I've worked through the Glass-Steagal and post-Glass-Steagal eras. I agree in part with some of what you say Dino, not least because nothing has changed on Wall Street since the bail out. With the recovery in bond and equity markets the investment banks are carrying on where they left off - well sort of. I don't buy some of your suggestions though, particularly the idea of state control. I don't have time right now but I'll reply in detail. In the meatime can you clarify what you mean by functions defined as "systemically-critical".

By the way I think this does deserve it's own thread.

Dino, your point about Glass Steagal is a natural one to ask. I could write a long essay about it but this isn’t the place. And a short post won’t do it justice. Upshot of it is I don’t think we’ll go back to Glass Steagal for a number of reasons but chiefly:
1. Investment banks need access to capital
2. The Germans, the French and the Swiss who never had a Glass Steagal equivalent are unlikely to embrace it as necessary. Any country that went it alone would be forcing it's financial institutions to compete on a playing field that wasn't level.

Fact is the Glass Steagal separation of commercial, deposit taking banks from investment banks was being circumvented for years before it was finally abolished. And there were a number of reasons for that. Traditional Investment banking is all about bringing together providers and users of capital. From the 1930s through to 1970 the world was a smaller place. Investment banks were private partnership boutiques and the only capital they put at risk was the partner’s own capital. That was enough because the deals were small. Even in the 1970s, a bond or equity issue of a couple of hundred million dollars was a big one so the partner’s capital was enough if the deal was sub underwritten.

In the 1970s and 1980s the world globalised and deals became much, much bigger. So investment banks needed access to capital pools much bigger than the pool the partners could provide on their own. US investment banks solved this by “going public” ie converting from private partnerships to public companies so they could increase capital by issuing shares to the public. Accessing bigger capital pools were also important for competitive reasons because the playing field wasn’t level - the German, Swiss and French “Universal” banks didn’t have a Glass Steagal equivalent and their investment banking arms were able to draw on the capital base of their Deposit taking arms.

Today you can see bond and equity placements of 2 to 5 billion dollars. That size and the advent of bought deals where one bank assumes the whole risk takes a lot of capital to underwrite and a global placing power so size matters. We’re never going back to the world of the 1930’s or even 1970s, again not least because the Germans, the French and the Swiss won’t see it as necessary.

In any case I don’t think it’s necessary for banks to wholesale amputate their investment banking arms. What matters so much isn’t the bank’s size but what it does. The underwriting of bond and equity securities and M&A are all vanilla in terms of risk or leverage and aren’t going to lead to a systemic collapse of the banking system. Size of these activities could be constrained by proper capital, leverage and liquidity requirements and more stringent treatment of off balance sheet positions which are often used to warehouse illiquid securities. And when I say capital requirements I mean proper capital requirements. One Investment banking CEO was on TV yesterday saying his investment bank was wrong to count as capital, assets deposited with them by their hedge fund clients - assets which could be withdrawn and transferred to another bank overnight. He’s right. - that caused a huge liquidity crisis for his shop.

What I could see is justification for some separation along the lines of client facilitation businesses vs prop trading. There are too many conflicts of interest here which lip service to chinese walls doesn’t really address. This might involve hiving off the more speculative and risky prop. trading activities into separate hedge fund type vehicles so that depositors and shareholders of deposit taking banks (and certainly taxpayers) are ring fenced from losses from these activities. And hedge funds aren’t currently regulated. These should be so that any individual hedge fund’s size is also constrained by capital and liquidity requirements so these could be allowed to fail.

I think State control in any way would be a bad idea.

The question of bonuses is another issue altogether. Banking is at it’s heart a risk business. Even consumer banking. Don’t forget the credit crisis has it’s roots with poor mortgage lending discipline by deposit-taking banks. Not the Investment banks. Suffice to say the bonus system needs changing it’s only one cog in the wheel. Proper board oversight, proper regulation and effective internal checks and balances are more important. As is having effective risk management. You can't manage risk unless you know what it is. That's not primarily a systems issue. It's a people issue. I could write an essay on that too.

The investment banks had the brilliant idea to package and gift wrap the sub-prime mortgages. The package. carrying a "good housekeeping" approval from the rating agencies, became immensely popular. The investment banks then encouraged the mortgage lenders to bring more sub-primes for repackaging.

So there was a whole chain of "players". The investment banks had the best brains and insights to be aware of this fragile pyramid. That is why most people blame the investment banks. And when the pyramid crumbled, the taxpayer had to bail out the investment banks.

Goldtop, I don't mean to downplay the role investment banks played in the downward spiral, or defend them. My comment was more pointed to the fact that you can't isolate depositors from risk and all banking activities involve some risk. Freddie and Fannie also had to bailed out by the taxpayer, as did AIG. And they weren't investment banks. Neither was Northern Rock. It needed to be bailed out too - not because it invested in toxic assets but because it relied wholly on the wholesale funding market. The taxpayer will probably get it's money back from the investment banks - and probably at a profit. Not sure the same can be said of Freddie, Fannie and AIG. And going back to Dino's point on State control - the fact that Freddie and Fannie were state sponsored didn't save them from their fate.

I am recommending state control of activities that are being defined (not my words, the US govt's) as "systemically critical" - i.e. the rest of the financial system would collapse without them.

of course printing banknotes, setting interest rates and capital ratios are systemically critical tasks and will always be under state control. I am sure there are many more. What i am not clear on is what services currently provided by profit-making companies could truly be systemically critical.

For example, the US claimed AIG had to be rescued because it is systemically critical. Of course there is nothing critical about life and auto and home insurance. If AIG went under, a new buyer would service those policies.

What I believe they saw as systemically critical was the fact that AIG had sold hundreds of billion dollars worth of protection on other companies' debt (the infamous CDSs), to large investors - mostly investment banks. If AIG went under, every investment bak on earth would have simultaneously faced the choice of either raising more capital or dumping the insured debt. And that would have led to disaster, no doubt.

The solution here is not state control, but realizing that CDS is really insurance, and not a financial product. The financial solutions group at AIG was not regulated as an insurance co.

So i am not recommending more state intervention. I am firmly for the state getting out of markets. But if there are functions that are indeed systemically critical, then by definition, you cannot have a profit making co control them. Simple examples, not from the financial world, would be the police and the army, immigration, foreign policy.

So if there is something systemically critical, isolate that, have the state exercise control over it, and let the free market take the rest.

I hope that explains that ...

Well strictly speaking the setting of interest rates isn't necessarily under state control - the UK is a prime example. The Bank of England is supposed to free of state control at least in the setting of interest rates.

I don't know what the US govt. means, especially in relation to this crisis which whatever the cause, was first and foremost a liquidity crisis - the usual providers of liquidity - the banks - stopped lending.. period. The answer to this isn't to operate all lending institutions under state control. In any event a mechanism for this systemically critical function - a lender of last resort - already existed in the form of the central banks ie the Fed, the SNB, the BofE etc.

What Obama has been talking about is bringing responsibility for regulatory oversight of systemic risk under state control. That's not systemically critical banking functions. Just the job of regulating those functions. I think maybe that's what you picked up on. I'm a seller of that. Just about every central bank I can think of singularly failed to prevent this crisis. Their track record sucks.

UBS is re-branding in the US. PB will again be under the Paine Webber banner. A preliminary to sale?

I don't know ..... is the Pope Catholic?

I do not think that simply passing new laws will fix it.
How will the laws be enforced & by whom?
what will be the punishment of not complying?
& which group or body will check compliance?

I do not see a local policeman knocking, for example, on the door of the UBS president & issuing a fine.

Who will care? Everybody assumes the worst will not happen, if it does the top managers will bail with handsome rewards, the investment bankers will move to other banks with handsome sign on bonuses & leave the shareholders with a bunch of worthless paper.

Bit off topic but a big part of police & army activities are already outsourced to profit making companies, examples are security firms, mercenary companies (look at Iraq), the so called safety partnerships in UK that run speed checking radars, etc.

Go to the Cayman Islands & live like a king?
"Barclays has unveiled a plan to sell more than $12bn of risky credit assets to a company it has created to try to reduce the risk of further writedowns.
Protium Finance, a partnership of so-far undisclosed investors , will buy the securities using a $12.6bn loan extended by the bank. Protium will be managed by Stephen King, the head of mortgage trading at Barclays, and Michael Keeley, a member of the Barclay’s Capital management committee.
Mr King and Mr Keeley are to leave their positions at the bank."

That was exactly the reason that the US government had to rescue AIG.

OK;

What is wrong with Deposit Taking banks also being Investment banks?

I would actually consider that the government should not even guarantee depositor's money. Why should they?

Well if Governments do not guarantee depositor's money then the risk is that they do not use banks and consequently the money system dries up?

I gather that is to make the assets on the Barclays balance sheet look more safe as Protium Finance will be seen to be a safe debtor as opposed to putting a provision in the accounts for the likely bad debts on the securities.

I think that there are a whole lot more bad debts to come from all the banks that have not been provided/provisioned on the accounts of the banks such as credit cards, small personal loans and small business loans etc etc.
It is not in the interest of the banks to release this information to shareholders but especially the government because the Capital Ratio would be screwed up for the banks. The Government doesn't want to know either because the markets would be effected.
If all the possible bad debts had been revealed by the banks (and I think the banks were aware), the UK government would have nationalised the banks. It is too late now, they are committed.

__________________
I do not have friends..........I have contingent liabilities

I don't agree. People need to use banks.

However, people would spread their monies into more banks to avoid the risk and hence this would create more banks and therefore more competition and more safety and even less reason for a government to guarantee deposits.
The banks would have to be more careful and take less risks because the media would be publishing capital ratios. Depositors would be moving their monies to other banks if figures looked dodgy.

Why would the money system dry up.
People would have to deposit their savings or put them into some kind of investment.

__________________
I do not have friends..........I have contingent liabilities

I think that "under the bed" would become popular again.

sorry but that is a bit of a juvenile response...

if you think passing laws does no good cause there is no possibility of enforcement, them we might as well grab our tins of baked beans and rush for the nearest cave, no..??

the financial crisis did not result from lawlessness, but from the fact that there were (and still are) no laws to prevent the sort of behaviour that recklessly endangered the global financial system.

indeed, the one force that shapes corporate (and individual) behavior in the US is the threat of a lawsuit. 'Who will enforce the law' may be a valid question in Venezuela, or Iran, or Russia... but in much of the civilized world, that is not a reason to not pass legislation.

I'm talking about CONTROL. You're worrying about who RUNs the operation.

Obviously it makes sense to outsource large chunks of 'systemically critical' activities to profit-making enterprises - they simply do it better.

What the state must do is retain CONTROL.

do you have any examples of profit making companies CONTROLLING the police or army function of a state? or foreign policy? or currency issuance? ...

Last year I said let the banks fail. My sister said that such an idiot statement is like nero watching Rome burn. However, I still think that they should let the banks fail, only then it seems, will the they get the message that they are failing the majority that underpin society.

http://www.huffingtonpost.com/ariann..._b_293407.html

Where are the financial laws and rules to protect the middle class?

Like Arianna Huffington says it's like trying to put Humpty Dumpty together again.