August 25, 2007

Fed Bends Rules for Monopolistic Insiders

The bigger they are, the more monopolistic they are, and the more protection they get from the Federal Reserve. What's wrong with this picture in a competitive "free market" economy?

An August 24 article, "Fed bends rules to help two big banks" reports:
August 20 letters from the Fed to Citigroup and Bank of America state that the Fed... has agreed to exempt both banks from rules that effectively limit the amount of lending that their federally-insured banks can do with their brokerage affiliates.

The Glass-Steagall Act, following the 1929 stock market crash, separated investment and commercial banking. It's claimed that Glass-Steagall worked for many years, but then became "anachronistic" as the financial sector modernized. "Commercial banks watched their market share of U.S. financial assets erode from nearly 50% to less than 32%." "Mutual fund assets grew 24% a year while [commercial bank] deposit growth has averaged just 3.4%." These comparisons in a March 1998 article by Nicole Olmstead Coulter are true, but one has to ask if the "modernization" was all healthy in the first place.

Experience suggests that the so-called "modernization" of laws is actually the rigging of arcane rules with the intent of making profits for the sector funding the lobbyists making the "modernization" pitch, and campaign donations, to the US Congress.

Coulter continues, "Through securitization, investment banks have taken away some of banks' traditional markets." "Increasingly, consumers demanded higher yields on their investments." Which could be followed by, "regardless of any underlying fundamentals." Who doesn't want more return? But should we do so if it is predicted to create boom/bust cycles? One can argue that, while in some ways securitization is beneficial, the greed-driven market is designed to drive "securitization" to the brink, as we are now witnessing the effects of runaway morgtage securitization. Cow manure has legitimate value as fertilizer and soil enhancement. Imagine warehouses of bullshit bundled and used as collateral for bonds (it probably exists).

The larger point is, however, that huge commercial banks can become huger if allowed to enter the brokerage business. In 1987, banking laws (Section 20) were changed to allow commercial banks to have subsidiaries that could offer investment services. By 1997, banks had successfully lobbied Congress, and Clinton, to allow banks to underwrite up to 25% of the subsidiaries' revenues. This "essentially wip[ed] out barriers toward bank acquisition of investment banks and securities firms," according to Coulter.

The merger and acquistion flood gates opened. The consolidation reduced diversity in the market place. The big banks accumulated more influence over the market, until ... they began influence the market, and that by text book definition is monopolistic. To help mitigate this, a limit on funding is still supposed to exist between commercial and brokerage operations. But, today's fiscal crisis is so bad, the Fed just bent the rules, proving my point. They can't let the big ones fail, because they too strongly influence the market.

The little ones? Too bad; the market isn't rigged to help the little guys. It isn't really a free market, and we all know it. A growing question is, given that the market is rigged, why don't we rig it to generate broader benefits rather than to enrich a few?

Sources: article, "Fed bends rules to help two big banks", August 24, 2007.

Registered Rep, "Bank/Brokerage Marriages," Nicole Olmstead Coulter, March 1, 1998,


Dusty said...

Its craptastic isn't it?

Meanwhile people are losing their homes in record numbers not seen since the depression.

GDAEman said...

Thanks for the note dusty.

Yes, loosing their homes. And a friend says that about 30,000 in the lending industry have lost their jobs, with more to come (I personally know of two).

I was in N. Virginia a few years ago, witnessing the sprawling McMansions and wondering how people could afford them. We were visiting a family friend, whose daughter worked in the real estate industry. She said that most were financed with risky loans; also, many of the people would default if the home prices didn't increase enough to allow them to refinance. People in the industry knew this was coming, but milked it for all it was worth.

On that note, the NY Times piece on CountryWide is a Must Read.