[veritas]

Disclaimer: not an economist.

My understanding is that the Glass Steagall act in the 1930s was passed to separate holding banks (like WaMu etc) and investment banks (GS) because when they were combined certain risks popped up.

One of the first that immediately comes to mind is that now investment banks will be in charge of deposits. Securities trading is pretty risky (especially when you're leveraged) and if something should happen (tech bubble or the current mess) then the deposits are threatened. Since deposits are also insured by the government (FDIC), the government then is automatically on the hook for the money.

This means that there is a need for new restrictions placed on the hybrid banks. If the regulation is too low, then we run the risk of putting deposits in danger. If the regulation is too much, we run the risk of crippling the investment banking industry.

Then again other countries seem to work fine without such separation, so hopefully this will work out. From the article it seems new regulations will be imposed on the banks.

If anyone else has additional insight, feel free to correct me :)

[Prrometheus]

Bank holding companies are subject to risk-based capital requirements which prohibit them from operating with high leverage or purchasing large amounts of risky assets. Basically, these companies are reorganizing to adopt a lower risk and lower return model.

>This means that there is a need for new restrictions placed on the hybrid banks. If the regulation is too low, then we run the risk of putting deposits in danger.

Regulators are way ahead of you. As bank holding companies they will be subject to a TON of regulation. Few firms are more regulated. Both the FDIC and the Federal Reserve will have authority over them.

It's good that Glass-Steagal was repealed since it allows them to take these risk-reducing moves. It also broadens the supply of capital that is capable of supporting the financial industry in hard times (see J.P. Morgan/Bear Stearns and BOA/Merrill Lynch). With Glass-Steagal, the default reorganization move would be failure rather than merger. More federal government money would be at risk in bail-outs rather than private money put at risk in mergers.

Also, diversified financial companies have weathered the storm far better than their more focused peers. Being big and diversified has its advantages in tough times, as one would expect.

It's weird that the Glass-Steagal Act keeps popping up as much as it is. As far as I know its repeal had nothing to do with the current crisis, and probably helped alleviate it. I thought this link had a good summary of the Glass-Steagal act as it pertains to the current crisis:

http://meganmcardle.theatlantic.com/archives/2008/09/clear_a...

[veritas]

>Bank holding companies are subject to risk-based capital requirements which prohibit them from operating with high leverage or purchasing large amounts of risky assets.

I figured the capital requirements would indeed get stricter (I believe the article also mentions this), but I'm still skeptical as to how long the banks can rein in their greed. Capital requirements should technically force them to be more careful, but IIRC the big 5 had already managed to get their requirements increased before (from 12:1 to 40:1).

As for mergers alleviating risk, would it not also expose the system to a different risk: market consolidation? The reason given for the current bailouts is that if these handful of investment banks (or even just AIG for that matter) failed it would set off a catastrophe. If there were more consolidation wouldn't it just aggravate this risk of one failure causing a significant impact?

Like I said before, I'm not an economist, but it seems better to keep the WaMu's and Goldman Sachs' separate, in more or less mutually exclusive risk pools so that if GS fails, the deposits in WaMu don't go with it.

Anyway, good points! I'm sure if handled correctly the situation will work since it does seem to work elsewhere.

[Prrometheus]

>Capital requirements should technically force them to be more careful, but IIRC the big 5 had already managed to get their requirements increased before (from 12:1 to 40:1).

Independent investment banks are not subject to the capital requirements of FDIC insured institutions. The big 5 were previously under no regulation as to their leverage ratios.

>As for mergers alleviating risk, would it not also expose the system to a different risk: market consolidation? The reason given for the current bailouts is that if these handful of investment banks (or even just AIG for that matter) failed it would set off a catastrophe.

The financial markets are highly fragmented and competitive, or at least they were 18 months ago. The risk isn't so much that one big firm will go under, but that some firms going under will set off a panic that will force lots of firms to go under. There were hundreds of independent mortgage originators, and as far as I'm aware they are now all gone.

[veritas]

>The big 5 were previously under no regulation as to their leverage ratios.

http://www.nysun.com/business/ex-sec-official-blames-agency-... That article suggests that the SEC enforced a 12:1 ratio for banks... or am I getting incorrect information?

[eru]

I guesse, the big 5 were not 'banks'.