Gary Cohn Backs Reinstating Glass-Steagal, Breaking Up Big Banks

In an unexpected statement made by the former COO of Goldman Sachs and current director of Trump's National Economic Council, Gary Cohn told a private meeting with lawmakers on the Senate Banking Committee on Wednesday evening that he could support legislation breaking up the largest U.S. banks - a development that could provide support to congressional efforts to reinstate the Depression-era Glass-Steagall law - and impact if not so much his former employer, Goldman Sachs, whose depository business is relatively modest, then certainly the balance sheets of some of Goldman's biggest competitors including JPM and BofA.

According to Bloomberg, Cohn said he generally favors banking going back to how it was "when firms like Goldman focused on trading and underwriting securities, and companies such as Citigroup Inc. primarily issued loans."

What Cohn may not have mentioned is that with rates as low as they are, issuing loans - i.e., profiting from the Net Interest Margin spread - remains far less profitable than trading and underwriting securities in a world in which virtually every "developed world" central banker is either directly spawned from Goldman, or is advised by an ex-Goldman employee,

The remarks surprised some senators and congressional aides who attended the Wednesday meeting, as they didn’t expect a former top Wall Street executive to speak favorably of proposals that would force banks to dramatically rethink how they do business.

 

Yet Cohn’s comments echo what Trump and Republican lawmakers have previously said about wanting to bring back the Glass-Steagall Act, the Depression-era law that kept bricks-and-mortar lending separate from investment banking for more than six decades.

As Bloomberg further notes, Wednesday’s Capitol Hill meeting with Cohn was arranged by Senate Banking Committee Chairman Mike Crapo, and included lawmakers from both political parties and their staffs. The discussion covered a wide range of topics, including financial regulations and overhauling the tax code, the people said.

The WSJ adds that Cohn was asked by Sen. Elizabeth Warren (D., Mass.) whether the administration planned to carry out a promise included in the Republican 2016 platform—and made by the Trump campaign—to restore the law separating traditional commercial banking from Wall Street investment banking. The law was repealed in 1999. Cohn expressed an openness to working with Warren on the issue, and said he could support a simple policy completely separating the two businesses, these people said.

There are various ideas for restoring some form of Glass-Steagall, running the gamut from splitting apart firms completely to separating their various operations under an umbrella holding company.

 

While Cohn’s comments are consistent with other statements by Trump administration officials, it isn’t clear how much support there is for the idea among Republicans more broadly. Warren has in the past introduced a bill she called the 21st Century Glass-Steagall Act. In the last Congress, it received one Republican co-sponsor. Additionally, while Treasury Secretary Steven Mnuchin has also said the administration is open to implementing some version of President Donald Trump’s campaign promise. But in his Jan. 17 confirmation hearing, he expressed concern that “separating out banks and investment banks right now under Glass-Steagall would have very big implications to the liquidity in the capital markets and banks being able to perform necessary lending.”

While the Trump team has endorsed the Glass-Steagall idea, it hasn’t come forward with its own proposal. Meanwhile, Treasury officials are meeting with financial-industry officials to discuss ways to roll back rules adopted under the Obama administration. They are due to make recommendations to the White House in early June.

Some observers said they didn’t view Mr. Cohn’s comments as a threat. “We continue to believe that a return of some form of Glass-Steagall remains more of a headline risk rather than a real policy risk and we think the odds are against the reinstatement of the law,” Brian Gardner, an analyst with Keefe, Bruyette & Woods, said in a note to clients Thursday.

 

“I don’t think we’re concerned,” said one banker at a large firm. The bank is “pleased with the direction” of Mr. Trump’s administration and its executives aren’t racing to change strategy or make a big new lobbying push. “It’s the same day as it was yesterday,” this person said. “It’s not a time to go crazy.”

 

Tim Pawlenty, president of the Financial Services Roundtable trade group, said Thursday: “Large financial institutions play a role in the American economy other institutions are not able to fill. We are working with Congress and the administration on a common-sense approach to financial regulation modernization and look forward to more progress.”

Still, while Cohn's statement may be simply posturing, some see Cohn's support as notable: “he was the most likely obstacle within the Trump White House” to restoring Glass-Steagall, said Jaret Seiberg, an analyst with Cowen & Co., in a note to clients. “With him supporting Glass-Steagall’s restoration, there is no one in the inner circle left to fight it.”

Mr. Seiberg said banks may be underestimating the threat: “At some point the market is going to have to accept that the Trump administration is serious about restoring the Glass-Steagall separation between commercial and investment banking.”

As a reminder, Glass-Steagall was adopted in the 1930s as a way to keep securities businesses separate from taxpayer-insured banks. The separation between lending and investment banking slowly eroded in the latter part of the 20th century, as banks won regulatory exceptions to diversify their businesses. Since Congress repealed the law in 1999 under Bill Clinton, some liberals have pushed for reinstating it, "calling such a move a simple way to make the economy more stable by removing a taxpayer backstop from risky activities. Proponents of bringing back the law also say it would diminish the size and political influence of large Wall Street banks."

The 2010 Dodd-Frank regulatory-overhaul law took a half-step toward Glass-Steagall when it mandated the Volcker rule, which bars banks from certain activities unless they are trading on behalf of their customers. Many banks have since closed so-called proprietary trading desks.

Ultimately, even with Cohn allegedly behind the push repeal, the Glass-Steagall idea hasn’t gained broad support yet, even among Democrats. As the WSJ concludes, former Federal Reserve Gov. Daniel Tarullo, the Fed regulatory guru who stepped down Wednesday, was asked about Glass-Steagall earlier this week. He pointed out that in 2008, Bear Stearns and Lehman Brothers—two investment banks without traditional lending businesses—caused significant financial stress.

“Just by separating things doesn’t mean people stay out of trouble,” he said, adding that there would be costs to forcing banks to separate and lose the potential business advantages of combining their operations. “If you are going to have those costs and still have financial stability problems…then maybe we are not getting much after all.”

Unfortunately he may be right: the current financial environment is one in which the concern is not so much separating securities businesses from taxpayer-insured operations, as separating the $14 trillion in global liquidity sloshing around courtesy of central banks, from the rest of "organic" liquidity. It is that particular separation that will be a far bigger headache in the coming years than even reinstating Glass-Steagal.

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Finally, while the likelihood of a new Glass-Steagall is low, the financial industry is already preparing for a worst case scenario, and firms such as Credit Sights are warning that a return of the Depression-era law would hurt banks.

In a note from CreditSights' Pri de Silva, he writes that while some politicians and regulators, including Donald Trump, have been calling for a new Glass-Steagall Act separating investment and commercial banking, only FDIC Vice Chairman Thomas Hoenig has put forward a detailed proposal; "implementing it could hurt global financial markets and financial stability."

  • Sees severely harming credit profiles of the big 6 banks (BofA, Citigroup, Goldman, JPMorgan, Morgan Stanley, Wells Fargo), bondholders, trading counterparties and other bank creditors of these banks, U.S. banks’ global competitive advantage, and liquidity in bond, repo markets
  • Could also curtail credit creation due to constraints placed on banks/brokers, steep capital requirements, which in turn would become headwind for economic growth and "the smooth functioning" of financial markets
  • If broker-¬dealers’ ability to make markets is constrained, ability to act as shock absorbers would be pruned, spikes in volatility may increase
  • Notes potential lack of clarity about parent-¬level debt (issued for TLAC)
  • Notes proposal calls for eliminating or watering down many of the "prudent safeguards" implemented since the credit crisis, including CCAR, DFAST stress tests, and replacing them with 10% tangible equity ratio that doesn’t distinguish between a subprime mortgage or a leveraged loan and a U.S. government obligation

In short, while it was the post-Glass Steagall world that led to the 2008 financial crisis, Wall Street has already fallen back to its traditional defense mechanism: threatening that far greater doom and gloom lie in story if the Trump administration does the one thing that may actually protect taxpayers. As a result, with Wall Street effectively running the current administration, we doubt the probability of a Glass Steagall reinstatement is even worth talking about.