Friday, December 5, 2008

Did Deregulation Create Too Big To Fail

In 1999, a major piece of revolutionary legislation deregulated banking and financial services.

An agreement between the Clinton administration and congressional Republicans, reached during all-night negotiations which concluded in the early hours of October 22, sets the stage for passage of the most sweeping banking deregulation bill in American history, lifting virtually all restraints on the operation of the giant monopolies which dominate the financial system.

The proposed Financial Services Modernization Act of 1999 would do away with restrictions on the integration of banking, insurance and stock trading imposed by the Glass-Steagall Act of 1933, one of the central pillars of Roosevelt's New Deal. Under the old law, banks, brokerages and insurance companies were effectively barred from entering each others' industries, and investment banking and commercial banking were separated.

The certain result of repeal of Glass-Steagall will be a wave of mergers surpassing even the colossal combinations of the past several years. The Wall Street Journal wrote, "With the stroke of the president's pen, investment firms like Merrill Lynch & Co. and banks like Bank of America Corp., are expected to be on the prowl for acquisitions." The financial press predicted that the most likely mergers would come from big banks acquiring insurance companies, with John Hancock, Prudential and The Hartford all expected to be targeted.

This piece of legislation has been demonized especially by liberals, however most folks have no idea exactly what it did and even less what effect it had. Now, the deregulation bill did several different things but the most important, at least in my opinion, was breaking down the proverbial wall between commercial banks, investment banks, and other financial institutions. What this allowed was for most financial institutions to engage in a variety of financial transactions: banking, mortgages, insurance, investments, etc. One of the effects was the explosion of mergers and acquisitions in the financial field. I was on the inside of one of these transactions. In 2000, I worked for Everen Securities when it was bought by First Union Financial. Such a transaction wouldn't have been possible only a year earlier since a brokerage firm couldn't have merged with a bank. Eventually, First Union was bought Wachovia and a financial conglomerate was born.

Citibank (at the time) took advantage of this as well, and they merged with the Travelers and with their subsidiary Primerica, another financial conglomerate was born. AIG also turned from merely a full service insurance firm to a full service financial services firm offering banking, investment, insurance, and loans. The list goes on and on, and most recognize many of these names as companies that claimed to be in need of a bailout because they were "too big to fail.".

The reason that something like AIG became too big to fail is because they now had tentacles in just about every area of finance. If AIG had failed then millions of insurance policies, 401k's, bank accounts, and all sorts of other financial plans would have been threatened. Yet, this sort of financial cross selling was made possible only because of the deregulation bill of 1999. It also made it possible for companies to become too big to fail.

I worked for Primerica for a bit before getting into mortgages. That company sold a variety of products from all the other companies of Citigroup. This included insurance, investments, and mortgages. Of course, Citibank also offered credit cards, checking accounts, and their subsidiary Solomon Smith Barney offered brokerage. This means that a company like Citigroup has a financial tentacle in all ends of finance. It's destruction sends shockwaves to every corner of finance. It happened because of deregulation, but more than that, it happened because regulators allowed for all of these mergers to occur without examining this idea that these mergers were creating companies too big to fail.

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