In the 1930s, Congress passed a series of laws, collectively known as Glass Steagall, that barred commercial banks from engaging in brokerage/investment banking activities. The rationale: the linking of banking and brokerage in one company had spawned abuses that had a big hand in causing the Great Depression.
Fast-forward to the late 1990s. Glass Steagall was gradually rolled back and then discarded. The rationale advanced by bank lobbyists in Washington? …commercial banks were older, wiser and better-managed. Banks also needed to expand their size and activities to compete successfully with the “universal” banks of the EU, which already were allowed to combine commercial and investment banking under one roof.
How’s that been working for us?
Well, in the decade-plus since, the new domestic “universal” banks:
–destroyed the mortgage market through wild speculative lending and widespread misrepresentation of the poor character of the mortgages they subsequently bundled up and sold off to others. Voilà! …the Great Recession. (Perversely, though, the American banks caused near-fatal wounds to their EU rivals, who were the eventual “dumb money” buyers of much of the sketchy mortgage-backed paper.)
–last year, regulators began investigating the big banks for illegally colluding to manipulate short-term interest rates through LIBOR (the London Interbank Offered Rate).
–recently, a similar investigation has been opened up to look at illegal bank collusion in foreign currency markets. According to the Wall Street Journal, so many bank senior currency traders have been suspended that too few honest traders (not an oxymoron, but close) may be left for global currency trading to function smoothly.
–reportedly, more investigations will be opened for other bank commodities trading, notably oil.
Wow! I find this all hard to take in. I have several reactions.
The first is that, either by accident or design, these investigations are only being launched after the worst of the financial crisis is over–meaning that the banks can withstand the financial and reputational shocks these inquiries are causing without triggering panic withdrawals by depositors.
The downsizing of the banks, now underway, probably still has a long way to go. The best and the brightest younger minds will search for jobs elsewhere, fearing the industry taint may be deep and more enduring.
Despite the financial industry’s enormous political clout in Washington, continuing scandals argue that further legal restrictions on banks’ activities are probably inevitable.
This all suggests to me that big money-center banks will be uninteresting investments for a considerable time to come.
As a citizen, the banking mess is appalling.
As an investor, the current situation suits me fine. I’ve never understood banks, I’ve never been willing to do the work needed to see what’s going on underneath the covers–although I’m sure I would never have guessed the extent of the criminality they’ve been involved in.
In a practical sense, the banking scandals mean I can focus my attention on IT and Consumer Discretionary as sources for individual stock ideas, without worrying that Financials will move to the head of the pack.
What makes this important is that Financials account for a big chunk of the index.
As the S&P 500 stands today, the largest sector by market weight is IT at 17.7% of the index. Financials (16%) is second. Healthcare is #3 (13%). Consumer Discretionary (12.5%) is #4. Together, these four sectors make up about half the index. Being able to ignore/underweight one of them with a high degree of confidence is a big deal.