The Bankers Who Cried Wolf: Wall Street's History Of Hyperbole About Regulation
NEW YORK -- Coming from all over the country, hundreds of investment bankers from financial powerhouses like J.P. Morgan gathered for dinner at the Waldorf-Astoria to discuss their shared concerns.
Chief among them: The spread of investor protection laws, which they denounced as "foolish, crude and unconstitutional." Bond broker Warren S. Hayden said the laws were paternalistic and wrong in theory, arguing that they would hurt the industry by limiting the activity of securities dealers. Bank attorney Robert R. Reed called the new rules an "unwarranted" and "revolutionary" attack upon legitimate business.
That was almost 100 years ago at the inaugural meeting of the Investment Bankers Association in New York City. The group was opposed to laws passed by Kansas and other states that sought to protect investors from fraudulent sales and practices by requiring companies issuing securities to register and receive a permit before selling stocks.
These "blue sky laws" were prompted by an epidemic of securities fraud. Hucksters, who were so dishonest that it was said they would sell "building lots in the blue sky," ripped off thousands of unsuspecting farmers in the Midwest during in the first decade of the 20th century. The laws were supported by small- and community-banks and were popular with the public.
By 1913, two years after Kansas passed the first investor protection law, 22 other states passed similar regulations. An effort to enact a federal version failed amid intense pressure by Wall Street executives, who claimed that it would have a disastrous impact on the financial services industry. Bankers magazine warned that such laws would create "a nation of fools and weaklings" by protecting people against their own mistakes.
But those predictions proved mistaken. Bank profits grew in the five years after the adoption of the most stringent blue sky laws, according to research by University of Virginia School of Law professor Paul G. Mahoney. And the big national banks that opposed the laws mushroomed in size, with average total individual deposits increasing more than 25 percent from 1914 to 1916. (Much of that can also be attributed to a flood of European money amid the First World War.)
While it is difficult to quantify the precise impact of these laws, they certainly did not hinder investment activity or crimp bank profits.
THE NEW BATTLE, SAME TACTICS
Today, Wall Street is again on the attack against a regulatory overhaul that includes more stringent investor and consumer protections. Though the financial landscape is far different and the details of the proposals have changed since 1912, the industry is using much of the same alarmist rhetoric to oppose new regulations and rules.
JPMorgan chairman Jamie Dimon recently complained that proposed rules on derivatives, capital buffers and too-big-to-fail banks are bad for America. Wall Street could lose customers to European banks, he said.
At a congressional hearing on the Consumer Financial Protection Bureau, banking consultant David S. Evans attacked the "hard paternalism" of its interim director Elizabeth Warren. He cautioned that the bureau "could make it harder and more expensive for consumers to borrow money."
Such Cassandra-like warnings are common in the history of financial regulation.
"The standard Wall Street argument is that any type of regulation will cost them money and threaten their existence, and that has not happened," says Charles Geisst, the author of "Wall Street: A History." "It really began with the Securities Act of 1933, which created the [Securities and Exchange Commission] amid fears that the industry would be devastated. The strategy is well-known and has been played many times before."
When President Franklin Roosevelt's administration proposed establishing financial regulatory agencies that are now taken for granted -- such as the SEC and the Federal Deposit Insurance Corporation (FDIC) -- he was met with fierce resistance from Wall Street.
In January 1933, a group of bankers gathered again at the Waldorf-Astoria to denounce banking reform legislation that included deposit insurance requirements. "The effect of the proposed banking reform is to renounce investment banking rather than regulate it," American Bankers Association leader Francis H. Sisson said at the time.
More than 300 lobbyists roamed Capitol Hill at the height of the New Deal era regulatory battles. They raised alarms about "business regimentation," or the fear that the excessive regulation would hurt the economy.
To avoid regulation, the New York Stock Exchange amassed a $2 million war chest to fight back. It argued that stricter laws would hurt business and hamper the recovery from the Great Depression.
Wall Street strongly protested the Fletcher-Rayburn bill, which sought to impose standard margin requirements on traders claiming that it would hurt veteran investors and hamper the activities of securities dealers.
And the American Bankers Association feared that the Glass-Steagall Act, which separated investment banking's highly leverage risk-taking from commercial banking, would hurt their profits -- 36 percent of which came from investment banking activities.
Four years after the Securities Act passed in 1933, the rhetoric on Wall Street had toned down. Some of the act's most vehement critics in investment banking told the New York Times that they supported the SEC and its rules. But they had now become critical of the commission's staff and its "crusading spirit."
Decades later, many of those fears have largely been relegated to the dustbin of history. Though the impact of New Deal programs on the recovery from the Great Depression are still debated, the benefits of financial industry oversight are largely accepted.
THE BENEFITS OF REGULATION
Investor protection and market integrity are generally seen as enhancing efficient competitive markets and stimulating lending. Though the concept of deposit insurance was once equated with socialism by bank-friendly lawmakers, the FDIC reduced bank collapses and helped restore confidence in the financial and banking industry, say economic historians.
"This fear that new regulation would hurt the industry and wouldn't make capital available to the small investor was overblown," says Anne Khademian, program director at the Center for Public Administration and Policy at Virginia Tech. "Today, you'd be really hard-pressed to see someone who would say that the creation of the SEC was a bad thing."
Though Glass-Steagall was feared by banks, it actually helped create the modern investment banking industry, says Geisst. "These firms didn't go out of business. It helped stabilize the industry, and I don't think we would have survived all these years without Glass-Steagall. I wish someone would dust it off, and bring it back."
In the 1950s, proposals to raise the insurance coverage for bank depositors up to $10,000 were at first opposed by some large bankers. But when the increase passed Congress, it benefited the larger banks due to a reduction in their effective assessment rate, and the outcry disappeared.
Later bouts of hysteria accompanied the stricter regulation of mutual funds in the 1960s. "There was a lot of resistance from the industry at first, but after a few years the mutual funds were on board, saying that the SEC needs more money to do its job," says Khademian.
When the Johnson administration proposed the Truth in Lending Act in 1968, which required increased disclosures by lenders about borrowing costs, it was also opposed by Wall Street. "The only thing it cost the finance industry was some very creative people who wrote prose for their statements," says Geisst. "That was not significant. They didn't lose customers -- except perhaps for a few undiscriminating customers."
When the SEC moved to get rid of fixed commissions in 1975 -- at the time, Wall Street firms charged the same fee to execute trades -- the industry screamed in protest. After the rule was adopted, some firms lost profits. "But the new discounters that formed brought in millions of new investors -- who eagerly snapped up the mutual funds and stock offerings of the big Wall Street firms," noted Slate's Daniel Gross in 2010.
Despite the hyperbole, most regulation has aided the profitability of the financial sector in the long run, argues Edwin J. Perkins, emeritus professor in history at the University of Southern California. "It certainly added more stability and therefore a reasonable level of profitability from 1933 to 1980. Deregulation of [savings and loan associations] was the first false step. The weakening and final repeal of Glass-Steagall was the second false step because it eventually allowed the more powerful investment banking houses to seize vast assets of commercial banks for speculative activity that was largely unregulated."