BEING TOO BIG TO FAIL IS OKAY AFTER ALL? June 12, 2009

BEING STREET SMART

Sy Harding

BEING TOO BIG TO FAIL IS OKAY AFTER ALL? June 12, 2009.

Government officials, regulators, and Congress told us what we already knew, that one of the biggest contributors to the financial crisis was that in the wild merger and acquisition binge of the 1990s some major financial firms had become “too big to fail”, too intertwined with each other to fail. They had to be bailed out or the collapse of one or two could collapse the entire financial system.

Of course what they didn’t say is that they, government officials, regulators, and Congress, made most of it possible, when in 1999 they rescinded the Glass-Steagall Act of 1933.

Investigations after the 1929 stock market crash had revealed widespread conflicts of interest and outright fraud in the activities of numerous banks that had also become involved in investment banking and brokerage activities. By 1933 a large portion of the commercial banking system had collapsed, and the Great Depression was underway.

As one of several actions taken to help prevent it from ever happening again the Glass-Steagall Act was passed, which separated commercial banking, investment banking, and brokerage activities, setting up substantial barriers between them. Savings banks could take in deposits from the public and make home mortgage loans. Commercial banks could take in deposits from corporations and make commercial loans. Investment banks could raise capital for businesses by taking them public, arrange mergers and acquisitions and so forth. Brokerage firms could provide a market for stocks and engage in brokering and investing in them.

It worked quite well for 70 years.

In the strong economy of the 1990’s banks of all types, and brokerage firms, grew larger within their own areas through mergers and acquisitions of competitors, the larger gobbling up the smaller, which was dangerous enough in concentrating financial strength in fewer and fewer but larger and larger hands.

Commercial banks then began peering over the barriers and saw the huge profits being made by investment banks and brokerage firms in the soaring stock market of the 1990’s. The investment banks and brokerage firms peered over and were enticed by the prospects they could see on the banking side, particularly in home mortgages.

And by spending humongous amounts of money lobbying regulators and Congress they managed to have the walls come down, when Congress repealed the barrier portion of the Glass-Steagall Act in November, 1999.

That opened the doors to financial firms being able to get into each other’s businesses (as had been the situation leading up to the 1929 crash), and they plunged headlong into doing so. Commercial banks established or acquired stock brokerage services, launched mutual funds and money-management services. Brokerage firms began offering banking services and mortgages. Commercial banks, investment banks, and brokerage firms all plunged into derivatives activity, excited particularly about the potential profits from packaging and marketing mortgage derivatives to institutional investors, even forming hedge funds of their own to invest in them.

Well, we know what happened when it collapsed last year. It came very close to a repeat of the collapse of the banking system in 1933 and the Great Depression.

So Congress and the regulators are saying – whoops! – let’s investigate and find out how that happened, who it should be blamed on, and what we can promise as assurance it won’t happen again.

We aren’t hearing anything at all about re-installing Glass-Steagall type barriers.

However, we are hearing promises about how the financial industry will be closely regulated and supervised so this ‘too big to fail’ stuff won’t happen again.

Yet, as part of the panicked rescue efforts, in various weekend meetings between regulators and major financial firms, Bank of America was encouraged to buy troubled Countrywide Financial (itself the 2nd largest mortgage provider in the country). A few months later Bank of America was encouraged, perhaps even forced, to buy Merrill Lynch. Wells Fargo was encouraged to buy troubled Wachovia Bank. JP Morgan was assisted in its purchase of Washington Mutual. The list goes on and on.

The too big to fail have been made even larger as part of the solution?

This week it was announced that BlackRock, the 4th largest money-management firm in the world, with $1.3 trillion of investor assets under management, will acquire Barclay Global Investors, the largest money-management firm in the world, from troubled British bank, Barclay’s.

The deal more than doubles the size of BlackRock, making it not only the world’s largest money-management firm (with $2.7 trillion under management), but double that of the second largest (State Street Global Advisors).

Wall Street analysts can’t seem to praise the deal enough because BlackRock is one of the few asset-managers that have remained relatively stable through the bear market, and the acquisition will provide needed capital to Barclay’s Bank.

That’s okay for now. But all the major financial institutions were strong and stable in the late 1990s and early 2000’s too, when they were allowed to make the many big acquisitions that made them too big to fail.

Are acquisitions like the BlackRock deal, merging two of the largest money-management firms in the world, not something that should have to meet the new supervision of the financial industry in the efforts to fix the too big to fail dangers of the past? Does the vision of $2.7 trillion of investor assets being managed by one firm not make Congress and the regulators a tad nervous?

Just what are the reforms and oversight we are being assured will prevent the financial industry from bringing devastation down on the nation again at some now unexpected, but inevitable troubled time down the road?

Looks like more of the same old same old to me.

Sy Harding publishes the financial website www.StreetSmartReport.com and a free daily market blog at www.SyHardingblog.com.