The Law of Unintended Consequences - Strikes again!

The Law of Unintended Consequences - Strikes again!

It seems to me that every time Congress reacts to a painful market situation, they're like an army preparing to fight the last war.  They wind up creating completely new aberrations, that of themselves generate new demon offspring that have to have a stake driven through their hearts somewhere down the line.  Guaranteed, with the recent problems in the financial industry, our Wizard's in Washington will boil up a new brew that will stink to heaven.  Given the election year convergence with the market problems, this will undoubtedly be a potent brew that's cooked up, especially with Pelosi, Rangel, Reid, and Schumer holding the wands....

Some think that this weekend's melt down can be traced directly back to this legislation, which allowed significantly greater latitude for investment banks in the market.  As you may have noticed, Fmr. Sen. Phil Gramm, who had been fairly visible in the McCain entourage, has now virtually disappeared.

From Wikipedia....

The Gramm-Leach-Bliley Act, also known as the Gramm-Leach-Bliley Financial Services Modernization Act, Pub. L. No. 106-102, 113 Stat. 1338 (November 12, 1999), is an Act of the United States Congress which repealed the Glass-Steagall Act, opening up competition amongbanks, securities companies and insurance companies. The Glass-Steagall Act prohibited a bank from offering investment, commercial banking, and insurance services.

The Gramm-Leach-Bliley Act (GLBA) allowed commercial and investment banks to consolidate. For example, Citibank merged with Travelers Group, an insurance company, and in 1998 formed the conglomerate Citigroup, a corporation combining banking and insurance underwriting services. Other major mergers in the financial sector had already taken place such as the Smith-Barney, Shearson, Primerica and Travelers Insurance Corporation combination in the mid-1990s. This combination, announced in 1993 and finalized in 1994, would have violated the Glass-Steagall Act and the Bank Holding Acts by combining insurance and securities companies, if not for a temporary waiver process [1]. The law was passed to legalize these mergers on a permanent basis. Historically, the combined industry has been known as the financial servicesindustry.

Many of the largest banks, brokerages, and insurance companies desired the Act at the time. The justification was that individuals usually put more money in investments when economy is good, but they put their money into savings accounts when it turns bad. With the new Act, they would do both with the same company, so it would be doing well in all economic times.

Prior to the Act, most financial services companies were doing this anyway. On the retail/consumer side, a bank called Norwest led the charge in offering all types of financial services products in 1986. American Express attempted to own almost every field of financial business (although there was little synergy between them). Things culminated in 1998 when Travelers, a financial services company with everything but a retail/commercial bank, bought out Citibank, creating the largest and the most profitable company in the world. The move was technically illegal and provided impetus for the passage of the Gramm-Leach-Bliley Act.

Also prior to the passage of the Act, there were many relaxations to the Glass-Steagall Act. For example, a few years earlier, commercial Banks were allowed to get into investment banking, and before that banks were also allowed to get into stock and insurance brokerage. Insurance underwriting was the only main operation they weren't allowed to do, something rarely done by banks even after the passage of the Act.

Much consolidation occurred in the financial services industry since, but not at the scale some had expected. Retail banks, for example, do not tend to buy insurance underwriters, as they seek to engage in a more profitable business of insurance brokerage by selling products of other insurance companies. Other retail banks were slow to market investments and insurance products and package those products in a convincing way. Brokerage companies had a hard time getting into banking, because they do not have a large branch and backshop footprint. Banks have recently tended to buy other banks, such as the recent Bank of America and Fleet Boston merger, yet they have had less success integrating with investment and insurance companies. Many banks have expanded into investment banking, but have found it hard to package it with their banking services, without resorting to questionable tie-ins which caused scandals at Smith Barney.

Senator Phil Gramm led the Senate Banking Committee which sponsored the Act; he later joined UBS Warburg, at the time the investment banking arm of the largest Swiss bank.

By the way, here's a sampling of the opinions of the market back in 2000 from Patrick McGeehan:

Published: December 18, 2000  NY Times

''What we have seen is the last frenetic scramble for the big firms to position themselves as global top-tier companies,'' said Jerome Kenney, who plots corporate strategy for Merrill Lynch. Foreign banks rushed to capitalize on relaxed regulations about who could own what, and some American companies did not want to be left without a partner, he said.

''You can make a lot of money as a major investment bank, but the market can't support 50 of them,'' Mr. Kenney added.

Few analysts or financial executives think that the merger trend is over, but some say that they expect fewer marriages of convenience and more strategically focused transactions. They may be stating the obvious because, by most measures, only two major Wall Street firms of digestible size remain independent -- Lehman Brothers Holdings and the Bear Stearns Companies. But they argue that simply becoming bigger is not a panacea; what is more important is having a leading market share in core businesses.....

Given the situation today, with the bankruptcy filing for Lehman Bros., can you believe that the following issue was the preeminent issue of concern for our lawmakers at the time?  Doesn't surprise me.  If any of those folks had been financial genius' they wouldn't have been working as our Representatives. In fact most of the articles published since the inception of the act have focused on this issue rather than the new lattitude in operation that the Act provided the investment community.  Amazing!  MORE...

Victoria's Secret and Financial Privacy

By Chris Jay Hoofnagle and Emily Honig

Outside the Beltway, it is not well known that a Victoria's Secret catalog is one of the key reasons that Congress included privacy protections for financial information when passing the Gramm-Leach-Bliley Act (GLBA). The GLBA sought to "modernize" financial services--that is, end regulations that prevented the merger of banks, stock brokerage companies, and insurance companies. The removal of these regulations raised significant risks that these new financial institutions would have access to an incredible amount of personal information, with no restrictions upon its use.In a session where House Commerce Committee Members "marked up" a draft version of the GLBA, Representative Ed Markey (D-MA) introduced an amendment that would add privacy protections. The Markey Amendment was strongly opposed by the banking industry. It added "Title V" to the Act, giving individuals notice and an ability to control some information sharing.

Prospects for privacy protection remained dim despite a series of testimonials by Members who recounted their experiences of having their Social Security Numbers and financial information sold. Representative John Dingell (D-MI) complained that the information sharing operated primarily to enrich banks at the expense of individuals' privacy. Referring to a recent speech by then OCC Comptroller John Hawke and a lawsuit brought by Minnesota Attorney General Mike Hatch, Dingell noted that big banks had sold account information to telemarketers who defrauded consumers. Representative Gene Green (D-TX) complained that his mortgage was sold along with his personal information to another bank. Representative Anna Eshoo (D-CA) noted that someone had obtained her Social Security Number and used it to file a false IRS claim.
Critical support for the Markey Amendment came from Representative Joe Barton (R-TX). Barton expressed concern that his credit union had sold his address to Victoria's Secret. Representative Barton noted that he started receiving Victoria's Secret catalogs at his Washington home. This was troubling—he didn't want his wife thinking that he bought lingerie for women in Washington, or that he spent his time browsing through such material.
Barton explained that he maintained an account in Washington for incidental expenses, but used it very little. Neither he nor his wife had purchased anything from Victoria's Secret at the Washington address. Barton smelled a skunk; he reasoned that since he spent so little money in Washington, his credit union was the only business with his address. Barton believed that he should be able to stop financial institutions from selling personal information to third parties, and supported the Markey Amendment. Congress enacted the bill, and now individuals have the right to direct financial institutions not to sell personal information to third parties. MORE....