(Author’s Note: The cartoonist Al Capp’s literally delicious 1948 invention was the shmoo — if one looked at a shmoo with hunger in his or her eyes, the shmoo would jump into a pan and cook itself up. The plural is shmoon or shmoos; all shmoos come from The Valley of the Shmoon.)
During the waning months of the Clinton administration, in 1999, President Bill (remember him?) famously signed the Gramm-Leach-Bliley Act — named for one senator and two congressmen, the folks who sponsored it, in case you thought that it was all due to the then-president. The law repealed the provisions in the Glass-Steagall Act that prevented banks, securities firms and insurance companies from acting as investment banks, commercial banks and insurance companies, or a combination of the three, at the same time.
Passage of the act allowed for consolidation of the three activities in one company. The truth is that there was already some consolidating going on. (Travelers and Citicorp, along with Primerica, Citibank and Smith Barney, became Citigroup, for example, before the act was passed into law. According to Wikipedia, Citigroup had a temporary 1998 waiver, granting permission.)
How has this worked out? Well, how has the economy and market been since 2000, a year after passage of the law? We are currently in a secular bear market, in its 12th ugly year. And the U.S. economy is slowly trying to pull itself together after The Great Debacle, which was essentially caused by — what? — banks, investment houses and insurance companies after they were permitted to commit financial incest.
Banks, insurance companies and investment houses have required huge federal bailouts or forced mergers. The banks may have recently passed some federal stress tests, but, gee, couldn’t almost anyone — even up-again-down-again Donald Trump — pass one? Especially if he or she had virtually unlimited access to federal funds. (And, make no mistake about it, federal funds are taxpayer funds.)
Exporting financial cocaine
After mixing investments and banking, JP Morgan Chase and other U.S. banks have exported financial instruments of mass destruction, like credit-default and interest-rate swaps, to Greece and other countries and municipalities overseas. In an interest-rate swap, Country G can exchange some high-rate fixed interest to low-rate variable interest and make things seem okay — or even good — for awhile. That is, at least until the variable rate interest (or derivatives) climbs higher than the original fixed-rate interest. JPM Chase was apparently expert in making certain the initial interest rates were low and friendly. The higher interest came after the original approving politicians were mostly out of office and could pass along the problem of the growing interest burden to others. Did this just happen overseas? Not hardly. JPM Chase and other banks played a major part in the fall of sewer bond defaults of Jefferson County, Ala., a.k.a. Birmingham. The fees for these manipulations provide large commissions and add to bonus pools. The lure of the big money is apparently irresistible — maybe the only thing better is being a politician in the capitol, Washington, D.C.
Washington: Where the milk is a bit sweeter
Pity the modern senator or congressperson. He or she is subject to attack, daily, by millions of dollars-worth of lobbyists. These lobbyists are so good at suggesting and writing legislation that our elected officials, after a pretty darn nice lunch, dinner or “educational” meeting at a nice resort, seem to pretty much adopt most all of the lobby’s ideas. One of the best lobbyist skills is obfuscation — making legislation so weighty and dense that hardly anyone can understand much of it, until it’s too late.
Gramm-Leach-Bliley still exists of course. Instead of repealing it, politicians have embraced it. After all, it has given them the opportunity to increase the size of the federal government by adding new agencies to oversee things that would not be possible if Glass-Steagall’s principles were reinstated. It makes no difference that the federal agencies we have now do relatively little to protect consumers. All politicians rejoice at the opportunity to add still another regulatory agency. They must think it makes us citizens think they are doing something important in the District of Columbia.
The last I looked, state, federal and municipal government, combined, provided work for about 37% of us. One can only hope that the politicians understand that once total government is more than 50% of the workforce, we will inexorably move to and soon thereafter become a non-productive welfare state. When we get there, the result may be that there are only government workers, politicians (different than “workers”), the unemployed, people living on welfare and a relative handful of workers and capitalists. The latter two groups, who will provide most of the nation’s financial support, including pay for those in government, will probably have a 90% income tax rate and be pilloried by the media daily.
What does a shmoo have in common with a U.S. citizen?
We poor shmoon (my favorite part of Al Capp’s Li’l Abner comic strip) put up with all of this nonsense, which should earn us all some sort of glutton-for-punishment award. Or maybe we like being punished. In that case, we are shmoon for taxing and regulating, not shmoon for eating. We hop into the tax frying pan as soon as a legislator looks our way.
The insanity of regulation—a nation of agencies
Only in government would a model that has been constantly proven not to work — the regulation model — be replicated. What does this statement mean? The SEC missed Madoff, right? The news show, “60 Minutes” still manages to hold one’s interest. (Even though the show now seems to have 20 or 30 news readers, instead of just a cohesive group, like the original news folks — Wallace, Reasoner, Bradley, Safer, Stahl and Rooney. The original originals were just two, Mike Wallace and Harry Reasoner. Safer, for a time, replaced Reasoner, and then, when Reasoner returned, Safer stuck around.) Not long ago, the program took the SEC to task over, among other things, the failure of Lehman Brothers. Did you know that the SEC was present at Lehman Brothers, providing oversight, for five or more months before Lehman Brothers failed and during its failure? “60 Minutes” interviews suggested that the SEC failed to grasp many of the complex financial deals at Lehman day by day. (The folks on “60 Minutes” did pronounce Lehman correctly. Upfront, it’s like “lee,” not “lay,” as most past — like me — and present New Yorkers know.) This ties in nicely with the Harry Markopolis view of the SEC as an agency that — at least during the Madoff scandal — had no one on board with a finance degree.
An example of one semi-complex arrangement at Lehman was its participation in overnight repos — money electronically borrowed overnight by selling securities on Day 1 with the proviso to rebuy them the following day, Day 2. The Day 2 purchase was at an agreed-upon-in-advance higher rate, the difference being “interest” — the overnight repo rate. In other words, Lehman paid more to buy back the securities than it earned selling them, and it, along with other investment banks, used this technique to finance operations. This technique is still used by investment banks. Problems occur, though, when one counterparty suddenly seems to have credit problems — then no one will take their paper.
One voice in the wilderness about the impending financial crisis was the head of the Commodity Futures Trading Commission (CFTC), an agency designed to regulate the futures and commodities markets. Brooksley Born correctly identified problems down the road with derivatives, which she thought her agency should regulate, and she did so in the 1990s. In a way, she predicted the credit crises of 2007-2008. Her voice in the wilderness was quickly silenced by heavyweights like Alan Greenspan, Larry Summers and Robert Rubin. They thought that if the CFTC regulated derivatives, it would cause legal uncertainty. So, when a government agency gets it right, the agency is penalized heavily. When an agency gets it wrong, it isn’t punished — except for a few uncomfortable hours for its top officers, who are grilled to Guy Fieri-perfection by the same legislators who may have created the problem in the first place.
Failed regulation begets more agencies, not better regulation
Because the SEC did not protect consumers in Madoff, the politicians did not suggest disbanding the agency. Instead, they created another agency, the Consumer Financial Protection Bureau (CFPB), which protects citizens from banks and credit companies. (And banks, as we know, thanks to Gramm-Leach-Bliley, may now be banks and insurance companies and investment companies all at the same time.) The government must think, why have one ineffective agency when there can be two?
No one in Washington seems to genuinely fix problems. There’s probably not a thing wrong with the SEC — it just needs a representation of people with experience in finance and investing. Why not require that at least 25% of the people there have (1) experience in the markets (in managing the selling of IPOs, dealing with customers as a financial planner or broker, etc. — not just writing prospectuses), (2) an academic degree in finance/financial planning or post-secondary designations like ChFC, CFP, CIMA and CFA, (3) hands-on experience as a branch (OSJ) manager, and/or (4) actual work experience as a trader? You get where I’m going right? After 9/11, the government could have fixed the non-cooperation problems at the FBI, CIA and NSA. Instead, it created a whole new agency. At times, I suspect federal agencies even have lobbyists — why else would there be two or three agencies to do the work of one?
At the federal level, government does not seem to solve problems. Instead, it starts new agencies, increases the number of federal employees and kicks the expenses-to-pay can further and further down the road. The president now gets to nominate and appoint the head of the SEC and the head of the CFPB. The view seems always to be that two heads are better than one; three (easy to include the CFTC — the commodities commission once headed by Brooksley Born) heads are better than two; four heads are better than three…ad infinitum.
Creating more and more agencies is nuts. Fixing agencies makes more sense. Why would any sane government keep creating new agencies — all of which seem to be quickly watered down by lobbyists, who buy spineless politicians for banks and big business? Soon there won’t be room for us citizens to vote. Then companies will have it all. There will be nothing left for us shmoon but video entertainment, buying company stuff and paying taxes. We’ll truly be shmoon, ready to leap into any pan.
If Glass-Steagall worked so well for all those years at protecting us from banks and protecting bankers from themselves, and if it would have avoided many of the excesses that led to the crisis of 2007-2008, why don’t we re-adopt it? Do we want to continue to use the weapons of financial mass destruction domestically and export them to friends overseas? Is it that important that bankers and sales folks earn huge bonuses every year? Are we really shmoon? Really?
This information is intended for financial professionals only, not the general public. This is not a solicitation to buy or sell any specific security. Mr. Hoe may have positions in the securities or other investments discussed. Investments in securities do not offer a fixed rate of return. Principal, yield and/or share price will fluctuate with changes in market conditions, and when sold or redeemed, one may receive more or less than originally invested.