A lot of people think the problem with our banks is that they tried to do too much. Peter Wallison of the American Enterprise Institute argues the opposite:
as banks have been forced out of lending to public companies–which in themselves offer significant diversification–they have focused more and more of their resources on fewer and fewer market sectors, particularly riskier kinds of business like commercial and residential real estate lending.
Starting in the 1970s, banks were shoved aside by securities markets as the main lenders to corporate America. So they got stuck mostly with real estate lending. And since Fannie Mae and Freddie Mac bought most of the plain-vanilla residential mortgages out there, the banks’ portfolios are full of commercial real estate loans and some high-end residential loans—not the most safe and stable mix.
The Gramm-Leach-Bliley Act that repealed the Glass-Steagall division between banks and securities firms was an attempt to address this problem. It didn’t really succeed at that, Wallison admits, but he thinks the basic idea was sound:
We need a policy that will enable banks to adjust to changes in the economy and the financial system in the future. If the GLBA is not effective for this purpose, then another mechanism should be tried. Banks should not be required–as they are now–to focus their activities only in the areas of the economy where they are still competitive. As long as banks issue deposits that are seen as government insured, however, they must be regulated and limited in their activities. The result, as we see today, will be continuing weakness in the banking sector.
It’s a really interesting argument. But I’ve got one problem with it: The financial crisis of the past couple of years did not begin in the loan portfolios of banks. It began in securitized debt markets that totally failed at assessing and spreading risk, then seized up and failed just like banks facing a depositor run. These securities markets had sucked lots of business away from banks over the past few decades, but in some cases (money market mutual funds spring to mind) they did so not (just) by being more efficient than banks but by taking risks that taxpayers eventually had shoulder to prevent a financial meltdown.
So it could be that the issue isn’t so much that we’ve been overregulating banks, as Wallison argues, but that since the 1970s we’ve been underregulating securities markets.
Update: Wallison replies.