Who’s afraid of Glass-Steagall (or the uptick rule)?
Remember (ah, it seems like eons ago) the first few months of Obama’s presidency?
The focus was on the economy and attempts to foster its recovery. There were a gazillion articles about what had gone wrong: blame the Democrats, blame the Republicans, blame both, blame the 2007 repeal of the uptick rule, blame the 1999 end of Glass-Steagall.
The uptick rule. Back in June, I wondered about the delay in reinstating it. Well, it’s the end of October now, and I haven’t heard a thing about the topic since late spring. Wiki, which often tends to have the most current information about things, reports a flurry of discussion and activity about it in the first few months after the inauguration, but nothing since then.
I admit that, until the financial crisis hit about a year ago, I’d never even heard of the uptick rule. But a crash course (pun intended) in what had happened to the markets introduced me to the uptick rule and more. And I was shocked when I learned on what basis it had been repealed in the first place:
…[T]he “uptick” rule…helped limit downward spirals by allowing a stock to be sold short only after a rise (an “uptick”) from its immediately prior price. Adopted in 1938, the uptick rule was repealed by the SEC on July 3, 2007, primarily on the basis of a pilot program conducted in 2005. In the pilot program the agency compared 943 randomly selected stocks from the Russell 3000 not subject to the uptick rule to the remaining stocks in the Russell 3000 (a broad-based index of U.S. stocks of all sizes) still subject to this rule.
The comparison was only for six months — far too brief a time to draw conclusions about a rule that had been in effect for 70 years. The comparison also did not take place when repeal of the uptick rule could be stress-tested: 2005 was a year of rising stock prices with low volatility.
I’m not a financial wizard. But I do know something about research design. So, long before I read that last paragraph, I realized that a 6-month pilot study, performed under relatively stable market conditions, concerning a rule that had worked for approximately seventy years and is most vital under volatile market conditions, does not a proper pilot study make.
But we can’t expect the SEC to know that, can we? After all—as we’ve learned to our dismay in recent months—the SEC couldn’t even recognize a Ponzi scheme when it was handed one on a platinum platter.
While we’re on the subject, what about Glass-Steagall? That was another long-standing post-Depression rule that had stood the test of time, and whose repeal paved the way for the current crisis, at least in the view of many experts. I wrote about it in some depth back in March, and noted then that Paul Volcker had suggested that Glass-Steagall be reinstated.
If you Google “reinstate Glass-Steagall,” you’ll come up with a list of articles pro and con (mostly pro its re-establishment, however). Here, for example, is an eye-witness report of the pernicious influence of Glass-Steagall’s repeal on the insurance industry. And, although this author thinks believes that Glass-Steagall’s repeal was not instrumental in the financial breakdown of a year ago (look at the comments for a counter-argument), he finds that there is nevertheless a case to be made for its reinstatement (here’s another piece that unequivocally calls for reinstatement).
But where does the administration stand on this issue? Isn’t Volcker a top adviser, appointed Chairman of Obama’s Economic Recovery Advisory Board back in February?
Is this inaction another case of Obama as Hamlet? Or is it just the usual situation involving the influence of monied interest groups determined to prevent needed reforms? Or has there actually been an in-depth review, and a rejection of the case for repeal of the uptick rule and reinstatement of Glass-Steagall on the merits? If so, I can’t find anything about it.
The most relevant article I could locate on the subject appeared recently in the business section of the NY Times. In it, Volcker was described as firmly behind the reinstatement of Glass-Steagall, but he’s been given the cold shoulder by this administration because of its belief that this action would make the US less competitive in the world market. Instead, Obama would prefer to more closely regulate the institutions in question—but hasn’t yet done so (Hamlet again?):
The Obama team, in contrast, would let the giants survive, but would regulate them extensively, so they could not get themselves and the nation into trouble again. While the administration’s proposal languishes, giants like Goldman Sachs have re-engaged in old trading practices, once again earning big profits and planning big bonuses.
Unlike Volcker, Alan Greenspan thinks Glass-Steagall should remain repealed. But I have to say that at this point Greenspan has lost almost all the credibility he once had. But Volcker has lost something too: his influence on Obama—that is, if he ever had any in the first place. Let’s hear what he has to say:
[Volcker’s] disagreement with the Obama people on whether to restore some version of Glass-Steagall appears to have contributed to published reports that his influence in the administration is fading and that he is rarely if ever in the small Washington office assigned to him.
He operates from his own offices in New York, communicating with administration officials and other members of the advisory board mainly by telephone. (He does not use e-mail, although his support staff does.) He travels infrequently to Washington, he says, and when he does, the visits are too short to bother with the office. The advisory board has been asked to study, amid other issues, the tax law on corporate profits earned overseas, hardly a headline concern.
So Mr. Volcker scoffs at the reports that he is losing clout. “I did not have influence to start with,” he said.
Who does, I wonder?
The SEC issued reopened the comment period for its proposed reinstatement of some version of the “uptick rule” on August 17th and required answers by Sep 21st. This is the usual method of rule change adopted by the SEC other than for emergancy short term measures. Therefore this is still under serious consideration and I would expect something before year end.
Glass-Steagall on the other hand would be a matter for Congess. I did see recent talk from regulators in the UK that they were in favour of some sort of split between Investment and Commercial banking activities. This is interesting as the UK has never had the equivelent rule.
All you have to do to understand this is to consult those famous investment advisors, The Beatles:
“I told you about recessional panic
You know the place where everything’s frantic
Well here’s another stock you can short
When there’s an uptick yell “Abort!”
Looking at Investment bank interests
To see how the other half trades
Looking through a Glass-Steagall”
“So Mr. Volcker scoffs at the reports that he is losing clout. ‘I did not have influence to start with,’ he said.”
Wonderful! The man stays in character, and should get some kind of prize for limpidly clear speech, with more than a touch of humor!
I recall Charlie Gasparino saying that while geitner and volker are on the outside, jarrett has the inside track.
In very brief, Carter signed the Community Reinvestment Act that required insured banks to provide credit to serve the needs of the communities they served. In the early 90’s Congress passed and Clinton signed legislation that was designed to further home ownership for those who could not afford homes. During this time community groups, such as ACORN, objected to any proposed branching or mergers or acquisitions by insured banks on the grounds that they were not meeting their CRA responsibilities. Congress goosed the federal banking agencies but especially the federal reserve board, to push the banks to meet their CRA targets. In this way, ACORN and other community groups gained enormous power and were able to force banks to pledge to make trillions in mortgage loans to those who could not afford them.
In the meantime, FNMA and FHLBB were induced by Congress to increase the percentage of loans they purchased that were made to subprime borrowers. When they purchased all the loans that could be made using conservative underwriting guidelines, they invented liar loans, no downpayment loans, and other forms of loans that the bank regulators required the banks to originate and sell into the secondary market. The fact that these loans were crap was not material to the demand by the regulators that they be made or the banks would be deemed in violation of the CRA. The crap loans were sold to FNMA and FHLBB, which packaged and sold them with the implied guaranty of the USA taxpayer. efforts to bring this under control were fended off by Barney Frank and Chris DOdd, among others, who did not see any problem in unloading these crap loans to investors.
The investment banks, like Lehman Bros and Goldman, which were not FDIC insured, were able to purchase large amounts of these loan portfolios because the capital requirements were reduced, I think 5 or so years ago. As any good capitalists, they sliced and diced these loan pools into various risk pools and sold interests in them to investors around the world. In the meantime, The Financial Accounting Standards Board (FASB), against the strong opposition of the bank regulators, adopted the mark-to-market rule for valuing assets. The banks and other financial companies had long valued assets using historical repayment experience. Loans that were current were valued at 100% of the outstanding balance. Loans that were 60 or 120 days days delinquent were written down, to 80% or 60% of the current balance, but not below the liquidation value of the collateral. Under the MTM rule, which became effective in the last quarter of 2007, loans had to be valued on the basis of their value in the market. Early in 2008 a portfolio of crap loans went unsold and, within days, the value of crap mortgage loans was reduced to near nothing, even though only about 10% or so, were not performing. So, by changing the accounting rules the investment banks, FNMA, FHLBB, the bank regulators and the investors in crap were caught short by the sudden loss in value of crap.
The problems were not caused by the free market but by laws designed to put people into home they could not afford. And, Congress is considering a CRA improvements act while the FHA and Ginnie Mae (taking over for FNMA and FHLBB) are continuing to originate crap loans even though they have not been unable to unload them into the secondary market.
If you believe that centrally managed economies are just more fair than market economies, and believe you must force a revolution to make this occur, you will want a major market failure. The first rule of revolution is to make things as bad as possible so people will accept radical change. So why would Obama want to fix the current system?
Colby King on Inside Washington this past Sunday advocated essentially unrepealing Glass-Steagall. That would, he said, let the commercial banks go back to collecting deposits, making loans, getting those loans repaid, and being carefully regulated while investment banks would be free to take whatever risks they wanted – and pay their employees ridiculous amounts of money. Then when the investment banks took one too many risk or made one many stupid decision, they could fail without putting the taxpayers in the position of having to either bail the out or take the chance of crashing the whole economy. And Bill Clinton thought the repeal of the uptick rule was a bad idea.
It seems to me that both Glass-Steagall and the uptick rule are excellent regulatory ideas because they help protect the economy as a whole without requiring constant hands-on government micromanagement.
I have to say after all the reading I’ve done on this, I’m indifferent about the uptick rule (I think Naked Shorting was a much bigger problem). OTOH I don’t see how repealing Glass-Stegal caused any harm. If anything, it prevented some panics by allowing banks to buy trouble brokerages and vice versa. That would not have been possible before.
A number of things are responsible for this mess:
– Political (read Congressional) preasure on both banks and Freddie/Fannie to make bad loans.
– Fannie, Freddie’s lower capital requirements their implicit gov guarantee.
– The Fed keeping interest rates too low from 2005-2007.
– Lower capital requirements for banks holding MBSes (mortgage backed securities) compared to actual mortgages. (Generally, the Basel I and II capital requirements to base capital requirements on risk led banks and rating agencies to systemically understate the level of risk. Because of the Fed window, capital requirements, not reserves, is the limiting factor in lending. In general, the financial sector is procyclical, leading to a bubble/bust cycle, unless the rules of the system are set up to slow the mania on the upside and the panic on the downside.)
– Allowing institutions to become “to big to fail”. (Any institution that large should, at minimum, have higher capital requirements than smaller competitors. Rule: capital requirements should increase progressively with size.)
– Naked shorting allowed short sellers to drive down the
market by shorting stock they didn’t actually borrow.
Did I miss anything?
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