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Trump Redraws the Thin Red Line in Banking

By WallStreetDaily.com Trump Redraws the Thin Red Line in Banking

Louis BaseneseIf I had to pick one event that led to the housing bubble and subsequent financial crisis, it wouldn’t be difficult…

The answer is easily the erosion of the Glass-Steagall Act — also known as the U.S. Banking Act of 1933.

In the purest spirit of the legislation, Glass-Steagall was intended to keep commercial banking and investing banking separate.

It worked quite well for the first 30 years.

But greed would ultimately triumph over prudence.

Banks began figuring out that Glass-Steagall was a hindrance to growth in the early 1960s.

By 1962, under lobbying pressure, bank regulators began interpreting Glass-Steagall differently.

So the thin red line between commercial banking and investment banking was already blurring — that is, before Bill Clinton fired the kill-shot in 1999 officially repealing Glass-Steagall.

The chart below shows how the demise of Glass-Steagall gave rise to the term “too big to fail.”

the rise of too big to fail

But now there’s a movement within the Trump administration — driven by top economic aide Gary Cohn — to put Glass-Steagall back on the books.

Such a move would send profound aftershocks across the financial system.

So I asked my senior analyst, Martin Hutchinson, to get the scoop.

Is this more empty rhetoric from Republicans… or should we be preparing our portfolios?

Hutch’s full analysis is below.

Ahead of the tape,

Louis Basenese
Chief Investment Strategist, Wall Street Daily

Question: Martin, Gary Cohn says he wants to reinstate the Glass-Steagall Act, which was repealed in 1999. What’s that all about?

Martin Hutchinson: Cohn is the director of the Council of Economic Advisers in President Trump’s Cabinet. So when he says something like that, particularly since he’s ex-Goldman Sachs, one pays attention. It’s something that could happen.

Glass-Steagall in the 1930s split commercial and investment banks. Then the 1999 legislation allowed them to re-merge again.

Basically, commercial banks take deposits and lend. And investment banks play around in capital markets and advise on financings and mergers.

Back in 1929, there was no separation of the two, and so banks got in trouble playing with share issues.

After the crash, there were two pieces of legislation. One was Glass-Steagall, which separated commercial and investment banks. And the other was deposit insurance, which insured deposits in commercial banks — making the banks safe for little old ladies.

The trouble with deposit insurance is it encouraged the banks to leverage like maniacs. Banks were leveraged about 5-to-1 before deposit insurance. They’re about 20-to-1 now.

Question: Does reinstating Glass-Steagall solve the problem?

Martin Hutchinson: To some extent Glass-Steagall separated deposit trading from underwriting, which is arranging financings. But the real problem these days is trading, which wasn’t as big in 1929. They didn’t have computers.

It’s the big trading in derivatives and other things that brings the big risks.

If you’ve got big trading in a bank with insured deposits, the bank is essentially gambling with both small savers’ money and, indeed, with taxpayers’ money (taxpayers have to bail the mess out if it goes bust). And hence, you need something a bit stronger than Glass-Steagall. Something that separates both investment banking and trading from banks, except maybe short-term foreign exchange and commercial paper.

The Volcker Rule, which came in with Dodd-Frank, does a lot of the work here. But it’s too complicated, because the banks got at it and made it incomprehensible.

The objective is the banks that pay guaranteed deposits should be limited to small-scale and short-term trading — as well as, of course, their normal lending business.

All the big trading rubbish should then go in hedge funds, which nobody guarantees and go bust all the time. And the real investment banking — advising on mergers and financings — should be done in medium-sized houses, where the bureaucracy doesn’t overwhelm you and there aren’t too many conflicts of interest. You don’t have a huge trading desk playing games, and you don’t have a huge lending business for the companies you’re advising.

Question: Interesting. Hutch. Give us the bottom line for investors.

Martin Hutchinson: The bottom line for investors is that I think Glass-Steagall — or something like it — is likely to come back. So you don’t want to own a big behemoth bank like J.P. Morgan Chase or Citigroup.

You might buy a pure commercial bank like Wells Fargo (WFC), which is pretty well a pure commercial bank. But my preference would be to buy a medium-sized investment bank, one doing advisory work and asset management.

The one I like is Lazard Ltd. (LAZ). That has a $6 billion market cap — as opposed to $100 billion for the biggies. It has 2,700 employees, which is a size where people know each other and the bureaucracy’s not too bad. And its business is worldwide advisory, mergers and asset management work. So 15 times P/E, 12 times prospective P/E, with a 3.3% yield. To me that looks like a very attractive proposition.

Question: Great stuff as always. Thank you, Hutch.

Martin Hutchinson: A great pleasure.

Question: This is Wall Street Daily, signing off.

Smart Investing,

Martin Hutchinson
Senior Analyst, Wall Street Daily

The post Trump Redraws the Thin Red Line in Banking appeared first on Wall Street Daily.


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About Louie Lewis

Louie Lewis
Successful forex trading starts with you first. Then comes the actual strategies and techniques. I have been involved with forex and forex trading for a few years now. It is a wonderful way to build wealth. The learning never stops and I want to help others along their journey into this wonderful market of opportunity.

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