The Source of ‘Too Big to Fail’

Commercial Banking, Investment banking, and Insurance companies are three different animals.  They look different, smell different and act different.

 A successful Commercial Bank concentrates on safely managing customer deposits, savings plans and making collateralized loans to individuals and companies.  Commercial Bank managers are usually conservative and risk adverse.   The FDIC regulates member banks and guarantees deposits against mismanagement of funds (up to a current limit of $250,000). 

An Investment Bank underwrites new stock issues (where they guarantee IPOs), act as broker/dealers, and provide investment advice.  Investment bank managers are more aggressive and often take significant risks.  The SEC regulates most of these activities.

Insurance companies protect individuals and companies from financial loss in exchange for a fee. It is a form of risk management used to hedge against the risk of a contingent or uncertain loss.  Insurance companies may offer a number of policy types including property, life, auto, business, and others.  A successful insurance company must carefully manage risk to be profitable.  Insurance companies are regulated by the state in which they provide services.

The 1933 Banking Act (Glass-Steagall), recognized these inherent differences after the stock market crashed in 1929.  The GSA clearly states that the same bank can provide only one of these services at a time.  Two or more were strictly verboten.

Starting in the 1970s, larger banks began to push back on the GSA’s regulations, claiming they were rendering the large banks less competitive against foreign securities firms. The argument was that if banks were permitted to engage in investment strategies, they could increase the return for their banking customers while avoiding risk by diversifying their businesses.  These efforts culminated in the 1999 Gramm-Leach-Bliley Act (GLBA), which repealed the provisions restricting affiliations between banks and securities firms. 

The GLBA Act allowed Bank Holding Companies to act as Commercial Banks and offer other financial services. including insurance underwriting, securities dealing, merchant banking, stock underwriting, and investment advisory services.  Prior to this Act, most financial services companies were already starting to offer both saving and investment opportunities to their customers. On the retail/consumer side, a bank called Norwest Corporation, which would later merge with Wells Fargo Bank, led the charge in offering all types of financial services products in 1986.  American Express attempted to own participants in almost every field of financial business (even if there was little synergy among the businesses).

Things culminated in 1998 when Citibank merged with The Travelers Insurance Companies, creating Citigroup. The merger violated the Bank Holding Company Act (BHCA) of 1956, but Citibank was given a two-year forbearance based on an assumption that Congress would change the law.  They did!  Talk about the power of lobbies.

The BHCA essentially negated the Glass-Segal Act, allowing Commercial Banks to become Investment banks and vice-versa.  The only significant difference between pre 1929 and post BHCA is that these activities existed under the umbrella of a Bank Holding Company rather than a single entity.   

Banks Holding Companies then grew at an enormous rates creating giga from mega companies.  Risk management became exponentially more complex and difficult for auditors, federal agencies, owners, depositors, loanees and others to judge bank liquidly.

If the savings & loan bankruptcies, due to other causes, are removed from all bank bankruptcies, during 1970 - 2000, fewer than a dozen banking firms went bankrupt, totaling $125 billion (Continental Illinois National Bank and Trust accounted for $104 billion of this total). From 2000 – 2023, in fewer years, the totals included 62 banks for $742.4 billion.  Add SVB and Signature at $327 billion, the total for this period is $1,069.0 billion, over a trillion dollars.  As a result, in the last 23 years, following the passage of BHCA, bank bankruptcies have risen by a factor of 10 (not inflation-adjusted). 

We need to get back to bank basics. Fast.  I rest my case.

Graphic credit:  public domain

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