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Web Letter

Banks own the government: that has already been stipulated by Senator Durbin. As he said, "They own the place," referring to Capitol Hill.

And today we get hearings on a regulatory scheme that doesn't even address the problems that have bankrupted the banking system. The re-enactment of Glass-Steagall to separate deposits and risky trading from insured deposits and prohibiting the proliferation of trillions of dollars of derivatives is a dead letter in the hearings and on the Hill.

In fact, the privately owned and operated Federal Reserve did exactly the opposite of what Glass-Steagall called for. Banks bought even more brokerages. Investment banks became insured FDIC banks. Banks bought mortgage companies.

Trillions of tax payer dollars paid, yet the "new" regulation and proposed regulatory body will do nothing for the deregulation that allowed "too big to fail" banks to buy investment banks and brokerages and trade in trillions of opaque instruments that could blow the whole financial system sky-high and take the country down in the process.

Michael McKinlay

Hercules, CA

Aug 5 2009 - 12:53pm

Web Letter

Once upon a time, maybe thirty years ago, there were lots of strong, well capitalized commercial banks. They were highly regulated and rarely failed.

They had low leverage (by today's standards) of maybe 9 or 10X. A well performing bank earned 1 percent+ on total assets and 10 percent+ on equity. They loaned out perhaps 80 percent of their deposit base to local or regional customers. They rarely funded themselves with "hot" money. They paid solid if uninspiring dividends to the little old ladies and local businessmen who owned their stock.

There were thousands of these banks from the largest cities to the most rural area.

They operated in virtually protected franchises as hostile take-over, or virtually any take-over for that matter that didn't involve a failing bank was not an option. Banking regulators simply wouldn't allow it. Branching was severely restricted, save for North Carolina, by state statutes, protecting smaller banks from intense competition from major metropolitan area banks. There was plenty of credit available and plenty of banks from which to choose. Banks developed their own specialities in order to effectively compete. Bank of Boston had vast trading contacts in Latin America. Irving Trust was the largest commercial factor in America. Morgan Guaranty was the premier corporate bank. Citi was NYC's largest retail bank. Regional banks dominated their geographic areas as branching restrictions kept others away. North Carolina allowed statewide banking, which nurtured NCNB, First Union and Wachovia.

The largest commercial bank failure during that period was Continental Illinois of Chicago. Illinois was a "unit" bank state--no branches were allowed. Continental Illinois was housed in one building in downtown Chicago. As a result of the Illinois branch restrictions, Continental had a relatively small retail deposit base. It funded itself each day in the money markets--considered a somewhat risky strategy at the time. When it ran into credit difficulties its sources of funding dried up. It was seized by the FDIC and liquidated. The last real estate crisis brought down a few banks--Republic of Dallas, Texas Commerce--but nothing that would threaten the stability of the banking system as a whole.

The system worked fine even if it could be criticized as dowdy. Banking was not the most exciting profession to be in.

Then came deregulation. Branching and nationwide banking came into existence. With it came the hostile take-over. Glass-Steagle was revoked. Suddenly there was money to be made in bank stocks..

It all began in 1988 when Bank of New York put a take-over offer in front of the Board of Irving Trust. Irving rejected the offer. BONY sweetened it. It was rejected again. Irving was counting on the Fed and regulators to do what they had always done--reject hostile takeovers. But the wind of change was in the air. Wall Street smelled blood, money and defeat for Irving. After battling BONY for a year Irving lost in court and the Regulators gave approval. The rout was on. Chairman Rice of Irving Trust caved the day after losing in Court and Irving was acquired. Rice immediately retired.

Thus was set in motion the creation of the banking system we have today. Plenty of money was made by Wall Street, bank stockholders and insiders holding shares and options, including me. Venture funds began buying up bank stocks with the sole purpose of selling off to the highest bidder. The major regional banks were acquired and disappeared along with thousands of jobs.

"Growth, growth, growth!" was the mantra. "Marketing" rather than credit worthiness became the norm, as loans were marketed as if selling soap. Credit insurance from AIG made it possible to shovel billions of dollars into mortgage assets without worrying about the loans themselves--after all, they were insured by AIG or some other sterling counter-party and carried a Moody's/S&P investment grade ratings. Trading rooms moved from customer-based trading activities to "own account" trading activities. After all, there were enormous profits to be made, especially when betting other people's money.

Within all of the major banks in trouble today there were those who had serious doubts about how business was being conducted. "Nay-sayers." "Old fashioned." "Not up to date." They were ignored. There was no money in their Cassandra prognostications; not for "business development officers," executive management or shareholders.

What was the matter with the old system? Not much. It just wasn't sexy.

Deregulation, the revocation of Glass-Steagall and the cowboy mentality of growth and consolidation brought us to where we are. Bank shares were bought up by funds whose only interest was to sell the bank at a profit. So now we have perhaps a dozen "too big to fail" financial institutions. If they are too big to fail, then they are too big not to be strictly regulated.

Unfortunately, the banking system needed to be rescued. It is more than the system deserved.

Frank J. Scarangello

Spring Hill, FL

Aug 5 2009 - 9:25am