Thursday, November 3, 2011

PIMCO's Bill Gross: "Wall Street Sort of Lost Its Way"

According to Bill Gross, getting back to a system where traditional banking and investment banking are separate would be a good thing in terms of reform.

Here's what he had to say about it in this Reuters article:

"Do we have a better example today than MF Global in terms of the mingling of those two particular aspects of capital allocation...the closer we get back to separating the two, I suppose the better from the standpoint of reform."

In 1933 the Glass-Steagall Act introduced reforms that were, in part, designed to control speculation and separate investment banking from commercial banking. We'd just learned the hard way the dangers of intermingling the two. The repeal of Glass–Steagall by the Gramm–Leach–Bliley Act in 1999 effectively removed the separation.

For 66 years that separation seemed to serve us well.

Yet, by 1999 many with enough influence had come to believe that human nature had somehow changed. In their view, the world was now once again ready to combine the two activities.

"The problem today is to look ahead, and try to anticipate the problems that may arise that will give rise to the next crisis. And I tell you, sure as I am sitting here, that if banking institutions are protected by the taxpayer and they are given free rein to speculate, I may not live long enough to see the crisis, but my soul is going to come back and haunt you." - Paul Volcker speaking to the Senate Banking Committee in February 2010

The Volcker rule is a sort of Glass-Steagall-Light. It has been a struggle to put the rule in place (entrenched interests don't like it, of course) but the rule attempts to move us back toward what Carter Glass and Henry Steagall had in mind back in 1933.

More from the Reuters article:

"Wall Street sort of lost its way, in that investment banking became a function not of allocating capital properly, but levering capital and levering the returns on capital as opposed to transferring capital to productive industries," Gross said.

Gross added that banks should be more conservatively capitalized to create confidence in the system.

I think it comes down to:
  • Separating speculative activities from traditional banking
  • Making short-term highly leveraged trading less attractive via disincentives
  • Making long-term capital formation and allocation more attractive via incentives
  • Requiring more capital in the system
  • Changing the compensation systems at the executive level
Do the above and you've gone a long way toward a more sound and trusted financial system.

Adam
 
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