Banking Surgery or Amputation?

January 22, 2010 at 1:30 am 2 comments

Photo Source: (c)iStockphoto.com Artist: Powerofforever

Deciding whether to sever the proprietary trading arms of the commercial banks, rather than instituting regulation, seems a lot like deciding whether amputation is a healthier path for those suffering terrible frostbite cases. Even if this legislation is unlikely to pass, I find the recommendations severe in relation to other measured alternatives. I’m no right-wing conspiracy theorist, but I don’t think the timing of the Obama administration’s announcement is coincidental. Why is this proposal surfacing two years into the financial crisis and a whole year after the President entered office?

Politicians have always been masterful at introducing coincidental distractions at opportune times, in order to generate patriotic voter sympathies. Some examples include, Margaret Thatcher in the Falkand Islands; George Bush #41 in the Iraqi war; and President Obama’s current ant-banker populist brigade. Perhaps miserable and declining approval ratings and a healthcare bill on the verge of collapse may have something to do with the timing? I want President Obama to succeed, and he may have good intentions, but let’s not rush to an overzealous knee-jerk reactions before other less-draconian solutions are thoroughly explored.

Glass-Steagall Redux

Theoretically, the argument of forcing banks to adopt lower risk sounds great on paper. Overall, I think this initiative is a worthy one Americans could buy into. As a matter of fact, investment guru Jeremy Grantham makes the same argument in my Investing Caffeine article (“Too Big to Sink). However, I think a more relevant question is, “How do we implement more responsible risk taking by the banks, without a massive overhaul to the system?” Certainly there were some regulators asleep at the switch, and some financial institutions that pushed the envelope on risk assumption, but I’m not convinced a return to Glass-Steagall (or Glass-Steagall Lite) is going to bring miracles. If the regulators cannot adequately curb risk taking by the banks, then cross the more dangerous bridge later. The economy is presently in the midst of a fragile recovery and we do not want to change the airplane engine during mid-flight.

Political Pendulum Swings

This isn’t the first time Washington has reversed previous decisions. If the cries of voters reach a feverish pitch, and these wishes coincide with a politician’s re-election agenda, then the probabilities of sub-optimal, rushed legislation increases. Consider AT&T (T), which because of antitrust concerns was forced to split operations in 1982. Lo and behold, some twenty years later, we witnessed the re-consolidation of the “Baby Bells” back into AT&T. Now, Glass-Steagall is the topic of conversation and with an unambiguous scapegoat needed by politicians, Washington is targeting the banks with taxes and operations splitting.

Hasty legislation is nothing new with the populist flames fanning in the background. Sarbanes-Oxley is another example of less-than-ideal legislation introduced in the wake of  relatively low number of corporate scandals, such as Enron, WorldCom, and Tyco (TYC).

Regulation Reform Solution

Here are 3 constructive steps:

1)      Institute transparent trading of derivatives (i.e., Credit default Swaps) over exchanges with adequately capitalized clearing houses.

2)      Require higher capital requirements for banks conducting proprietary trading and mandate adequate disclosure.

3)      Consolidation of regulators, thereby creating a more simplified, accountable structure (see also Regulatory Web article). Savings from redundant costs could be used to hire additional regulatory oversight staff.

Blood is in the streets and with mid-term elections just around the corner, the Obama administration is looking to salvage anything they can bring back to the voters. Frost bite (and greedy bankers) is a painful and horrible predicament, however if healthy functioning limbs can be saved with targeted surgery rather than amputation, then I vote for this solution.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds (including VFH), and at the time of publishing had no direct positions in T, TYC. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

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