The last post on the Finance Addict looked at London’s role in many recent banking scandals and failures. (Is dangerous banking a new Olympic sport, one wonders?) As that post pointed out, many of these banks were actually not British yet they were ultimately undone by activities going on in their British subsidiaries.
A new paper by the Federal Reserve Bank of New York sheds more light on the incredibly complex bank organizational structures that sprung up after the repeal of the Glass-Steagall Act. In their paper Dafna Avraham, Patricia Selvaggi and James Vickery show how subsidiaries at America’s largest banks have sprouted like so many wildflowers after a nourishing rain:
Today, the four most complex firms measured on this dimension each have more than 2,000 subsidiaries, and two have more than 3,000 subsidiaries. In contrast, only one firm exceeded 500 subsidiaries in 1991. [Bank holding companies] have also expanded their geographic reach; each of the seven most internationally active banks controls subsidiaries in at least forty countries.
What’s the point of all this? The emphasis is mine:
These subsidiaries have been created for a variety of purposes: (i) for regulatory reasons, for example, because separate subsidiaries are required in each country in which the firm operates, or for particular activities; (ii) to limit taxation, for example, by shifting certain activities into lower-tax jurisdictions; (iii) to manage the regulatory burden of the firm, for example, to avoid burdensome laws or regulatory regimes; (iv) to secure or limit the position of different claimholders on the firm in the case of bankruptcy.
That makes us feel so much better!
The report illustrates the critical role that legislation and regulation have played in getting us to this point. We started out on the right foot, with the Bank Holding Company Act of 1956 which the authors tell us was
[...] intended to prevent self-dealing and monopoly power through lending to nonfinancial affiliates and to prevent situations where risk-taking by nonbanking affiliates erodes the stability of the bank’s core financial activities, such as lending and deposit-taking.
This Act gave the bank holding companies, or BHCs, rather narrow limits on what they could and could not do. However, this changed with amendments to the Act made in 1970 and then again in 1999 with the passage of the Gramm-Leach Bliley Act to repeal Glass-Steagall and sanction the birth of Citigroup. The authors note:
While it is difficult to prove causality, it is notable that the striking growth in the size and importance of nonbank BHC subsidiaries dates almost entirely to the period after the passage of the [Gramm-Leach Bliley Act].
Have we now come full circle in the aftermath of the financial crisis? What of Dodd-Frank and the Volcker Rule? Where do these lead?
As Avraham, Selvaggi and Vickery point out, the passage of these two pieces of legislation do indicate that the mood has shifted. Yet the key question is, will it do any good? Federal Reserve governor Sarah Bloom Raskin doesn’t think so. Here’s what she recently said during a speech at the Graduate School of Banking in Colorado:
I dissented in the vote for approval of the proposed implementation of the Volcker Rule. Let me say a bit about that dissent now. One reason for my vote was my sense that the proposed regulation’s guard rails were insufficient. I was concerned that, as proposed, the guard rails were too broad and would allow banks to be able to go too far off the road. Further, I was concerned that the guard rails as crafted could be subject to significant abuse–abuse that would be very hard for even the best supervisors to catch.
Only time will tell if Raskin’s right. I suspect that she is for the simple reason that profit-chasing banks have better incentives to hire people who can outgun the regulators at every turn. What do you think?