Monday, April 23, 2012

Calomiris puffs CoCos

Columbia's Charles Calomiris checks in with Gene Epstein, promoting a forthcoming book, and proves he knows his Glass-Steagall history.  Responding to a point blank question about whether the Gramm, Leach, Blilely Act of 1999 was the cause of the financial crisis, he says;
No, and the irony is that even the original of the Glass-Steagall Act, as passed in 1933, had nothing to do with the crisis it was supposed to address. ....
On Carter Glass's laundry list was the notion that mixing investment banking with commercial banking was a bad idea. There was no evidence for that, and all subsequent research has rejected Glass's view. It's not even a close call. The Bank of United States' failure here in New York in 1930 had nothing to do with securities markets; it was exposed to Manhattan real estate and suffered losses related to the New York real-estate crash in Manhattan in 1929. Most of the other U.S. banks that failed in the 1930s did so as a result of farm problems and especially farm real-estate problems.
....Remember some of the illustrious names that got into deep trouble during the crisis -- Bear Stearns, Lehman Brothers, Merrill Lynch. They were all stand-alone investment banks at the time, unaffected by the partial repeal of Glass-Steagall. And we can only wish that commercial banks had done more of the relatively low-risk underwriting of [corporate] securities that the repeal of Glass-Steagall permitted them to do, instead of accumulating toxic mortgages, which Glass-Steagall had not prevented them from doing. 
Calomiris goes on to quote FDR himself as believing,  in October 1932 that deposit insurance would "lead to laxity in bank management and carelessness on the part of both banker and depositor."  Which he clearly believes is what happened.

Finally, the Columbia economist offers a suggestion to improve the banking system;
 I would establish a minimum uninsured debt requirement for large banks in the form of subordinated debt, known as contingent capital certificates, or "CoCos." The CoCos would automatically convert to equity based on predetermined market triggers, which would be very dilutive to pre-existing shareholders. One banker who understood my proposal for CoCo's said, "You are putting an electric fence behind me. "
The potential for dilution of stockholder equity being the key incentive for management to work to prevent that from happening.

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