Too Big for a Single Regulator?

Think back to America History class. Do you remember learning about the Glass-Steagall Act? The law dates back to the Great Depression and enforced a strict separation between banks that take deposits and those that invest in capital markets – that is until it was repealed in 1999.

Ironically, former Citigroup chairman Sanford "Sandy" Weill, who was the architect behind the 1998 merger of Citigroup and Travelers Group (which also owned the investment firm Salomon Smith Barney at the time) that resulted in the repeal of Glass-Steagall recently suggested adopting a new two-tiered banking model. Weill would split banks into the traditional deposit takers who could make loans and more “creative” institutions that could take more risk. In a recent interview, he urged, “Let's have a creative banking system, like we always had, where the financial industry can again attract the best and the brightest young people like they do in Silicon Valley, so that we can lead innovation that is necessary and [encourage] the entrepreneurship that's necessary. We can't have a world where it is impossible to make a mistake."

Allowing bankers to makes mistakes will be a tough sell in the wake of the recent financial crisis, and with the recent London Whale trades and Libor scandal now playing out. While Weill’s unlikely to garner much support to allow bankers to operate in a more risky fashion, the question of just how commercial banking and investment banking should be regulated will persist.

In an article in Knowledge@Wharton, Wharton management professor Mauro Guillén expressed his preference for central regulation for the big banks, noting, "When a bank is in 10 kinds of financial services, it does not need more regulation; it needs one regulator." He says the Dodd-Frank Wall Street Reform and Consumer Protection Act “hands more powers to the Fed, the Treasury and other agencies with authority over systemically important financial institutions. But owing to political pushback, none have full powers.”

Let’s hope that financial regulation and reform stay at the forefront of Washington’s agenda because, as Guillén wisely notes, “Untrustworthy banks are the last thing that’s needed if we are to overcome this crisis.”

The Unexpected Recovery

Last week on March 9, 2011, the world celebrated the two-year anniversaryof the low point in the global markets, the point of maximum pain and panic following the 2008 financial crisis and Great Recession.

On March 9, 2009, the S&P 500 Index had fallen to its low of 676.53, which is about where it had been almost 13 years before--on June 10th and October 3rd of 1996 it closed at 672.16 and 692.78, respectively. On March 9, 2011, the S&P 500 Index closed at 1321.15--a 95% increase from its low two years earlier but still down 18% from its all time high of 1565.15 on October 9, 2007. During the same two year period of time the Russell 2000 Index--an index that tracks small cap stocks--rose almost 140% from 343.26 to 821.19.

If you look back at the economic forecasts and market reports in March of 2009, you will not find a prediction that the markets would recover as they have. There was even some doubt whether the U.S. economy would survive intact, and the most common prediction was deflation, continued recession and more downside in the stock markets.

In retrospect, this most frightening time was the ideal time to shove all the chips on the table and bet everything on a stock market recover--but who had the intestinal fortitude for that? After the losses that virtually all investors had sustained, no matter where they had deployed their assets, few had the stomach, or the heart, to bet on a robust recovery. This is a terrific lesson in the value of disciplined investing; the consensus and our own gut feelings are often wrong and inevitably point us in the opposite direction from where the returns are going to come from next. In the past, every long-term upturn has been greater than the losses sustained in the prior bear market. We don't know how this one will end, but it seems to be following the same seemingly unlikely, but not unusual, course.