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The  Case  for  Banking  Reform  No  More  Bailouts  by  Taxpayers  

Robert  N.  Downey           Delivered  at  Dartmouth  College,  June  11,  2013      Senior  Director       Updated  version  delivered  at  NYU  Law  School,  September    30,  2013  Goldman  Sachs                

The  following  is  the  full  text  of  the  updated  address.  Abbreviated  versions  were  delivered  on  June  11th  and  September  30th.  

In  five  days  it  will  be  June  16th.  That’s  a  famous  day  historically.    Can  anyone  tell  me  the  significance  of  June  16th?    What  about  you  English  majors?    And  devotees  of  James  Joyce’s  Ulysses.    Though  based  on  a  fictional  account,  on  every  June  16th  tens  of  thousands  follow  the  footsteps  of  Joyce’s  Leopold  Bloom  in  his  walk  around  Dublin  which  took  place  on  June  16th,  1904,  according  to  the  novel.    

There  is  another  June  16th  that  is  of  immense  historical  significance.    And  that  was  in  1933.    This  coming  Sunday,  June  16th,  will  be  the  80th  Anniversary  of  the  signing  of  monumental  legislation  -­‐  The  Banking  Act  of  1933.  

This  talk  is  an  updated  version  of  a  speech  I  gave  at  a  gathering  in  Washington  on  June  6th  last  year.    At  that  time,  my  talk  was  rather  quixotic  in  nature.    I  described  the  serious  financial  problems  facing  our  nation  and  a  proposed  solution,  but  last  year  odds-­‐makers  would  have  bet  50  to  1  against  any  serious  legislative  change  actually  occurring  in  the  foreseeable  future,  especially  with  a  gridlocked  Congress.    Congress,  if  anything,  is  even  more  deadlocked  today,  but  a  lot  of  very  positive  developments  have  occurred  in  the  intervening  year  (a  very  important  one  as  recently  as  July  12th),  and  I’ll  describe  them  later  in  the  talk.  

I’ve  worked  in  the  securities  industry  for  over  50  years,  the  last  44  with  Goldman  Sachs.  Nothing  in  my  business  career  was  as  important  as  the  role  I  played  many  years  ago  as  the  lead  defender,  on  the  part  of  the  independent  securities  industry,  of  The  Banking  Act  of  1933,  which  created  Federal  Deposit  Insurance  and  is  more  commonly  called  the  Glass  Steagall  Act,  the  names  of  its  Senate  and  House  co-­‐authors.  

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Messrs.  Glass  and  Steagall  sure  knew  what  they  were  doing  in  1933.  If  commercial  banks  were  to  enjoy  Federally  insured  deposits  (Part  I  of  Glass  Steagall),  they  certainly  should  not  be  speculating  with  Uncle  Sam’s  money.  So,  in  addition  to  creating  the  FDIC,  Congress  also  separated  commercial  banks  from  investment  banks  (Part  II  of  Glass  Steagall).  Unfortunately,  those  provisions  were  severely  

weakened  by  Federal  banking  regulators  over  the  years,  and  the  few  remaining  provisions  of  Part  II  were  eventually  repealed  by  Congress  in  1999.  

To  my  knowledge,  there  have  been  few  if  any  calls  to  repeal  Part  I,  the  Federal  Deposit  Insurance  aspect  of  the  Glass  Steagall  Law.  It  was  instituted  to  prevent  runs  on  banks  by  nervous  depositors  by  giving  such  depositors  confidence  that  Uncle  Sam  was  the  

ultimate  protector  of  their  money.    It  certainly  was  not  created  to  permit  Federally  insured  banks  to  trade,  underwrite  and  speculate  in  securities  or  commodities,  let  alone  so-­‐called  derivatives.  

As  I  stated,  by  the  time  Congress  decided  to  repeal  those  few  remaining  provisions  in  Glass  Steagall  that  separated  investment  banking  from  commercial  banking,  most  of  the  damage  had  already  been  done  based  not  on  any  amendments  to  the  law,  but  solely  on  prior  decisions  by  federal  banking  regulators,  primarily  the  Federal  Reserve  Board.    In  effect,  the  Fed  determined  that  when  Congress  passed  

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The  Banking  Act  of  1933  (the  Glass  Steagall  Law),  they  did  not  really  mean  what  the  law  they  had  just  enacted  clearly  stated.  The  tragedy  was  that  at  the  time  the  Fed  took  such  actions,  there  was  no  person  or  industry  group  that  had  the  financial  resources,  the  incentive,  or  the  inclination  to  challenge  the  Fed  in  court  on  behalf  of  the  American  taxpayers.    To  my  recollection,  Congress  failed  to  even  hold  meaningful  hearings  on  the  Fed’s  deregulatory  activism.    

What  a  crying  shame!  Congress  surely  had  the  perfect  example  of  what  could  go  horribly  wrong  when  the  Federally  insured  Savings  and  Loan  companies  were  given  additional  powers  by  Congress  in  the  late  70s  and  early  80s.  By  the  mid  to  late  1980s,  more  than  1,000  S&Ls  had  collapsed  costing  American  taxpayers  more  than  $340  billion  according  to  a  1996  estimate  by  the  General  Accounting  Office.  Why  did  the  banking  regulators  and  later  the  Congress  choose  to  ignore  that  obvious  history  lesson?  

When  Congress  finally  repealed  Part  II  of  Glass  Steagall  it  seemed  as  though  it  was  no  big  deal  since,  except  for  the  insurance  provisions,  Part  II  had  already  been  effectively  repealed  de  facto  by  the  banking  regulators.    Thus,  there  was  little  opposition  to  de  jure  repeal  in  Congress  and  it  passed  by  an  overwhelming  majority.    But  that  action  was  also  a  tragedy.    Without  the  Congressional  repeal,  two  positive  developments  might  have  taken  place:  (i)  a  future,  more  enlightened  Federal  Reserve  Board  might  have  seen  the  errors  of  its  predecessors’  ways  and  reversed  those  prior  decisions,  or  (ii)  a  suit  on  behalf  of  concerned  taxpayers  might  have  taken  the  issue  to  court  and  won  based  on  the  Fed’s  misinterpretation  of  the  clear  intent  of  the  Glass  Steagall  Statute.  

In  defense  of  the  Fed’s  deregulatory  actions  in  the  late  1980s  and  early  1990s,  which  dismantled  Part  II  of  Glass  Steagall  by  fiat,  such  actions  were  encouraged  by  a  fair  number  of  economists  and  by  editorials  in  much  of  the  financial  press,  including  the  Wall  Street  Journal  and  the  New  York  Times.    And  even  in  recent  years,  the  Economist,  Financial  Times  and  other  sophisticated  financial  publications  have  referred  to  the  Glass  Steagall  law  with  such  derogatory  terms  as  “that  Depression  era  statute”  and  “that  relic  of  the  thirties”.    Of  course  they  were  all  referring  to  Part  II,  not  Part  I.  

Why  did  none  of  these  economists,  editorial  writers,  federal  banking  regulators  or  Congress  itself  advocate  for  the  repeal  of  those  Part  I  provisions  that  provided  for  federally  insured  deposits  as  well  as  the  Part  II  provisions?    Why  indeed  did  the  

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financial  press  and  Congress  fail  to  refer  to  the  FDIC  as  a  “relic  of  the  thirties”?    Instead  of  retaining  Federal  Deposit  Insurance,  why  didn’t  Congress  permit  the  market  to  create  a  system  of  private  (not  governmental)  guarantors  of  bank  deposits  and  get  Uncle  Sam  out  of  the  business  of  insuring  deposits?  It  would  have  been  entirely  consistent  and  intellectually  honest  to  repeal  both  sections  of  Glass  Steagall:  Federal  Deposit  Insurance  as  well  as  the  separation  of  investment  and  commercial  banking.  But  of  course  it  would  have  been  politically  near  impossible  to  have  done  so.  It  is  hard  to  imagine  a  member  of  Congress  running  for  re-­‐election  based  on  having  voted  to  repeal  that  “relic  of  the  thirties”,  Federally  Insured  Deposit  Insurance.  

As  a  result  of  those  earlier  actions  by  the  Fed,  and  then  the  repeal  by  Congress  itself  of  those  provisions  which  separated  investment  banking  from  commercial  banking  while  retaining  Federal  Deposit  Insurance,  and  the  subsequent  debacle  in  the  financial  markets  in  late  2008  and  early  2009,  aside  from  a  few  strong  regionally  headquartered  investment  banking  firms  and  a  few  New  York-­‐based  boutique  advisory  firms,  there  no  longer  exists  a  vibrant,  independent  securities  industry  in  the  United  States.    

Think  of  it.  Of  the  five  largest  independent  securities  firms  five  years  ago,  Bear  Stearns,  about  to  fail  in  early  2008,  was  absorbed  by  J.P.  Morgan  with  strong  encouragement  by  the  US  Treasury  and  the  Federal  Reserve  and  immense  financial  help  from  the  Fed;  Lehman  Brothers  went  bankrupt;  a  shaky  Merrill  Lynch  was  bought  by  Bank  of  America;  and  shortly  thereafter  the  two  strongest,  Goldman  Sachs  and  Morgan  Stanley,  were  firmly  encouraged  by  the  Fed  and  the  Treasury  to  become,  and  quickly  became,  bank  holding  companies.  

A  little  aside  here…  Though  I  am  a  Senior  Director  of  Goldman  Sachs  (which,  as  I  said,  is  now  a  bank  holding  company),  this  is  primarily  an  honorary  title;  I  have  not  been  active  with  Goldman  since  before  the  firm  went  public  in  1999.  Therefore,  although  I  have  been  associated  with  The  Firm  since  I  joined  it  in  1969  and  have  immense  affection  and  respect  for  The  Firm,  its  leadership  and  the  integrity  of  its  people,  please  understand  that  I  am  not  speaking  for  Goldman  Sachs  in  any  way.  The  following  comments  are  solely  my  own  views.  

Another  aside…As  a  matter  of  fact,  unless  current  banking  laws  were  to  be  reformed  by  Congress,  Goldman  Sachs  would  be  foolish  to  give  up  its  present  structure  as  a  bank  holding  company  with  its  Too  Big  To  Fail  status  and  then  try  to  

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compete  with  Too  Big  To  Fail  bank  holding  companies  such  as  JP  Morgan,  Citigroup,  Bank  of  America  and  Morgan  Stanley.  It  would  be  unilateral  disarmament.  

As  everyone  knows,  the  financial  world  has  been  through  the  wringer  for  the  past  five  years.  There  were  many  causes  of  the  financial  crisis  of  2008:    

1. Toxic  mortgages  consisting  of  liar  loans  brought  to  market  by  unscrupulous  mortgage  brokers  which  were  then  securitized  and  repackaged  by  Wall  Street  banks  and  securities  firms;    

2. Careless  and  sometimes  venal  individual  borrowers  that  took  on  debts  which  they  didn’t  understand  but  knew  they  couldn’t  afford  unless  the  housing  bubble  continued  to  expand;    

3. Credit  rating  agencies  which  blessed  many  hundreds  of  questionable  mortgage  backed  securities  issues  with  their  highest  ratings  of  AAA,  the  same  rating  they  gave  to  United  States  Treasury  securities;    

4. Irresponsible  lending  by  Fannie  Mae  and  Freddie  Mac  (at  that  time  investor  owned  but  characterized  as  U.S.  government  sponsored  enterprises)  which  lowered  their  own  credit  standards  so  as  not  to  lose  market  share  to  Wall  Street;    

5. Federal  regulators  that  failed  to  do  their  jobs;    

6. And,  of  absolutely  vital  importance  the  fact  that,  due  to  the  initial  deregulation  by  banking  regulators  and  then  to  the  final  repeal  of  the  Glass-­‐Steagall  Act  in  1999,  large  Federally  insured  banks  (considered  too  big  to  fail)  could  and  did  speculate  in  mortgage  backed  securities  and  derivatives  underwriting  and  trading  just  like  non-­‐federally  insured  investment  banking  firms.  

One  of  the  most  compelling  arguments  against  those  who  minimize  the  risks  involved  in  underwriting  securities  can  be  gleaned  from  articles  in  August  2012  in  the  New  York  Times  and  the  Wall  Street  Journal  which  described  a  $590  million  settlement  by  Citigroup  with  its  stockholders.    

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Apparently,  according  to  the  Times,  "Citigroup  represented  that  subprime  exposure  in  its  investment  banking  unit  was  $13  billion  or  less,  when  in  fact  it  was  more  than  $50  billion.”  Had  the  bank  not  been  permitted  to  underwrite  securities  how  on  earth  would  it  ever  have  had  even  $1  billion  of  these  toxic  assets  in  inventory,  let  alone  $13  billion,  or  God  forbid,  more  than  $50  billion.    Since  the  articles  also  point  out  that  the  bank  underwrote  some  $70  billion  of  collateralized  debt  obligations  from  2004-­‐2008,  the  conclusion  of  where  most  of  those  assets  came  from  is  inescapable.    See  the  accompanying  “Debt  Craze”  table  for  further  evidence.    When  considering  the  gigantic  losses  that  Citigroup  suffered  from  underwriting  C.D.O.’s  and  other  mortgage-­‐backed  securities,  I  recall  with  more  than  mild  bemusement  the  arguments  that  the  banks  and  their  surrogates  employed  to  convince  their  banking  regulators  to  dismantle  

Part  II  of  Glass  Steagall.  They  essentially  argued  that,  since  underwriting  securities  was  a  virtually  riskless  business,  banks  should  be  permitted  to  underwrite  and  trade  them  because  the  profits  they  earned  therefrom  would  serve  to  more  fully  protect  taxpayers.  The  real  world  result  of  course  was  just  the  opposite,  requiring  a  $45  billion  bailout  of  Citigroup  by  America’s  taxpayers.    Whenever  a  nation  privatizes  the  gains  while  it  socializes  the  losses,  no  societal  good  can  be  achieved  —  unless  the  lessons  learned  set  us  on  a  new  sensible  path  where  failure  is  permitted  as  well  as  success.  And  for  failure  to  be  at  all  meaningful,  not  just  stockholders  but  unsecured  bondholders  and  other  lenders  must  also  suffer  losses,  as  was  the  case  when  Lehman  Brothers  went  bankrupt.  Otherwise,  lenders  will  have  no  incentive  to  lend  wisely.  No  private  institution,  financial  or  otherwise,  should  be  considered  too  big  to  fail.  Unfortunately,  that’s  today’s  world.  Just  consider  the  bailouts  by  American  

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taxpayers  of  the  S&Ls  some  25  years  ago  and,  more  recently,  Fannie  Mae,  Freddie  Mac,  AIG,  Citigroup,  BofA,  the  nation’s  money  market  funds  and  others.

Part  II  of  the  Glass  Steagall  Act  worked  effectively  for  over  50  years  in  the  United  States  with  hundreds  of  investment  banks,  large  and  small,  being  allowed  to  fail  (such  as  giant  Drexel  Burnham  which,  at  the  time  of  its  failure,  dominated  the  high  yield  corporate  bond  market)  without  a  penny  of  taxpayers’  money  expended.  A  good  number  

of  commercial  banks  also  failed,  including  a  large  one,  Continental  Illinois  Bank  in  1984,  but  they  were  taken  over  by  the  FDIC.  Nonetheless,  in  spite  of  the  many  examples  of  failure  by  investment  banks,  the  large  federally  insured  commercial  banks  were  relentless  in  their  desire  to  engage  in  the  risk-­‐taking  that  non-­‐insured  investment  banks  were  permitted  under  Part  II  of  Glass  Steagall.    

Initially  those  banks  lobbied  their  regulators  to  interpret  the  law  in  a  manner  that  would  allow  them  to  underwrite  and  trade  municipal  revenue  bonds  since  they  were  already  permitted  to  underwrite  municipal  general  obligation  bonds  secured  by  taxes.    They  initially  only  wanted  revenue  bonds.  (Sure,  and  Hitler  only  wanted  the  Sudetenland).  Later,  they  sought  and  won  the  power  to  underwrite  and  trade  corporate  bonds  and  mortgage-­‐backed  securities,  and  eventually,  equities.    

Unfortunately,  the  Federal  banking  regulators  allowed  them  to  do  so.  The  only  way  the  securities  industry  could  prevent  this  was  to  take  the  banking  regulators  to  court.  But  that  soon  came  to  be  prohibitively  expensive.  The  independent  securities  firms  simply  could  not  afford  to  defend  Part  II  of  Glass  Steagall  in  that  manner,  so  we  proposed  a  reasonable  alternative  that  permitted  commercial  banks  to  engage  in  investment  banking.    

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Some  23  years  ago,  as  Chairman  of  The  Securities  Industry  Association  (which  then  represented  all  the  nation’s  investment  banking  firms,  large  and  small),  I  proposed  Federal  legislation  –  supported  unanimously  by  the  SIA  Board  –  which  would  have  permitted  separately  capitalized  investment  banking  subsidiaries  of  bank  holding  companies  to  compete  with  traditional  investment  banks,  but  with  very  strong  firewalls  to  prevent  access  to  Federal  Deposit  Insurance.    The  proposed  legislation,  the  SIA  Plan,  was  drafted  in  1990  primarily  by  the  Securities  Industry  Association’s  highly  qualified  outside  counsel,  Mr.  Francis  X.  Meaney.  

The  staunch  Congressional  defenders  of  the  Glass  Steagall  separation  of  investment  from  commercial  banking  were,  not  surprisingly,  extremely  disappointed  in  the  SIA’s  decision.    I  remember  a  day  in  1989  when  the  late  Dick  Fisher,  then  CEO  of  Morgan  Stanley  and  Vice  Chairman  of  the  SIA,  and  I  had  a  rather  tense  meeting  with  Congressman  John  Dingell  of  Michigan,  the  then  very  formidable  Chairman  of  the  House  Energy  and  Commerce  Committee,  and  today  the  longest  serving  member  of  Congress.  

We  explained  that,  since  the  SIA  could  no  longer  afford  to  sue  the  Fed  and  the  US  Controller  of  the  Currency  every  time  they  bestowed  an  additional  underwriting  power  on  the  commercial  banks  in  violation,  in  our  view,  of  the  clear  intent  of  the  Glass  Steagall  statute,  we  were  forced  to  go  in  a  different  direction.    Chairman  Dingell  was  clearly  upset  with  us  but  reluctantly  agreed  that  we  had  no  choice  but  to  pursue  our  proposed  alternative.  

Incidentally,  the  SIA  later  merged  with  the  Bond  Market  Association  and  is  now  called  the  Securities  Industry  and  Financial  Markets  Association  (SIFMA),  and  is  dominated  by  bank  holding  companies.  

Under  the  SIA  Plan  of  1990,  such  investment  banking  subsidiaries  could  succeed  or  fail  with  no  help  or  hindrance  from  Uncle  Sam  in  the  same  manner  as  independent  investment  banking  firms.  Seems  pretty  simple!  Unfortunately,  that  simple  plan  was  never  adopted  by  Congress.  The  commercial  banks  fought  it  tooth  and  nail,  since  supporting  it  would  mean  the  loss  of  their  unfair  advantage  in  pursuing  investment  banking  business  as  Federally-­‐insured  banks.  Instead,  they  continued  to  successfully  advocate  for  more  trading  and  underwriting  powers  through  the  intercession  of  their  regulators  and  for  the  eventual  repeal  by  Congress  of  Part  II  of  of  Glass  Steagall  through  their  lobbyists.  

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Moreover,  the  commercial  bank  holding  companies’  lobbyists  succeeded,  in  truly  spectacular  fashion,  in  having  a  large  portion  of  their  investment  banking  operations  housed  primarily  in  their  Federally  insured  banks  rather  than  as  separately  capitalized  investment  banking  subsidiaries  which  would  succeed  or  fail  with  no  access  to  Federal  Deposit  Insurance.  Think  of  what  that  means.  The  credit  ratings  agencies  rate  the  bank  holding  companies’  Federally  insured  banks  several  notches  higher  than  the  holding  companies  themselves.    

It  is  not  difficult  to  conclude  where  most  large  bank  holding  companies  locate  the  vast  majority  of  their  derivative  trading  businesses.  The  Federally  insured  bank  subsidiary,  of  course,  because  with  higher  credit  ratings  significantly  less  capital  is  required  to  trade  such  instruments.  That  location  would  have  been  prohibited  under  the  SIA  Plan.  In  order  to  protect  the  taxpayer,  such  activity  would  have  been  required  to  be  executed  in  the  separately  capitalized,  non-­‐Federally  insured  investment  banking  subsidiary  of  the  bank  holding  company.  Unfortunately,  the  SIA  Plan  was  never  enacted.  

However,  as  a  result  of  the  worldwide  financial  debacle  over  the  last  several  years,  the  key  elements  of  the  SIA  Plan  are  in  the  process  of  being  adopted  in  the  United  Kingdom  by  the  British  government  based  on  Sir  John  Vickers’  Commission’s  recommendations.    I  had  a  very  productive  meeting  in  September  2012  with  Sir  John  in  Oxford  where  he  serves  as  the  Warden  of  All  Souls  College.    (In  the  US,  he  would  be  the  president  or  provost  of  the  College).  While  in  the  U.K.  I  also  visited  with  influential  officials  of  Her  Majesty’s  Treasury  and  the  Bank  of  England.    They  all  seemed  determined  to  go  forward  with  the  separation  of  commercial  and  investment  banking,  although,  never  fear,  the  UK’s  bank  lobbyists  will  vehemently  oppose  such  reform.  

With  the  world  in  such  financial  flux,  we  can  only  hope  that  the  Vickers  plan  succeeds  in  being  implemented  in  the  U.K.    It’s  essentially  the  SIA  Plan  of  23  years  ago.  Where  we  used  the  term  “Firewalls”  to  segregate  

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the  riskier  businesses  from  government  insured  deposit  taking,  they  use  the  term  “Ring  Fencing”  and  they  ring  fence  the  retail  bank  rather  than  the  investment  bank,  but  the  concept  is  the  same.  

In  addition  to  the  SIA  plan  and  the  Vickers  Plan,  the  European  Union  is  considering  a  plan  offered  by  an  expert  group  chaired  by  Erkki  Liikanen,  Governor  of  Finland’s  Central  Bank,  to  make  the  EU’s  banks  safer.    The  Liikanen  Plan  is  similar  to  the  SIA  Plan  but  is,  not  surprisingly,  being  vehemently  resisted  by  the  Universal  Banks  of  Europe.  

When  the  Dodd  Frank  legislation  was  being  drafted  by  Congress  a  couple  of  years  ago,  apparently  neither  the  SIA  Plan  nor  anything  similar  to  the  Vickers’  Commission’s  plan  was  seriously  considered.  Instead,  in  a  well-­‐meaning  attempt  to  protect  the  American  taxpayers  from  picking  up  the  tab  for  Federally  insured  bank  speculation,  Congress  adopted  the  so-­‐called  “Volcker  Rule,”  which  prohibited  Federally  insured  banks  from  engaging  in  proprietary  trading.  The  trouble  with  that,  as  has  been  amply  described  in  the  financial  press,  is  distinguishing  between  a  bank’s  “market  making”  and  “hedging,”  which  are  permitted  under  the  law,  and  its  proprietary  trading,  which  is  not.    

 Though  the  Dodd-­‐Frank  legislation  with  its  “Volcker  Rule”  and  its  attendant  complications  will  surely  put  a  lot  of  lobbyists’  and  lawyers’  sons  and  daughters  through  college  and  graduate  school,  my  wish  would  be  for  Congress  to  take  another  look  at  the  SIA  Plan  or  The  Vickers  Plan  or  the  Liikanen  Plan,  which  

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are  much  simpler  and  cleaner  and  entirely  non-­‐partisan.  Make  no  mistake,  however,  rather  than  the  SIA  Plan  or  Vickers'  or  Liikanen’s,  readopting  Part  II  of  the  Glass  Steagall  statute  would  be  the  ideal  solution.      In  July,  Senators  Elizabeth  Warren,  D-­‐Mass,  John  McCain,  R-­‐Ariz,  Maria  Cantwell,  D-­‐Wash,  and  Angus  King,  Independent-­‐Maine,  introduced  a  non-­‐partisan  bill  entitled  the  “21st  Century  Glass  Steagall  Act  of  2013”  which  would  recreate  and  expand  Part  II  of  the  original  1933  act.    I  heartily  applaud  the  four  senators  for  their  concern  for  the  American  taxpayers  and  their  courage  in  taking  on  the  giant  banks  with  their  vast  armies  of  highly  compensated  surrogates.    Based  on  all  my  history  on  this  issue,  I  couldn’t  be  more  supportive  philosophically  of  their  efforts,  I  pray  for  their  success  and  endorse  the  bill.  However,  sometimes  the  ideal  solution  might  not  be  politically  possible,  and  should  their  efforts  come  up  short,  I  hope  they  will  not  give  up  and  instead  consider  substituting  the  SIA  plan,  Vickers’,  Liikanen’s  or  something  similar,  which  might  have  a  better  chance  of  passage,  especially  since,  in  order  for  bank  reform  to  work  effectively  on  a  global  basis,  there  should  be  a  measure  of  international  cooperation.      In  the  fall  of  2008  a  Republican  Administration  and  a  Democratic  Congress  worked  together  in  a  bi-­‐partisan  manner  to  prevent  the  nation’s  financial  system  from  collapsing.    They  accomplished  this  by,  among  other  actions,  authorizing  the  U.  S.  Treasury  and  the  Federal  Reserve  to  inject  capital  into  the  largest  banks.    I  believe  that  America  and  the  world  owe  then  Treasury  Secretary  Henry  “Hank”  Paulson,  an  enormous  debt  of  gratitude  for  his  role  in  leading  our  nation  through  the  financial  crisis  of  late  2008  and  further,  that  the  history  books  will  look  very  favorably  on  the  necessary  and  proactive  actions  he  took  at  the  time.  (Full  disclosure:  Hank  and  I  were  fellow  partners  at  Goldman  Sachs  for  many  years  and  remain  good  friends).    The  capital  injection  from  the  government  in  2008  was  an  absolutely  necessary  action  that  saved  the  financial  system  and  most  of  the  taxpayer  funds  advanced  to  the  banks  have  since  been  returned  to  the  Treasury  with  interest.    Nevertheless,  should  the  banks  get  into  similar  trouble  again,  the  American  taxpayers  will  not  stand  for  another  bailout  by  Congress.    Therefore,  the  nation  would  have  to  rely  on  the  uncertainty  of  the  “Living  Wills”  section  of  the  Dodd  Frank  law  to  provide  for  orderly  wind  downs  of  failing  Federally  insured  banks.    But  no  one  knows  what  would  happen  if  the  contagion  from  such  failing  banks  were  to  spread  rapidly  

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throughout  the  system  as  it  did  in  2008.    The  result  could  well  be  financial  Armageddon.    After  my  June  6,  2012  Washington  talk,  the  Wall  Street  Journal  published  an  edited  version  on  their  Op-­‐Ed  page  on  July  31st  2012.  I  received  many  positive  responses  to  the  piece,  as  well  as  to  an  interview  I  gave  on  Fox  Business  News  on  August  30th  2012.  For  those  interested,  copies  of  the  op-­‐ed  and  the  interview  are  on  my  website:  betterbankinglaw.com.      Also  on  that  website  is  the  full  text  of  my  1990  interview  with  Investors  Dealers’  Digest  which  describes  the  SIA  Plan  in  considerable  detail.    Except  for  updating  the  plan  to  include  references  to  derivatives,  etc.,  I  would  change  little  today.    Subsequent  to  the  publication  of  the  WSJ  Op-­‐Ed,  I  have  had  productive  meetings  with  Paul  Volcker,  former  Chairman  of  the  Federal  Reserve  (by  telephone),  Bill  Dudley,  President  of  the  NY  Fed,  and  Richard  Fisher,  President  of  the  Dallas  Fed.    Richard's  brilliant  and  authoritative  articles,  interviews  and  addresses  have  made  the  strongest  possible  case  against  the  continuation  of  Too  Big  To  Fail.  (Note:  Richard  Fisher  is  not  related  to  the  aforementioned  late  Dick  Fisher,  who  was  the  former  beloved  CEO  of  Morgan  Stanley).    Within  the  past  few  years,  many  prominent  former  chief  executives  of  banks  and  securities  firms  have  come  to  the  same  conclusion  that  I  have,  and  believe  that  Congress  should  take  action  before  it  is  too  late.  

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Examples of Major Bank CEOS and Influential Media Reversing Positions

Name and background Date of Public Statement John S. Reed Former CEO of Citibank and, after the merger with Travelers Insurance, later became Co-CEO of Citigroup. Long term advocate for repeal of Glass Steagall.

2009 – Apologized for creating financial firm that required a taxpayer bailout. January 2010 – Issued public statement.

David Komansky Former CEO of Merrill Lynch from 1996-2002. Retired as Chairman in 2003.

May 5, 2010 – Stated he "regrets" pushing for the repeal of the Glass-Steagall Act on Bloomberg News.

Philip J. Purcell Former CEO of Morgan Stanley and its predecessor company, Dean Witter Discover from 1986-2005. Former strong advocate for repeal.

June 25, 2012 – Op-Ed in WSJ which maintained stockholders in TBTF banks would be better off if investment banking was spun off in a separate company.

Sandy Weill Former CEO of Citigroup, former Co-CEO of Citigroup (with John Reed), and prior to that, CEO of Travelers Insurance which owned the securities firms Salomon Brothers and Smith Barney. Perhaps the most notable advocate for repeal.

July 25, 2012 – Reversed position in CNBC live interview.

New York Times The Times said in 1988 – “Few economic historians now find the logic behind Glass-Steagall persuasive” and confirmed that view in another editorial in 1990.

July 27, 2012 – Editorial stating “Add the NYT to the list of the converted. We forcefully advocated repeal of the Glass Steagall Act. Having seen the results of this sweeping deregulation, we now think we were wrong to have supported it.”

   

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Several  other  members  of  the  Federal  Reserve  have  also  publicly  expressed  great  concern  regarding  the  Too  Big  To  Fail  banks,  in  addition  to  Richard  Fisher  and  Bill  Dudley.    They  are,  among  others:  James  Bullard,  President  of  the  St.  Louis  Fed,  Daniel  Tarullo,  Member  of  the  Federal  Reserve  Board  and  Ben  Bernanke,  Chairman  of  the  Fed.    When  I  think  of  those  Fed  governors  thoughtful  public  positions  today,  it  fills  me  with  sadness  since  many  of  their  predecessors  at  the  Fed  some  15-­‐25  years  ago  must  not  have  considered  the  consequences  of  their  deregulatory  actions  and  reached  diametrically  opposite  positions  from  the  enlightened  views  of  the  current  Fed  board  members  noted  above.      Though  the  former  Fed  governors  were  acting  in  good  faith  and  surely  did  not  anticipate  how  severely  their  actions  would  contribute  to  the  future  weakening  of  our  financial  system  and  the  risk  to  America’s  taxpayers,  in  my  view  they  should  have  given  more  deference  to  the  authors  of  the  Banking  Act  of  1933.    After  all,  Messrs.  Glass  and  Steagall  and  their  colleagues  had  witnessed  a  financial  debacle  without  precedent  in  our  nation  and,  as  I  said  at  the  start:  “They  knew  what  they  were  doing”.      Some  might  conclude  that  the  enlightened  views  of  the  current  Fed  governors  are  a  result  of  their  being  mugged  by  the  reality  of  the  financial  melt-­‐down  of  a  few  years  

ago,  whereas  the  former  Fed  governors  has  no  such  distressing  historical  event  to  make  them  cautious  about  permitting  Federally  insured  banks  to  speculate  with  taxpayer  money.  However,  those  former  governors  certainly  had  

the  stark  example  of  the  failure  of  the  Savings  and  Loan  industry  in  the  1980s  and  the  $340  billion  cost  to  American  taxpayers,  largely  as  a  result  of  the  expanded  powers  given  by  Congress  to  the  S&Ls.      

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It’s  comforting  to  finally  have  such  prominent  supporters  as  the  former  banking  and  investment  banking  CEOs  in  the  prior  table  and  the  present  Fed  Governors  mentioned  above.  Five  years  ago,  to  borrow  Dartmouth’s  motto,  “Vox  Clamantis  in  Deserto”,  I  was  truly  “a  voice  crying  in  the  wilderness.”  In  fairness,  though  I  had  few  allies  over  the  last  20  plus  years  (for  example,  only  eight  out  of  100  Senators  voted  against  the  repeal  of  Glass  Steagall  in  1999),  I  was  not  entirely  alone.  Two  of  the  most  thoughtful  and  eloquent  advocates  of  views  similar  to  mine  over  the  years  have  been  leaders  of  the  FDIC,  Sheila  Bair,  former  Chair  and  Thomas  Hoenig,  current  Vice-­‐Chair  and  formerly  the  President  of  the  Federal  Reserve  Bank  of  Kansas  City.  Another  very  supportive  voice  has  been  that  of  George  Will,  the  Pulitzer  Prize  winning  columnist  for  the  Washington  Post  and  Newsweek.    A  very  encouraging  recent  legislative  development  is  that  in  April  Senators  Sherrod  Brown,  D-­‐OH,  and  David  Vitter,  R-­‐LA,  introduced  their  comprehensive  Brown-­‐Vitter  legislation  which  addresses  the  "Too  Big  To  Fail"  issue.  Their  bill  requires  that  large  banks  hold  substantially  more  capital  than  smaller  institutions,  and  a  lot  more  capital  than  current  regulations  and  international  banking  standards  require.      The  supporters  of  that  bill  acknowledge  that  one  purpose  of  the  high  capital  requirements  is  to  encourage  such  giant  banks  to  downsize  resulting  in  their  no  longer  being  considered  Too  Big  To  Fail.  I  certainly  support  the  Brown-­‐Vitter  approach  as  does  Dallas  Fed  President  Richard  Fisher,  and  I  hope  it  is  successful,  since,  until  this  summer’s  21st  Century  Glass  Steagall  bill,  it  was  the  only  approach  on  offer.  However,  the  opposition  from  the  Too  Big  To  Fail  banks,  their  lobbyists  and  lawyers  has  been  ferocious.    Those  opponents  argue  that  America’s  largest  banks  would  then  be  unable  to  compete  effectively  with  giant  banks  from  other  nations.    Of  course  that  same  argument  was  used  a  generation  ago  to  convince  banking  regulators  to  weaken  and  Congress  to  repeal  Part  II  of  Glass  Steagall.    They  won  that  argument  and  the  resulting  chaos  almost  brought  down  the  U.S.  and  the  world’s  financial  system.    

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I  am  also  encouraged  that  on  July  9  the  federal  banking  regulators,  led  by  the  FDIC,  and  supported  by  the  Federal  Reserve  and  the  Office  of  the  Comptroller  of  the  Currency,  proposed  stricter  rules  that  would  require  giant  banks  to  hold  additional  capital.    It  is  certainly  gratifying  that  such  regulators,  some  of  whose  predecessors’  attitudes  had  been  overly  accommodative  to  the  wishes  of  the  regulated  banks  and  whose  deregulatory  actions  were  instrumental  in  causing  the  nation’s  acute  financial  problems,  should  now  help  lead  the  charge  the  other  way.    “Specifically,”  to  quote  a  favorable  editorial  in  the  July  10th  Wall  Street  Journal,  the  banking  regulators  “proposed  to  increase  the  leverage  ratio  at  giant  bank  holding  companies  to  5%  from  3%,  and  to  6%  for  the  insured-­‐deposit  taking  banks  inside  these  holding  companies.  For  either  the  parent  companies  or  the  FDIC-­‐insured  banks  inside  them,  our  preference  would  be  to  go  north  of  6%.  Why  not  approach  the  capital  levels  that  small  finance  companies  without  government  backing  are  required  by  markets  to  hold,  which  can  run  into  the  teens?    But  the  proposal  is  still  a  major  step  toward  taxpayer  protection  and  might  require  the  giants  to  increase  capital  by  close  to  $90  billion  by  2018,  or  to  shrink  their  balance  sheets  to  operate  more  safely  with  the  level  of  capital  they  hold  today.”        I  completely  support  the  Wall  Street  Journal’s  view  which,  like  the  Brown-­‐Vitter  bill,  would  require  that  giant  banks  hold  significantly  higher  levels  of  capital  to  protect  the  American  taxpayer.  

 In  spite  of  the  message  conveyed  in  this  dinosaur  cartoon,  neither  my  approach  nor  Vickers’  nor  the  21st  Century  Glass  Steagall  bill  requires  downsizing,  rather  they  require  

segregating  the  investment  banking  business  from  federally  insured  commercial  

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banking.  I  am  not  against  bank  size  per  se,  so  long  as  bank  failure  is  permitted  and  Uncle  Sam  is  off  the  hook.    I  am  strongly  against  the  corruption  of  capitalism  which  allows  Too  Big  To  Fail  banks  to  exist.    As  noted,  the  US  taxpayer  bailout  of  banks  in  2008  was  accomplished  on  a  bipartisan  basis  with  a  Republican  Administration  and  a  Democratic  Congress.  Nine  years  earlier,  in  1999,  the  repeal  of  the  few  remaining  provisions  of  Glass  Steagall  which  separated  investment  banking  from  commercial  banking  was  also  done  on  a  bipartisan  basis.  At  that  time  there  was  a  Democratic  Administration  and  a  Republican  Congress.  Thus  I  permit  myself  some  guarded  optimism  by  asking:  why  cannot  the  correction  of  that  costly  bi-­‐partisan  error  in  1999  and  the  avoidance  of  a  potential  financial  Armageddon  be  accomplished  in  a  bi-­‐partisan  manner  as  well?      If  this  critical  topic  has  piqued  your  interest,  and  I  certainly  hope  it  has,  I  invite  you  to  visit  my  website  betterbankinglaw.com.  Thank  you.    I  welcome  your  comments  and  questions.      

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 Robert  N.  Downey  biography  

Bob  Downey  joined  Goldman  Sachs  in  1969.  He  was  made  a  general  partner  in  1976  and  head  of  the  Municipal  Bond  Division  in  1980.  Mr.  Downey  was  also  responsible  for  Goldman’s  Washington,  D.C.  office  until  becoming  a  limited  partner  in  the  early  ’90s.  He  still  holds  the  honorary  title  of  Senior  Director  with  the  firm,  but  has  not  been  active  with  Goldman  since  before  the  firm  went  public  in  1999.  Though  he  has  immense  affection  and  respect  for  Goldman  Sachs,  its  leadership  and  the  integrity  of  its  people,  this  talk  reflects  Mr.  Downey’s  personal  views  only.  

During  his  more  than  40  years  in  investment  banking,  Mr.  Downey  was  instrumental  in  the  creation  of  numerous  financing  techniques.  He  was  ranked  the  best  Leader  of  Public  Finance  for  the  “Ultimate  Firm”  (an  all-­‐star  team  made  up  of  industry  leading  specialists  from  various  investment  banking  firms)  in  a  survey  by  Investment  Dealer’s  Digest.  He  was  selected  as  the  Outstanding  Municipal  Industry  Person  by  the  Municipal  Forum,  and  received  the  Bond  Market  Association  Municipal  Division’s  Honor  Roll  Award.  He  also  was  Vice  Chairman  of  the  Municipal  Securities  Rulemaking  Board.  

Mr.  Downey  served  as  the  1990  Chairman  of  the  Securities  Industry  Association,  the  primary  trade  group  of  the  nation’s  brokerage  and  investment  banking  firms,  having  been  Vice  Chairman  in  1988  and  1989.  During  the  1980s  and  early  ’90s,  Mr.  Downey  led  the  nation’s  investment  banking  firms’  efforts  to  prevent  the  evisceration  by  Federal  banking  regulators  of  those  provisions  of  the  Banking  Act  of  1933  which  separated  investment  banking  from  commercial  banking  and  deposit  taking.  Unfortunately,  such  provisions  were  severely  weakened  by  such  banking  regulators  over  the  years,  and  the  provisions  themselves  were  eventually  repealed  by  Congress  in  1999.    Those  provisions  of  the  Banking  Act  of  1933  which  created  Federal  Deposit  Insurance  were  not  repealed.  

Mr.  Downey  served  as  a  Director  of  Financial  Security  Assurance  Holdings,  Ltd.,  a  major  bond  insurance  company,  from  1994  until  2009.  He  serves  as  a  Trustee  of  the  North  Shore/LIJ  Hospital  System  and  is  a  member  of  the  Executive  Committee  of  Lenox  Hill  Hospital  in  NYC.  He  is  a  Director  of  the  International  Tennis  Hall  of  Fame  in  Newport,  RI.  and  is  a  former  Trustee  of  The  Keystone  Center,  The  Taft  School,  The  Spence  School  and  Westover  School,  and  was  the  former  Chairman  of  the  Blue  Light  Theater.    Mr.  Downey  is  also  deeply  involved  with  his  alma  mater,  Dartmouth  College