Episode 110 – Taming the Megabanks with Art Wilmarth

Macro N Cheese – Episode 110
Taming the Megabanks with Art Wilmarth
March 6, 2021

 

[00:00:03.180] – Art Wilmarth [music/intro]

Any system that crashes twice in 12 years and requires a systematic bailout to the entire financial system cannot be considered a successful, viable or sustainable financial system.

[00:00:19.150] – Art Wilmarth [music/intro]

I make the joke that back when I was getting into this business, they used to call the financial services industry because they actually served the rest of the economy. And then somewhere along the way, they stopped using that name. It just became the financial industry. They were serving nobody but themselves.

[00:01:26.690] – Geoff Ginter [intro/music]

Now, let’s see if we can avoid the apocalypse altogether. Here’s another episode of Macaroni and Cheese with your host, Steve Grumbine.

[00:01:34.520] – Steve Grumbine

All right. And this is Steve with Macro N Cheese. Today, I have Art Wilmarth and Arthur E. Wilmarth Jr. is an expert in banking. He’s an expert in fraud. And he’s got a great book that has come out here recently. It’s called Taming the Mega Banks by Art E. Wilmarth Jr.. Please look it up. Please go get it. But let me tell you about my guest here momentarily, because Art is also a part of our series, The New Untouchables: The Pecora Files.

And he’s also featured heavily in the docuseries called The Con with Bill Black and Patrick Lovell and Eric Vaughan. Just an amazing amount of research and work has gone into this. So I want to give him the proper introduction so that everyone knows why this expert that we have with us is the voice to listen to. So Art is a professor emeritus of law at George Washington University’s Law School in Washington, D.C. He has been a part of GW law facility in 1986 after 11 years in private law practice, including as a partner in Jones Day’s Washington office.

During his 34 years on the faculty he taught courses in banking law, contracts, corporations, professional responsibility, and American constitutional history. He served as the executive director of George Washington Law School’s Center for Law, Economics and Finance from 2011 to 2014. And his book, Taming the Mega Banks, is going to be the topic of discussion today. So without further ado, let me bring on my guest, Mr. Wilmarth, welcome to the show, sir.

[00:03:17.330] – Art Wilmarth

Thank you very much, Steve. It’s great to be here. And thank you for inviting me.

[00:03:21.810] – Grumbine

This subject is so important. I was blown away by this book. When I purchased the book, I tell the audience full disclosure, this book is a solid 600 plus pages and it’s a hardback. It’s a beautifully bound, beautiful cover. Really nice to look at. And you open it up. And it is approximately 360 pages of text as far as the actual book goes, but the notes and the bibliography are easily a couple hundred pages and why that matters when you’re taking on the big dogs and you’re really trying to make your case, they have tons of money.

They have tons of lawyers, they have tons of spinmeisters, and they can poke holes into anything. And by the amount of documentation that Professor Wilmarth put in, I believe it’s unassailable. And that’s why I brought him on. This goes back to the 1880s and… I guess, Art, what I’d like to hear from you is can you give us the brief CliffsNotes overview of what the book’s about and then we’ll dive into the origins?

[00:04:35.740] – Wilmarth

Yes, absolutely. So the book tells the story of how commercial banks, banks that are deposit-taking institutions, got into the securities business, the capital markets business, at two different points in our nation’s history. One beginning in the 1880s, but really accelerating between World War I and the Great Depression. And then secondly, beginning in the late 1980s and then accelerating through the 1990s and 2000s.

And on each occasion, they became what I call, what people call, universal banks, universal banks, meaning that they can engage in securities activities and other capital markets activities, as well as deposit-taking and lending. And the thrust of the book is that on each occasion when this happened, there was an enormous boom and bust in the US economy and indeed in the global economy, which the universal banks played a very large role in creating, essentially by taking very high risk loans and packaging them up into securities which they then sold to investors around the world.

And also to a significant extent, selling very high risk stocks that the banks very large footprint in the form of their branches and other offices, their deposit resources and the trust that they held with their customers, gave them the ability to raise these massive volumes of securities, high risk securities, and to sell them in ways that the nonbanks, the traditional securities firms or traditional investment banks could not have done. And so you have these two enormous boom and bust cycles.

The first one ending in the Great Depression and the second one ending in the global financial crisis of 2007 to 09. And I make the argument that we should have learned, obviously, that this is a very unsound, unstable, and dangerous system. Congress had the good sense to abolish it in 1933 with the Glass-Steagall Act. Unfortunately, we did not abolish it in 2010 with the Dodd-Frank Act. We allowed it to continue.

And so it shouldn’t be a surprise that the system has continued to be very risky and unstable and that although the book was completed before the pandemic started, as we can discuss later perhaps, to me, the pandemic crisis confirms that we still continue to be in this very unstable, dangerous system dominated by universal banks who are not going to get out of the system until we adopt a new Glass-Steagall Act to separate banks from the capital markets.

[00:07:25.000] – Grumbine

Can you describe Glass-Steagall and how Glass-Steagall came to be?

[00:07:30.190] – Wilmarth

Yes. So Glass-Steagall again was one of the laws adopted in really literally the first few months of the Franklin Roosevelt administration, an early part of the New Deal. It was passed in direct response to the Great Depression. And Congress through a series of hearings and studies determined that allowing banks to get into the securities business and allowing them to sell these very high-risk securities to investors around the world played a very large role in creating the conditions for the Great Depression, and it had to be stopped.

And so basically the Glass-Steagall Act did several things, but we can focus on three. One basically said we’re going to give federal deposit insurance for bank deposits. So people’s money is going to be safe within banks because we see what happens when banks fail and people lose their money or can’t get to it. The money is frozen. We can’t have that again. So they created the Federal Deposit Insurance Program.

Secondly, they said we’re going to get banks out of the securities business. Banks that take deposits cannot be allowed to underwrite or trade in securities except for government bonds. We understand that banks have to deal in government bonds because governments need large financial institutions to act as dealers for their debt securities. So, OK, banks can do that, but no other type of securities. We want banks to be basically taking deposits, making loans, and providing investment advice to their customers through their trust departments.

And we’re quite convinced, Congress said, that banks will not be objective lenders and they won’t be impartial investment advisers if they’re taking these loans and packaging them up into securities and selling them. They are then biased and inclined to take lots of risks, and that’s not what we want banks to do. On the other hand, the third thing they said was we don’t want nonbanks or so-called shadow banks to be engaged in the banking business.

So we’re not going to let securities firms or anybody else who’s a non-bank take anything that looks like deposits. And so there was a very strict wall of separation created between banks and the capital markets, which operated very effectively, and helped maintain a very stable financial system from 1933 at least into the 1980s. There were no major systemic financial crises during that period. There were problems, but the crises that happened tended to occur within particular sectors and they could be contained because you didn’t have banks exposed to what was going on in the capital markets.

Essentially, when we took that wall down, sort of in a progressive series of liberalizations during the late 80s and early 90s, and then it was officially repealed in 1999, we then put banks and the capital markets back together again. There was no longer any wall of separation. There was no longer any firewall that would contain risk. And so when the next boom and bust cycle came and the global financial crisis happened, the crisis started in the shadow banking area in the capital markets.

But then it spread very quickly to the banks because they were totally exposed. So essentially, we forgot what Mark Twain is supposed to have said, although it’s hard to verify it, at least by legend, he was supposed to have said, that you can put all your eggs in one basket, but you better watch that basket. Of course, what we did is put all our eggs in one basket and then we didn’t watch the basket.

We let risk run wild. And so when the financial crisis came, as I said, it started on the capital market shadow banking side, but it quickly spread to the traditional banking side. So we bailed out essentially all of our largest banks, as well as many of our largest shadow banks. So the contagion went right across the whole spectrum of the financial system.

[00:11:36.410] – Grumbine

You go back in time, and I believe your book, when we were talking, you said that it started basically in the Gilded Age in the 1880s. And I’m curious, take us back to 1880 for a second.

[00:11:48.990] – Wilmarth

Sure, what was happening then is that, under what was called the National Bank Act of 1864, national banks were very limited in what they could do. They could basically take deposits, they could make short-term business loans, and they could obviously provide payment services, but they couldn’t do a lot else. What began to happen was on the state side of the system, the states also chartered banks and trust companies, and they began, particularly through trust companies, to allow their institutions to do more.

And so the national banks began complaining, hey, we need broader powers so we can compete against our state chartered competitors. What was also happening is you had the growth of Wall Street. So the Gilded Age was a period when Wall Street really greatly expanded and large securities firms began to be formed and one of the first, of course, was JP Morgan and Company. Another was Kuhn, Loeb & Company.

And these Wall Street firms basically specialize in financing large corporate formations and acquisitions and mergers. So this was the age of the growth of the great trusts, Standard Oil, the United States Steel, all these different large business combinations, particularly in railroads, iron and steel, oil, a number of the other big manufacturing and energy, transportation sectors.

But JPMorgan and company, Kuhn, Loeb & Company and the other Wall Street firms, they were limited in their ability to distribute these securities widely because they didn’t have lots of deposits. They had maybe a few, but not lots. They didn’t have the big networks of offices. And they looked at the big banks and said, “Hey, you know, the banks could really help us because they have lots of deposits. They could provide loans to support these underwriting syndicates and support the customers.

Oh, they have a lot of deposit customers. They have trust customers. So we ought to be partnering with these big banks.” And the banks were eager to make more money in a new area. So beginning in the 1880s, you begin to have JPMorgan, Kuhn, Loeb, some of these other big securities firms partnering with the big banks, and forming underwriting syndicates mainly for bonds. There wasn’t much stock underwriting at that time. And the banks liked what they experienced.

They make quite a bit of money doing that. But they sort of say we don’t really want to be the junior partners anymore. We want to be the senior partners. But the law didn’t allow them to do a securities business. They were sort of doing it kind of on the edges. And in the early 1900s, the federal authorities said, “No, you can’t be doing this. This is illegal.”

So what the banks did is they said, “OK, well, let’s set up separate companies. We’ll call them securities affiliates, and the companies will be set up so they’re commonly owned by our shareholders. They own the bank and they own the securities affiliate.” They would often create stock certificates with the banks name on one side and the securities affiliates name on the other. So you couldn’t sell the bank’s stock without selling the securities affiliate stock, and they would use other methods to link these things together.

But the idea was, oh, the bank isn’t doing this. It’s being done through a commonly owned affiliate but that’s a separate company and it’s state-chartered. That’s OK under the law. There was actually a lot of controversy about that. And there were some people that tried to stop it, but basically the federal authorities said, “Oh, yes, we actually want the banks to be more profitable, to be larger, to be more significant.”

And the Treasury Department, which kind of controlled what national banks did, sort of turned a blind eye to it, said, “Yeah, let them keep doing it.” Well, then during World War I, you had this tremendous increase in securities activities because first the allied nations, Britain and France especially, started selling war bonds in the United States and they sold them through these banks and securities affiliates.

And then the United States government, when we got into the war in 1917, the United States government floated huge amounts of war bonds and the commercial banks and the investment banks were both big players in that effort. Well, the commercial banks, having sold all these war bonds, of course, got lists of literally thousands and thousands of customers. And these were good bonds.

They were US government bonds that were going to pay off well. Everybody’s going to get paid. So customers began to get used to buying bonds from the banks and they trusted the banks. And so after the war was over, the banks said, “Hey, let’s take all these customers we built up, and let’s create private bonds that we can sell and our customers are going to buy them because they trust us.”

So at that point, the big banks were competing directly with the securities firms or the investment banks in selling these private bonds, many domestic bonds, but increasingly foreign bonds. They began underwriting bonds for Central and Eastern European countries and companies and South American countries and companies. Very risky stuff. But they said, “Look, if we, the big New York or Chicago banks, are selling this, it must be good. We say it’s good.”

They advertise to their customers, “Trust us. We know what we’re doing. We wouldn’t steer you wrong.” And of course, this competition between the big commercial banks and the securities firms or the investment banks became more and more heated as the decade of the 20s went along. This was the roaring 20s and they began taking more and more risk to win more and more business.

And then they started, as the decade got to the second half, they began selling stocks of all kinds, some of them extremely risky and an early form of mutual funds called the Investment Trusts. Well you literally have an explosion of stocks and bonds during the 1920s that are sold all over the United States to a lot of unsophisticated people, to a lot of small banks and small insurance companies that didn’t know what they were buying, but relied on the big banks that were advising them, and then to people all around the world.

So you had this enormous boom. But by 1929, the country is extremely leveraged, both on the consumer side and on the commercial corporate side, because consumers are borrowing money to do all sorts of things buying automobiles, buying houses, buying appliances. So everybody is going into debt. The companies are going into debt to expand their businesses. But in 1929, basically, there’s a huge debt overhang in this country.

And so when people start to pull back, when the Fed decides to cool off the economy, they’re afraid of the boom and they raise interest rates and the economy cools off, you first have the stock market crash, but very quickly thereafter you have a generalized crash because consumers begin defaulting, companies begin defaulting, the real estate market collapses, both commercial real estate and residential real estate.

And so you have a series of collapses all across the economy. So by the end of 1930, the US is in bad shape. And then pretty quickly, because the US banks and securities firms are no longer providing credit abroad, you have a series of crises in Europe because they had become totally reliant on US credit. And then it hit South America.

So you then have these crises in Europe and Latin America, including many defaults on the bonds that they had taken out. And of course, those bond defaults come back and reverberate back on US investors and US financial institutions. And so you have just a continuous spiraling down between 1930 and 33 in the United States and, obviously, disasters abroad.

So it was like a pyramid of cards that all imploded and Congress understood very well what had happened and they said, “We’re not going to let this happen again.” Well, unfortunately by the 1980s, we either forgot or chose to forget that history and basically said, gee, why not let big banks back into the capital market again?

[00:20:14.690] – Grumbine

Ronnie Reagan’s nice history.

[00:20:17.660] – Wilmarth

Right? It started under Reagan and then unfortunately accelerated under Clinton.

[00:20:22.430] – Grumbine

Absolutely.

[00:20:23.480] – Wilmarth

Clinton was the one who gave the coup de grace to the Glass-Steagall Act in 1999.

[00:20:29.270] – Grumbine

Can I ask you a question on that real quickly?

[00:20:31.500] – Wilmarth

Yeah.

[00:20:31.940] – Grumbine

I read a paper some time ago, a particular Wall Street guy named Sandy Weill.

[00:20:38.000] – Wilmarth

Yes. He started out in subprime consumer credit in Baltimore and built up a nonbank financial empire, first with his subprime consumer credit company. And then he picked up first, I think it was Shearson and then Smith Barney and then ultimately Solomon Brothers. And then he picked up Traveler’s Insurance Company.

So he built this enormous nonbank financial conglomerate called Travelers, and they merged with Citicorp in 1998 to form Citigroup. Now, what’s really interesting about that merger is at the time this is 1998, the Glass-Steagall Act had not been repealed yet. They had opened a bunch of loopholes in it, but it was still there. And so literally the merger of Travelers and Citicorp to form Citigroup was an illegal merger.

What they relied upon was a loophole in the Bank Holding Company Act that said, when you first become a bank holding company, you have two years and it could be extended up to five to get rid of all your nonconforming activities. And that was put in when the Bank Holding Company Act was passed in 1956 because they understood, OK, we’re going to create all these bank holding companies and they’re going to need time to get rid of nonconforming things.

What that meant was Travelers became a bank holding company by merging with Citicorp and they basically said, OK, Travelers, you now have two years which could be extended up to five by the Federal Reserve to get rid of all your capital markets activities and indeed most of your insurance activities. So essentially, they were saying to Congress, and this was done by Bill Clinton, by Robert Rubin, who was secretary of the Treasury.

[00:22:19.220] – Grumbine

Oh, yeah.

[00:22:20.450] – Wilmarth

And who later became chairman of the executive committee of Citi, and by Alan Greenspan, the chair of the Fed. They all said that the Citi and Travelers we’ll let this happen. We want it to happen. But they were putting a gun to the head of Congress and they were saying, “We’re creating this trillion-dollar-plus conglomerate, Citigroup, and Congress, if you don’t repeal the Glass-Steagall Act within two years or at most within five years, we’ll have to blow this up into pieces again.”

And so what had happened was they were tired of Congress not repealing the Glass-Steagall Act. There had been many, many attempts from the late 80s, to the late 90s, and they had never have been able to get it done. But essentially, they created a Frankenstein monster and put a gun to the head of Congress saying either you repeal Glass-Steagall now or this Frankenstein monster is going to have to be taken apart and who knows what’s going to happen then.

And of course, Congress didn’t need too much more persuasion and about a year and a half later, they repealed the Glass-Steagall Act and Citigroup became one of the largest of the new universal banks. But it shows you how corrupt the whole process was.

[00:23:27.680] – Grumbine

I got to tell you, the grossest part of this, and this is one of the very few pieces of history that I have never let go of – there’s a picture of Sandy Weill, Bill Clinton and other cronies standing there as Bill Clinton hands the pen he signed away Glass-Steagall with.

[00:23:44.270] – Wilmarth

Right.

[00:23:44.780] – Grumbine

Over to Sandy Weill

[00:23:45.920] – Wilmarth

Right.

[00:23:46.100] – Grumbine

A disgusting situation.

[00:23:49.360] – Wilmarth

And for a time, you know, Sandy had a picture of himself. Some magazine called him the shatterer of Glass-Steagall. And he had the picture of him in front of that magazine in his office. Interesting that by 2012, he had changed his tune and he said, “You know what? We made a mistake. They ought to separate banks from the capital markets,” he said, so that banks would do safe things and securities firms could take risks without threatening the whole banking industry.

[00:24:16.850] – Grumbine

Funny, huh?

[00:24:18.080] – Wilmarth

And the guy who was the head of Citicorp, John Reed, was even more emphatic. He recanted in 2009 and has continued to speak out against Gramm Leach Bliley, which was the act that destroyed Glass-Steagall, and he said we should bring Glass-Steagall back. The two creators of Citigroup really kind of changed their minds afterwards after they saw what happened during the global financial crisis.

[00:24:42.330] – Grumbine

So let’s go back — we’ve now instituted Glass-Steagall and we’re starting to climb out of the Great Depression and we’ve got World War II happening. Take me back to that era now.

[00:24:55.650] – Wilmarth

Sure. The 1930s was a time of repairing the banking industry, and the Federal Deposit Insurance Corporation had a huge part in that, obviously. The Fed itself had a huge part and then something called the Reconstruction Finance Corporation, which lent out billions of dollars to recapitalize many of the banks, but particularly the largest banks.

So the three largest recipients of bailouts from the Reconstruction Finance Corporation were National City, which became Citibank, eventually, Chase National Bank, which eventually became part of JP Morgan Chase and Continental Illinois, which was the biggest Chicago bank, which then failed again in 1984, was bailed out a second time.

So these were the three largest bailout recipients and they had all been heavily involved in this universal banking and securities capital markets activities, and they’d all suffered enormous losses. Now none of them failed. And you’ll see some people argue, well, none of these universal banks failed. Well, actually some of them did. Some mid-sized universal banks failed, particularly in Detroit and Cleveland.

And there was one in Chicago and one in Nashville that had actually very significant spillover effects. But they said, well, the biggest guys didn’t fail. Well, the reason they didn’t fail was they were bailed out. So what happened in 1933 is very similar to what happened in 2008 and 09 when we bailed out all the biggest banks then.

So they never were in a sense required to pay for their sins, so to speak, by failing. So during the remainder of the thirties, you have a slow repair rebuilding process, but what’s interesting is that we never really recovered fully from the Great Depression because banks were very reluctant to lend to anybody who wasn’t a blue-chip borrower and securities firms were very reluctant to underwrite for anybody who wasn’t a blue-chip issuer of securities.

So it was very hard for small or middle-sized companies to get credit and expand. Of course, World War II came along. With the armament industry and the mobilization of the country, World War II definitely pulled us out of the Depression. But then you get to the late 40s and 50s and 60s and you have a really golden period, very prosperous economy.

Banks are doing well. Securities firms are doing well. Insurance companies are doing well. Yes, there are certainly some hiccups along the way. I mean, there were certainly some problems as you get into the late 60s and 70s with the inflation and the currency exchange rate problems and the collapse of the Bretton Woods currency exchange system, those were serious problems. But interestingly, none of them destabilized the whole financial system.

One of the more I think striking episodes is in 1987, when we have, as you may remember, an enormous stock market crash in 1987. But it didn’t affect the banks because the banks weren’t involved in the stock market. They were separate. And so the Fed could turn to the banks and say, “we’re going to open the discount window and lend money to you so you can lend money to these securities firms and prevent them from failing.”

So the banks, with the help of the Fed, basically stabilized and saved most of the securities firms so the securities firms didn’t collapse. Contrast that to 2007 and 08 when the banks were deeply involved in the securities markets. So when the securities markets began to fall apart in 2007 and 08, particularly after the collapse of Lehman Brothers, the banks were immediately infected and threatened and would have failed if they hadn’t been bailed out. The contrast between 1987 and what happened 20 years later I think is very instructive.

[00:28:52.530] – Intermission

You are listening to Macro N Cheese, a podcast brought to you by Real Progressives, a nonprofit organization dedicated to teaching the masses about MMT or Modern Monetary Theory. Please help our efforts and become a monthly donor at PayPal or Patreon, like and follow our pages on Facebook and YouTube, and follow us on Periscope, Twitter, and Instagram.

[00:29:41.670] – Grumbine

I wonder about the general public. These things are stuff that the average person, probably, it’s way over their head. The complexity is enormous. So the kinds of crimes that we were guarding against, even regulatory aspects here are above the average voter’s head.

[00:30:02.400] – Wilmarth

Yeah.

[00:30:02.820] – Grumbine

This is not something that you could run a campaign on unless you were just using outcomes and describing individual stories. So I’m interested because a large part of what was able to draw out what happened during the collapse in 08/09 is the regulatory bodies and the auditors that were able to dig in and see what was going on. It seems like there’s this huge delta between this cabal of bankers and interests on one side, while the public just suffers the consequences of what they decide behind closed doors, on the other.

[00:30:39.990] – Wilmarth

Right.

[00:30:40.590] – Grumbine

And so I guess my question to you is, having spoken with our mutual friend, Bill Black several times, it’s quite clear that the ability to regulate these things is highly dependent on not only an administration, they want to fund auditing, fund regulation. They want to put an emphasis on it, number one. Number two is to have the resources, the people.

I understand the ratio of auditors is ridiculously low. We don’t have anywhere near enough people to do more than just pay lip service to regulation at this point. And then number three is the idea that the average public won’t understand anyway and so they can do whatever they want.

[00:31:21.360] – Wilmarth

Yeah. So I think it’s really interesting to look back at what happened that, say, in 1933 versus what happened in 2009 and 10. In 33, and this of course is discussed in the first episode of The Untouchables, they set up a Senate investigating committee which was led by a New York prosecutor who became chief counsel named Ferdinand Pecora.

And it was essentially a forensic investigation into what happened at the big banks, what happened at the securities firms, what caused the Great Depression. And Pecora, who was a very skillful investigator and cross-examiner, essentially laid bare for the American people the corruption, the self-dealing, the incredible recklessness, the riskiness and just the wrongdoing that occurred on Wall Street and in the big banks during the 1920s.

And he put it in terms that the ordinary person could understand. And there were headlines every day in the major newspapers about what he uncovered. And I think that mobilized the public. It made the public extremely angry and gave FDR and Congress the support it needed to pass the Glass-Steagall Act to pass the Securities Act of 1933, the Securities Exchange Act in 1934, essentially exert meaningful control over both banks and Wall Street in ways that were effective because the people understood.

And the other thing was, although there were bailouts, the bailouts didn’t come until after the country had already experienced an enormous economic collapse. And indeed, when Roosevelt came into office, all the banks had been closed and were closed for over a week. And so people saw in very stark terms just how bad the crisis was.

And Pecora taught them many of the people who were to blame for what happened. When you come to 2009 and 10, first of all, the government bails out everybody. And so I’m not saying they shouldn’t have. My complaint is that they allowed the system to get to where it was that it had to be bailed out. That was a mistake.

But once you’re in the middle of a crisis, I agree that you can’t do what we did during the Depression, which is allow everything to fail. That’s just catastrophic. But by bailing everybody out, the public didn’t really fully understand just how bad the situation was. And then the Financial Crisis Inquiry Commission, which I worked on for several months in 2010, was a very different animal than the Pecora Committee.

It was a group of seven commissioners, four Democrats, three Republicans, and it was very divided. There was no consensus or coherence in how the commission proceeded. And each of the commissioners would sort of question the witnesses for about 10 or 15 minutes at a time so the witnesses could filibuster like you see in the congressional committees.

They weren’t really pinned down. You didn’t have one questioner, one essentially prosecutor like Pecora just going after and after and after these people, undressing them in public, although I think the Financial Crisis Inquiry Commission report is a very good report with a lot of good facts. It wasn’t brought home to the public with televised reported hearings in dramatic fashion or with newspaper headlines in dramatic fashion.

So I think you’re right that people didn’t fully understand what brought this crisis, who was responsible for it, who was to blame. And therefore the Dodd-Frank Act, which came along in 2010, I don’t think the Obama administration had any interest in breaking up the big banks, but it’s not clear to me that there would have been enough political popular push or impulse to break up the big banks because the populace, the people, hadn’t been mobilized in the way that they were in 1933.

[00:35:24.020] – Grumbine

Can I stop you? This is such an important thing as far as our organization. Real Progressives, Real Progress in Action, this podcast Macro N Cheese, The New Untouchables: The Pecora Files, and other work that we do.

It is very clear even to this day as we’re putting out this content, we still see that people have been divided up into such small little containers, small little cliques of different class, different interests. They have divided it so much that the idea of us taking this podcast that everyone should listen to. This doesn’t even make it to maybe if we’re lucky, let’s say, 10,000 people.

[00:36:05.610] – Wilmarth

Sure.

[00:36:06.380] – Grumbine

But think of it. There’s 350 million people in the United States alone. Say we get 10,000 downloads of this podcast. I sure hope 10,000 people are enough to make change. I don’t know if that’s true, but hopefully they spread the word  – each one teach one – they get this stuff out there. But as of right now, I’ll be perfectly honest with you, as somebody who lives and dies by getting this kind of information out the door, this is vital information in order to get that populist energy to, in fact, take on the big banks. I just wanted to put that out there.

[00:36:37.480] – Wilmarth

The big banks, as you point out in the introduction, are very skilled and have all kinds of money. They can hire all sorts of opinion shapers and issue all sorts of sponsored white papers and so on. They’ve come up with a set of narratives to try to shield themselves. They say, “well, it wasn’t us, it was these nonbank non-depository lenders like Ameriquest or New Century or Option one. They were the ones.”

Of course, what they don’t tell you is that the money that those lenders used to make the mortgages came from the big banks. They gave them warehouse lines of credit to finance those mortgages, and then they bought the mortgages, which those guys created, and then they packaged them up and sold them in securities. So they were working cheek by jowl with these people.

And then they’ll say, “well, you know, no, it was those borrowers, these fraudulent borrowers who took out mortgages they shouldn’t have done and then they couldn’t pay.” And of course, they don’t tell you that they and the people they were working with, were trying to convince these people to take out mortgages they couldn’t afford. “Oh, we’ll, refinance you,” they said. “We’ll keep rolling it over in a two or three year increment.

We’ll keep refinancing. You don’t need to worry if you can’t pay it off right away and eventually you can sell the house if you want to.” And so they were pushing people to take mortgages that they knew they couldn’t pay and then they say, “oh, it’s all Fannie and Freddie’s fault.” But Fannie and Freddie were actually issuing primarily good mortgages. And at some point the big banks threatened Fannie and Freddie, “Hey, if you don’t start buying our mortgage-backed securities that are risky, we won’t bring any business to you.”

Fannie and Freddie are not without guilt, but they were pushed by Wall Street to get in on the game late in the day. Wall Street is right at the center of this. And Adam Levitin and Susan Wachter have recently published a very good book about the mortgage crisis that shows just how central Wall Street was to the whole thing. But they have alternate narratives they push to sort of deflect blame away from themselves.

[00:38:44.750] – Grumbine

It’s interesting because what I see is two narratives that serve to triangulate away from the real criminals, so to speak. Number one: punch down and punch hard and punch often to make sure that people feel shame, guilt, that they’re the reason everything fell apart. The economy blew up because poor people couldn’t pay their mortgages. The other narrative, which is equally grotesque, is that the government is too weak and small to actually regulate and control these things because it’s broke, it’s out of money.

And reality is that it’s because they don’t want to finance it. They don’t want to resource it. They want it to be weak and flimsy so that they can continue this cabal, so they can continue this criminal behavior. And you nailed it. Obama didn’t have any interest in solving these problems, nor did his AG. And you see repeatedly the too big to jail, too big to fail mindset.

[00:39:39.110] – Wilmarth

Right.

[00:39:39.740] – Grumbine

Has been there nonstop. So people believe that government is too weak to do anything or that it’s ineffectual, that it’s wasteful. They don’t want to hear anything about regulatory because that’s just slowing it down.

[00:39:50.660] – Wilmarth

Eric Holder came from Covington & Burling, one of the major people representing all the biggest banks. The head of the criminal division, Lanny Breuer, came from Covington. And my understanding was that they kept their offices open for them until they went back. In other words, they knew they were going back to Covington & Burling.

[00:40:09.410] – Grumbine

True revolving door.

[00:40:11.150] – Wilmarth

Yeah, a revolving door. If you know you’re going back to a firm that represents all these huge, enormous financial institutions, what incentive do you have to break them up? And Timothy Geithner, who was his Treasury Secretary and before that the president of the Federal Reserve in New York, I mean, he would became president of one of the largest private equity funds.

And so, again, he’s going to Wall Street. He must have had that at least in the back of his mind to some degree. So it’s interesting. It’ll be fascinating to see how Gary Gensler does if he’s confirmed as the SEC chairman. But, you know, he was the one exception as the head of the Commodities Futures Trading Commission. He actually did what he was supposed to do and implemented very tough new rules on derivatives, which had not been regulated at all.

When his term was completed, I mean, the report was that he wanted to go to the SEC and become chairman at that time, and he was not given any new appointment. And the attitude was sort of – this was in 2014 – don’t let the door hit you on the way out. And he then basically went back into the private sector and I think went up to MIT for some years and taught there.

But in other words, he had no interest in going to Wall Street and he was like considered a pariah by Wall Street. It’s very interesting when you connect what these regulators did during their term and where they ended up after their term, there’s some very interesting correlations, in my opinion. One thing my book does argue is one reason I think we need a new Glass-Steagall Act to break up banks and separate them from the capital markets is I do believe that these enormous universal banks.

I mean, look at JP Morgan, they’re closing in on three trillion dollars of assets and they have literally thousands of subsidiaries all over the world – I don’t think any human being can manage them effectively, and I don’t think any regulator can regulate them effectively. So there is sort of a level of complexity and sheer size that I think makes it extremely difficult.

And then the complexity of the financial businesses and activities and instruments they’re involved with because they’re doing so many different things, as we saw in Citigroup. I mean, Citigroup didn’t even know what many of its internal units were doing. Some of them are working at cross purposes. And so there’s a feeling that there is a too big to manage, too big to regulate problem. But I agree with you, a lot of the problem was there was no will to regulate them.

[00:42:41.340] – Grumbine

Art, one of the big concerns I have is having experienced some time with you recording The New Untouchables and talking with Patrick and Eric and Bill, it seems like in order for us to win the game, we need a massive amount of people to really understand this, because the people that are getting into Congress, the people that are getting elected into these offices, there’s a whole lot of money at play getting them there.

[00:43:09.210] – Wilmarth

Right.

[00:43:09.630] – Grumbine

And there’s expectations when they get there of what they’re expected to do.

[00:43:13.550] – Wilmarth

Yes, IOU, right.

[00:43:15.360] – Grumbine

Absolutely. And without having people understand how vital this is, you brought up something at the very beginning, which was, hey, we’ll get to covid. And people listening to this may be tempted to say, well, the great financial crisis happened in 08 and 09. That’s ancient history, that housing thing. It’s not pertinent today. And they may say the Great Depression, that’s not pertinent today.

[00:43:39.330] – Wilmarth

Right. Right.

[00:43:40.710] – Grumbine

And we’re here to tell you that based on everything I’ve learned, my focus is largely Modern Monetary Theory and trying to advance this idea that we can spend on the people. And every time we have a problem, there is the Fed backstopping criminal behavior. But every time the people need something, they are left out in the cold.

[00:44:01.060] – Wilmarth

Right.

[00:44:01.650] – Grumbine

In reality, this is by design. They don’t want us to see that. I wonder how we get people angry enough

[00:44:09.600] – Wilmarth

Right

[00:44:10.110] – Grumbine

To take this seriously.

[00:44:12.310] – Wilmarth

You look at what happened then, the global financial crisis through the pandemic crisis. What you have is a continued expansion and explosion of debts of all kinds. We had a record amount of corporate debt by 2020, and about half of that corporate debt was either junk related debt unrated or at the very lowest investment grade rated.

We’d never had such a risky mountain of corporate debt. Much of that debt was used to fund stock buybacks, which essentially serve the interest primarily of the insiders, the executives, by driving up their stock price. The companies literally borrowing trillions of dollars to finance buybacks, which benefit the insiders.

You have a continuing run up of consumer debt, not so much in the mortgage side, although the mortgage side is growing, but particularly in things like credit card debt and especially student debt, auto debt. So the consumers are very over-leveraged. So by the time you get to 2020 in March, essentially, the Treasury market seizes up, stops functioning.

The commercial paper market, which is short term corporate debt, seizes up, stops functioning. The corporate debt market seizes up, stops functioning. The Fed rushes in. Recreates all the programs that it had done back in 2008 and nine, and then creates new programs that were designed to prop up corporate debt. So essentially they bailed out the entire financial system again, thereby protecting all the big banks, all the big shadow banks, like private equity firms, hedge funds.

So we bailed out the whole financial system twice in 12 years, and Neel Kashkari, who was in the Treasury Department in 2008 and then went to become president of the Federal Reserve Bank of Minneapolis, gave a speech in September of 2020 in which he said, and I fully agree with him, “any system that crashes twice in 12 years and requires systematic bailouts of the entire financial system cannot be considered a successful, viable or sustainable financial system. We gotta do something different.”

[00:46:29.210] – Grumbine

Amen.

[00:46:31.010] – Wilmarth

I think I raise this point in The Untouchables, you know, that the definition of insanity is doing the same thing over and over and expecting a different result. And that’s what we’re doing. We’re continuing the system that all it does is churn out debt and protects Wall Street and then bails out Wall Street when the crisis comes. So they then simply have incentives to take on more risk. Shoot the moon. They think that they won’t fail. Eventually they will fail.

And eventually they’ll get to the point where the government can’t bail them out. But I think the pandemic crisis, in my opinion, confirms everything that I argued in my book that we’re in this global doom loop, I say, where the central banks and the governments are backing up the universal banks and the shadow banks on Wall Street, and everybody is churning out more and more debt without any understanding of how we could make that sustainable over the long term.

[00:47:23.780] – Grumbine

When I talked to Steve Keen, Steve Keen talked about a modern day debt jubilee and we spoke about how the way that the interest piles on itself.

[00:47:33.230] – Wilmarth

Right. Right.

[00:47:34.790] – Grumbine

There’s absolutely zero percent chance of it being paid back, number one. And number two, it poses a very strong systemic risk to the entire system, not just the system, to every human being on the planet.

[00:47:49.000] – Wilmarth

Oh, yes, definitely.

[00:47:50.600] – Grumbine

I guess what I’m trying to say is I consider this to be more lethal than all the shootings. And quite honestly, I bet you more people have died from suicide and lack of health care than our wars combined.

[00:48:03.830] – Wilmarth

Suicides, of course, go up tremendously during financial crises, and when you think of the number of people, something like 12 million people lost their homes and nine million people lost their jobs during 2007 to 10. And I’m sure that – we haven’t seen the statistics for this crisis – but I’m sure we know that the job losses are even higher and I’m sure the home losses are very significant. So you have people’s lives being destroyed, obviously.

I’m old enough to remember the great inflation of particularly the 70s and early 80s, so that this notion, as you say, that we could just keep the machine going. And, of course, it’s a deal machine where every new underwriting of debt or every new deal that’s underwritten provides fees for Wall Street. That’s how they get paid. There’s a short term incentive to keep the machine going. But the long term, I certainly think it’s not sustainable. As you say, it’s a systemic risk. It’s very dangerous.

[00:49:01.420] – Grumbine

So let me ask you, when they bail out corporations and we always hear talk about bailing out Wall Street, bailing out these firms. What does it really mean to bail out these firms? What are they actually doing?

[00:49:15.810] – Wilmarth

Certainly in 2007 and ’09, you had a combination of recapitalization where, much like the Reconstruction Finance Corporation, we put money directly into the banks in the hundreds of billions of dollars. So we actually injected new capital into the banks. One study showed that the Fed, if you put every transaction end to end as a separate transaction, there was something like 19 trillion dollars of loans made to the financial institutions on a rollover basis, which about 16 trillion went to the top eight or 12.

So enormous infusions of credit to keep them alive and keep them afloat. Then guarantees were given, huge asset guarantees were given, debt guarantees were given, again, to allow them to keep issuing debt and roll it over and not default. This crisis has mostly been done again in the form of very liberal loans from the Fed and again, all kinds of asset and debt guarantees.

The Fed basically coming in and acting as, whether you call the market maker or investor of last resort saying, “Hey, you know, we’ll buy the commercial paper, or we’ll buy the corporate debt if nobody else will buy it.” Now, the Fed having done that, of course, they did buy some, but they basically made a promise, an open-ended promise to buy as much as needed. So ultimately, they didn’t need to buy huge, huge quantities, but they were there as the ultimate backstop.

And of course, in addition, they were buying enormous amounts of Treasury debt and mortgage-backed securities to keep interest rates low, which again helps borrowers. If you keep interest rates low, it’s cheaper for them, bail out companies to refinance a lot of this very risky corporate debt that otherwise would have blown up in their faces. They basically keep them afloat, allowing them to keep refinancing, keep paying the interest.

But if you look at the Fed’s balance sheet, the Fed’s balance sheet before the financial crisis of 2007 through ’09 was about $800, $900 billion dollars. By the time you get to 2017 or ’18, it’s four and a half trillion. Then it fell down a little bit, but then it started rising again in 2019. The last I saw, the balance sheet is somewhere between seven and seven and a half trillion dollars.

So the Fed has put effectively between six and seven trillion dollars on its balance sheet, dealing with the last two crises. And most of that is either Treasuries, which basically allow the government to spend money to bail out people, or mortgage-backed securities, which keeps the housing market afloat. But all of these things keep interest rates low and help the borrowers.

Then if you looked at their balance sheet on a more granular basis when they’re making these emergency loans, until those loans are paid back, I mean, that money is on their balance sheet. So we’re talking about several trillions of dollars of backstop from the Fed. And, of course, the other big central banks around the world have done similar things just on a global basis, not counting China, which is sort of a unique case.

But the major central banks have gone from four trillion dollars on their balance sheet in 2007 to $15 trillion in 2017 or 18. And right now it’s about 24 trillion. So this gives you a global sense of just how much financing these central banks have taken on to keep all these markets afloat. And of course, when markets are kept afloat, companies don’t fail, investments don’t fail, and the people who have made those investments keep cashing in, right?

They can keep doing more deals. And the deals they did before don’t go sour on them. To me, this is crony capitalism, right? This is no longer a market. It’s a one way market because the Fed and the other central banks have put a floor under it, but they allow the market players to keep reaching for more risk.

[00:53:18.730] – Grumbine

So, Art, you know, I guess at the conclusion of your book, you say our work isn’t done yet. First of all, I guess, tell us what a solution looks like and tell us what the fight going forward looks like.

[00:53:32.120] – Wilmarth

So my argument is that we should go back to the wisdom of 1933 and say banks have to be banks – deposit taking, lending, payment systems, trust services, but no securities underwriting, no trading, no other capital markets activities, again, except for dealing with government bonds. And the securities firms, capital markets have to be out of banking, which means they can’t be taking things that look like deposits.

And as an example, money market funds are certainly deposits. We bailed those out twice now. Everybody thinks they’re deposits. They shouldn’t be anywhere but in banks. So the capital markets. My argument is they should not be able to fund themselves with any financial instrument that has a term of less than 91 days and would be paid at 100 percent of face value because that’s what a deposit is.

You put your money in, you get it back. And my view is I think anything with the maturity of less than 91 days is essentially a deposit if you’re expecting to get full value back. And that’s certainly true with the conventional money market fund, for example. So all those things would have to go into banks. That would shrink the shadow banking market considerably.

Private equity funds, hedge funds, money market funds would disappear. They’d go into banks, private equity funds, hedge funds would shrink tremendously and they would have to fund themselves with a longer term, which would create more market discipline. Of course, we would have to try to convince people that the government’s not going to rush in and bail everybody out every time there’s a hiccup in the capital markets.

That’s going to take some work. But markets are supposed to be where you take risk. And if you lose, you lose. If you win, you win. If we keep bailing them out, they’re not markets anymore. They’re just one way gambles on the federal government and as I say, they’re crony capitalism. So we’ve got to stop that. I think that if we broke up the universal banks, I think it would make the system much more competitive.

I think a number of these big banks would basically have to slim down considerably because I don’t think they would be very economical doing a conventional banking business at a very large size. And I think you’d have more providers, more competition, a greater diversity of providers, in my opinion. So I think that that’s the beginning of getting a more sane and controllable system.

And I think certainly we need to go back to a strong focus on consumer protection. We’ve got way too many what I call fringe lenders, payday lenders, auto title lenders, predatory lenders of all different sorts. Some of them call themselves fintechs, but they’re just predatory lenders in disguise. And I think certainly we need to think very hard about what Mehrsa Baradaran and others have talked about in terms of getting access to people, to bank accounts so they can actually conduct financial transactions in the economy without paying enormous fees.

I don’t understand why we can’t have basic banking accounts for people that would be sensible. So I think we need a much more diverse, decentralized, better regulated system that is actually serving the public. I make the joke that back when I was getting into this business, they used to call it the financial services industry because they actually served the rest of the economy.

And then somewhere along the way, they stop using that name. It just became the financial industry. They were serving nobody but themselves. I think we need to get back to the notion of the financial services industry that actually serves the public and serves the business community instead of just being wealth-grabbing exercises for the insiders.

[00:57:12.750] – Grumbine

That is absolutely fantastic. I have one final question for you.

[00:57:17.160] – Wilmarth

Sure.

[00:57:17.790] – Grumbine

With an understanding of decentralization, how would we regulate a decentralized ledger? You look at blockchain, blockchain is basically unmanageable in that sense. It’s not able to be overseen in the same way. I know there’s a push for central banks in general to adopt blockchain technology.

[00:57:39.150] – Wilmarth

Yeah.

[00:57:39.150] – Grumbine

What are your thoughts there?

[00:57:40.950] – Wilmarth

I would say decentralized in terms of fewer giant institutions and a more diverse group of institutions. I’m certainly not in favor of unregulated. So it seems to me I’m not an expert on blockchain, but no one has ever been able to explain it in a way that at least makes a great deal of sense to me for most things. Maybe for very large scale, large value transactions, you could justify the extra cost in what seems to me inefficiency of block chain.

But when you’re talking about normal consumer-oriented transactions or smaller business transactions, I do not see what block chain adds. And some people say, well, we would have what’s called curated block chain, which means somebody is controlling it and somebody is deciding what goes into it, what stays out of it. And my view is curated blockchain is not blockchain.

The whole idea of blockchain is that everybody can add to it, nobody can take away from it. And so then it becomes something completely different. But I certainly think we need very strong regulation of any payment system so that people can rely on it and the institutions that conduct it. We know what they’re doing and we know that they’re doing it honestly and effectively.

So all the stuff about Bitcoin, again, I’m not an expert on Bitcoin, but can anyone tell me who controls it, who owns it, who runs it? We have these periodic crashes where suddenly huge amounts of bitcoin just disappear. As far as I know, I’ve never seen anyone explain who actually runs it, controls it, organizes it. My view is that’s the recipe for madness. You need to have accountability.

People who are asking people to invest money or to transmit money, you have to know who’s behind it and are they accountable, or are they responsible? Are they well capitalized? Are they well regulated? So I certainly am not in favor of unregulated players when you’re dealing with people’s savings and their household money.

We’ve had crisis after crisis where unregulated investment for payment devices have collapsed and maybe one of the most recent ones is look at Wirecard over in Germany. I mean, Wirecard ought to tell us a great deal about how dangerous these poorly regulated or unregulated providers of payment systems can be.

[01:00:06.070] – Grumbine

That’s very good insight, because I think to myself with a blockchain type of distributed Bitcoinish type thing, it really is a commodity.

[01:00:15.070] – Wilmarth

Right.

[01:00:15.250] – Grumbine

And it fluctuates and it’s decentralized, meaning it’s on servers, a decentralized ledger.

[01:00:20.890] – Wilmarth

Yeah.

[01:00:21.310] – Grumbine

And it is owned by no one, really.

[01:00:23.260] – Wilmarth

Right.

[01:00:23.870] – Grumbine

And there’s no regulatory body. There’s no way to really regulate it other than to just shut it down.

[01:00:29.080] – Wilmarth

Right. Right. Presumably the Commodities Futures Trading Commission should be in charge of it. And I think you’re right. I think Bitcoin is a commodity and they should be overlooking it. And if they can’t figure out who’s running it, who’s responsible for it, who you can actually hold accountable for anything, I don’t know how you can allow someone like that to be doing business in this country.

[01:00:50.960] – Grumbine

On that note, let me just say thank you so much for your time. Your book, Taming the Mega Banks: Why We Need a New Glass-Steagall Act by Art Wilmarth is a must-read book. Art, thank you so much for your time. Thank you for joining me on The New Untouchables. And also just thank you so much for just being a great, unrelenting voice in a wilderness full of people that really don’t know what’s going on. So thank you, sir.

[01:01:18.520] – Wilmarth

Well, Steve, it’s my pleasure. And thank you very much for your interest in the book and for this conversation, as well as The Untouchables. A great pleasure.

[01:01:26.230] – Grumbine

Absolutely. So this is Steve Grumbine and Art Wilmarth, Macro N Cheese. We’re out of here.

[01:01:37.710] – Ending credits

Macro N Cheese is produced by Andy Kennedy, descriptive writing by Virginia Cotts, and promotional artwork by Mindy Donham. Macro N Cheese is publicly funded by our Real Progressives Patreon account. If you would like to donate to Macro N Cheese, please visit patreon.com/realprogressives.