Saturday, March 21, 2009

Too Big To Fail

The US Government in the world of bailouts has frequently commented that companies like AIG, Citi, Fannie Mae and other are too big to fail. Other companies, like auto manufacturers also want to make the case that they too are too big to fail.

With bailouts and stimulus plans, regulations, and new taxes every one is trying to figure out to save these big companies from failing.

But maybe, just maybe, they are concentrating on the wrong part of the expression...maybe instead of concentrating on how to stop these companies from failing, they need to focus on how to keep these companies from getting big.

Gramm-Leach-Bliley Act of 1999 and Glass-Steagall Act of 1933.

In 1933 the Glass-Steagall Act was put together by democratic senator from Virginia Carter Glass and former secretary of the treasure (and democratic Congressman of Alabama) Henry B. Steagall. The Glass-Steagall Act created the Federal Deposit Insurance Corporation (FDIC) as well as created banking regulation that we rely on today. This act is frequently referered to as the Banking Act of 1933.

In 1999 Phil Gramm (Republican Senator -Texas), Jim Leach (Republic Congressman - Iowa), and Thomas J. Blailey (Republican Congressman - Virginia) introduced the Gramm-Leach-Bliley Financial Services Modernization Act. The Bill passed and was signed by Democratic President Bill Clinton.

The Gramm-Leach-Blailey Act (GLBA) repealed language of the Glass-Steagall Act and allowed deregulation in the financial services industry. It is because of the GLBA that for the first time since the great depression Commercial Banking and Investment Banking was allowed to happen with in the same corporation.

For example, in 1993 Citibank received special waivers to combine commercial banking and insurance underwriting under one conglomorated company. The GLBA allowed this conglomeration to be legal and allowed Citigroup-Travelers Insurance, to further merge with Smith-Barney.

Investment Banking Combines with Commercial Banking

City Bank of New Yorks story is not the only example of commercial banking and investment banking being done by the same company. Under the 1999 legislation, this became legal behavior, with the purpose of allowing American companies to compete on a global scale and to combine resources.

Examples of current companies that combine Investment Banking with Commercial Banking include: Bank of America, Barclays, Lehman Brothers Bank, Morgan Stanley, Goldman Sachs, Deutsche Bank, Wells Fargo, USAA, Nomura Securities Co., Ltd., ING Group, HSBC, JPMorgan Chase, and KeyCorp.

Your local commercial banks are not involved in investment banking, and there are many investment banks that are not involved in commercial banking (Oppenheimer & Co., Fidelity Investments, Raymond James).

Mergers, Consolidation & Federally Supported Buy-Outs

With the financial crisis we are currently in, I believe, the problem of big companies too big to fail is only made worse. Many investment banking operations are being absorbed into large commercial/investment banking companies in ways that would have been illegal before the 1999 GLBA.

Examples: Bear Sterns became a part of JP Morgan Chase in 2008, A.G. Edwards became a part of Wachovia in 2007,Wachovia became a part of Wells Fargo, Petrie Parkman & Co. was acquired by Merill Lynch in 2006, Merill Lynch was acquired by Bank of America in 2008.

Too Big to Fail - My Thoughts

Perhaps it's time to revisit this act again. There was a time when the government was more eager to tackle monopolies, but lobbyist, politicians, and lawyers have figured out a way to keep large companies in tact, and as companies diversify. Andrew Carnegie might be proud of the ways his intergration of multiple business became such a model and pattern for American business. In fact, his company Carnegie Steel Company was sold to J.P. Morgan in 1901 and although J.P. Morgan died in 1913 we still know his name, and his name is associated with a lot of money, and huge portions of the global marketplace.

Perhaps instead of bailing out companies like AIG, the government should be breaking up companies like AIG with multiple holding. Create AIG Finance to deal with lending, and AIG Real Estate to deal with real estate, and AIG Aerospace, and so forth so that each business unit can be handled independently, and perhaps some of these different groups then would be small enough to fail, and the parts that can't will have to be saved. AIG even owns it's own ski resort, Stowe Mountain Resort in Vermont.

Seperate the Ski Resort from the Aerospace, and Telecommunications, and then see what parts of the business are too big to fail.

Maybe the same should happen for Lehman, Citi, GE, and any other company seeking federal bailouts. Maybe once these companies are made smaller, it'll be easier to see where the money really needs to go.

And as companies fail, government support of making J.P. Morgan Chase, Wells Fargo, and other "stronger" companies expand, only makes the potential risk in the future greater. In fact, it makes it so the only saviors of these massive companies is the government, which is the situation were getting into now.

Let's change up the leadership in these larger failed companies, and make smaller companies. And let's revisit the Gramm-Leach-Bliley Act of 1999. The goals of commercial banking and investment banking are different and putting these under the same roof might be too great a risk.

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