The Blog Post to End All Blog Posts: 1 of 2

On this Armistice Veteran’s Day, let’s try to do a counterfactual and Make Brad DeLong Happy.*

Let’s assume that the Gramm-Leach-Bliley—commonly referred to, incorrectly, as “the repeal of Glass_Steagall”—is A Good Thing. Well, I won’t go that far. An Inevitable Thing. [Many sentences about Larry Summers omitted here.] After all, anyone who was paying attention knew that Glass-Steagall had already been shivved several times by 1999, and that letting Citi buy Travelers banks buy insurance companies (and vice versa) was only a matter of time.

(If you tell me that’s a good thing, I’m going to point out that the risks of banks and the risks of insurance companies are the same, that combining them in no way makes the financial system safer or improves risk management, and that, therefore, you’re an idiot. But pointing something so fundamental out to a Summers or a Bob Rubin would be like telling your two-year-old not to pull the cat’s tail; the only question is who ends up getting stitches.)

Let’s assume that commercial banks, investment banks, and insurance companies are essentially fungible entities. What will we see?:

1. Commercial banks will be able to outcompete investment banks, due to Gresham’s Law. They have more money, and can afford to make mistakes.
2. As a result of this, investment banks, with less capital and therefore less room for mistakes, will become more likely to fail as independent entities. (You would have to be stupid, or McMegan, to assume the brunt of the damage would go the other way.)
   Results:
   1. Morgan Stanley Dean Witter, which occurred two years earlier, will serve as a warning sign that will be ignored by the banks, which “know” that the acquisition was backwards
   2. J.P. Morgan will be acquired by Manny HannyChase,
   3. Goldman Sachs has to go public to acquire capital; Jon Corzine is forced out because he realizes (having seen Bear and Merrill and Morgan Stanley do it before) that it will fundamentally destroy the incentive structure and culture of the firm.
   4. Investors working on the Greater Fool Theory will decide that Investment Banks might win the battle, and will bid up the BSCs and LEHs of the world, figuring that either (a) they will be acquired (JPM) or (b) they will grow on their own (GS, MS). This will be temporarily self-fulfilling, until it isn’t.

3. Insurance companies will move more into banking services (as their subsidiaries have for years) in search of more cash to search for more yield and more long-term investments and short-term arbitrage. Since they do much of this now, the only additional risk will be if there is a flurry of mergers. Or a rogue insurance company. And that would never happen in insurance, just as it would never happen in energy.
4. There will be very little demand from banks to buy insurance companies outright, since (a) there are very few Sandy Weill’s in the market and (b) even Citigroup used to be able to admit mistakes.

So what do we have, post-Gramm, Leach, Bliley? A marginal-at-best difference from 1997. The high likelihood that investment banks will lose the battle they’ve been fighting to less capable but better capitalized entities. A growing encroachment of insurance companies into the banking industry, while bankers go for the easy prey (IBs). The same consolidation and move toward plutocracy-pandering that was the rule.

Short version: there isn’t a fundamental change in the management, financing, or control of anything that arises from Gramm-Leach-Bliley or its predecessor. There is, as Ben Bernanke noted, “a failure of economic engineering and economic management,” but it’s marginal, and there’s a strong possibility that the system can recover.

But there are two later pieces of legislation that do cause a fundamental shift.

Next rock: 2000 and 2005; Summers and Biden pillage while Geithner fiddles.

*The more I think about this, the more I expect to fail, for reasons stated elsewhere. But it is NaNoWriMo, so this is at worst part of my 50,000 words.