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Commentary: Some new and old ideas for banks

Let’s just junk the Dodd-Frank bank regulation act and its unruly child, the Volcker rule.

Though the $2 billion-and-counting trading loss by JPMorgan has spurred on those who want tough implementation of the two measures, other voices are saying the debacle should bring focus on better ways to carefully watch our banks.

One way is a relatively new idea: the SAFE Banking Act of 2012. The other is an old one: bringing back a version of the Glass-Stegall Act of 1933.

They would both be more effective and, better yet, simpler. And good ideas, new or old, should never die — even in Washington.

The JPMorgan trading strategy was, in CEO Jamie Dimon’s words, “sloppy” and “egregious” and “stupid.” Besides embarrassing the bank and regulators, it again brings into relief shortcomings in Dodd-Frank and the Volcker rule.

Regulators implementing Dodd-Frank still haven’t agreed on procedures to shut down failing institutions that pose a systemic risk.

And even if they did, other provisions in Dodd-Frank make it likely that the government — when push comes to shove — would end up rescuing failing megabanks anyway.

“Too big to fail” lives on.

It also appears no one can figure out how to implement the Volcker rule, which would regulate speculative proprietary trading bankers make with their own profits or capital.

It may prove impossible to separate that from market-making — whereby banks buy securities and hold them for sale to clients. Or from portfolio hedging, the legitimate use of derivatives to offset risk.

In JPMorgan’s case, first reports said the loss stemmed from portfolio hedging and wouldn’t have been forbidden under the Volcker rule. But Dimon is now saying the trade — in the end possibly a $5 billion debacle — “morphed” into something else. It may have crossed the line.

JPMorgan defenders argue that consternation over the deal amounts to histrionics, that the loss was minor given the bank’s nearly $200 billion in equity.

They contend that the stanching of the loss before it became a disaster shows that banks don’t need increased regulations, that the drop in JPMorgan’s stock price and the ousting of executives are free-market punishment enough.

That’s rather dismissive of the $25 billion hit to holders of JPMorgan stock. And it doesn’t take into account that because of the loss, JPMorgan will have less capacity to make loans.

It also doesn’t get at what’s really at stake. A sloppy, egregious and stupid trade is a half step away from recklessness and the imprudent and excessive risk taking that led to taxpayer bailouts the last time.

It shows even the best executives can’t stay on top of the complexity of their megabanks.

Whichever side you’re on in this yanking and tugging, more logs have been tossed onto the fiery debate over megabanks.

Is Dodd-Frank little more than a regulatory tweak to the current system? Is the Volcker rule just too complex? Have bankers thrown enough sand in their gears that they will still be able to game the system?

The two measures will survive, for now. Too much has been invested in them. But more and more banking experts, politicians and commentators are saying that eventually we’ll have to move beyond them.

A flight to SAFE

Which brings us to the new idea — the Safe, Accountable, Fair & Efficient Banking Act of 2012.

Simply, it would break up the megabanks and ensure that banks finance themselves more with equity and less with debt.

Dallas Federal Reserve Bank data show that in 1970, the five biggest U.S. banks owned 17 percent of bank assets. By 2010, even after the financial crisis, they held just more than half. Three of the five big banks hold about $2 trillion in assets.

Democratic Sens. Sherrod Brown of Ohio and Ted Kaufman of Delaware first proposed the SAFE Act as an amendment to Dodd-Frank two years ago. It got 33 votes, including that of Republican Richard Shelby of Alabama, the ranking member of the Banking Committee.

The current version would put a 10 percent cap on any individual bank’s share of U.S. deposits and cap the liabilities any one company can hold at 10 percent of the financial sector. It would limit the non-depository liabilities of bank holding companies to 2 percent of GDP, and no bank holding company could exceed $1.3 trillion in liabilities.

The liabilities of non-bank financial companies, part of the so-called shadow banking system, would be held to 3 percent of GDP. And non-bank financial companies couldn’t grow larger than $436 billion.

Finally, it would cap the leverage of bank and non-bank financial institutions at 10 percent.

Reducing the size of the megabanks would make them easier to oversee. The SAFE Act says the Federal Reserve Bank of Kansas City estimates that it would require 70,000 examiners to study a trillion-dollar bank with the same level of scrutiny as a community bank.

And cutting the big banks down to size would reduce the advantage they have over regional and community banks. According to a report by the Dallas Federal Reserve, the too-big-to-fail banks’ “sheer size and their presumed guarantee of government help in time of crisis have provided a significant edge — perhaps a percentage point or more — in the cost of raising funds.”

Because banks would be smaller after SAFE, a failure would be less likely to cause a panic that burns down the rest of the economy.

Some heavy hitters from across the political spectrum made up a recent online gallery from the American Banker magazine titled “Who wants to break up the big banks?”

One was Kansas City’s own Tom Hoenig, a former president of the Kansas City Federal Reserve Bank and now a board member of the Federal Deposit Insurance Corp.

Some others: Richard Fisher, president of the Federal Reserve Bank of Dallas; Sheila Bair, former chairwoman of the FDIC; Jon Huntsman, a former Republican presidential candidate and former governor of Utah; Mervyn King, governor of the Bank of England; Sen. Bernard Sanders, an independent from Vermont; and Camden Fine, president of the Independent Community Bankers of America.

In MIT economist Simon Johnson’s words, “Informed sentiment has shifted against continuing to allow very large banks to operate in their current highly leveraged form, with a great deal of debt and very little equity. There is increasing recognition of the huge and unfair costs that these structures impose on the rest of the economy. The implicit subsidies provided to too-big-to-fail companies allow them to increase compensation by hundreds of millions of dollars. But the costs imposed on the rest of us are in the trillions of dollars. This is a monstrously unfair and inefficient system.”

The tried and true

Which brings us to the old idea, the Glass-Stegall Act of 1933. After the banking crisis of the Great Depression, it separated traditional banking activities — holding deposits for consumers and making loans to homeowners and businesses — from investment banking — the often speculative raising of money for corporations through the stock and bond markets.

Despite the act’s success in a more or less stable and growing economy for decades, it was tossed aside in the late 1990s by both Democrats and Republicans responding to pressure from the banking industry. But we know how that turned out: The investment banking sides of the newly combined companies, taking advantage of too-big-to-fail and the safety net provided by the Federal Deposit Insurance Corp., overleveraged their assets in the subprime mortgage market.

Banks no longer cared as much about being good stewards of community assets. Instead, they pursued supersized profits for their shareholders and executives.

Peter Morici, a business professor at the University of Maryland, points out correctly that we can’t resurrect Glass-Stegall’s strict separation of traditional and investment banking because of decades-long changes in how consumers save money. With the higher returns offered in money market funds and through bonds and bond funds, banks wouldn’t be able to finance all the demand for loans from deposits.

Morici recommends a modernized Glass-Stegall, whereby traditional banks could still sell loans to investors through investment banks that would bundle them into securities. Traditional banks could even own securities backed by loans in other regions to hedge the default risk in their own loan portfolios. If the farm sector goes bad, you don’t want the banks in that region to also go belly up.

But the business of making markets, capital formation for corporations and speculative trading would be left to investment banks. If they failed, the taxpayers wouldn’t be bailing them out.

(Hint to banks: Go ahead and, on your own, separate the investment bank money makers from your traditional banking role.)

When you talk about breaking up the big banks and restoring Glass-Stegall, many object that this is interference in the free market. That it’s almost un-American.

But banking is not a strictly a free-market good. Without a government-backed Federal Reserve central bank standing behind financial system and without the FDIC and too-big-to-fail protection, banks would not be nearly as profitable as they are.

Banks should be there to store and help us manage OUR money. Traditional banks are the foundation of the economy. Investment banks are the dance floors on which capitalists dance.

“Commercial banks,” Morici writes, “are essential to the smooth function of a market economy — capitalism runs on credit much as air conditioning runs on electricity — and without stable commercial banks the economy can’t grow.”

As for un-American?

Having to use taxpayer dollars to bail out banks and their high-paid execs is even more so.

When Dimon was interviewed by Wall Street Journal reporters after he announced the $2 billion loss, he was asked what, in hindsight, he wished he had paid more attention to.

“Newspapers,” he deadpanned.

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