NEW LOW OBSERVER

If the repeal of the Glass-Steagall Act of 1934 is the reason that we got into this financial mess, then the path to destruction began long before the intermingling of banks, brokerages, and insurances companies with the passage of the Gramm-Leach-Bliley Act of 1999. Republicans have justifiably accused the Democrats of the fall of the financial systems by allowing Democrat supported regulators to not do their respective jobs of regulating. Not to be outdone, the Democrats have accused the Republicans for the demise of the banking system through the effort to de-regulate. And in fact, this charge by the Democrats is also true. Acting in a bipartisan manner, the Democrats and Republicans have unanimously undermined the very system that they earlier created.

Now that we’re clear as to who is responsible for our current malaise, let’s look at the other parties that are vital to the repeal of the Glass-Steagall Act. First and foremost is the Federal Reserve. Once the politicians set the ball in motion the Fed picked it up and started running. The Fed’s stance on the matter was, “if anyone is gonna change things it might as well be in our favor.” To preempt any discussion of the matter, the Federal Reserve drew up its own vision of the way things should be. But there were those who didn’t quit agree with this vision.

Along comes the FDIC with an alternate view of the way things should work. The FDIC says, “Why should the Fed write the rules but we have to insure the failures without any input?” This eventually turned into a turf war between regulatory agencies. The question wasn’t about the sensibility of repealing the Glass-Steagall Act, instead the debate was about who was going to get the biggest piece of the regulatory pie.

Recognizing that the only debate regarding repealing Glass-Steagall was who gets the most regulatory power, the insurance, brokerage and banking industries decided to take action. Nothing puts the nail in the coffin more than ignoring the current law in anticipation of the expected change. The string of mergers that followed the Swiss Bank and Dillon, Read and Co. partnership in May of 1997 ensured that Glass-Steagall was effectively repealed.

Finally, the last participant in this process was the American public. The public lacked the understanding, or concern, that the repeal of such a law was holding back the flood that would eventually push our economy to the brink. Advocacy groups who routinely rail against the banks and the Federal Reserve had lost, in the eyes of the public, the credibility necessary to demonstrate why this time, as opposed to all the other times, things were different and we as the public needed to debate the issue of the repeal of Glass-Steagall Act.

Glass-Steagall is officially a relic of a bygone era. It seems that our politicians, both Democrat and Republican, will now have to create a new regulatory framework that will ensure their own viability as a going concern. All that is left is the turf war over who gets the 1% majority to run Congress and the White House. To bad the duopoly in government has a death grip on any and all competing ideas.

Timeline/Sources:

July 1983: Treasury Secretary presents to the President the proposed bank industry deregulation that includes “both bank and thrift holding companies to engage in a wide range of securities, insurance, and other financial activities.” Rosenstein, Jay. "Reagan hears Treasury's dereg plan; growing opposition causes delay action." American Banker (July 8, 1983)

July 11, 1983: President sends to Congress the Financial Institutions Deregulation Act. “Deregulation bill is sent to Congress: proposal would expand bank, thrift activities." American Banker (July 11, 1983)

January 17, 1984: Treasury Secretary feels that competitors to the banking industry are "…chipping away at [the system]. If that continues and banks aren't given the identical opportunities to other financial services companies, the banking system's base will simply erode and could collapse.” Ringer, Richard. "Regan says Bush panel to finish report this week. (Donald T. Regan; George Bush)." American Banker (Jan 17, 1984)

In February 1985: Acting general counsel Margery Waxman “recommends that Treasury Secretary James Baker add provisions empowering banks to underwrite mutual funds, and to allow bank holding companies to own securities brokerage houses, items missing from last year's [1984] Senate bill.” Naylor, Bartlett. "Will Baker, former bank attorney, fight hard for new banking laws?." American Banker (June 3, 1985)

November 5, 1985: “George Gould, nominated to be Treasury undersecretary for domestic finance, seeks additional powers for banks to underwrite commercial paper and mutual funds.” Naylor, Bartlett. "Treasury to limit new bank powers quest, nominee says." American Banker (Nov 8, 1985)

August 14, 1992: “Banking lawyer Peter Wallison, former general counsel at the Treasury Dept, is promoting the same ideas for bank reform he touted in the early days of the Reagan administration. Wallison believes that restrictions on capital should be relaxed and banks allowed to diversify into markets more lucrative than loans. He says Congress is too focused on capital and has weakened good deregulation legislation promoted by the Bush Administration.”Cummins, Claudia. "Former Reagan official still fighting for banks." American Banker (August 14, 1992)

March 9, 1995: “Federal Reserve Board Chairman Alan Greenspan testified recently in favor of repealing the provisions of the Glass-Steagall Act that prohibit affiliations between investment banking firms and member banks.” Isaac, William M. "Fed plan for securities powers isn't prudence but turf war. " American Banker. (March 9, 1995)

March 9, 1995: The proposal to repeal the Glass-Steagall Act was submitted to the Federal Deposit Insurance Corporation. The FDIC said that it was in favor of repealing the provision that prohibited banks from affiliating with investment banks. Isaac, William M. "Fed plan for securities powers isn't prudence but turf war. " American Banker. (March 9, 1995)

May 16, 1997: Swiss Bank Corp. announces that it will buy investment bank Dillon, Read and Co. Ring, Niamh. "Swiss bank to acquire Dillon Read; fate of municipal division is unclear." The Bond Buyer (May 16, 1997)

June 9, 1997: BankAmerica acquires investment bank Robertson Stephens. Treaster, Joseph B. "BankAmerica to Buy Robertson, Stephens Investment Company." The New York Times (June 9, 1997)

July 7, 1997: NationsBank acquired investment bank Montgomery Securities. Haber, Carol. "Montgomery goes to NationsBank in rich and risky deal, some say." Electronic News (1991) 43.n2175 (July 7, 1997)

November 15, 1999: President repeals Glass-Steagall Act by signing the Gramm-Leach-Bliley Act of 1999. Iowa Republican Jim Leach “hailed the successful bipartisan effort after decades of failure.” Anason, Dean. "Clinton Enacts Glass-Steagall Repeal." American Banker 164.219 (Nov 15, 1999)

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Posted in banking, banking system, Federal Reserve Bank, Glass-Steagall

U.S. Dividend Watch List: March 10, 2023

Posted on March 12, 2023 by nlo-admin | 1 comment

The fall out of Silicon Valley Bank (SVB) shook the market and dragged the S&P down nearly 5% for the week. We will have to wait and see if this issue is contagious or if regulators can contain this. As a result, our dividend watch list ballooned to more than 100 companies. Continue reading →

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1929-1932 Decline Largely Impacted by Index Changes

Posted on March 12, 2023 by nlo-admin | Leave a comment

As originally published on April 22, 2009 at SeekingAlpha & DividendInc

After considerable pondering on the subject, I have come to the conclusion that the 89% decline in the Dow Industrials from 1929 to 1932 had little to do with the economic state of the nation. In fact, a simpler explanation lies behind the cause of the decline in the Dow which was thankfully never repeated since. A good portion of the blame should rest squarely on the shoulders of Dow Jones, now a subsidiary of News Corp. (NWS).

First, this is not an article to explain away the various levels of overvaluation in the market of 1929. It was clear then, as it is clear now, that the stock market was extremely overvalued. Also, the explanation that follows isn't the only reason for the decline of '29 to '32. We all know that various economic and political events pushed our economy and stock market to the known limits in the shortest period of time. In this article, I'm trying to point out or explain the reason for the extent of the decline in the stock market. I am hopeful that readers of this article will be open to a "different" perspective on this reasonably unique period which might broaden the minds of the reader rather than convince the reader to buy or sell their stocks.

As a person who tries to examine the Dow Jones Industrial Average from every angle, I have often wondered what the impact of the changes to the index would be if the changes to the index were never made. For example, where would the index be if AIG wasn't added to the index on April 2004? How about if Bank of America (BAC) was never part of the index? Bank of America was added to the Dow on February 2008. What about if Microsoft (MSFT), Intel (INTC), and Home Depot (HD) weren't added to the index in November of 1999? Where would we be if Citigroup (C) and Hewlett-Packard (HPQ) weren't added to the index in March 1997.

These questions have significant bearing on why the index has fallen so much in the last year and a half. It is worth noting that the selection of these stocks were at or near the peak in the respective industry groups that these companies are members. As an example, when Bank of America was added to the index in 2008 it replaced Altria (MO) and/or Honeywell (HON). Both of these companies, when compared to BAC, fared much better in the time after being taken out of the index. In fact, Kraft (KFT), a successful spinoff of MO when it was taken out of the index, was added back into the index on September 22, 2008 replacing AIG. Unfortunately, once KFT was added to the index it promptly fell from its relatively high price of $34.97 to the current level of $22.55.

The decision to take AIG out of the index and put KFT into the index couldn't have happened at a worse time. After all, the Dow Jones Industrial Average is a price weighted index. This means that the higher the stock price, the greater the impact the stock would have on the overall movement of the index. Essentially, the people at Dow-Jones traded a low priced stock with little impact on the index for a high priced stock that was susceptible to falling during a crummy economy. Furthermore, by choosing KFT, Dow-Jones ensured that the index would fall further because high quality stocks like KFT are the last to go when the market hits the skids. And so, KFT promptly fell 33% after being added to the index. Being a relatively high priced stock in the index, KFT had a much more significant impact on the Dow Industrials than the 90% decline in AIG over the same period.

Effectively, what I am describing is a "buy high and sell low" strategy that Dow-Jones exhibited in recent years. Which got me wondering, how did they manage during the "Great" Crash of 1929? Well, the results were what I would consider to be astonishing. The untimely inclusion of companies like KFT, C, HPQ, INTC, MSFT, AIG, BAC and HD were nothing new. However, what was unique about the period of 1929 to 1932 was the number of changes to the index that took place in such a short period of time. A total of 18 companies were taken in and taken out of the Dow.

Never before and never since has the Dow had so many companies added and dropped as constituents of the index. The only other period that came close was the period from 1899 to 1901, when the index had 9 companies added and dropped from the index. As demonstrated earlier, the timing of the selections were not the most optimal. As one company was added at a relatively high price the outgoing company with a low price, which would have had little impact on the downside, was given the boot. This resulted in a vicious cycle which propelled the index much lower than was otherwise necessary.

I contrasted the period of 1929 to 1932 with other known bear markets like 1906 to 1924, when the Dow languished around the 100 level, and the period from 1966 to 1982, when the Dow traded at or below 1000. In each case, the number of changes to the index was marginal, at best. The 18 year period from 1906 to 1924 had only 13 changes or 1.38 changes per year. The 16 year period from 1966 to 1982 had only 4 changes or 0.25 changes per year. This is contrasted with the 1929 to 1932 period which had 6 changes per year.

If looked at from the perspective that Dow-Jones is always going to "buy high and sell low" then we can reasonably assume that much of the decline in the Dow from 1929 to 1932 was due primarily to the constant changes to the index. Frequent changes to the index causes "the market" to grope about for a bottom (no pun intended) that doesn't exist. It appears that Dow-Jones learned the lesson that "buy and hold" works better than trading in and out. However, the timing of their changes to the index has caused more pain to last much longer than if they just let sleeping dogs lie.