Why Banks Will Continue To Blow Up

Although there were a multitude of factors involved in the banking collapse of 2008, many analysts believe that the repeal of Glass-Steagall was one of the major triggers.  No less an authority than Sandy Weill, former Citigroup CEO, joined the chorus of voices last week in calling for the reinstatement of the Glass-Steagall Act.

Would forcing banks to get out of the investment banking business and confine their business activity to “low risk” prosaic lending make banks any safer?  Writing in this week’s Barron’s, Randall Forsyth notes that none of the large financial institutions that failed in 2008 were due to the repeal of Glass-Steagall and cites Bear Stearns, Lehman Brothers, AIG, Fannie Mae and Freddie Mac as examples.

In addition, bank failures occurred regularly when banks were operating simply as banks, as witnessed by the collapse of Continental Illinois and the huge savings and loan meltdown of some two decades ago.  So can anything stop us from having another banking crisis?  Barron’s cites Edward Yardeni of Yardeni Research on why nothing has changed and what to do about it:

“The problem with banks is that they tend to blow up on a regular basis. That’s because bankers are playing with other people’s money (OPM). They consistently abuse the privilege and shirk their fiduciary responsibilities. Whenever they get into trouble, government regulators scramble to bail them out first and then scramble to regulate them more strictly. Without fail, the bankers respond to tougher rules by using some of the OPM to hire financial engineers and political lobbyists to figure out ways around the new regulations.

“In my opinion, banks are the Achilles’ heel of capitalism. They really do need to be regulated like utilities if their liabilities are either explicitly or implicitly guaranteed by the government, i.e., by taxpayers. Banks should be permitted to earn a very low utility-like stable return. Bankers should receive compensation in the middle of the pay scale for government employees, somewhere between the pay of a postal worker and the head of the FDIC. It should be the capital markets, hedge funds, and private-equity investors that provide credit to risky borrowers instead of the banks.”

Will anything change?  Don’t hold your breath.  Yardeni concludes that due to the powerful lobbyists employed by the banks along with generous campaign contributions, the too big to fail banks have nothing to fear.