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Saturday, October 4, 2008

Repeal Banking Deregulation: Be Careful What You Wish For

As I recently pointed out, there is a vigor in D.C. and elsewhere to roll back the demonized deregulation atmosphere. As such, it is likely, regardless of who gets elected, that we will see all sorts of new regulations especially inside the financial services arena. One of the first casualties will likely be the 1999 banking deregulation bill. The details of that bill are rather complicated but at its core it tore down the figurative wall between traditional banks and other financial services institutions. it caused, among other things, a consolidation in the industry with banks, investment firms, and insurance companies going through serious merger activity. By repealing this bill, it will cause the wall to go up. As such, each of those activities will once again be isolated from each other.

The danger in such a repeal at this time could be devastating. Right now, we are all seeing a series of bank failures all over the country and the world for that matter. By repealing such an act, it will disallow any non bank from being able to buy these failing banks. Furthermore, as more and more banks fail. what this will cause is a shrinking of banking into a small group of massive banks along with a whole bunch of much less powerful regional and local banks. As such, the industry will be dominated by a small group of four to six banks.

It's also likely other sectors of financial services will also go through a similar transformation. As such, first, we will have a group of oligopolies in several sectors of financial services. If you think that the oil companies aren't playing fair in setting gas prices, watch for banks and other financial institutions to do something similar in a whole host of financial services.

Even more troubling is that we will also create institutions that will be too large to fail. If a government bailout is necessary for AIG because its tentacles go into all parts of financial services, then it is even more vital if one of four super banks happens to fail.

Another problem is that liquidity in the exact areas of finance necessary to move the economy forward will be that much harder. By removing the ability of financial services firms from conducting the business of commercial banks and vice versa, you are also limiting the number of firms that can get into such things as Mortgage Backed Securities. As such, an already weak market will only get even weaker because many of its current players will be removed from it by government force.

As I said in the earlier post, there is greater danger in riding a wave of demonization to government action...like a new spirit of regulation. In this case, the remedy may wind up being worse than the ailment. The unintended consequences of repealing the 1999 bank deregulation bill are massive and they should be considered if this bill is repealed.

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