A lot of energy and a lot of talent go into creating Wall Street products that take advantage of regulatory loopholes and stay one step ahead of the laws. In the last decade, it seems that much of the organizing energy for Wall Street products has been in generating fees for Wall Street firms, which have the well known characteristic of rewarding the managers when they work and penalizing the taxpayers when they don't.
The global financial economy is superimposed on a world of finite nation states whose laws stop at the political borders, and so it is within the imagination of very clever people to exploit the gap between these literal countries with their literal jurisdictions and the global scope and pace of the financial economy.
In their article, The Great Bank Robbery, Nassim Nicholas Taleb and Mark Spitznagel put it this way:
The largest, most sophisticated banks have become expert at remaining one step ahead of regulators constantly creating complex financial products and derivatives that skirt the letter of the rules. In these circumstances, more complicated regulations merely mean more billable hours for lawyers, more income for regulators switching sides, and more profits for derivatives traders.
Now Sens. Elizabeth Warren, D-Mass., and John McCain, R-Ariz., have proposed a bill to separate banking and trading – the 21st Century Glass Steagall. Since the financial crash, we've seen regulators scramble for ways to address the issues caused by risky bank behavior with little effect. Yet banks still engage in risky behavior and taxpayers are still on the hook if anything goes wrong; a key element of the crash – derivatives trading – is still very much with us. Slowly, many have come around to the idea that Glass-Steagall is essential. Even old Wall Street lions, and conspicuously, the banker most responsible for the repeal – Sandy Weill – now recognize its necessity.
Coming on the heels of the Dodd-Frank financial reform law, it's hard to be optimistic about this bill even if I'm enthusiastic about the idea of it. When that law was passed there was much fanfare and trumpeting because it was going to solve "too big to fail" and protect consumers.
But as rule-making dragged on and lobbyists got to work, the promised safeguards have become a watery soup. It may be years before all the rules are fully formed and whether new regulations have any teeth remains to be seen. So, while a new version of Glass-Steagall is welcome and very necessary, we'll have to see if it will have the intended impact once passed or if it dies a death by a thousand cuts.
Here's the thing: banking and trading are two separate businesses. I know traditional banking isn't sexy and it's not always very profitable. Trading is much riskier, much sexier and more profitable. Until it isn't. But banking should be boring and should operate like a public utility. Let trading be the exciting and daring friend – but the risk of loss should be on the investors only and not on the public.
These days, some of the brightest people work on Wall Street. When I graduated from Harvard in 1954, I don't remember anyone going to work on Wall Street. Now, the best and the brightest are seduced right out of university to take jobs that promise lucrative pay. Everyone wants to make money while they can, but I think there's another attraction, as well. Very smart, very creative people want to be challenged and one of the constant challenges on Wall Street is to create new products that make a lot of money.
As we've seen, this includes technically legal products that skirt the law or are one step ahead of laws. It must be a thrill to find that open space where law hasn't yet been created. The global financial market has some wide-open frontiers and there's no sheriff in town.
How do we change this? We separate banking from trading and people make a choice on which career path to follow. Banks accept deposits, make relatively safe loans, make modest profits, give modest salaries – and deposits are federally guaranteed. Trading houses use capital for risk investments, use leverage and have huge profits or huge losses. Their losses are not federally guaranteed.
Can this bring order and peace to the banking frontier? I think it's the only option we have. Trading is not a crime and those inclined to take risks should be free to take that route. But taxpayers shouldn't be responsible for those risks – private money, private risk and private problems when they fail. Let's separate banking and trading.
About Robert A.G. Monks Corporate Governance Adviser