I see that Donald Trump is thinking about bringing back Glass-Steagall style laws to the US banks. This would force the banks to separate and break up their operations between their investment bank and the retail and commercial bank structures. It intrigues me that this is being considered 18 years after the law was repealed, but why was it repealed in the first place?
Showing my age, I remember the golden years of the 1990s in banking, when all the European banks were building ‘bancassurance’ models of integrated insurance and banking systems. One US financier in particular was keen to copy this model: Sanford I Weill, CEO of Travelers Group.
Sanford, or Sandy as everyone knew him, had built Travelers over a quarter of a century, from a small regional subsidiary of CDC to a major US insurance and stock broker through various acquisitions, including Salomon Smith Barney, the renowned Wall Street firm that made Michael Lewis’s career as an author when he described the firm’s culture in the bestselling book Liar’s Poker:
Everyone wanted to be a Big Swinging Dick, even the women. Big Swinging Dickettes.
Weill himself had grown up on Wall Street, building Shearson Loeb Rhoades into the second largest securities brokerage in the US, just behind Merrill Lynch. He sold out to American Express and then became CEO of Commercial Credit, a consumer finance company.
In 1987, he acquired Gulf Insurance. The next year, he paid $1.5bn for Primerica, the parent company of Smith Barney and the AL Williams insurance company. In 1989, he acquired Drexel Burnham Lambert’s retail brokerage outlets. In 1992, he paid $722m to buy a 27% share of Travelers Insurance. In 1993, he reacquired his old Shearson brokerage from American Express for $1.2bn. By the end of the year, he had completely taken over Travelers Corp in a $4bn stock deal and officially began calling his corporation Travelers Group Inc. In 1996, he added to his holdings, at a cost of $4bn, the property and casualty operations of Aetna Life & Casualty. In September 1997, Weill acquired Salomon Inc, parent company of Salomon Brothers Inc, for over $9bn in stock.
As you can see, Weill was an aggressive acquirer, building a massive insurance and securities brokerage group over a decade of takeovers. Then came the dream: to get a full service bank as part of the Group’s operations. The problem was that this wouldn’t be allowed under the regulatory rules of Glass-Steagall. So Weill just thought screw it, and set out to repeal the law by pressing ahead with a merger of Travelers and Citibank, which would be co-run by Weill and Citibank’s CEO John Reed, who Sandy knew well.
Fundamental change in banking
Soon after the merger was announced, Reed stepped down and Weill continued on his ambition to build the world’s biggest financial group. Intriguingly, at the time of the merger, it was noted that there was a regulatory problem. From CNN, April 1998:
A more immediate concern for the companies may be getting regulatory approval for the deal. The Glass-Steagall Act of 1933 prevents commercial banks from owning brokerage firms and insurance units, but the companies said they are taking a chance because they expect those laws to change in the near future. Indeed, legislation is winding its way through Congress which would allow greater flexibility of ownership. Even without those changes, the law has more and more been interpreted in favor of merging companies. Sen. Alfonse D’Amato, chairman of the Senate Banking Committee, said Monday that most legal obstacles to the Citigroup merger have already been eliminated …
Robert Froehlich, market analyst at Scudder Kemper Investments, said that the two companies’ determination to go ahead with the deal is a clear indicator of their confidence. “The markets lead Washington. Washington doesn’t lead the markets,” he declared. “I think this deal is going to force Congress to look at the Glass-Steagall again because this deal will be able to figure out ways to get around that outdated law. It’s going to send a signal to Congress to say ‘Wake up. It’s not 1933 anymore,’” he added.
The force of will of Weill and his vision could overcome all. In this case, it helped by hiring ex-president Gerald Ford (Republican) to the board of directors, and Robert Rubin (secretary of treasury during the Democratic Clinton administration) whom Weill was close to. With both Democrats and Republicans on their side, the law was taken down in less than two years and replaced by the Gramm-Leach-Bliley Act (GLBA), also known as the Financial Services Modernization Act, of 1999. It repealed part of the Glass-Steagall Act of 1933, removing barriers in the market among banking companies, securities companies and insurance companies that prohibited any one institution from acting as any combination of an investment bank, a commercial bank and an insurance company.
Weill denies that this led to the global financial crisis, but it did lead to fundamental change in banking. For example, the repeal of Glass-Steagall led to the private partnerships of firms such as Goldman Sachs, which paid partners well because it was investing its own money in the firm, to become public firms now betting shareholders’ money on the markets. In other words, the bonus culture of casino banking came off the back of the repeal of Glass-Steagall.
Equally, the high risks created in mortgage securitisation was fuelled by the change of cultures, where investment firms’ thinking took over the helm of what had previously been boring commercial banks. Glass-Steagall was there for a reason: to avoid wrecking retail and commercial banks through high-risk investments, and it’s no wonder it’s back on the table again today.
Meantime, it won’t happen. Donald Trump’s corridors of power are run by Goldman Sachs, and I just cannot comprehend the idea that Trump would force an act through that would break up the big banks of America. Equally, his biggest opposition would be Jamie Dimon, a protégé of Sandy Weill*.
So what will happen? I guess the most likely outcome in the US will be the repeal of Dodd-Frank and a replacement that allows investment and retail banking groups to continue, but with living wills and ring fencing in some form similar to the European bank rules.
US banks are already required to submit living wills to regulators which detail the company’s process of liquidation under US bankruptcy code, should it fail. Ring fencing is the UK response to the financial crisis, and forces banks to separate investment operations from their retail and commercial structure such that, should the investment bank fail, it can be liquidated without impacting the rest of the bank.
It will be interesting to see what the US does do, as ring fencing isn’t easy and costs billions. Equally, all the big American banks will fight any change, especially the reintroduction of Glass-Steagall, so ring fencing would make sense as a compromise. Watch that space.
– This article is reproduced with kind permission. Some minor changes have been made to reflect BankNXT style considerations. Chris included a New York Times article in the original version, which you can find here, and a Bloomberg article, which you can find here. Read more here. Photo by Windover Way Photography, Shutterstock.com