The meltdown of America’s investment banking industry in 2008 (disappearing into commercial banks via government-induced mergers or morphing into bank holding companies with access to the Federal Reserve’s credit window) precipitated the federal bailout that created such angst in the American populace through the 2010 elections and beyond. Senate hearings in April 2010 painted a picture of investment banks “funneling” for cash in ways that appeared to create fundamental conflicts with customers. Senator Carl Levin, for example, berated Goldman Sachs bankers for continuing to sell to customers securities that Goldman Sachs employees had vividly disparaged with barnyard epithets.
In tone and impact the 2010 hearings echoed the Pecora hearings of 1933 that crystallized for Main Street a similar disconnect between bankers on Wall Street and their customers. The denouement of those hearings occurred in the final ten days of the Hoover administration and the dying days of a lame duck Congress. Ferdinand Pecora, having been appointed as Chief Counsel to the Senate Committee on Banking and Currency only weeks before those hearings, focused on a leading Wall Street icon, National City Bank, and its chief executive officer, Charles Mitchell. The hearings revealed a degree of executive compensation previously unknown to the American public, illusory stock transactions seemingly used to avoid income taxes on Mitchell’s million dollar salary, and National City’s securities arm selling securities to investors that the company itself was dumping.
The Pecora hearings, like their 2010 counterpart, gave the final boost to financial reform legislation that passed the Senate within weeks and was on the President’s desk within a hundred days. The Securities Act of 1933 regulated the issuance of securities and cabined the influence investment banks previously had in that process. The Glass-Steagall Act, passed in the same month, fenced off investment banks and their speculative activities from commercial banks. In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) banned banks from the proprietary trading that seemed to have caused the worrisome activities discussed in the Senate hearings, set in motion a process to expand a broker-dealer’s fiduciary duties to retail customers, shifted much of the troublesome derivatives trading onto exchanges and clearing houses, and provided for new capital regulation and resolution authority for the country’s largest financial institutions.
The defense of the investment bankers in the 2010 hearings was that they were simply making markets for buyers and sellers who could take care of themselves, so that conflict didn’t really matter in that setting. Fabrice Tourre, one such banker who gained a measure of notoriety during the hearings, described this function as connecting clients who wished to take a long exposure to an asset—meaning they anticipated the value of the asset would rise—with clients who wished to take a short exposure to an asset—meaning they anticipated the value of the asset would fall. I was an intermediary between highly sophisticated professional investors—all of which were institutions.
While the argument failed to deter Congress from including the Volcker Rule banning proprietary trading in the 2010 legislation, market making and conflicts between securities intermediaries and investors remain core issues at the heart of understanding and framing financial reform of the securities industry.