Storm clouds and static keep threatening the already uneasy relationship between Wall Street and Washington DC, and many disgruntled investors and bankers believe the financial services industry is being unfairly singled out for blame by Congress and the Obama Administration.
As a veteran investment banker with more than 20 years’ worth of deal-making under my belt, I must seriously disagree with my colleagues.
I think the President and his seasoned economic team, in particular, are doing admirable work in trying to fix a very broken financial system. And, after considerable analysis, I’m particularly impressed with the way The White House has balanced restraint and respect for free market capitalism with bold and much-needed reform proposals that are designed to gently de-leverage and re-liquefy the financial system while regulating fairness and stimulating newfound prosperity.
It’s a tall order. And avoiding true nationalization and letting the forces of supply and demand play out as naturally as possible reveals a graceful sophistication not often seen in the political arena.
Having said that, I strongly believe that some of the Administration’s efforts at repairing the financial services sector are, perhaps, a bit misguided. So, in the spirit of constructive criticism, I’d like to offer the following five suggestions that might help fine-tune the plans, programs and proposals that are currently on the table.
Get Rid of Too Big To Fail
First, too big to fail is too risky and too expensive. So much of Washington’s efforts have been focused on the nation’s 19 largest financial institutions, the institutions that regulators are determined not to lose – at almost any prop-up or bail-out cost. But if one or more of these institutions remain technically insolvent, I believe we should either shrink them down to profitability or proceed with an orderly wind-down. That doesn’t mean a Lehman Brothers-style run-for-the-exits shutdown. But it does mean that too big to fail must give way as a guiding doctrine. We simply can’t move forward again if we are forced to support massive banks that are money-losers. The oversight costs, alone, are outsized and unfair to taxpayers.
Separating Investment Banking and Commercial Banking
Second, we must give serious consideration to separating investment banking and commercial banking again. Glass-Steagall had its flaws, to be sure, but it recognized that these two businesses are very different and have different risk profiles.
Both JP Morgan and Bank of America reported rough going in March after a good January and February. The reason March was tough had to do with trading losses – not because of anything related to commercial banking.
If we revive part of Glass-Steagall and partition investment banking off from commercial banking, people may then say that the investment banks won’t have enough capital to survive on their own. My response is that if investment banks dramatically reduce their trading risks, they won’t need all that capital, and they could then reduce their risk profiles pretty considerably.
The bottom line is that investment banking absolutely must return to being a customer facilitation business – and it must move away from being a hedge fund business. Thus far, Morgan Stanley seems to be the only firm changing its business model to reflect a renewed emphasis on customer facilitation. Let’s watch and wait and see if any other firms follow suit in the months and quarters to come.
Third, more attention, more focus and more assistance need to be given to regional and community banks all across the United States. These institutions are the real backbone of “Main Street,” and it’s important to point out that they haven’t been barraged and brought down by the same set of problems that the money center banks have.
If we’re serious about opening up the clogged credit ducts in this country, then we must be serious about supporting regional and community banks. These institutions are closest to the real economy, and they’re the ones who have forged the rich and meaningful two-way relationships with small- and medium-sized businesses, the true growth drivers of American capitalism.
Not All Hedge Funds Are the Same
Fourth, we need to manage hedge funds better. We don’t have to take out a sledge hammer here, but we do have to remember that not all hedge funds are created equally. Some are very leveraged and generate high trade volumes that pose big risks to the system; others are non-leveraged and invest based on fairly sound fundamentals. As a result, the two categories should not be regulated in the same way. But there does need to be transparency into all funds – whether they’re hedge funds, private equity or venture capital. And large, leveraged trading funds like Long Term Capital Management should be regulated in a manner that’s consistent with the systemic risk they present. Finally, I believe that carried interest should be taxed at ordinary income rates.
Fifth, and finally, we need to look more carefully at the boards of our large financial institutions. One thought worth considering: migrating to a European / British model, in which board members are de-facto full-time employees of the financial institution. That means many more hours of supervision and involvement. Board members in this country simply can’t (and don’t) know what’s going on in these mammoth institutions and they risk having the CEO filter all the data that comes to them.
Giving Boards the Right Tools
Of course, if we ask more of the boards at financial institutions, we must give them better tools to do an end-to-end job. But my firm belief is that – in a more perfect world – it would be better to have the boards doing the oversight at these large financial services conglomerates than the federal government.
I recognize that the Obama Administration’s vision for the financial sector in this country is still a work in progress, an experiment, if you will. But the basic blueprint it has designed is a good start. Now it’s imperative that policy architects and private-sector wealth builders join together to help make the structure safe and sound for the next generation of Americans.
Michael Butler is Chairman and CEO of Cascadia Capital, LLC, a Seattle-based national investment banking firm that finances the future for companies in Sustainable and Information Technology Industries, and the Middle Market.