Political pundits are having a field day with how many millions in contributions were raised by both political parties during the month of August. Obama and Romney each raised more than $110 million for the period, but these amounts do not even include private "PAC" fund collections. Are we witnessing an overt attempt to "buy" the White House?
When we hear sums such as these, our minds may immediately wonder what role our major banks may have played in this ever-expanding largesse. Both political conventions are now behind us, but neither of the parties nor public speakers so much as mentioned bankers in their addresses. Yes, Wall Street was derided, but the root cause of our struggling economy has much more to do with our banking sector than with any other area of business.
When it comes to influencing the goings on in Washington, the banking lobby is often cited as the strongest and most formidable on Capitol Hill. Their current objective is to emasculate the Dodd-Frank Act and thereby render it ineffective. While credit card reform is a potential threat, our bankers are more concerned about the "shackles" envisioned by the Act to curb their reckless activities of "trading for one’s account," Wall Street-speak for highly leveraged "gambling" on securities.
The lessons that have played out over the past five years were the result of three decades of incessant pounding on legislators to unleash the power of American banking interests. The "tipping point" may have occurred when Lehman Brothers and others collapsed in 2008, but the pressure had been building both before and after the controls, instituted by the Glass-Steagall Act of 1933, were disposed of in 1999, a change forced upon Bill Clinton by a Republican-led Congress. Up to that point, commercial banks generally took deposits and earned money from making loans, while investment bankers received commissions related to raising capital and trading securities.
How did such a simple change result in the "Great Recession"? In "Economics 101," one of the first principles taught is that incentives work, but you had best be careful in how they are placed because the outcome may not be exactly what you desired. In banking, financial incentives in the form of enormous annual bonuses are the source that drives reckless trading activities in the backrooms of banking across America. Dodd-Frank merely "tiptoed" around this fact, and lobbyists are presently hard at work trying to carve out exemptions to maintain the new "status quo."
Commercial bankers back in the 1980s were known to be notoriously poor competitors when it came to protecting their "turf" from non-banking entities, relying primarily on the spread on loans to cover 90% of their revenue needs. Consultants at the time advised these bankers to shift to a more "transaction-driven" business model to provide both a recurring revenue stream, as well as a reduction in their dependence on loan markups. An abundance of new and senseless fees that followed is a testament to this "shift" to modern-day "best practices" in banking.
Internal compensation programs were soon tied to these new fees, too, rendering them harder still to eliminate. At the higher end, however, commercial bank executives were envious of the enormous fee streams that belonged to their investment banking "brethren." Commercial banking bonuses had heretofore been quite conservative, but the sky would be the limit if only they could partake from the "capital-raising and trading trough" just over the banking picket fence.
The Glass-Steagall Act, however, was a serious obstacle. An all-out frontal assault commenced, and the restrictions were soon lifted before the millennium crossover. Investment bankers were suddenly under threat of losing their precious "hunting grounds" to the major banking conglomerates that had formed in anticipation of this new ball game. No one has come forward to take credit for the idea, but someone suggested quietly that "co-opitition" may be a "win-win" for all participants. The securitization of mortgages would become the new "golden egg" that would galvanize the industry and keep on giving.
Auto loans and credit card receivables had been securitized for some time, but mortgages always seemed too large and unwieldy to package in a fund and then sell shares in the over-the-counter, unregulated market. Early testing, however, confirmed that a new "vein of gold" had definitely been found. Commercial bankers prepared to originate and collect fees for the paper, while investment bankers prepared to package and sell shares to pension funds and governments across the globe. Fees and bonuses quickly began to soar on all fronts.
All was well, except for one thing. The demand for these shares had been grossly underestimated. Marketing agents shouted for more "supply," regardless of the quality of the mortgage paper. The result was the infamous mountain of "no-doc-ninja" loans, where no income, no job, and no assets were necessary for the right adjustable rate loan. Rating agencies were asleep at the wheel, and when "teaser" rate periods expired, loan defaults occurred in mass. The global "ponzi" scheme imploded.
Consequently, portfolio managers dumped their highly leveraged shares on the open market, but there were no buyers. Market valuations plummeted. Collateral margin calls resulted, and credit liquidity disappeared, first for the bankers and then for the business community at large. Loans to small and medium-sized businesses became a low priority. This lack of credit liquidity persists today, the primary reason why our economic recovery remains in a near-neutral position. No one wants to take anymore risk than they have to, especially commercial loan risk.
Sandy Weill, a former CEO of Citicorp, caused quite a stir recently when he suggested that Glass-Steagall should be re-instated. He had been foremost in helping to repeal the legislation, but now had apparently recanted. He was roundly criticized by the new breed of bankers who remain addicted to the potential for large year-end bonuses. Commercial bankers now regard attempts to fix the broken incentive structure as the "enemy," and enormous political contributions to both parties are one sure way to secure the power to defeat them.
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