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Every other day, the crisis in the global banking system
claims a new victim. Bear Stearns and Northern Rock have
already passed into the annals of history. Capital calls
at Citigroup, Merrill Lynch, Barclays and the Royal Bank
of Scotland Group are old news. Today, we are grappling
with the implications of court rulings about auction rate
securities in the US. Soon, Fannie and Freddie, the twin
pillars of the US mortgage financing system will de facto
be nationalized—by a Republican administration, no
less—and down the road they may be consigned to history
books as well.
It is difficult to imagine that just a few years ago, the
banking industry was flush with optimism and wheels of financial
engineering were turning smoothly, with not a wrinkle in
sight. Just think of the US. The Glass-Steagall Act had
fallen by the wayside, reversing the shotgun separation
of traditional banking and underwriting activities. Interstate
branching regulations had been swept aside and international
banking was on the rise, giving banks access to new markets.
Greater information sought by new accounting rules and calls
to adhere to Basel capital norms were offset by the ability
of banks to use models instead of market prices for fair
value estimation and for marking portfolios to `markets'.
Sun was shining, spring was in the air, and everything seemed
possible; the regulators had been tamed and the creative
beasts of banking had been set free.
It was easy to forget that regulations may not have been
the problem to begin with. The default in the banking industry
has been freedom from regulation, with regulators trying
to make amends in the wake of crises. It is equally easy
to forget that financial liberalization is often what precipitates
the crises. Sticking to the US banking industry, abode of
the original sinners in the current saga of injudicious
mortgage financing and the subsequent credit crunch, the
Federal Reserve System was created in 1913 only after a
crisis in 1907 demonstrated that not having a central bank
might not be a wise idea after all. The aforementioned Glass-Steagall
Act, which essentially separated commercial and investment
banking (and insurance underwriting) activities, and the
Federal Deposit Insurance Corporation Act aimed at preventing
bank runs, were enacted in 1933, as a reaction to the banking
crisis that accompanied the Great Depression.
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