The Glass Steagall Act

[GqArtguy]

This clip follows a little bit about the history of this bill, its repeal, and the subsequent effect:

http://www.youtube.com/user/TheYoung.../0/vky9cz3Usls

[OldGuy]

Interesting video. I'm currently reading Ron Paul's End the Fed and was wondering what your feelings are on his idea to go back to the gold standard as a monetary policy (not looking for a thesis, just some thoughts. I'm not well versed on the topic. Yet).

[GqArtguy]

Originally Posted by OldGuy

Interesting video. I'm currently reading Ron Paul's End the Fed and was wondering what your feelings are on his idea to go back to the gold standard as a monetary policy (not looking for a thesis, just some thoughts. I'm not well versed on the topic. Yet).

I think there is a viable process towards competitive currencies and research that supports improving outcomes over our current system. It would certainly keep government spending in a greater check. The issue is that you have to cut off existing political routes that currently get in the way (i.e. lobbying, having the fed run by the banks, allowing the government to bail out companies, etc.) and many of the shocks under commodity standards were caused by speculation in those markets (usually gold or silver markets). The government also needs to follow Adam Smith and go after monopolies and instances of market failure.

Back in the day, trading was much slower (and most economic models assumed that capital couldnt move quickly) so there were adjustment periods, but with instant capital flight, speculation is an issue that needs to be seriously dealt with. Some countries explicitly prevent capital flight (i.e. Malaysia) so that you dont crumble the economy in a few minutes. Additionally, customers need to be informed otherwise you have issues of power where people can exploit markets (such as insider trading, and we have seen the 'talent' of such traders).

So in short, its a nice idea and it can work. I see more government involvement than most Austrians do to address the political economy realities that stand in the way. Im not very convinced that those would be addressed given that the government cant follow Keynes' note that deficits have to be temporary and that surpluses should be run in non-crisis years.

[OldGuy]

Thanks for that. It's an interesting book and topic that I really need to do more reading about.

[kuri]

Good episode of Democracy Now yesterday on the Glass Seagall act, deregulation, and how that played out.

[Lou Schuler]

Manuel, thanks. Interesting stuff.

[RobLL]

Would some micro-taxes on transactions slow some of this stuff down without unacceptable bad consequences? IIRC daily trading exceeds the value of everything that the market values in some very short period.

[GqArtguy]

Originally Posted by RobLL

Would some micro-taxes on transactions slow some of this stuff down without unacceptable bad consequences? IIRC daily trading exceeds the value of everything that the market values in some very short period.

Im not sure if trades are already taxed or if only the capital gains/profits are taxed. If they are, well then we can see that theyre not effective. If trades are not taxed, then a per-unit tax could decrease the amount of them since the price of trades goes up (assuming that trading is competitive) but that gets passed on to the consumer, not the firm. As technology improves the speed of trades, theres more profit to be had, so more people are willing to pay the tax. Thus you will still end up in a similar spot.

What would probably be more effective is to cap the speed of trades so that a certain amount of time elapses before buying and selling. Then taxing can be more effective in reducing the amount of trades. The problem is that legislation can only be so broad, so if you cant trade in derivatives or whatever, they can make some other sort of financial junk that creates no value but is speculative and outside the purview of rules. So transparency is needed in what is being traded so that a regulatory body can reject speculative instruments that create no value. Either that, or limit the size/risk of such firms so that they dont take everyone else with them when they fail.

[RobLL]

So far as I know, no taxes on transaction (dividends, capital gains another matter), but your point on difficulty of even in "finding what is being traded...) is likely.

[Lou Schuler]

Manuel, I appreciate what you said, but it seems to me that the value of a tax would be to give the U.S. Treasury something back for the mess created by out of control trading of no-value-added investment instruments.

It's like excise taxes on liquor and cigarettes -- in part, the goal of those taxes is to pay for the mess created by alcohol and tobacco.

It acknowledges that there's a demand for rapid trading of stocks and bonds, but it helps the taxpayer get something back.

[eastcoastsurfer]

Basically what GQ said. What is really needed is transparency to what's being traded. Mark to market accounting was a proxy to try to fix this issue, but the unintended consequences made it a poor solution. The other side of the spectrum are things like banks telling us what they 'think' their assets are worth. Instead, what needs to happen is that their assets are fully transparent to everyone and each individual can value them as they see fit.

Adding taxes to transactions is a bad idea. You'll skew the value of a said investment (artificially keep it higher). People may hold on to losers to avoid paying the transaction tax. You then end up with capital trapped in losing investments and thus less available for new promising investments.

Slowing down transactions is also not something I would agree with. The stock market is supposed to be a liquid environment. The US stock markets in general are the most liquid investment environments in the world. People like liquidity and this liquidity helps to get prices to their proper level faster than anything else. Again, you also don't want to artificially trap capital in losing investments.

I understand the hate and blaming of speculation, but speculation is not the problem as much as people not getting punished financially for speculating incorrectly. The government has removed so much risk for the large players (see GS) that of course they are going to speculate. Put the risk back in and you will see speculation get curbed or at least end sooner than it has in the recent past.

[GqArtguy]

Originally Posted by eastcoastsurfer

Slowing down transactions is also not something I would agree with. The stock market is supposed to be a liquid environment. The US stock markets in general are the most liquid investment environments in the world. People like liquidity and this liquidity helps to get prices to their proper level faster than anything else. Again, you also don't want to artificially trap capital in losing investments.

Im talking about the type of trading where someone has an algorithm that buys faster than anyone else only to turn around and sell it, only to make profits off the trading fees. I cant remember if it was you or NFL that posted the paper on that. But that kind of crap needs to go.

I understand the hate and blaming of speculation, but speculation is not the problem as much as people not getting punished financially for speculating incorrectly. The government has removed so much risk for the large players (see GS) that of course they are going to speculate. Put the risk back in and you will see speculation get curbed or at least end sooner than it has in the recent past.

Yes, but I think there do need to be limits on agglomeration and too much interconnectedness. Back in the pre-1930s, we definitely had speculative bubbles even though there were no bailouts and lots of consumers got screwed in the process due to company speculation. Strong consumer protection have shielded some of these effects (such as bank runs), transparency and long term performance pay would help, Id support greater voice of shareholders to balance the CEO and boards, but youre still going to have idiots speculating especially as they make 'innovative' financial instruments. Trapping capital is exactly how some export-oriented companies survive crises. Malaysia is a good example of this. You can buy in but they make it hard to pull out so that you dont crash their economy in seconds.

I know there are more details in finance that would help. Ill let NFL or TomK elaborate more on those.

[TomK]

The original video clip was amusing. The repeal of the Glass Steagall rules on Bank Combinations was not a primary contributor to the economic or financial crisis. Nor, did this legislation create “moral hazard.”

In the TYT clip, the point is missed that the “moral hazard” is created by the existence of FDIC insurance for Depositors. Combining FDIC Banks with Investment Banks expanded balance sheets and created economies of scale; the combination didn’t create “moral hazard.”

The clip also fundamentally misses the point about derivatives trading, which many on this forum characterize as “betting” or non substantive activity. The proposed rules, some of which call for registration and supervision of all derivatives are amazing. If imposed, my predication is that the second and third order effects will be to completely displace individuals and small firms from the market – effectively giving the largest money center banks a lucrative cartel capturing the economic rent (profits).

Some additional thoughts:
1. Big banks are essential for US competitiveness. At the same time, the size of our largest banks has been effectively capped by the crisis. No State or Federal regulator is going to approve a bank merger creating a large institution.
2. Many more derivative trades could be standardized and disclosed. The government could create a small business program to guarantee their access to these markets at fair capital levels.
3. Any limitations on capital – movement or transaction speed – will only serve to move the liquidity away from the US market to the market of least regulation. Without a global agreement, you are simply pissing in the wind.

[GqArtguy]

The original video clip was amusing. The repeal of the Glass Steagall rules on Bank Combinations was not a primary contributor to the economic or financial crisis. Nor, did this legislation create “moral hazard.”

I agree with this. There is collective responsibility on banks, government, the Fed, etc.

In the TYT clip, the point is missed that the “moral hazard” is created by the existence of FDIC insurance for Depositors. Combining FDIC Banks with Investment Banks expanded balance sheets and created economies of scale; the combination didn’t create “moral hazard.”

How do you figure? Without that, we would have had massive bank runs.

The clip also fundamentally misses the point about derivatives trading, which many on this forum characterize as “betting” or non substantive activity. The proposed rules, some of which call for registration and supervision of all derivatives are amazing. If imposed, my predication is that the second and third order effects will be to completely displace individuals and small firms from the market – effectively giving the largest money center banks a lucrative cartel capturing the economic rent (profits).

Whats your rationale for that prediction?

Some additional thoughts:
1. Big banks are essential for US competitiveness. At the same time, the size of our largest banks has been effectively capped by the crisis. No State or Federal regulator is going to approve a bank merger creating a large institution.

On an international basis, yes. But at local levels, I dont see why people would solely rely on a bank. In terms of interest rate, safety, convenience, and credit access, you can get those services elsewhere without being shafted by local branches of big banks.

2. Many more derivative trades could be standardized and disclosed. The government could create a small business program to guarantee their access to these markets at fair capital levels.

How would you standardize them? How would you determine 'fair' levels?

3. Any limitations on capital – movement or transaction speed – will only serve to move the liquidity away from the US market to the market of least regulation. Without a global agreement, you are simply pissing in the wind.

I disagree. We didnt lose investment volume or profitability in the long run after post-depression regulations. East Asia has way more regulations than we do, but they are not suffering from FDI.

[TomK]

Originally Posted by GqArtguy

I agree with this. There is collective responsibility on banks, government, the Fed, etc.

How do you figure? Without that, we would have had massive bank runs.

I have no issue with FDIC insurance. My point is that “moral hazard” - correctly defined is created by the FDIC. The solution is better application of the existing oversight regulations.

Originally Posted by GqArtguy

Whats your rationale for that prediction?

Most of the current recommendations call for moving all derivatives to cleared exchanges with standardized contracts. That works for large well capitalized firms able to post significant margin or collateral. Small firm and businesses will be forced out of the direct bilateral market. They will have to manage risk via contracts fronted by the biggest trade houses. Big guy wins, small guy losses.

Originally Posted by GqArtguy

On an international basis, yes. But at local levels, I dont see why people would solely rely on a bank. In terms of interest rate, safety, convenience, and credit access, you can get those services elsewhere without being shafted by local branches of big banks.

We already have a diverse system in the US. There are lots of State Chartered Banks as well as Credit Unions. We need big banks for our economic recovery and international competitive position. Bashing them for being big doesn’t help create jobs or encourage lending.

Originally Posted by GqArtguy

How would you standardize them? How would you determine 'fair' levels?

We could easily simplify the current crop of ISDA, EEI or NAESB contracts and apply them to other commodity situations. What is Fair? I don’t know, it will be a political compromise – something under $50 mm in equity?

Originally Posted by GqArtguy

I disagree. We didnt lose investment volume or profitability in the long run after post-depression regulations. East Asia has way more regulations than we do, but they are not suffering from FDI.

I agree about FDI. Although we now live in a different time I would argue. The Baht debacle had long term effects, the Argentine default – less so it turned out. Changing “trading” systems or flows will just drive them to another market – London today, Dubai in the near future. We don’t know what will happen – good or bad. We are just know discovering the true costs of SarBox.


How about that, a civil exchange on CE!

[eastcoastsurfer]

Originally Posted by TomK

I have no issue with FDIC insurance. My point is that “moral hazard” - correctly defined is created by the FDIC. The solution is better application of the existing oversight regulations.

I never thought of it that way, but it makes complete sense. Thanks!

Originally Posted by TomK

We already have a diverse system in the US. There are lots of State Chartered Banks as well as Credit Unions. We need big banks for our economic recovery and international competitive position. Bashing them for being big doesn’t help create jobs or encourage lending.

I agree! I currently have 4 financial institutions. A credit union (which btw, was completely fine through the whole 'crisis'), a big bank CC, an online bank, and a brokerage. There are lots of options out there other than the big banks.

Originally Posted by TomK

I agree about FDI. Although we now live in a different time I would argue. The Baht debacle had long term effects, the Argentine default – less so it turned out. Changing “trading” systems or flows will just drive them to another market – London today, Dubai in the near future. We don’t know what will happen – good or bad. We are just know discovering the true costs of SarBox.

Again, right on. Unintended consequences are everywhere in a system as complex as the world financial system. Restricting liquidity WILL drive the capital elsewhere. SarBox is a great example. I have a friend who used to be an auditor for one of the big 5 accounting firms. The money that even small public companies had to spend to be SBOX compliant was insane. Instead, many new and growing companies just remain private with the hopes of being purchased by a larger, already public company. In the end you have larger companies with less competition since a small company who needs capital doesn't want to take on the expense of SBOX and thus never reaches the level to compete with the big guys.

[OldGuy]

Ron Paul must be doing cartwheels.