Super banks -- friend or faux?
Millions of Americans are having difficulty making their mortgage payments. Some are facing foreclosure proceedings by their lender, often a bank. Banks maintain they are helping to alleviate borrowers' woes. But the truth is far from clear. The banks are in a mess and so are we.
Can they help us get out of it?
In the movie classic, "It's a Wonderful Life," the townspeople of Bedford Falls run to their building and loan. Having waited for its doors to open, they rush the lobby demanding a return of their money.
Uncle Billy, the president, had locked the doors in a panic. His nephew, George Bailey, aka Jimmy Stewart, tells the depositors that the money they want to withdraw is tied up in the homes of friends and neighbors; there's not enough cash in-house to return all the deposits. The crowd is calmed. The building and loan is saved. So is the town.
George Bailey is long gone. But escalating gas and food costs are not. Many teens cannot find summer jobs. The friendly community bank has been devoured by the multi-departmental, hierarchical super bank.
Historically, local banks enjoyed a relationship of trust and confidence with their customers. The men who owned these banks gained depositors' confidence through individual accountability and willingness to assume any and all losses. Cautious and conservative by nature and with an eye toward profitability, the personal relationship with each depositor was foremost in their minds. This allowed bankers to assess not just the financial ability but also the personal willingness to repay a loan. This personal nexus was the factor that J. P. Morgan considered crucial to successful banking.
In the late 1800s, community banks in major ports such as Boston, New York and Philadelphia were joined by "money center" banks that financed the massive trade passing through their cities. The financial viability of these larger banks could affect the nation as a whole. The liquidity of these money center banks therefore attracted national concern.
In response, Congress enacted the Owen-Glass Federal Reserve Act of 1913, which established the Federal Reserve Bank or "the Fed." Effectively a central bank, it was charged with ensuring banking liquidity. It also was given the notorious and often conflicting "dual mandate" of maintaining currency stability and full employment. The Fed was empowered not only to set short-term interest rates but also to issue money.
Prior to the Great Crash of 1929, banks loaned investors "easy money" to encourage the purchase of the securities underwritten and sold by them. This, in turn, spawned speculation, making the crash all the more severe. The easy money associated with the current bank and mortgage fiasco is reminiscent of 1929.
To help thwart another crash, in 1933, Congress enacted the Glass-Steagall Act, which precluded deposit banks from underwriting securities. It provided protection for investors and banks alike.
Following World War II, banks continued to grow and prosper. The privileged access to low-cost money enjoyed by banks made them particularly attractive to aggressive businessmen. The personal relationship between the banker and the depositor thinned.
By the end of 2007, Wall Street's five-largest investment banks were expected to pay $38 billion in bonuses. Meanwhile, their shareholders collectively lost about $74 billion in declining stock prices.
Today, the U.S. dollar is in near free-fall. Unemployment is rising and financial inflation and economic recession threaten simultaneously. The public is cautious, concerned and critical of its banks. Even mother Fed no longer is above reproach.
Several crucial changes, taken as a whole, have eroded our trust in the essential soundness of banks.
Waves of rationalization replaced many small local banks with large nationwide super banks. Personal contact and knowledge gave way to corporate relationships.
Principally, the conservative bank "owners" of old who risked their wealth, gave way to a new breed of aggressive and often ambitious bank "managers." These new managers held onto their own money while that of their customers and shareholders was exposed to risk. Once these banks went "public," pressures mounted to boost earnings. Conservative caution gave way to reckless greed.
The aggressiveness of the new managers of the super banks forced the repeal of the Glass-Steagall Act. "Open competition" became the cry. But with it, mortgage brokers and others elbowed their way into real estate financing, forcing some banks to invest alternatively in mortgage-backed securities for high returns, profits and management bonuses.
When the house of mortgage finance crumbled, the magnitude of unwinding the speculative assets acquired by the banks became apparent only gradually. The massive cost called into question the very survival of some of Wall Street's biggest banking names. There were buyouts. There were bailouts. The situation became so alarming that the "Wall Street model," once thought to be untouchable and an example for the world's financiers, simply no longer worked.
What America needs is a "bank holiday" -- not just a day off from work but a holiday from the effect the banks have had on our financial security and daily lives. Banks appear to do very little to assuage our problems in these difficult times. The Fed may have lowered short-term interest rates but our local banks alarmingly appear less willing to lend at all. Credit is tight, jobs are threatened and Main Street prices rise far above the official inflation figures.
The present banking mess means that, for most of us, it's not such "a wonderful life." In short, our "friendly" banks have given way to the faux antics of super banks that often ignore the person for the purse.
A first step toward restoring trust in banks must be the restoration of personal service and relationships with depositors.
Both Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke probably would agree that there is no clear answer to salvaging the banks and restoring the confidence of both depositors and investors.
As Uncle Billy in Bedford Falls concluded: "This is a pickle, George. This is a pickle."