Meanwhile, J.P. Morgan and Wells Fargo — two large banks with big investment banking arms — resisted taking government capital and arguably could have weathered the crisis without it.
Did U.S. investment banks create a shadow banking system and derivatives market outside the normal regulatory framework that encouraged sloppy lending and created what turned out to be toxic securities? You betcha.
Steven Pearlstein is a Pulitzer Prize-winning business and economics columnist at The Washington Post.
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And did regular banks make some of those bad loans and buy up some of those toxic securities? Yes, they did.
But that was as much a problem at the banks and investment banks that combined as those that remained independent. More significantly, the bulk of the money that flowed through the shadow banking system didn’t come from government-insured bank deposits. It came from money market funds, hedge funds, pension funds, insurance companies, foreign banks and foreign central banks.
Confronted with these inconvenient facts, the conspiracists like to double-down and argue that the real damage caused by repeal of Glass-Steagall is that it triggered a wave of bank consolidation — which has now left more than half of the country’s banking assets under the control of a handful of institutions that are so big that the government has no choice but to bail them out if they risk a meltdown of the financial system.
No doubt about it — too-big-to-fail is a problem. It turns out, however, that it was also a problem in 1984, when Continental Illinois, the seventh-largest U.S. bank with a whopping $40 billion in assets, had to be rescued. It was a problem a few years later when the Fed quietly rescued Citicorp because of mountains of loans to Latin American governments that turned sour. It was a problem in 1998 when the Fed had to orchestrate the rescue of Long-Term Capital Management, a hedge fund with less than $5 billion in capital. And it was the reason behind the Fed’s 2007 rescue of Bear Stearns, with less than a quarter the size of its biggest Wall Street rivals.
A bank doesn’t have to have $1 trillion in assets to be too big to fail. Context matters. It depends on how much it has borrowed from, or lent to, other financial institutions. And it depends on the degree to which the banks are a counterparty on futures, credit-default swaps and other derivatives contracts.
The decision of whether an institution needs to be rescued also depends on the overall state of the market. When markets are strong, the failure of even a highly visible institution might be dismissed as a one-off event. But when markets are nervous, even the failure of a second-tier institution can spook investors and lenders to begin pulling back from all similar institutions, creating a contagion effect that can send global markets crashing.
Don’t infer that I think bank consolidation has been a good thing. There aren’t many who have railed against it in print for as long, or as consistently, as I have — to no particular effect, I might add. But repeal of Glass-Steagall has not been the key driver of this consolidation, which began long before 1999.
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