Bank issues: More of the same for 200 years

Numerous and significant bank issues have headlined news since the financial crisis began in 2007 and these issues continue through the present.

U.S. citizens are well aware that U.S. banks have behaved very badly… from underwriting subpar credit mortgage to pooling them into a securitized, superior credit rated pool to dumping such securitized pools into their clients’ portfolios (while they were shorting the same securities) to taking huge bonuses based on bank earnings inflated by this flawed and often fraudulent business model. Bottom line, it was wrong and unfair that the banks used government-guaranteed deposits as a basis for their speculation and that their flawed speculation required taxpayer bailouts while bankers still got their bonuses.

What the bankers did was odiferous. It was a multi-step process and at each step, the bankers were promoting bad upon the public while richly compensating themselves.

The most recent example of horrific banking practices comes from across the pond as the UK-based Barclay’s Bank has admitted that it manipulated, over a long period of time, an international inter-bank lending rate, LIBOR (London’s Inter Bank Offered Rate, the rate at which banks offer funds to each other). Barclay’s has agreed to pay a fine of some $453 million.

LIBOR is hugely important as it is an interesti ncc rate index used in trillions of international loans. LIBOR is not a complicated calculation as it measures what it would cost a bank to borrow unsecured money. at If banks are mucking-up the transparent and very important, they might well be distorting much else in their banking business. If the simple transactions are manipulated, then there are even more possibilities with the complex aspects of banking.

The furor over banks’ powers is not unique to this new millennium. The debate about bank power raged for centuries. Yes, from long before the financial crisis of 2008, long before the savings and loan debacle of the late 1980s, long before the banking collapse in the Great Depression (1929-1930) and before the string of banking panics in 1907, 1893, 1873, 1857, 1836 and 1819.

The debate about bank activities — powers, leverage, use of deposits and regulations/ regulators — began immediately after the Revolutionary War. British colonies, such as we once were, could not establish their own banks. Only British (branch) banks were used. So, after the Revolutionary War, the founding fathers discussed the need for a national bank for deposit of government funds and for issuance of debt to finance the government. Not all Congressional leaders were in agreement about what type(s) of bank (federal or state chartered) should be created, who would regulate them and what types of borrowing activities would be allowed.

The key proponents for banks were Alexander Hamilton and merchants. But there were various arguments against banks being made by by Thomas Jefferson, James Madison, Martin Van Buren, farmers and other organizations.

Fact was, post the Revolution, there was very little physical money in circulation. Transactions were done by barter or personal notes and the non-merchant classes felt that they would have a big disadvantage (lack of access to the power and financing) that the banks ultimately would wield.

Specifically, Alexander Hamilton wanted to create a bank to act as intermediary for allocation of capital needed to rebuild the war torn country. His opponents argued that, by their very nature, the banks and those who controlled them would wield great power and in effect take away power from popularly elected government officials. Further, they argued that there was nothing specifically stated in the constitution to allow a national bank.

Hamilton won the fierce debate: he won the approval of George Washington by arguing that while the Constitution was silent on the creation of banks, banking was critical to business expansion and the constitutional silence was not a prohibition. The First Bank of the United States was created in 1791; it was based in Philadelphia and had branches through the states. But with the strengthening hand of Jeffersonian thinkers in Congress, the banks’ charter was not renewed in 1811. (“A short banking history of the US,” John Steele Gordon, Wall Street Journal, Oct. 10, 2008)

Therefore, lacking congressional support for a national bank, Hamilton went to the states, specifically New York State to get charters to open banks. And so began the powerful reign of New York City’s banks. Union bank began in 1811; Bank of America in 1812; City Bank in 1812 etc. These banks issued IOUs for deposits and these IOUs became a form of currency.

Now, some 200 years later, the U.S. citizenry finds itself in much the same quandary: what is to be done about the banks that wield great power and certainly fill the coffers of senior bank executives. Unlike 200 years ago, when banks were allowed to fail, these banks are thought to be too big to fail.

The TBTF issue will plague the U.S. until such time as it is no longer a threat, actual or perceived. The solution for the TBTF issue seems rather simple: Break up the banks so that the much smaller pieces can be allowed to fail. Because senior bank management has an incredibly sweet deal via stock options, salaries and bonuses based on billions that they control, there is huge incentive to keep the billions under one roof .

Will a breakup of the big banks ever be congressionally mandated? For those really wanting to understand the nitty-gritty of this issue, a very good read is “Will There Ever Be a Meaningful Volcker Rule?,” June 7, 2012, New York Times. There is a groundswell of public support for a breakup of the big banks by both citizens on the left and right. Because there are very important bankers/political donors on both sides of the political spectrum, there will probably be hedged rhetoric by both Presidential candidates. ¦

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