A rather unusual plank made it into the platforms of both political parties this year. It’s a proposal to bring back Glass-Stegall.
That’s the Great Depression-era law that created a wall between banks. As a result, they could only operate in two categories. The first is traditional banking, with its savings and checking accounts, mortgages and business loans. The second is investment banking, where corporate clients are advised on mergers and acquisitions, the bank sets up an initial public offering for a company, and other activities like trading.
On paper, the law sounds like a good idea. Nobody likes the idea of a bank gambling with a depositor’s money. Everyone and their grandmother wants to know that their money is safe and available at a moment’s notice. If there’s palpable fear that that isn’t happening, it’s time to call up the FDIC and report a run on the bank. It’s believed that this legislation kept the banking sector from getting too big to fail for over 60 years.
That’s why Glass-Stegall has gotten good press, especially since the financial crisis in 2008. It seems like a reasonable, common-sense solution to avoiding another crisis. That analysis has usually come from Democrats like Massachusetts senator Elizabeth Warren.
So seeing this law in the Republican and Democrat party’s platform seems out of place. Yet it hits the right populist tones for Donald Trump’s anti-establishment campaign (it’s another proposed wall!). Hillary Clinton has been criticized by some on the left for her closeness to the big Wall Street banks, so calling for the restoration of this law placates the base.
In short, this is one proposal that could become reality under a bipartisan effort no matter who becomes president.
But what, if anything, did Glass-Stegall do? In the book FDR’s Folly by Jim Powell, the author shows that the law didn’t do much, if anything. By the time it was passed in the 1930’s, the worst of the market selloff and bank bankruptcy wave was over. Investment banks had access to capital not just nationally but internationally, so even with the law in place, the big banks were better off.
What the law might have done was made local bankers more dependent on local communities. In that case, the law made our financial system worse off. A local bank lending to a largely agricultural base had to deal with falling commodity prices and the complete loss of properties as a result of the Dust Bowl.
And separate laws at both the state and federal level the time typically kept banks within state lines. That means your family’s bank in Kansas could open as many branches as you want in Kansas, but not Kansas City, Missouri. Those geographical limitations kept banks from making diversified loans that could have avoided bankruptcy. These laws against interstate banks were loosened over time.
Glass-Stegall’s repeal in 1999, likewise, did nothing to stop the growing tech bubble. The investment banks were already profiting like gangbusters from taking companies public. It didn’t matter that many of those companies weren’t profitable and even on paper wouldn’t claim profitability for years, if ever. The public wanted them… and they got them.
While investors in tech stocks got burned, investment banks reaped billions in fees. And by that point, even without a banking law in place, the big banks had something even better.
In 1987, newly-minted Fed Chairman Alan Greenspan came out after the one-day, 22 percent crash, reminding the banks that the Fed was standing by to provide liquidity if it was needed.
That was the day the Greenspan Put came into creation. That’s the notion that stocks and other financial assets would never go down particularly far without a counter-move from America’s central bank. The Greenspan Put didn’t hold up well with the tech bubble. Nor did the Bernanke Put handle the financial crisis well. Here’s hoping we don’t see a Yellen Put.
What’s the problem with having a central bank on your side in the markets?
There’s an old saying: Capitalism without bankruptcy is like Christianity without hell. In other words, without fear of a dark and permanent downside, some people will act in outrageous, illegal, and immoral ways.
Rather than bring back the “firewall” between traditional banking and investment banking, a better strategy would be to wean the too big to fail banks off of government dependency.
If it takes a similar law like Glass-Stegall to make it happen, great. It might not actually make things safer, but the perception of safety is important to investors and depositors alike.
There’s probably no one clear solution to making the “too big to fail banks” impervious to failure. But that’s okay. Capitalism can provide the answers. Make the big banks accountable for their book of business and they’ll have the incentive of staying in business as a check on their greed. Some may want to increase reserves. Some may want to deleverage. Other solutions will emerge.
But until one of those banks goes through a crisis without government help, most won’t take the challenge seriously. Whether we get new legislation to build a wall between investment banking and traditional banking remains to be seen.
Whatever happens, however, the banking sector has shrunk from over 60,000 names in the 1950’s to under 5,000 today. Many are smaller banks with just a handful of branches, but even many of those are publicly-traded. Investors can continue to bet on these smaller names to merge with larger banks over time. With many names in the space, there are plenty of values here relative to S&P 500, which is still enjoying its post-Brexit mania.
For instance, subscribers of my Insider Hotline trading service picked up 23.75 percent returns earlier this year buying PacWest Bancorp (PACW), a mid-sized bank based out of Beverly Hills.
I expect similar returns in other smaller banks in the years ahead thanks to today’s solid valuations and their appeal as takeover targets. Since many investors won’t even think about bank stocks following the financial crisis, it’s a great sector to look at for both income and capital gains, irrespective of any new laws designed to change the banking sector.
Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and is managing editor of Financial Intelligence Report. To read more of his work, GO HERE NOW.
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