AMERICAN ENTERPRISE INSTITUTE

IS IT TIME TO REINSTATE THE GLASS-STEAGALL ACT?

INTRODUCTION: PAUL H. KUPIEC, AEI

REMARKS ON THE HISTORY OF THE GLASS-STEAGALL ACT: RICHARD SYLLA, NEW YORK UNIVERSITY STERN SCHOOL

PANEL DISCUSSION

PANELISTS: MARTIN BAILY, THE BROOKINGS INSTITUTION; OLIVER IRELAND, MORRISON AND FOERSTER LLP; PAUL H. KUPIEC, AEI; NORBERT MICHEL, THE HERITAGE FOUNDATION

MODERATOR: ALEX J. POLLOCK, R STREET INSTITUTE

10:00 AM–12:00 PM THURSDAY, JUNE 1, 2017

EVENT PAGE: http://www.aei.org/events/is-it-time-to-reinstate-the-glass-steagall- act/

TRANSCRIPT PROVIDED BY DC TRANSCRIPTION – WWW.DCTMR.COM PAUL KUPIEC: Well, welcome to AEI this morning. We have a very interesting event on — if I can get the slides up. The event today is entitled “Is It Time to Reinstate the Glass-Steagall Act?”

Now, commercial , as you all know, take in checking account and savings account deposits, and with the proceeds they make consumer and commercial loans. Investment banks underwrite corporate stocks and bond issues. They make some large business loans, but their primary business is underwriting and trading securities.

Before the of 1929, many banks in the US — let’s say some banks in the US — were universal banks. They conducted both commercial banking and activities under one roof. Some politicians blame the Great Depression on banks. Throughout the 1920s, as you can see in the chart up here, from the 1930s I think is where the chart was made, hundreds of banks failed in each year in the 1920s. And by the early 1930s, banks were failing by the thousands. And many depositors lost money. This is a prize-winning cartoon from the era, where a depositor, of course, is saying — the squirrel asks him, “Why didn’t you save money for the future?” And the guy, of course, did, and he lost it when his failed.

In response to the banking crisis, Congress passed and President Roosevelt signed the Banking Act of 1933, which included Senator Carter Glass and Congressman Henry Steagall’s compromise that created federal deposit insurance and simultaneously imposed what became known as the Glass-Steagall Act prohibition, making it illegal to do commercial banking and investment banking in the same institution.

Large universal banks like JPMorgan and Company were forced to break into separate commercial and investment banking operations. JPMorgan and Company, for example, split into JPMorgan, a commercial bank, and , an investment bank. Other institutions had to divest their investment banking businesses.

Commercial and investment banking remained separate until the late 1980s, when the Board began allowing holding companies to do a limited amount of investment banking in Section 20 bank holding company subsidiaries. By the late 1990s, bank holding companies were actually doing a lot of investment banking in Sector 20 subs, and there was a push to repeal Glass-Steagall prohibitions. The 1998 -Smith Barney- Travelers mega-merger, a banking insurance and investment banking, brought the issue to the fore. In 1999, Congress passed the Gramm-Leach-Bliley Act that legalized the merger by repealing certain parts of the banking act of 1933 and allowing investment bank, commercial banking, and insurance to be conducted in a new type of institution, a financial holding company.

Some blame the 2008 financial crisis on the Gramm-Leach-Bliley repeal of Glass- Steagall separation provisions. These folks believe that the repeal of Glass-Steagall prohibitions allowed banks to shift into risky investment activities and that these risk investment activities ultimately caused the large bank losses that required a taxpayer bailout.

In the recent presidential election campaign, candidate Donald Trump said he was in favor of considering the reimposition of Glass-Steagall Act prohibitions. And in March of this year, a bipartisan group of senators introduced a bill, the 21st Century Glass-Steagall Act of 2017, which would reimpose the 1933 prohibition on conducting investment and commercial banking in the same institution.

In this session today, Professor Richard Sylla, a renowned expert on history of the US financial system, will discuss the origins of the original 1933 Glass-Steagall Act and its ramifications for the development of the US financial system over the next 70 years or so. With this historical context fresh in our minds, we will turn to a panel of experts moderated by Alex Pollock. The experts — Oliver Ireland, Martin Baily, Norbert Michel, myself — will discuss the benefits and costs associated with the reimposition of the Glass-Steagall Act provisions today.

Now, let me begin by introducing our first speaker. Richard Sylla is the recently retired Henry Kaufman Professor of the History of Financial Institutions and Markets at the New York University Stern School of Business, and he is the current chairman of the Museum of American Finance in New York City. Dick’s research focuses on the history of money, banking, finance, and their influence on economic growth. He’s the author of many well-known books, including a history of interest rates. His writings appear in numerous scholarly journals, and he has served as the president of the Economic History Association and the Business History Conference.

Please join me in welcoming Dick Sylla. (Applause.)

RICHARD SYLLA: Thank you, Paul. It’s very nice to be back at AEI once again. The weather is better than it was in December.

Is it time to reinstate the Glass-Steagall Act? My comparative advantage, as Paul hinted, as a financial historian, will be to discuss how we managed to get the 1933 Glass- Steagall Act’s provisions separating commercial and investment banking to note that they were just a part of the Banking Act of 1933, which had other important provisions, such as deposit insurance, regulation of interest rates that banks could pay on deposits — later on, this became called Federal Reserve — a ban on investment banks receiving deposits. So Glass-Steagall was not just about separating commercial and investment banking. It brought in deposit insurance, Regulation Q you might say, and a ban which is still in effect; it was not repealed by Gramm-Leach-Bliley or Dodd-Frank, a ban on investment banks receiving deposits.

These provisions and others were key features of an act that passed the House by — get this, you know, and hard to get anything through today, but Glass-Steagall passed by a vote of 343 to 86. FDR signed the law, despite some misgivings. He didn’t like deposit insurance. The other provisions of the act are important for understanding its popularity at the time, as well as its impacts on our later — on our financial system.

Perhaps we shouldn’t be surprised that we’re talking about an issue like this today. There’s certain similarities between 1933 and now or recent years anyway. There were crises — financial crises, 1929–33, 2007–2009. These featured bank failures, bailouts.

Another similarity, the public was very angry at the banks and bankers in 1933. They had lost jobs. They had lost houses and they had lost bank deposits. Now, or at least recently, they lost jobs and houses, but they didn’t lose their bank deposits thanks to Glass- Steagall’s bringing in deposit insurance.

Then and now, there were banking scandals. Then there was — First National City Bank was one of the problems. That’s today’s Citibank. Chase had some scandal problems, had some scandal problems, and JPMorgan and others had what were viewed as scandal problems. And now, guess what? The institutions are not all that different. In the recent crisis, Citibank had scandals. JPMorgan Chase had some scandals. We all remember the London whale. Goldman Sachs had a number of scandals. And JPMorgan Chase — I guess I mentioned that one — yeah, they had some scandals.

So the scandalous players were not so different in 1933 than they were in the recent crisis. And in both cases, 1933 and recently, there were investigations. Then it was the Pecora hearings; more recently, in 2010–11, to mention just one, the Angelides Financial Crisis Inquiry Commission. Then, as now, there were populist politicians involved in banking, talking about banking reform. Then it was Henry Steagall and guys like and others. Now, it’s Bernie Sanders, Elizabeth Warren, and Donald Trump, maybe, and some others. And there were nonpopulist political reformers. Then it was Carter Glass — Senator Carter Glass, whose name is on the Glass-Steagall Act. Now we see Senators John McCain, Maria Cantwell, and Angus King, among others, sponsoring the idea of a 21st-century Glass-Steagall. So there were some similarities between then and now.

There are also some important differences. Then, some of the universal banks that Paul referred to — namely, First National City Bank, the Citibank, and Chase, actually before Glass-Steagall passed — said they were willing to get out of investment banking by winding down their investment banking affiliates. Now the universal banks, including JPMorgan, Chase, and Citi, say they want to keep on being universal banks, so they’re in a different position today than they were in 1933.

Back then, most banks were unit banks with one office and branch. Banking was quite limited in the United States, and where allowed, it was only within states or even cities and towns. And in contrast now, since 1994, we have nationwide branch banking. So that’s a big difference between that era and now. Finally, before Glass-Steagall, we did not have deposit insurance. And now, ever since Glass-Steagall, we’ve had deposit insurance.

So Glass-Steagall 1933 resulted from Carter Glass’ desire to separate commercial and investment banking. That seems to be what people think of as Glass-Steagall. They separate commercial and investment banking, and in the original act, that was what Carter Glass wanted. He was — he considered himself, whether rightly or wrongly, to be the father of the Federal Reserve system, and he thought the combination of the two, universal banks, investment and commercial banking was too risky, had messed up his cherished Federal Reserve, contributed to the 1929 Wall Street crash and the Depression’s bank failures. So that was where Glass came down.

And I said Glass-Steagall resulted from Glass’ point of view and the point of view of Henry Steagall, a congressman from Alabama. His desire was to institute deposit insurance as a way of preserving unit banking after many small unit banks had failed with depositor losses. Paul had this nice slide. Maybe you could put it up again because it reminds us what happened. Oh, you’ve got the cast of characters there too, right? But I think the one on the bank failures from 1921 to ’33 is something to impress on our minds.

So Steagall wanted to have deposit insurance as an alternative — you know, to protect the small banks as an alternative to the extension of branch banking. It seems strange to us today, but there were thousands, even tens of thousands of little unit banks in the United States. And one of their greatest fears was some big branch bank would come in and open a branch next door and undercut them. So they seemed to have a strong interest in preventing an extension of branch banking, but they were failing right and left, as the slide shows you, and Henry Steagall’s way of preventing that was to put in deposit insurance. The banks still might fail, but the public wouldn’t care because they were insured.

Deposit insurance basically was popular only with Steagall and the small unit banks and maybe the depositors who had lost their money in those banks when they failed, big millions of dollars of losses. Because of the historical record of deposit insurance in the United States, both before the Civil War, when there were some experiments, and in the 1910s and ’20s when some states tried to put in deposit insurance, that history was rather tainted. Most of the deposit insurance schemes before the Civil War and all of them in the 1920s failed.

And apart from those small bankers and Steagall and maybe the depositors who lost money, most people were against deposit insurance. The antis included Carter Glass, Franklin Roosevelt, and the larger diversified banks. The big banks saw deposit insurance as a way of taxing them to subsidize all of these thousands of small banks. So respectable opinion — which I think counts for a lot in Washington, DC — respectable opinion was against deposit insurance.

So how did we get Glass-Steagall? Carter Glass had said he could not support a banking reform bill with deposit insurance, and Henry Steagall said he could not support a bill without it. Steagall had failed to get his pet scheme on numerous earlier occasions, but by 1933 all those bank failures — that’s why they become very relevant to this discussion. All of those bank failures and people, you know, losing lots of money, had shifted the public’s opinion in Steagall’s favor. And so he took public opinion and used it to get through his favorite scheme after he had failed earlier.

So a compromise was crafted. Glass got his separation of commercial and investment banking. And Steagall got his deposit insurance. And Franklin Roosevelt swallowed his distaste for deposit insurance and signed the bill.

Many both then and later thought Glass-Steagall was a law to punish bankers for their misdeeds. The real story is a bit more complex. The various constituencies involved came to see gains as well as losses from this supposed crackdown on bankers. These constituencies included, of course, the big money centers, sometimes universal banks. That was one. Another one was the small unit banks. Third one was the securities firms, the broker- dealers, and investment banks. And a fourth constituency was, of course, the public. Maybe that was the most important one.

The big money setter banks had to get out of the securities business they were in. You know, that seems like a government cracking down on these big banks that nobody likes. But they gained something because Glass-Steagall had, as I mentioned, a ban of interest on demand deposits and federal regulatory ceilings on interest paid on savings and time deposits.

Now, the big banks, you know, used to have to compete, and they competed by raising interest. Wasn’t it nice that the US government came in and said, “You guys no longer can pay any interest on demand deposit, none of you. And we’re going to tell how high the interest can be on other deposits.” That was something that the big banks kind of liked. The small unit banks, of course, another constituency, gained from deposit insurance and staving off further development of branch banking. That was what Henry Steagall wanted. The securities firms gained in this way. They no longer had the competition of Citibank’s investment banking affiliate, the National City Company it was called, and Chase’s investment banking affiliate.

So the investment firms actually thought, you know, this is — gets rid of some of our competitors, even if they reconstitute in some ways. They won’t be as strong and powerful. I thought it was very curious: Around the time Paul Kupiac invited me today, I came across a piece where Gary Cohn, formerly of Goldman Sachs, now having a job somewhat nearer to here, actually came out and said, “Maybe we should think about Glass-Steagall.” You know, I was thinking, well, he’s at Goldman Sachs. You know, he’s not working for Goldman Sachs anymore, but he probably has stock involved in Sachs. If we had a new Glass-Steagall, that might cut down on the competition on the big universal banks with Goldman Sachs. So that I thought was interesting. And then the public or at least the bank depositors gained from deposit insurances. There’s that fourth constituency.

On the whole, this is a lesson of how legislations are actually made. It involves compromises, offsetting losses of particular constituencies, with something that they can regard as a gain. And was it good legislation that we should bring back? Well, you know, the best thing to be said in favor of that is that after 1933, this country had a half a century at least of kind of financial stability. One of the first things I learned in economics, of course, is that the post hoc propter hoc fallacy, you usually shouldn’t say that after this, because of this. But many people have kind of, whether it’s fallacious or not, have sort of said, you know, I think this is part of the motivation for bringing back Glass-Steagall — that we, under Glass-Steagall, for half a century or maybe a little longer, we had a lot of financial stability. And that’s in contrast with the financial turmoil or turbulence of recent years, which becomes a main argument for returning to Glass-Steagall. But Glass-Steagall led to some problems. In effect, it was a cartelization of commercial banking with price controls and limits on entry. For a while, commercial banks liked this, establishing the grand tradition of what some of you may have heard, maybe most of you heard called 3-6-3 banking. Without much competition, you know, you would pay the depositors 3 percent, lend the money out at 6 percent, and be out in the first tee of the golf course at 3:00 p.m. That’s what 3-6-3 banking was, you know, kind of nice and quiet, not too competitive.

But in time, those rules of the cartel led to a declining share of commercial banking in American finance as the innovative Wall Street firms increased their market share of all finance at the expense of bank share. Some of their innovations, like money market, mutual funds, brokers, sweep accounts on which you could write checks and expansion of commercial paper, led to disintermediation. The public started pulling money of the banks and taking it to the money markets since that caused problems for the banks.

Commercial banks, losing market share, increasingly chafed at the old cartel rules and regulations. They pushed for deregulation of banking, repeal of Glass-Steagall. By 1999, as Paul mentioned, they got virtually everything they wanted in the way of deregulation and repeal of Glass-Steagall. And then, of course, we had some more financial instability, the popping of the dot-com bubble in 2002, a bunch of scandals connected with names such as Enron, WorldCom, and then, finally, the crisis of 2007 and our rather slow growth thereafter.

Based on the history of how we got Glass-Steagall in the first place, I would guess that a 21st-century Glass-Steagall will be an unlikely event. Why? Mainly because I don’t see the various constituencies who would gain from it, so it will be difficult to cobble together a set of compromises to go with the Glass-Steagall separation. The big money center universal banks, unlike some of those in 1933, are against a new Glass-Steagall. Regulation Q, which benefited those big banks at first and then caused problems for them later — it’s gone now, and no one seems to want to bring it back. Small community banks now have deposit insurance and have nothing to gain from separation of commercial and investment banking. They can branch, and branch baking is no longer a great threat to them.

Securities firms have little or nothing to gain, unlike in the 1930s. , , and remnants of Lehman have been swallowed up by our modern universal banks. And Goldman and Morgan Stanley have become bank holding companies with access to Fed lending, so they don’t seem to have any great interest in the separation. The public may not like banks, but they perhaps like them or dislike them a little less than in the 1930s because they have deposit insurance. So it’s hard to see how a 21st-century Glass-Steagall would have appeal enough to interested constituencies to attract legislative support.

Its only appeal is to those who think that systemically important financial institutions and banks that are too big to fail need to be broken up and made smaller. It’s really about too big to fail, meaning banks are too big. That’s what I think is behind the 21st-century Glass-Steagall.

But is that really the problem? Did the combination of commercial and investment banking after 1999 cause the crisis? Most knowledgeable observers I think seem to think not. Lehman, the poster boy institution of the recent crisis, was not a universal bank. Neither were Bear Stearns or Merrill.

So a separation of commercial and investment banking today might be a solution to a problem that doesn’t exist. The real problem in the recent crisis was not universal banks that were too big. It was shadow banking, which financed the purchase of long-term assets with short-term money market borrowing — repo commercial paper, for example. Some chattel banks were run on and collapsed as that short-term money market financing dried up.

The old Glass-Steagall might contain the seeds of a solution to this shadow banking problem. It banned investment banks from taking deposits as a part of the separation of commercial and investment banking, but then in 1933 it defined deposits very narrowly as sort of your checkbook and your savings book and — in other words, just strictly defining deposits in regular commercial banks. That’s what investment banks couldn’t engage in.

Now, the shadow banks of our era could claim that their financing, like repo, commercial paper, and other forms of money market financing, were not deposits, and therefore, they could go out and — but, you know, in essence, they were like deposits. Repo and so commercial paper, these were — you know, a money market fund would sort of deposit its money in a bank, investment bank, chattel bank overnight and then take it back the next day. It really was something like a deposit.

So maybe we could look back to Glass-Steagall. If we broaden the definition of deposits that investment banks aren’t supposed to have that was in Section 21 of the Glass- Steagall Act, you might be able to solve this problem of short-term money market financing being recklessly engaged in until we have a crisis. And this idea is not original with me. I read it in a paper by a University of California law professor named John Crawford lately. He says that the way to solve a problem is to broaden the definition of deposits that investment banks can take to include repo and so on.

That, of course, would raise the — probably if we did that, it would raise the problem of how the shadow banks or, you know, shadow banks that I’ll say are the same as investment — how would they finance themselves? Well, they could borrow from commercial banks, and the commercial banks might be more careful than others were in monitoring those investments. Or they could have more, as many people say is a good solution, they could have more equity capital and retain more earnings. Either or both of those might make banking safer and still allow the shadow bank, investment banks to be financed.

Well, I got to the end of my remarks. I’m sure our panel will answer all these questions and solve this and other problems. And I don’t think there’s — well, I’m going to be able to answer questions later on, at the end of the table. So in the interest of moving the program along, maybe I should just stop now. So if you have a question for me, hold it until the discussion when I’ll be back up there. Thank you. (Applause.)

MR. KUPIEC: Let me just take a minute, although he needs no introduction, to introduce Alex Pollock, my former AEI colleague and now a distinguished scholar at R Street Institute. And Alex is going to moderate the panel session.

ALEX POLLOCK: If we can keep our speakers on the panel.

MR. KUPIEC: If we don’t lose any of them. (Laughter.)

MR. POLLOCK: Thank you, Paul. Ladies and gentlemen, we’re going to continue our discussion of is it time to reinstate the Glass-Steagall Act with our panel. As Dick Sylla made clear, really the part of the thing we’re really concerned with isn’t the Glass-Steagall Act at all. It’s the Glass Act. It’s Carter Glass’ particular idea that he got put into this act.

I’m going to introduce our distinguished and very knowledgeable panel shortly, but Paul asked me to begin with a few reflections of my own on the question of the day, so here are five minutes worth. Paul said we should discuss the benefits and costs of imposing a new version of the Glass-Steagall Act, but I don’t think there are any benefits, so that’s a short discussion. (Laughter.)

As far as I can see and as Dick said, not having the Glass-Steagall Act had nothing to do with the housing bubble of 1999 to 2006 or the resulting financial crisis of 2007 to 2009, and not having it had nothing to do with any other financial crisis, including the banking panic of 1932–33, whose numbers Paul put up there for us, or the Great Depression.

Meanwhile, having Glass-Steagall in effect did not prevent the huge financial crisis of the 1980s. Having Glass-Steagall in effect did require, I believe if you look over the history, making the commercial banks act as assistant lenders of last resort to the Federal Reserve when the Fed wanted to prop up floundering investment banks as it did, for example, in the commercial paper market collapse of 1970, which followed the bankruptcy of the Penn Central Railroad, or in the stock market panic of 1987. So you’ve got this funny role of Fed, commercial banks, and investment banks because you had Glass-Steagall.

Now, the fundamental problem of banking is in Walter Bagehot’s memorable phrase “smallness of capital” — in other words, bigness of leverage. And so-called traditional commercial banking is a very risky business, principally because making loans on a highly leveraged basis is very risky, and all financial history is witness to this fact. Moreover, making investments in securities — that is, buying securities, as opposed to being in the securities business of creating and distributing them — has always been part of so-called traditional commercial banking. You can make bad loans, and you can buy bad investments being a traditional commercial bank. Such bad investments were, for example, subprime MBS as it turned out and also, for example, the preferred stock of and , the buying of which sank a fair number of traditional commercial banks.

Now, just to the north of the United States is Canada, as you may recall. Canada’s banking system is generally viewed as one of the most stable, if not the most stable, in the world, and there’s no question that it has a much better, much better historical record than does the banking system of the United States. All of the big Canadian banks combine all financial businesses, including investment banking, with their commercial banking, and they’ve all done very well. So Canada represents a great counterexample for Glass- Steagall enthusiasts to ponder.

In Canada now, there is a question of a housing bubble. But if this does get the Canadian banks in trouble, it will be because of their purely traditional commercial banking business of making loans — in this case making real estate loans — and those banks will then be very glad of the business diversification, which is provided by their investment banking and other financial businesses.

It seems to me that if you really want to prohibit something to make the banking system safer, what you need to do is prohibit real estate lending. It’s certainly true that real estate is at the base of most banking disasters, and that’s why the National Banking Act did in fact prevent national banks from making any real estate loans. Now, if that seems a little too radical for you and you don’t want to prohibit real estate loans, you could just strictly limit them in the commercial banking system, and then you could perhaps call that a 21st- century Glass-Steagall Act. That’s my suggestion.

Now, to our panel. Our first speaker, Oliver Ireland, is a partner at Morrison and Foerster, where his practice focuses on retail financial services, including consumer protection regulations, and the powers of the CFPB and payment transactions and in general the regulation of banks, thrifts, and credit unions. Oliver was previously associate general counsel for monetary and reserve bank affairs at the Federal Reserve Board, and he advised the board on a broad array of financial issues from 1985 to 2000 as Glass-Steagall was fading away.

Next will be Martin Bailey, who is the Bernard L. Schwartz Chair in Economic Policy Development and a senior fellow in economic studies at the Brookings Institution. Martin is also a senior adviser to the McKinsey Global Institute, the Albright Stonebridge Group, co-chair of the Financial Regulatory Reform Initiative of the Bipartisan Policy Center, and a member of the Macroeconomic Advisors Board of Experts. And, previously, he was a member and a chairman of the President’s Council of Economic Advisers.

Our third speaker will be Norbert Michel, the Heritage Foundation’s research fellow in financial regulations, where he focuses on financial markets and monetary policy, including reforming the Dodd-Frank Act and the reform of Fannie Mae and Freddie Mac. Previously, he was a professor at the Nicholls State University’s College of Business Administration. I have the pleasure of sharing the panels so often with Norbert, and he usually has unambiguous views. And I suspect that’s also true of his views of a future Glass-Steagall Act.

Last will be Paul Kupiec, who, as you already know, is a resident scholar at AEI and is the organizer of this very timely and interesting conference. Paul brings his iconoclastic insights to the management and regulation of banks and financial markets, including so- called systemic risk and the impact of financial regulations on the economy. He was previously director of the Center for Financial Research at the Federal Deposit Insurance Corporation and served as chairman of the research task force of the Basel Committee on Banking Supervision, so, as I said, an extremely knowledgeable and expert panel.

Each panelist is going to talk for about eight minutes. And when we’re done with that, we’ll get Dick Sylla to come up and join us. We’ll then give everybody a chance to react to each other’s views on the panel, including Dick, or clarify points, as they like. And, after that, we’ll open the floor to your questions. And we will adjourn promptly at noon.

And, Oliver, great to have you here, and you have the floor.

OLIVER IRELAND: Thanks, Alex. When we talk about this — the return to Glass- Steagall — I hear this term thrown around a lot. I don’t think anybody that I’ve seen is actually talking about going back exactly to the Glass-Steagall Act provisions that have been subsequently changed. Nobody, for example, is talking about reinstating Regulation Q, and that was finally knocked out in Dodd-Frank. You know, that’s not what they’re talking about.

Even when I look at the Senate bill that purports to be a 21st-century Glass-Steagall, it talks about banking, it talks about — and in securities business, it talks about insurance business, it talks about derivatives business. It isn’t Glass-Steagall. It’s something different. It is separating banking from some other set of concerns rather than just investment banking.

And that seems to be premised on the theory — and I’ve heard this expressed two different ways — that either these other businesses are risky and, therefore, you’re protecting the bank from the risk of those businesses, which I think is sort of interesting. I once heard a Fed governor ask the board, “Does anybody really think there’s a difference in risk between investing in wheat futures and lending to wheat farmers?” And nobody thought that that was the case. Now, maybe that was just the wrong board, but at that time nobody thought there was a fundamental difference.

The other is that you want to separate post-Glass-Steagall because of the deposit insurance component of Glass-Steagall that you want to separate the insured bank from other businesses to prevent the spread of the effect of the deposit insurance subsidy. And so you’re trying to limit the spread of the deposit insurance subsidy and keep it from affecting those other businesses. And that’s part of the theory of separation of banking and commerce, part of the theory of holding company structure, and you already have that because you have — even within a bank holding company you have the bank and you have the activities. Investment banking activities are done in a holding company affiliate, and they are separated by the restrictions of 23A, which, by the way, was also part of Glass- Steagall.

So it’s not clear where that’s going. The other, which I think has already been mentioned, is it’s just this good, old “too big to fail,” and we’re trying to break up the big banks because the big banks had to get bailed out this last time around. Now, big banks have been bailed out before, and small banks have been bailed out before. We had a reconstruction finance corporation in the ’30s. We had a lot of thrifts fail in the ’80s, and we had a resolution trust company. A lot of those got closed. We had the state of Ohio and the state of Maryland bail out their small state-insured thrift depositors at least by after their insurance funds failed.

So the idea of bailing out organizations isn’t limited to the big guys. It can happen more broadly to include smaller organizations as well, so the idea of “too big to fail,” while popular, I think doesn’t really address financial crisis problems. I think financial crisis problems are basically asset quality problems. And if you have asset bubbles, you have bad effects in the economy, and it affects financial institutions and other people. That’s just what happens. And the problem is the asset bubble.

The fifth version of Glass-Steagall I think reminds me of a professor I had in college, and he was a Yale law professor named Charlie Reich. And he wrote in the ’60s “The Greening of America,” and it was a counterculture favorite at the time. And he used to talk in class about simple peasant rhythms and returning to the wonders of the Middle Ages, where people all lived better despite the Black Death and everything else. (Laughter.) And as I see the term Glass-Steagall thrown around, the sense I get is somebody is trying to argue that the system was better in the past. And this is a buzzword for better in the past, and so we’re going to talk about Glass-Steagall.

The question is: What proposals are we going to see on the table? I think the chances that we see an actual word for word, and there’s some technical language we can get into later if we get into questions about how this evolved. The idea we get to that actual Glass- Steagall, the chances of that are zero. The chances that the current proposed Senate bill on Glass-Steagall passes in the current administration I think are also probably zero. Maybe you can get them up to 1 percent, but who knows what happens.

Is somebody going to look at restructuring the financial system as part of the rollback of Dodd-Frank regulation? We expect to see a study of — the first report out of the Treasury, not the only report but first report following the Trump executive orders within a week, I think. I count the days. That might well happen. What’s it going to look like? Hopefully it’s going to try to adapt to the 21st-century markets, but a return to Glass-Steagall I think is a discussion under using that as a term and not really a realistic discussion.

MR. POLLOCK: Thanks.

Martin.

MARTIN BAILY: Thank you. It’s a pleasure to be here at AEI. My only hesitation is a lot of things have been said already, and most all of them I’ll agree with, so I may just reinforce some of the things that have been said.

Now, I’ll say one thing in which I may well differ quite a bill from other panelists, and that was I’ve been in general a supporter of the Dodd-Frank legislation. I think it would be helpful, particularly if we didn’t live in such polarized times, to sort of step back at this point and say, “How is Dodd-Frank working? Is it working in a way that we wanted it to? Are there things that need to be changed about it? Are there things that need to be changed about the way it’s being administered? Can it be done more efficiently?” So I’m not of the view that was this was set in stone, but I think, on balance, it contained a lot of provisions that were needed in order to stabilize the system.

Now, should we layer on top of this or layer onto whatever remains of Dodd-Frank after it is revised — and, by the way, probably much more likely that any changes to financial regulation are going to occur through the regulators — changes in the regulators are opposed to change in the legislation, since it’s so difficult to get things through Congress these days.

But should we think about Glass-Steagall? So the answer to the question in my view — should we reinstate Glass-Steagall — my answer would be no. I don’t think the benefits are very great, and the costs may be fairly high.

So if we look back historically — and this has been mentioned really — I mean, the sort of case for Glass-Steagall is to say, well, we went from 1933, we did have, of course, financial issues in the 1980s, so we didn’t have completely smooth a ride but we didn’t have a major financial crisis until the one we’ve just been through. So did Glass- Steagall play any great role in that?

Well, I think one thing that was important was to limit the margin borrowing on speculating in stocks so that when we had ups and downs in the stock market, they didn’t have the same impact that I think contributed to the Great Depression. So, for example, we had a — the stock market in the 1970s, if you adjust for inflation, looked almost as bad as the stock market in the 1930s, and while that was a difficult period, there were other reasons, oil prices and so on, for that. So the weakness of the stock market didn’t induce the same kind of financial crisis in the ’70s.

And then again, the stock market did poorly in other periods, 1987, and then after 2001, the crash of the technology stocks. And there was a recession I think that came as a result of that crash in the stock market or partly as a result. But it was a very relatively mild recession. So what we haven’t seen has been sort of leveraged buying of speculating in stocks, and so I think we have taken some of the instability out of the financial market as a result of that. But that doesn’t mean we have to have Glass-Steagall.

So, again, at the risk of repetition, I think if you look at the recent financial crisis, and you’d say, well, who failed? Bear Stearns, Lehman, , IndyMac, Countrywide, Fannie, and Freddie. So these were not universal banks. Citi, of course, got into trouble. Citi’s had a history of getting into trouble. But it doesn’t look as if being a universal bank particularly was a predictor that you were failing. So that really doesn’t suggest that Glass- Steagall or the end of Glass-Steagall played a particular role in the most recent financial crisis.

So what if you were to reinstate it anyway? Well, I think it would be costly. It is — for one thing, I think it’s a bit much. Regulators after all were sort of carrying the shotgun in some of the marriages that occurred around the time of the financial crisis. They were encouraging or almost telling some of the banks they needed to — in the country’s interest, they needed to merge with failing institutions, and so they became bigger as a result of that. JPMorgan Chase became bigger, and became bigger. So they were taking advantage of the strength of some of the institutions to try to absorb some of the failing institutions. And now we’re sort of going to turn around and say, “Oh, well, you know, now you’re too big” or “Now you should break up.” So I think that we ought to at least try to be reasonably consistent in the way that we diversify and not sort of whipsaw the institutions back and forth.

Now, I know there are a lot of people, maybe some in this audience, but certainly out there in the rest of America that hate the banks, and so they would say, “Oh, what the heck. I don’t care if we’re doing this to them.” But I think some degree of consistency would be something I would look for.

So if you think that the banks — if you — you know, despite the fact that we have promoted larger banks, if you think that now the banks are too big to fail, does breaking them up along these lines — would that be the right way to make them smaller?

Well, I think there is obviously — there are alternative ways, and I think the Federal Reserve has really pushed in the direction of saying, “Qe’re not going to try to break you up per se.” But the goal of making the largest institutions somewhat smaller and reducing the “too big to fail” threat will be achieved through capital standards and the capital surcharges associated with the largest banks. I have mixed feelings about those. I can see the logical reason for it: The larger the bank, the more the sort of spillovers that you would have to the rest of the economy and, therefore, the higher the risk you want the bank to internalize.

And I do think in general that having plenty of capital is an important part of having a more stable banking system. But if you really want to make the banks smaller, then I think doing it through the capital requirements is probably a better way to go than breaking them up on functional lines, which, as we said, doesn’t seem to have been a key factor.

And, in fact, one could make the argument that there are advantages to size and advantages to diversity of activities. As two or three people have noted already, lending money to small businesses, which is something we want banks to do, is a risky activity, probably the most risky thing that they could be doing. And so if they have other activities that they’re earning money on that can insulate them — so, for example, JPMorgan, the whale activities, well, that was obviously a failure by JPMorgan to make sure they had risk strategies in place for their own bank. But they were able to swallow those losses relatively easily so that being as large as JPMorgan was actually an advantage in that it was not threatened by that — by the London whale really. So there are advantages to size there as well.

I think so the last comment I’ll make, and that is that the issue, and I think it’s been identified here, is not only capital. We need to have enough capital, but there has to be some limitations or some regulations around the use of short-term wholesale funding. Obviously, in the old days, before deposit insurance, retail deposits were pretty runnable, and they did run. And in those countries that had limited deposit insurance, people were lining up to get rid of that, to get their deposits out. And, of course, some people were lined up here in the United States in the crisis, but it was very limited. I have an account in Citi Bank, and Citi Bank was looking very bad at different points, and I kind of thought, well, I don’t have to take my money out because it’s insured.

So you have in a sense through deposit insurance given banks a very stable form of funding, and you have to make sure that they don’t then go into wholesale markets and use repos and other forms of short-term funding and then endanger the whole system. So I think some of the regulations which are not only around capital but a net stable funding ratio and so on that were part of Dodd-Frank I think were also worthwhile. It sounds like I’m out of time, and I’ll stop. Thank you.

MR. POLLOCK: Thanks, Martin.

Norbert.

NORBERT MICHEL: Thank you. So I wish that I could share Oliver’s sort of optimism for there being no chance of any new version of Glass-Steagall being implemented. You’ve got it in both the Democratic Party and Republican Party platforms, and it’s in the Republican Party platform largely because of the president of the United States. The one member of the Senate Banking Committee is cosponsoring a bill to do exactly that, and the Banking Committee is chaired by a senator who is known for bipartisanship, which in this environment means doing what the other side wants to do. So I don’t share the optimism that this is a dead issue, and I wish it was. It’s incredibly unfortunate that this is the kind of stuff that we’re spending time on. And I say that because of various reasons.

One is the basic evidence of what has happened really in the postwar era. If you look, as of 1995, there are only two countries — two industrialized countries that had a separation of commercial and investment banking. It’s the United States and Japan. And Japan only had it because the United States forced them to have it. None of those other countries — none of those other major industrialized countries had a banking crisis. We had two. So superficially, you have a big hurdle to get over, OK?

Now, when you look beyond that superficial evidence, if you look at financial theory, it would tell you that you don’t want to have a bunch of narrowly constructed companies that can only invest in effectively one type of asset. That’s exactly what the Glass-Steagall type restrictions do. That’s the wrong approach. You want a diversified approach. You want a diversified portfolio if you’re an investor, and if you impose that theory on the firm, you end up in the exactly the same place. You want the firm to be well diversified, not narrowly dependent on one type of asset.

And I think Oliver had another great analogy. You know, this idea that Glass-Steagall prevented banks from making speculative risky investments is dead wrong. Commercial loan is a risky speculative investment, plain and simple. And the notion that you can prevent those sorts of risky investments by not letting the bank make a market or have its own trading book in something like wheat futures while at the same time lending to the wheat farmer is, again, dead wrong. You’re mixing things up because of things that you don’t understand when you argue that that’s what we should be doing.

Now, another part of this, if you look at the evidence from the pre-Glass-Steagall era, we have one of these rare instances where the theory and the evidence actually match. It’s almost unbelievable. I encourage everybody to read George Benston’s book “The Separation of Commercial Investment Banking.” It is almost unbelievable how little evidence and how little discussion of the effect that the separation would have on the safety and soundness of banks during those 1930 hearings. It’s almost unbelievable.

After I read the book, I had to go back and read some of the committee reports on my own — it’s that unbelievable. It just wasn’t done. This is nothing more than a Carter Glass pet project. He believed in the real bills doctrine, he wanted to impose that because he thought that was the right way to go, and that’s basically it.

They didn’t talk about this stuff. They did a lot of salacious stuff. They did a lot of public shaming. They did a lot of blame casting without a lot of evidence, much like what happened in the Dodd-Frank hearings, by the way, but that’s a separate issue. If you actually look at the evidence though of the pre-Glass-Steagall era, and I’ll just do as many highlights as I can quickly do here, these are various studies, and most of these studies with I think one exception were not discussion in any of the hearings, even in the later Pecora hearings. This was not done. This was not covered.

From 1930 to 1933, 26 percent of all national banks failed. Only 6.5 percent of the 62 banks with security affiliates failed. Similarly, of the 145 banks with large bond operations, only 8 percent of those failed as opposed to the rest. Overall, that study shows that securities underwriting and diversified banking come in reduced risk failure, which is exactly what the theory would predict.

A separate study from 1942 acknowledges this fact, that in the Glass Committee hearings, they did not actually compare securities floated by integrated banks, their performance to those that were floated by specialized investment banks. So the study did that, and it found that the bonds of the private banks performing both commercial and investment operations were superior to those of the non-affiliate and affiliate banks.

A separate Federal Reserve study, which was actually sent to Carter Glass prior to the passage of the 1933 act, suggested that the bond losses were not a disproportionate cause of bank failure. The study examined a sample of 105 member banks whose operations were suspended in 1931. Bond losses were cited as the primary cause of failure in only six of those 105 banks and as an important contributing cause of failure in only four other cases.

A separate study finds that in the pre-Glass-Steagall era, bonds underwritten by integrated banks defaulted significantly less often than similar issues underwritten by investment banks. And if you go through the hearings — I’ve still got about four minutes, right? If you go through the hearings, what is even more striking is that they actually took evidence that contradicted the premise that you should be separating these things because they would make things more risky.

And I’m not talking about, you know, just opinions of just anybody. Senator Glass in one of the hearings asked the comptroller, J. W. Pole, “What do you conceive to be the general cause of numerous bank failures for the last five or six years?” The comptroller blamed economic changes and stated, “I know of no instance where the shrinkage in value of collateral or bank investments as far as national banks are concerned has been responsible for any bank failure,” and then he kind of hedged and said, “Or at least very, very few.”

J. H. Case, chairman of the board of directors of the New York Fed, literally blamed the crisis on overbanking, too many banks relative to the demand for banking services.

H. Parker Willis, key adviser to Senator Glass, asked the vice chairman of what was the First of Boston, B. W. Trafford, “Do you think those investments in bonds, which was a lot of the securities at the time, do you think that those have had any significant cause of bank suspensions in the Northeast or in other parts of the country?” He went back and forth a little bit, Willis pressed him, and finally, he said the security movement. “Are you saying that the security movement has had nothing to do with the bank failures in your part of the country at all?” And he responded, “No, not this last year.”

The president of the First National Bank of Fergus Falls, Minnesota, testified, in the past eight years, nine banks have failed in our country. No national bank has failed. While the failure of these nine banks was due in part to unwise loans during the land boom period, there was dishonesty in nearly every one, and 10 officials of the banks which failed in the Fergus Falls area were sent to the penitentiary. Practically every one of these little banks which failed was in the farm land game, and that’s a whole other story, but that’s not commercial and investment banking combinations.

Senator Peter Norbeck from South Dakota asked a member of the Federal Trade Commission what he believed was the cause of the Minnesota bank failures, and March also replied, “I attribute the failure to the condition of the agricultural company.”

At the risk of not boring you to death, I won’t continue, but that’s what was actually going on. You don’t have evidence in this last crisis, and you don’t have evidence in that crisis that a separation of commercial and investment banking would really do anything for the safety and soundness of the banks other than make it less — make them less safe and less sound. I’ll stop there.

MR. POLLOCK: Thank you, Nor.

Paul.

MR. KUPIEC: So let me get this straight, Norbert. One powerful senator whose favorite pet project disagrees with all the evidence still could get something passed that lingered for 50 years?

MR. MICHEL: That’s my — (off mic).

MR. POLLOCK: When the opportunity was created by the crisis.

MR. KUPIEC: So I have some slides here somewhere that I will get to in a minute. Those are the two guys — that’s the guy on the left that was the — anyway. There’s only one concrete Glass-Steagall proposal that’s actually been drafted into a proposal for law, and it was introduced in March by Senator Warren, Senator McCain, Senator Cantwell, and King. And before you — and I know you all won’t believe me anyway. You think I stacked the panel to be against — I know you all think that, and everybody watching TV. I actually sent many an email to Senator Warren’s policy people trying to get them to put somebody on, you know, the panel, and they said there wasn’t any way they could possibly do it. And then I reached out to Sherrod Brown’s staff and asked him if he would or if his staff would, you know, want to put somebody up here that would want to talk about the law, and I couldn’t get anybody there either, and by that time I gave up.

But, anyway, so the law that’s been proposed in March, the goal is essentially to protect FDIC-insured deposits by eliminating the risky activities of insured institutions. And so if this were to become law, depository institutions would essentially have to become narrow banks. They would have to accept deposits and make consumer and commercial loans. They would be prohibited from being affiliated with any institutions engaged in what are wholesale securities market activities, investment banking, broker dealing, swap dealing, futures dealing, hedge fund ownership, prime brokerage services, issuing or investing in structured financial products. Those are mortgage-backed securities and other things, so that would be a pretty severe restriction.

So if the law were passed, the bank holding companies would have to divest ownership of affiliates engaging in prohibitive activities, and they’d have to get rid of their investments and derivative positions that weren’t allowed. So what I did was I went to the regulatory data and I looked at the top largest 10 bank holding companies, the 10 largest “too big to fail” financial institutions using December data from last year, the Y-9C reports of the Federal Reserve for the holding company. And I tried to estimate what would happen to the 10 largest bank holding companies if this law were imposed.

And there’s two ways you could look at this. You can look at their balance sheet, and you can sort of — by going through the balance sheet, you can try to pick out the assets that would have to be sold if the law were passed, and that’s one approach at it. And you’re never going to get it exactly right, but you can kind of guess. You kind of know what categories, you know, they couldn’t hold anymore. Or you can go to the income statement side, and you can look at the income components and determine which one of those they wouldn’t be allowed to earn anymore because they wouldn’t be allowed to do that business.

And so I looked at it both ways. And from the asset approach, here’s the 10 top bank holding companies in the US. And when I went down, you can see their assets, and you can see the percentage of the holding company assets that are actually funded by deposits. So that’s one thing. If we’re trying to protect deposits, you know, how much of these activities are funded by deposits, that’s the sort of second column of numbers over there. And then I tried to estimate the percentage of assets that would be prohibited under the new law and then estimate the size of the institution after it got rid of those assets.

And one notable thing is — my animation is not working, so anyway. I should have had a red box around Goldman Sachs and Morgan Stanley because Morgan Stanley and Goldman Sachs are primarily investment banks, and what they would divest under this, their assets would be their banking — they had banking subsidiaries. So they would only have to divest the little bit of their holding companies that are actually banking and, for Goldman Sachs, it’s about 12.3 percent and for — it’s a little bit bigger with Morgan Stanley. So both of them have actually what are grandfathered industrial loan corporations that are deposit- taking institutions. They’d have to get rid of those.

So those guys would specialize in investment banking, those two. Everybody else would go I assumed to be a specialized commercial bank, and what would happen at the end of the day, they’d still be the two the largest — if you compare these after you get rid of the assets — they’d still be the 10 largest “too big to fail” institutions in America with the possible exception of TD Group at the end, who might be eclipsed by New York Mellon bank, which is number 11 right now. It just depends on how — it’s close enough that you can’t call it. But, basically, they’d still be the biggest, 10 biggest “too big to fail” institutions in America.

And if you go and you look at the income approach side, you get different numbers, ballpark same thing. And, again, here, Morgan Stanley and US BANCORP the prohibited income here of — 70 percent, 75 percent, that’s actually the income they keep because they would keep their investment banking operations. So, here, that’s kind of they would shrink — their income would shrink because they have to get rid of commercial banks, and it would knock out for Morgan Stanley about 25 percent of its income and for Goldman Sachs about 30 percent of its income.

So, anyway, either way you look at it, income or asset side, the 10 largest “too big to fail” institutions in America would remain the 10 largest “too big to fail” institutions in America. But if you think about what would happen to the dynamics here in the market, you’d really just end up redistributing assets across these CFIs. The holding companies JPMorgan Chase, Bank of America, Citi, they would have to sell investment banking assets, businesses. Who’s going to buy them? Well, Goldman Sachs and Morgan Stanley. They’re going to be really big bidders for that.

And, you know, before the financial crisis, we had five large investment banks. Now we have two. So if we were to put a law into effect here, chances are you’d have this increase in concentration in investment banking. These two, Goldman Sachs and Morgan Stanley, are likely, you know, to take up the business of what the bigger banks are going to have to shed.

So, to me, if you look at it that way, maybe that’s not the outcome we were looking for. So the top 20 SIFIs remain CFIs. They all remain CFIs, and actually they probably remain the top 10 CFIs even if the law is passed. As many of my colleagues have mentioned, it’s not clear that the commercial bank depositories that are left are any safer after divestiture. They have less diversified income streams. The concentration in the investment banking sector is probably going to increase. Goldman Sachs and Morgan Stanley, while they’re going to shed their commercial banking activities, they’re going to accumulate investment banking activities and probably grow and no shrink in the end, and the concentration is going to increase the fragility of the financial system. You only have two big investment banks, and there’s little doubt that the government would have to come to their rescue I think if they got into trouble.

So I want to sign off there for now and continue on with the Qs and As.

MR. POLLOCK: Thank you, Paul, and thanks to all the panelists for really interesting discussions. At this point, we’d like to invite Dick Sylla to come up and join us.

Thanks, Dick.

What I want to do now is just go back down the panel, just start with Oliver and go down and end up with Dick and let everybody take a couple of minutes — let’s say three minutes maximum — either to react to anything somebody else has said or add some ideas or clarify ideas.

So, Oliver.

MR. IRELAND: Thanks. I’d like to just address one thing, and I think it was brought up by Martin, which is — and he said it in a couple of different contexts, but it was the emphasis on capital and margin.

And you hear the slogan. We have, you know, more capital that’s better, and there are a lot of people who think more margin is better. And you can — I remember a young Fed economist once did a study where they put all the margin requirements of all the exchanges in the world into a computer and compared volatility and didn’t find any real correlation between those.

But if you look at the history of bank capital in the United States, bank capital in the pre-national bank era tended to run about 40, 50 percent. And as you increased the level of regulation and supervision of banks progressively through the , the , the Federal Deposit Insurance Act, the Glass-Steagall Act, and so on, that number declined into something under 10 percent, and now it has started to go back up. And one of the points is that by regulating the institutions and overseeing the institutions, you reduce the cost of financial intermediation because capital is a cost. And as you raise capital you increase the cost of financial intermediation, and it’s essentially a tax on the economy. And we have had over the last — during this financial crisis, we have had an extremely accommodative monetary policy — the most accommodating monetary policy I could think of. And, at the same time, we keep raising capital requirements, which moves in exactly the opposite direction from a macroeconomic standpoint.

Just a side note on capital numbers, I took the current G-SIB capital requirements, including the total loss absorbing capacity requirement, and applied it to the balance sheet of the Continental Illinois Bank as of June 30, 1984. And the numbers you get out of that — assuming continental is a G-SIB and has a G-SIB surcharge because it was the seventh-largest institution in the world. There were G-SIBs in the US, not 10, and you left out State Street and Mellon.

MR. KUPIEC: Those are the 10 biggest by assets.

MR. IRELAND: Those are the 10 biggest by assets but not by the Fed scoring system. But anyway, you do that and you look at the capital in Continental, you look at the total FDIC bailout package, everything they put into it, and you come up with capital leftover after you’ve done that. So we are now at a capital level that exceeds one of the most significant failures, and Continental was in very bad shape. They were in asset quality position at that point in time. So if we’re trying to get rid of “too big to fail” just on a capital basis, I think you’ve done it. And if you think you need to go further and do that from a capital standpoint, I think that’s a mistake, and you’re just taxing the economy.

I would point out, on the margin front, there were margin requirements introduced in the ’30s, federal margin requirements for the stock market. Those margin requirements are initial margin requirements only they are not maintenance margin requirements, that is they do not adjust as the value of the securities fluctuates going forward. The exchanges have maintenance margin requirements. I think in the long run, in terms of risk control, maintenance margin is probably more significant that initial margin.

MR. POLLOCK: Thank you.

Martin, additional comments?

MR. BAILY: I’ll be very brief. I’ll really just sort of respond to the last comment. I agree that capital is a cost of intermediation, and I think it’s very hard to assess exactly what the right capital levels should be. I’ve had a number of conversations with Alan Greenspan where he’s pointed out that, historically, bank capital was much larger. And he says it was fine then — why shouldn’t we have 20 percent capital now? And the Choice Act, as we know, has suggested a 10 percent leverage ratio. It’s very hard to know what the right number is. But I agree, it’s a cost and margins are a cost to the economy. And we sort of have to weigh the probability of failure against that cost.

I do think using long-term unsecured debt to create a total loss absorbing capacity, which I think is less expensive for the banks and for the economy than capital itself, is a helpful innovation. And in the event a bank gets into trouble, then this long-term unsecured debt will basically turn into equity. So I think that helps to reduce the cost.

But I don’t know that you were disagreeing with my point that we have been able to avoid financial crises induced by gyrations in the stock market, but it does appear that that’s the case, and I think it’s been at least in part because of limits on the leverage associated with stock market holdings.

MR. POLLOCK: I am inspired to jump in here with a quick story. One of the speakers, I think Martin’s point on the margin requirement for stocks is a good one. One of the great cartoons that came out of the most recent of the many historical financial crises was in “Grant’s Interest Rates Observer.” And it shows a good-looking 40-some year old guy, obviously a senior trader at a Wall Street firm, but he’s looking very frazzled and his tie is loose and his shirt is rumpled and he’s on the phone and he’s saying, “OK. OK. I’ll try it again. Please, pretty please, Mr. Margin, clerk, sir.” (Laughter.) Norbert, additional comments.

MR. MICHEL: So I don’t have a cartoon story. I just — and I’m not really disagreeing with anybody in particular. Just a couple of things that I heard that I just want to come back to really quickly.

One is that, you know, we in Washington tend to have incredibly short memories. And, again, I’ll go back to a little bit of history, and I’m not the historian that Dick Sylla is, but I read a lot. Go back and read the hearings in the 1980s — early 1980s around implementing the Basel requirements. The regulators were tripping over themselves at how proud they were of increasing capital, literally, in an absolute sense of billions of dollars in capital, and in percentage terms of percentage increase in capital for the large banks and how safe this was going to make everybody. We know how that turned out. So we should be really careful now, I think, although I’m not saying that banks should have less capital. I’m just saying we should be really cognizant of how that might not actually solve the problem.

And another thing I’ll just kind of point out, in terms of the so-called shadow banking or these wholesale funds, repo markets and so forth, you know, maybe I am kind of disagreeing a little bit on that one. I don’t think that there’s any problem with those vehicles per se. If you look at the 2005 Bankruptcy Act, you see a lot of changes made that put — that essentially made all of the wholesale funding that we’re talking about, mortgage-backed securities, asset-backed securities, repos, derivatives. And in the process of doing that gave them all safe harbors from bankruptcy protections. You put them all in the front of the line. And the idea was that if you didn’t do that, you could cause a systemic crisis — that they would run. And it turns out that when you put them all in the front of the line, they actually ran because they were in the front of the line.

So it’s not the investment vehicle itself that was their problem. There’s a lot of policy issues there that have never been fully vetted in Congress and dealt with. The new Bankruptcy Act that is in Choice actually does implement a temporary stay to sort of deal with some of those issues. And I don’t know that it goes far enough for my taste, but I think those are the sorts of things that we need to look at. And we forget that these things happened. You know, 2005 was a pivotal year, it turns out.

MR. POLLOCK: Thank you.

Paul.

MR. KUPIEC: I think I’m going to pass for — let Dick —

MR. POLLOCK: OK. We’re going to let Dick — Paul has ceded you his time in addition to your own.

MR. SYLLA: Well, I won’t take that much time. I only have two comments. One is that — Norbert just referred to it. It seems to me that bankers, you know, have an incentive to reduce capital as much as possible, you know. And I remember I was the Henry Kaufman chair at NYU for a long time. Henry Kaufman said he was called in by Walter Wriston of Citibank once. And Henry was saying banks needed to hold more capital. And Wriston tried to straighten him out. Wriston was a great banker. He said, “Henry, you know, it’s not really necessary for banks to have any capital at all anymore.” This was in the 1970s.

So that just confirmed what I sort of see in history despite the fact that banks used to have, you know, more capital than they do now as a percent of assets. But, you know, if you think about it, you magnify the returns on whatever capital you invest in your bank by using a lot of other people’s money to make loans and so on. The problem is that, you know, if you make some bad loans, the capital gets wiped out, and the public could be left holding the bag. But I think bankers do have an incentive to reduce capital as much as they can. And one of the positive things of recent debates I think is that probably even Alan Greenspan, I gather from what Martin said, agrees that banks maybe ought to hold more capital than they do now.

The second point I would make is that, you know, we had an issue to debate here. Is it time to reinstate the Glass-Steagall Act? And I don’t think I’ve ever been on a panel where everybody had the same answer, “No.” And, therefore, following Paul giving up his time, there must be some of you out there that, you know, think that the answer is yes and maybe some of your questions will move us in that direction.

MR. POLLOCK: And we will get to the questions very shortly. Thanks.

I do want to mention that key as this discussion of the panelists made clear to the question of the Glass-Steagall Act or the Glass Act, as I said we should call it, and whether you’d want to do it again is the issue of concentration versus diversification in financial institutions, diversification of business lines, as well as of assets and their prices, and many of the panelists said that. I think it’s a right point and is supported, as I said, by the very strong evidence of the Canadian example.

But if we want to talk about what the banking system is concentrated in, as I said before, it’s concentrated in real estate. Now, we solved — I think Martin is right — basically the issue of margin in the stock market. So nobody will lend you 100 percent to buy a stock. But somebody is very likely to lend you 100 percent to buy a house, and a house is a lot less liquid than a traded share of stock is.

So if you think about it as — if you think about down payment requirements as margin requirements, we have an astonishing situation of very low or, in many cases, no margin required for real estate. And those risks are all in the banks. And if you put in a new Glass Act and took away the business diversification of the securities business, that real estate lending with very low margin or down payments real estate risk would become even more concentrated in the financial system. And, personally, I think that’s a huge issue if you’re trying to think about the nature of the system itself.

Let us come, ladies and gentlemen, to your questions. And let me first thank you all for being here. May I remind you of the procedure. If you would, please wait for the microphone — I see one here — for the microphone to reach you. Tell us your name and your affiliation. State your question. If you feel compelled to preface your question by a statement, the chair will ask you to limit that to one minute and remind you, if necessary, that it’s time to come to your question. Let me start right here. Wait for the mic, please. Then I’m going to get to you.

Q: Hi. Yes. Yaman Ar (ph). I’m from Bloomberg News. So several of you mentioned that perhaps the real aim for people who are advocating the new Glass-Steagall is to really break up the banks, not necessarily all the benefits, whatever. And several of you — and I’m sorry, I don’t remember which ones — mentioned some of the tremendous cost. But what would be the cost of breaking them up? Not whether it’s logical, reasonable, whatever, but when I’m sort of trying to look into this, I can’t — you know, there are certain bureaucratic costs — back offices have to separate, whatever. But then, just having more big banks — they wouldn’t change too much. Maybe instead of 10, we would have 15 because they’d have to, you know, split. But what would be the real cost to the banks and perhaps to the economy if we forced them to split up?

MR. POLLOCK: Thank you. Anybody want to take that? Paul?

MR. KUPIEC: I think some of us had mentioned before, you’d probably see a lot more concentration in investment banking than you had before, which means that the business of issuing and trading stocks and bonds is likely to become less competitive. The banks themselves are likely to become higher risk rather than lower risk because they won’t have diversified streams anymore.

And you could deal with that in a couple of ways. If the deposit insurance fund were actually to reflect the higher risk in their pricing, they could charge banks more for deposit insurance, and probably should, and that would pass through to customers of the banks who then deposit money there and earning nothing essentially now already. But somebody’s got to pay for it. So I think there’s many ways this would have a cost on the system, and I’m sure my colleagues have other —

MR. POLLOCK: Other comments on cost of the system — yeah. Oliver.

MR. IRELAND: Just in general terms, you’re letting a bunch of lawyers architect the economy. And as one noted economist put it to me, if he was good at predicting the economy going forward, he wouldn’t be doing what he was doing then, which was at the Federal Reserve, and that he thought the lawyers probably weren’t as good as he was. And I think that’s probably right. You’re managing the economy. We bailed out — we didn’t just bail out banks. We bailed out automobile companies along the way. Does that mean we break up automobile companies? What’s the size? What are your criteria? What is the basis for the conclusion that if you do that, the world is going to be better? And if you’re going to intervene in the market, I think you want to see — tie it to a market failure and identify the market failure and target the change narrowly to address that market failure. All right? What is it, and what’s the evidence of the market failure?

MR. BAILY: I’d just chip in that that’s — I think our recovery is still relatively slow. Maybe we’re getting a more robust recovery now, but it’s been a pretty fragile recovery for quite a long time. And one thing we know is that disruptions to the financial system caused disruptions to the real economy. So if you were to break the banks, I think you’d have to do it very carefully so that you didn’t in fact end up disrupting the real economy, reducing the number of available loans. You know, large companies in the US are generally doing pretty well with global companies, but small companies are not. And some of it is not the demand the loans isn’t there but some of it I think maybe the supply of loans isn’t there. So I’d be concerned at, you know, trying to figure out how to break up the banks without disrupting the rest of the economy would be a great concern I would have.

MR. KUPIEC: Can I go back for a second? So if you actually look at the data about where financing comes from, I mean, the banking system is important, but the securities financial markets, the financial markets are really an important source of finance for corporations. I don’t have the numbers off the top of my head. If Peter Wallison were here, he’d have his chart that he always pulls out. But bond markets and commercial paper markets and all the wholesale markets are a much more important source of finance for the corporations than is the banking system. And —

Q: Sixty-five percent of funding in the US comes from commercial — (off mic).

MR. BAILY: Yeah. But I stressed the small companies. And I think that’s where a lot of startup companies, surprisingly, do rely on bank borrowing.

MR. KUPIEC: That’s true. But taking the large banks out of the business of competing for that business has a bigger effect than you might imagine on the cost of raising wholesale finance. And so I think it’s really — it doesn’t — so there’s only two firms left, and well, they’ll break them up or something. But no, no, no. The concentration — there’s a lot of competition that goes on in wholesale finance markets now. And I don’t want to defend the big banks, but I think we would lose all that. And that could be much more important than you might think.

MR. POLLOCK: Thank you all. Thank you very much for a stimulating question. I thought I saw a hand sort of in the front. Oh, yes. This gentleman right here.

Q: Thank you. Bertie Lee (sp), a banking consultant. I wanted to get your reaction to a sense I’ve had as I’ve listened to the advocates of bringing back Glass-Steagall that what they’re really concerned about is getting rid of the big banks — that size itself is bad. This goes back to Paul’s figures that even if you spun off the investment banking activities, you still would have some very large banks. And so although this isn’t being articulated, my sense — (inaudible) — what they really want to do is turn back the clock on banking consolidation. And, in effect, have a lot of the deal — the consolidating deals of the last couple of decades really be unwound. So the , for instance, might be split into four or five smaller geographically concentrated banks.

I’d be interested in your thoughts about the extent that that might be part of the agenda of those who are advocating for a so-called Glass-Steagall return.

MR. IRELAND: Yes. I think that’s always been part of the agenda. But you, Bert, lived through the thrift crisis. And that was not a big institution crisis. It was a lot of little institutions. And is that – was that easier to manage than this crisis? I don’t think so. We went around with the resolution trust company closing hundreds of thrift institutions. And that was a difficult process, and supervising those hundreds of institutions that closed was a difficult process. The idea that that’s somehow inherently a safer structure I don’t think is true.

MR. POLLOCK: I agree with that, Oliver. And we have to mention in addition to all of this, there were more than 1,000 commercial banks that failed at the same time over the same decade.

MR. IRELAND: Yes.

MR. POLLOCK: I’m going to get the question over here then I’ll come to you.

Q: Thank you very much, Alex. I’m John Gizzi, White House correspondent and chief political correspondent for Newsmax. And I would just say if people could see what the outcome of a 21st-century Glass-Steagall is, and I hope you’ll pardon this, they would not have this attitude of “covfefe” when it came to reviving Glass-Steagall.

I would point out — I do have a question for Norbert and for Oliver. And that is you made the point about possible passage of Glass-Steagall and that it has bipartisan support. Bernie Sanders was for it, and it’s in the Republican platform. If you listen to Bernie Sanders or read the language of the platform, it’s identical. It’s revival of Glass-Steagall, no amendments, no changes, taking the legislation from the ’30s and putting it back on the books.

My question is this: With all the possible dangers that are there and with the effects, why does it have such bipartisan support?

MR. POLLOCK: There’s a political question. Do you want to take it up?

MR. MICHEL: I mean, I can’t — I can try to answer that. I mean, there’s a sort of — on at least one side of the aisle there’s a populist sort of fascination with Glass-Steagall. And sort of I think — to some extent, there’s always been sort of a populist angst against financial industry in the United States in general. So everybody is OK with small businesses. Everybody is OK with manufacturing. Everybody understands that. You see the product, you see the service, you understand it, you get it. And it’s not the case with the finance industry. And I think that that at least explains part of this fascination with this era of the past. I don’t really have a better answer for you than that.

MR. IRELAND: I would suggest — when I wonder about that, I go back, and I read ’s “Cross of Gold” speech. And I’m hearing it again. The words aren’t as eloquent now as they were then I think. He was a better speaker.

If you want to read Glass-Steagall, I brought my Glass-Steagall — I brought my Section 20. Nobody’s proposing to reenact Section 20 of Glass-Steagall. The Warren bill does not reenact Section 20 of Glass-Steagall. That language is very —

MR. POLLOCK: Remind us what Section 20 is.

MR. IRELAND: Section 20 says that no member bank shall be affiliated in any manner with any corporation engaged principally in the issue, flotation, underwriting, public sale, or distribution at wholesale or retail of stocks, bonds, debentures, notes, and other securities. And there are a lot of qualified words in there. There was a lot of debate in the ’80s and ’90s over “engaged principally” and what the rest of that sentence means. I haven’t seen anybody that in actual legislative language proposed to go back to that language.

MR. POLLOCK: I’m going to take this question, then we’ll come up to you here in the middle in just a minute.

Q: Paul Gallagher, EIR News Service. Directly related to Mr. Gizzi’s questions, I think your expertise is all being used to ignore the reason why there is so much popular support, constituency support for Glass-Steagall. There is, by the way, also a bill in the House with 50 sponsors called the Return to Prudent Banking Act.

And that reason is that the Glass-Steagall regulations were done away with during the course of the 1990s. Not only the size of the US major banks completely changed and they became megabanks in that sense for the first time in US history, but the characteristics of them, the structure of them completely changed.

The Federal Reserve has done studies on this. They went from 100 or 200 subsidiaries each to 3,000 or 4,000 subsidiaries each. They all became completely interconnected, buying each other’s securities, buying each other’s derivatives, all making the same bets, all making loans to each other, and then they all collapsed at once. And the only thing that determined which ones of them failed was which ones the Treasury and Fed decided not to bail out. They were all insolvent.

MR. POLLOCK: I’m going to ask you to get to your question.

Q: I don’t think I’ve met my minute yet.

MR. POLLOCK: You have. Yes.

Q: They were all insolvent, as Bernanke acknowledged. That is the fact which the American people can see, which generates the support. There has not been a credit channel, a significant —

MR. POLLOCK: I’m sorry. You have to get to a question.

Q: — credit channel in the US economy since. So my question to you, especially given that most of the credit driving the world economy since has come from the credit channel of China, which does have bank separation and has had it for the last 20 years, would you like to trust the credit channel of the US economy to a dozen banks, which effectively have all the deposits at this point and which are free to do any form of securities, derivatives, and other speculation with those deposits?

MR. POLLOCK: OK. Thanks. Dick, you asked for the opposite case. I think you just got it here. So anybody want to take that up?

MR. SYLLA: Let me think about it some. Anybody else?

MR. MICHEL: I’ll start. I mean, first of all, I don’t really accept your premise, and even if I did, I would say, so do you want to do something that makes absolutely no sense to rectify the problem that you perceive? And that’s how I would answer that. I mean, it doesn’t — I hear what you’re saying.

Q: Not much of an answer.

MR. MICHEL: Not much of a question either, but I hear what you’re saying.

MR. KUPIEC: Most of the changes in the banking system in the US were not due to the amalgamation of securities, investment banks, and commercial banks. It was due to the relaxation of state across — banking across state lines, interstate — the Riegle-Neal Act that allowed states to go across. That was the conglomeration of commercial banks. That’s how you got NationsBank and Bank of America. It was the changes in those laws to modernize the banking system, to get away from the unit banking that was, you know, imposed upon the country in the 1800s and early 1900s back in the days when Ollie says that the progressives want to go back to, when things were great in the late 1930s right after passage of the Glass- Steagall Act. I don’t think that’s true at all, that things were really, you know, great back then.

MR. POLLOCK: Or, as you point out, Paul, in your numbers in the 1920s, when hundreds, literally hundreds of banks failed per year. I’m sorry.

Q: (Off mic) — major banks were not simultaneously insolvent.

MR. POLLOCK: I’m sorry.

MR. KUPIEC: No, they weren’t. They weren’t.

MR. POLLOCK: You can come up afterwards and talk informally with the panel. Those banks failing in the 1920s, none of them were combined investment banks. All of them were traditional commercial banks, only highly concentrated geographically.

MR. SYLLA: Right. And your premise seems to be wrong, that not all of them were insolvent. In fact, you know —

Q: Bernanke said — (off mic) — not insolvent. That’s his testimony to the Angelides Commission.

MR. SYLLA: Many of the ones that were in trouble were absorbed by one of the bigger ones that were probably not insolvent. You know, Bank of America took over Merrill Lynch. JPMorgan Chase took over Bear Stearns.

MR. IRELAND: Go back and read the — go back and read the call reports. I don’t think they support that number. The call reports, quarterly call report and the Y-9s from the banks that report the assets and liabilities of the bank. Those are the numbers.

MR. BAILY: And I think you’re sort of — I mean, we have instituted a lot of things to make the banks safer, and it’s true that we have very large banks, but we have a very large economy. And America is a big economy. And we have companies that are very large, and they do business around the world. Actually, the concentration of banks in the United States is lower than it is in many or most other countries, including Canada, that you mentioned there.

So I wouldn’t agree that we are more concentrated than other countries or necessarily that we don’t have a good choice of banks. We have plenty of choice of banks. You can go to a community bank, a lot of different banks. And, as I say, that’s why I support the basic notions of Dodd-Frank, which I think have done a lot to make those banks safer and limit the interactions amongst them and to make sure they hold more capital.

MR. POLLOCK: Thanks for giving us a lively question. I’m going to come up to the next — here, right — the lady right here in the middle.

Q: Hi. Thank you. My name is Emily Liner, and I’m with Third Way. So I wanted to — well, first I’d like to highlight what Martin just said because I think this isn’t adequately understood by the general public that the United States banking system is less concentrated than a lot of our peers. And one thing in Dodd-Frank that never gets talked about and should be when it comes to “too big to fail” is there’s actually a ban on mergers of banks of a certain size. And I had to pull up the text and find it because it was driving me crazy. So it’s based on deposits. A bank can’t have more than 10 percent of the total amount of deposits in the United States.

How would you responding to using this policy lever instead of a 21st-century Glass- Steagall to address “too big to fail”?

MR. POLLOCK: Thank you.

MR. KUPIEC: Let me take that. So that’s been in place actually before Dodd-Frank. It’s been in place for a fair bit of time, and it was a restriction on I think Bank of America for a long time. However, if you read the fine print, it can be waived in the time of crisis. So if you’ve got another big bank that gets in trouble, they can look the other way. And, in fact, if we want to go back to the business about what created the big banks of America today, it was the last crisis, where we had banks buy up other big failing banks.

And to go back and now to tell those banks, after they bought the other banks to save them, “we’re breaking you all up because you’re too big now,” you’ve got to ask the question: Why did you tell us to buy that other bank to begin with? It’s a little bit — anyway.

So the 10 percent has been in place for a while. It was put — set again in Dodd- Frank, but it can be waived if in times — for financial stability reasons if one institution wants to acquire another that’s in trouble.

MR. IRELAND: If you look more broadly and you look at what’s happened in Dodd- Frank without judgment about whether it’s good or bad, there is an escalating regulatory cost and an escalating capital cost with size. And the capital requirements for a large bank, a G-SIB, are not just numerically larger. They are larger and significantly larger as a percentage of size. And so you already have a system that is scaled up and imposes significant additional safety and soundness as well as capital requirements on larger institutions.

MR. POLLOCK: Other questions, right here, and then we’ll get you.

Q: Hi. Zach Warmbrodt with Politico. I mean, Trump administration officials keep entertaining the idea of reviving Glass-Steagall. Do you have any idea what they’re getting at? What do you think they mean when they sort of say they’re open to maybe bringing it back? And do you think it would be wise for them to continue on with the Glass-Steagall branding regardless of what they mean?

MR. POLLOCK: What do they mean, and would it be wise? OK.

MR. KUPIEC: I actually invited folks from the administration to be on the panel, too, to talk about their ideas and what they meant. And they sort of said they (brought ?) it out in their Treasury report, and they didn’t want to talk about it. They would make it clear when they come out with their reports that are mandated by the Trump executive order. So I couldn’t get them to come and tell us.

I don’t know what they mean. I mean, I think when the secretary of Treasury was pressed in his hearing a week or so ago, when Elizabeth Warren wanted him to agree that her act was a great act, her 21st-century act, he backpedaled and said, “No, no, no. We’re not for that. That’s not our idea of what a new Glass-Steagall is.” I’m pretty sure that’s close to exactly what he said, and she was not particularly happy about that.

So I don’t know what they’re going to call their new Glass-Steagall. Maybe somebody else up here has a better feel.

MR. POLLOCK: Anybody?

MR. BAILY: I don’t. I mean, I was one of the —

MR. POLLOCK: Did they come tell Brookings maybe, Martin?

MR. BAILY: No. They don’t tell Brookings. There was a meeting at Treasury that I attended where a number of think tank folks, including some from AEI and academics, there was actually no discussion of reinstating Glass-Steagall in that Treasury meeting. I don’t know if there have been a series of other meetings with the banks and with regulators and so on. I don’t know what’s happened in all of the others.

I’m guessing that this is — I mean, Trump was elected on a relatively populist agenda. If you look at who supported him, I think the banks are just not very popular with those folks. And so this is a way of sort of saying, I’m going to — I’m going to deal with those guys that you don’t like that are on Wall Street that have too much money. So I think it’s sort of a populist move. What actually comes out of it remains to be seen. I doubt if Glass-Steagall will actually come out of it.

MR. MICHEL: I don’t have any idea either. My experience mirrors Paul’s. Everybody that I talk to says some version of that or I don’t know, on transition, still have no idea.

MR. POLLOCK: OK. Next, right here. And then I’ll come to you.

Q: Thank you. My name is Andrew, and I’m actually with the European Parliament Liaison Office. And my question is actually about maybe some of the anxiety around the “too big to fail.” I’ll preface this with a lot of the books that I thought had a particularly good insight around the financial crisis was that it was actually more of a problem of “too big to manage well” or “too big to kind of organize well.” And organizational management in a lot of these banks kind of broke down with their internal understandings of some of the assets they had and what they were actually doing. UBS, for example, a very risk-adverse bank, didn’t understand some of how it classified some of its positions it was taking.

And I was just wondering if you think that maybe some of the anxiety around this “too big to fail” mentality, at least in the public opinion, is actually trying to capture maybe some of this — how do we get banks that are very big and are doing lots of different things to understand themselves very well and operate as best as they can?

MR. KUPIEC: I’ll take a crack at that. In my former life, I went into large banks to help the bank examiners examine them and their models. I think it’s — if the public is very anxious about — if your premise is right, big banks, we’re not sure they know how to manage their risks, why would you ever ask a government regulator how to manage the banks’ risk? They don’t know how to manage it. So, I mean, bringing in the regulators to tell the banks how to manage their risk isn’t going to do it either.

I think people — when things are going well and banks are making money and they have a bunch of smart people that are making that money and telling them they completely understand, you know, how they’re making money and they’re going to make them more of it, and it filters all up to the CEOs, I mean, they have to listen to the people below them.

And nobody saw — there were some people that saw that the subprime market would blow, but not many people even in the business had realized how bad it might get. You know, yeah, there’s “The Big Short,” there’s a couple of people that bet on it, and they were right. But not the Federal Reserve, not the regulators. You know, we had inklings that things may not be so good, but everybody thought that the crisis would be contained, including Ben Bernanke. So you’ve got humans, and you’ve got people potentially playing by the rules, making a lot of money. And somebody’s got to go in and stop them. But we’re playing by the rules.

It becomes a very difficult game to know, you know, when to pull that punchbowl away, especially if you have to change the rules and there’s no losses out there yet. It’s me saying the sky is going to fall. When? Next week. Well, how do we — you said that last week. You know, how do we know that? There’s no easy answer to it, except these guys will have one. Ollie has got one.

MR. IRELAND: In the early 1980s, there was — and it led up through the rest of the ’80s and into the early ’90s — there were a series of real estate bubbles in the United States. And they burst. This was a real estate bubble that burst all over the place. It started in farms in the Midwest, and it brought down the US farm credit system that had to be recapitalized by Congress. They came in, bailed out the lender to farmers because the lenders to farmers, not great big banks, little banks out in the country had been making bad loans. It’s not a big bank issue. People don’t like big banks. I go back to the “Cross of Gold” speech. It’s very eloquent, but that sentiment is still here.

MR. POLLOCK: You know, thinking of the “Cross of Gold,” which is a great speech, by the way, and the spirit of the times, if you look at some of the other rhetoric of the times, you have things like we will defend our farms against the blood-sucking banks from the big cities and we’ll be out there with our shotguns. It was pretty hot rhetoric 130 years ago.

MR. IRELAND: If you burn down the cities, they’ll grow back, but if you destroy the farms, the nation will come to an end. It’s in the speech.

MR. POLLOCK: One thing Paul said, which we maybe should emphasize, is that one of the things that’s tricky about a financial boom is exactly that the loan losses are very good. Loans perform very well in booms or bubbles. There are almost no defaults. There are almost no losses until the end, and then you see it.

MR. BAILY: Can I make one comment?

MR. POLLOCK: Oh, yeah. Sure. Please. Please, Martin. Yeah.

MR. BAILY: And that is on the “too big to manage,” which I’m sympathetic to. I think that is a risk of banks if they get too large. One of the things, though, there’s been a big retrenchment of banks, both in Europe and in the United States. There’s a new report coming out from McKinsey Global Institute about financial globalization. And so I’ve been reading, revising that report, and it’s quite striking the number of — the reduction in the number of subsidiaries of a bank like Citi or even JPMorgan. Many of the banks in Europe are reducing their international activities.

It’s actually the banks in Canada and elsewhere that have been expanding some of their international activities, but the big banks in Europe and the United States have actually simplified their operations, reduced the number of subsidiaries, partly just because they realized that these things were too complicated and that they weren’t making enough money to justify the risk and because of regulation, anti-money laundering has also caused some retrenchment — meeting those regulations. So banks actually have been making themselves simpler.

And then living wills. Again, I agree with Paul, regulators are not going to know the perfect answer. But if you have to go through that living will process, which they’ve all had to go through, that does force them, I think, or encourage them to simply their operations.

MR. POLLOCK: Yeah. Dick.

MR. SYLLA: Yeah. Andrew’s question is I think one I’ve thought about. I mean, I think really large institutions may be hard to manage. One example of that is around 2005 or 2006, Mr. Chuck Prince, who was the head of Citibank, came to NYU Stern School and gave a talk. And in that talk, he had said that he was spending time lately going off to London to apologize for something that his bankers had done in London. You know, the British were away on holiday or something like that, and some Citi bankers cleverly shorted $10 billion of some government security so the price went way down and they bought it back at a lower price. This was a scandal, and Chuck Prince had to go to London to apologize for that.

And then he had to go to Japan because some Citi bankers in Japan had pulled a little trick like that too, and the Japanese government didn’t like it and so — and I said to myself, “Should the head of this great, big bank have to be spending his time going around the world apologizing for what his bankers did?”

Well, no, probably not. But, you know, small banks can fail too. I guess that the Barings Bank wasn’t so big, and one rogue trader did something. The problems — you know, and the big bank, if, as mentioned earlier, the London whale, yes, it was a scandal. Jamie Dimon was very embarrassed by it, especially since he first came out and said it’s not a problem. But it wasn’t really such a big problem because it’s such a big bank that it could lose five or six billion.

So the real problem all this illustrates is not that big banks are too big to manage, because small banks can be mismanaged as well. The problem is the incentives people have in these banks. You know, these institutions holding other people’s money have a fiduciary responsibility. That’s our money, our savings, our retirement accounts. And, on the other hand, they have this incentive to make as much money as they can because they might get a huge bonus. You have to find in these institutions the balance between fiduciary responsibility on the one hand and the desire to jack up the profits and make a huge bonus. And that’s the trick in managing a big bank or even a small bank I think. You know, we ought to think more about the incentive systems that the people working in these banks have right now.

MR. POLLOCK: Thank you. I have a question right here.

Q: Thank you. Nellie Liang with Brookings. So, first, before I ask my question, I just want to align myself with the view that there may not be that many great benefits from Glass-Steagall. But I do think there is this question that maybe Ollie’s example illustrated, which is: Is there a difference between making a loan to a wheat farmer and investing in wheat futures? And it’s related to culture of a commercial bank loan officer versus a trader. And how do you respond to that kind of question as to whether there would be benefits from changing the conduct of an organization if you were to reinstate Glass-Steagall?

MR. IRELAND: Culture is an issue. And I spent part of my life gambling, playing cards for money that affected my standard of living. And the —

MR. POLLOCK: That’s positively or negatively?

MR. IRELAND: It depends on whether I won or lost. (Laughs.) There’s a fear factor and a greed factor that operate in financial transactions for everybody. And if you’re going to — they create risk. They both create risk. And one of the focuses of is to make the culture more conservative. And I think that’s a real issue.

I think how you approach the business is a significant issue. I don’t think that’s a size issue. And I think that people that are in securities businesses and commodities businesses as well as banking businesses have come to realize that you want people who are traders, who make money because they trade well and not because they take a lot of risk and that you want to control the risk appetites of your people, whether they’re making loans or they’re trading wheat futures. And so I think if you do it right, you wind up in kind of the same place. If you don’t do it right, you’re in — it’s a short-term business.

MR. MICHEL: And I don’t think traders want to lose money. I don’t think they’re going to get large bonuses when they lose money. So, I mean, people are different, for sure. But, in the end, as long as those incentives are somewhat aligned, I think this isn’t — I don’t know.

I was on a panel with Dennis Keller a couple of weeks ago, and you know, I heard something very similar to what you just asked about the big bonus culture and — it was on the Volker rule. And they were talking about how, you know, they want to hold on to those things because they want to get those big bonuses, but it’s so risky. And you can’t have, on the one hand, say that these big bonuses are what’s driving it, and on the other hand you’re losing money, because if you’re losing money, you’re not making those big bonuses. So I don’t know. Maybe there’s something there, but —

MR. BAILY: I think the danger of the culture was that you would take a risk. If it paid off, you got a big bonus. If it didn’t pay off, then someone else paid the bill, so I don’t think it was — those were the bad incentives that were built into a system that we had to change.

MR. MICHEL: But that gets to —

MR. KUPIEC: In some sense, this is back to the old social debate about the investment horizon. Are corporations just investing for the next 10 minutes, or is it — are they looking 10 years out? So the trader looks for the next 10 minutes, and the credit analyst at a bank who’s making a loan has got to look over the next five years maturity. And, yeah, Nellie, that culture clash can maybe be a problem, but I think we talk about that in the corporate world too. And I don’t know that we have an answer for it.

MR. POLLOCK: You could — it is argued, I think rightly, that the trader, being mark-to-market every minute, they’re having constantly to margin the change in price creates less risk than the banker making a loan with a horizon of five years while the price slides away from him and finally the system collapses.

But we’ll be talking about this more, I’m sure. We have arrived at noon. I want to thank you all for coming. Thank you for great questions and a very lively session. And let’s show our appreciation to the excellent panel. (Applause.)

(END)