Once upon a time there was a world where there were banks, insurance companies and investment firms, and it was a very good world indeed. In that not so long ago time banks did what banks were designed to do which was take in deposits and make loans. The function of life and annuity insurance companies was to sell and service insurance, usually through captive agents. Investments, such as stocks, bonds and mutual funds, were sold through the large wire house such as MLPF&S and their registered representatives. Everyone knew what their roles were and stayed on their side of the fence. In fact all three worked together for the common good. Insurance companies worked with bank Trust departments as did investment firms, sharing information and clients. That was the order of things and they were never to change. One prominent insurance company VP swore his industry would never enter the investment business because risk was not what the insurance business was all about. Today that insurance company owns a very large and respected investment brokerage firm. All in the space of a generation. The VP is long retired and forgotten.
It was banks that first dipped their toe onto the other side of the fence by offering customers life insurance. Insurance agents thought it was the end of their business and that banks would have a monopoly. That didn’t happen. What insurance agents didn’t count on was that bank insurance agents were also bank employees and did not get paid any more or less if they sold or did not sell insurance. Banks were so cheap they did not offer sufficient incentives to build their insurance business. What banks did do fairly well was fight the regulatory concept of continuing education for their bank licensed agents which was mandatory for all licensed agents. For a while it appeared that they would win but in the end they didn’t. I should have realized back then that banks do not like playing with other people’s rules. Rules, according to what I witnessed, and how banks view them both now and then are for others and not for them.
Citi broke the investment barrier by merging with Travelers Insurance which at the time owned Salomon and Smith Barney and this merger flashed the digit to regulators and dared them to do something, which they didn’t. Lobbyists won the day and the merger opened the floodgates and banks were into the investment business with both feet. This was the beginning of the concept of the financial supermarkets – one stop shopping with all financial products from one source.
What makes banks powerful is the continuing flow of deposits from customers. Banks don’t need a lot of capital if they have OPM. People open accounts for certificates of deposit, checking and money markets. People don’t have to buy investments or insurance for banks to use that money in what is called proprietary trading. They trade for their own account using the money of customers, who usually don’t have a clue to what is going on, to make money for the bank and their shareholders. Banks do keep a small amount available in case a customer demands some or all their deposited money. But banks use OPM for their own purposes and if bank traders become stupid and lose significant amounts, as history has proven, the government through FDIC steps in to ensure the customer’s money and, depending on the size of the bank, may even bail the bank itself out from its own mistakes. And, we did see a lot of that lately.
The government, on the heels of the Goldman fiasco, is working on a bill to limit what a bank can and cannot do. It also is considering how to define what limits the government will go to to bail out a troubled institution. In other words how big and essential is big and essential. The public wants the government out of the bail out bank business.
Whether banks like it or not, and its pretty much guaranteed they won’t like it, the new law will hinder bank growth and seven digit salaries of bankers. Any new law that is passed will be good until memories fade and people start to think that they are whole lot smarter and can handle risk and allow banks to do things that they weren’t meant to do and the cycle starts all over. Throughout history every time we get an economic crisis it’s because of greed and someone thinking they’re smarter then anyone else and wanting to get rich over it without caring about the consequences.
Former Federal Reserve Chairman Paul Volcker, 82, has an idea that is getting White House attention. Over the last few months the ‘Volcker Rule’ was consigned to the back seat as something too drastic but with the alleged Goldman fraud and the possible criminal charges it seems that the former Chairman has one last contribution to make.
The Volcker Rule, as it is being called, proposes that it would effectively bar banks from the lucrative trading for their own accounts if they are also in the business of loans and offering fixed products to regular people. In other words, banks have a choice, either service customers or trade but you cannot do both. Banks, as expected, are arguing that trading for their own accounts did not cause the economic crisis. But it seems that Volcker has been able to gather major supporters including the current CEO of Citigroup.
Not all banks trade for their own account. A good many are and were incompetent the old fashioned way and lost money to projects that failed because the bank did not have sufficient collateral or did poor underwriting on the loan. The Volcker rule will not help or hurt those banks. What Volcker does is finally sets limits on gambling with customer accounts, making billions for the banks themselves while paying next to nothing to the very people who’s money was and is being used for that purpose. What Volcker is simply saying and wanting to make into law is what we all are thinking, ‘Enough is enough!’ Until the next time.
If you have questions on the blog call Paul @ 877 783 7080 or write pstanley@westminsterfinancial.com and share this with someone who cares about their money.
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