No pain-No gain.
    # 1–In having a President who was Produced-Directed-and Protected like a Grade B actor in a Role.
    # 1–In having a President who lied, over and over, about his wife’s age. Who cared?
    # 1–In having the first President to have had a Shotgun Wedding.
    # 1—In having a President who shacked up with love of his life while his wife was in the hospital delivering their child.
    # 1–To have a President who lied about having a close-knit family.
    # 1–To have a President guided in his decisions by the Stars
    # 1–In having a President who preached religious values but never had membership in a church and rarely attended worship services and was never known to pray
    # 1–In having a President who called a lying, stealing, wife abusing psychotic Marine a “Hero” then a “Liar”.
    # 1–In having a President who rarely used the word “ethics” during 16 years in Government.
    # 1–In losing 241 Marines from a stupid decision to shell civilian villages.
    # 1–In claiming a “Great Victory” after an attack on a small Island with 88,000 inhabitants armed with .22 rifles and pea shooters.
    # 1–In claiming as a “Great Victory” and proclaiming “we have finally killed the Vietnam Syndrome” and “America Stands Tall Again”. What would he have said had we conquered Haw River N C. Greatest victory since WWII?
    # 1–In pushing a “disinformation campaign” against a very small nation then bombing that nation which resulted in a revenge bombing of Pan Am 103 killing 270 Civilians.

    Then, bragging how he had “defeated Terrorism”. Till Bush resurrected it.

    # 1–In shooting down an airliner and killing 290 civilians. OOPS! Goof. Sorry Iran.
    # 1–In having a 20% Prime Interest Rate smiling and proclaiming “No Pain-No Gain”.
    # 1–In having the highest “real” Interest Rates since WWII.
    # 1–In having 15% Home Loan Interest Rates and smiling-No Pain-No Gain.
    # 1–in having 16% college loan interest rate
    # 1–In killing the Home Construction Business by allowing Raids on S & L’s to use money for golf course, resorts, business building etc. where in the past the primary purpose was to build homes in local communities.
    # 1–In having 10.8 % unemployment while smiling. No Pain-No Gain. Highest rate since great depression.
    # 1–In having a recession in one-third of twelve years.
    # 1—In scandals. Every Major Scandal in 20th Century was on a Republican Administration unless you want to call ML major.


    You don’t like children (screw them they don’t vote)
    You don’t like the poor (screw them they don’t vote)
    You don’t like the elderly (screw them they are unproductive and wasteful)
    You don’t like the infirmed elderly (screw then they don’t vote)
    You don’t like students ( keep them stupid so they will vote Republican)
    You hate unions
    You don’t like minorities ( screw them not enough vote)
    You don’t like legal immigrants ( screw them they don’t vote)
    You love profiteering from public service
    You love the very wealthy and cannot do enough for them
    You worship big business
    You love to tear down years of Progress and smile as you slash and burn yelling “No Pain-No gain”.
    You love, with a passion, the opportunity to transfer wealth from hard working middle class to those who will never spend their wealth but just keep yelling ”More-More-More-give us more and we will never be satisfied until we are like Haiti where 5% own 95 % of the wealth.
    You love to use the whip of punishment instead of the effort to change and save from sin.
    You love the threat of War which allows you the opportunity to send more wealth to big corporations and the rich
    67% poll to Torture—Great Christians?
    You like, admire, and almost worship that which 75% of Americans detest as mean and cruel–Your God-Newtnut
    You love all types of killing guns
    You love executions
    You love to steal elections
    You were against WWII Draft
    You hate Medicare (but love to use it)
    You hate Social Security (but love to get it)
    You hate Medicaid
    You love world’s largest rich man’s gambling casino-Wall Street
    You love to kill Mommie’s by denying abortion that will save her life

    Want a Deep Recession then take a chance with Republicans in total control for their history is that—ALL depressions—all “significant” recessions have been under a Republican Administration in the Twentieth Century.

    20 years of Conservatism—Reagan-Bush I-Bush II and we have been in a Recession in 7 of 20 years or in 35 percent of the years.

    —unbiased, impartial, objective political historian-old ugly- beautful inside-

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