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Wall Street Turmoil Marks Wholesale Shift in Banking Sector

September 19, 2008 at 6:20 PM EDT
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After a week on Wall Street that saw stalwart financial firms fall and unprecedented levels of government intervention, NewsHour economics correspondent Paul Solman and market historian Richard Sylla offer perspective on the events.
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JIM LEHRER: Next, a bit of a history lesson about this unprecedented week on Wall Street and in Washington. Jeffrey Brown has that part of the story.

JEFFREY BROWN: The fall of storied Wall Street institutions, huge government interventions, and a sense of spreading global panic. It has been a history-making week and one that has evoked much comparison to past crises.

To look at that big picture, we’re joined by Richard Sylla, an economist and financial historian at New York University’s Stern School of Business. And with me here is our own economics correspondent, Paul Solman.

Well, Professor Sylla, the comparisons have been made to the biggest crises of the past, including the Great Depression. How do you see all this?

RICHARD SYLLA, New York University: It’s similar to the crisis of the Great Depression, but it’s different, as well, because in the Great Depression a great deal of economic damage was done because there was not strong financial leadership in the early stages of the crisis. And so the — you know, the leadership sort of came after the economic damage was done.

I see this crisis as fundamentally different. It’s a very big one, but I see the leadership being exerted in — you know, in the financial crisis itself before the economic damage is done. We’re still not even sure we’re in a recession in this economy.

We may have one, but the leadership is coming in advance of the economic downturn. And because of it, we may have a very mild economic downturn or no downturn at all.

JEFFREY BROWN: But you did start by saying it was similar in some ways. How is it similar?

RICHARD SYLLA: It’s similar in that it’s a worldwide crisis and there are many financial institutions in deep trouble. And, you know, we — in the 1930s, 1930 to ’33, we lost something like 7,000 or 8,000 banks.

So that’s the — you know, we have the potential to do something like that now, but I think we’re going to avoid it.

Changing the business model

Richard Sylla
New York University
At the end of the 1990s, we repealed the Glass-Steagall Act and allowed huge organizations... And now the solution to this financial crisis is to fold the investment banks back in to the commercial banks.

JEFFREY BROWN: Paul, there's been a lot of talk all week about reshaping of the financial system before our eyes, investment banks falling, for example. Tell us what their role has been historically. And what does it mean if they're not there to do it anymore?

PAUL SOLMAN, NewsHour Economics Correspondent: Well, investment banks have been doing two very different things, one, consulting to companies, mergers, acquisitions, reconfiguring the company, helping the company to raise money through stocks and through bonds.

The other function has been trading for their own accounts with a lot of borrowed money. There's been tremendous tension within these banks. And the trading function, because of the apparent profitability of that function, has taken over in recent years. And that, of course, is what's got them into trouble.

They also had retail brokers for the public, so there was a third function, as well.

But so they were these kind of curious hybrids. And it looks like that business model of those two functions, those two primary functions -- or three, if you count brokerage -- is a thing of the past.

JEFFREY BROWN: To be replaced by what? In this sense, it's coming back together of investment banks and commercial banks, which is also a throw-back to the past.

PAUL SOLMAN: Yes, a throw-back to the past -- universal banks. That's what they have in Europe. Citigroup is such a bank. You now see investment banks like Merrill being folded into Bank of America, Bear Sterns into JPMorgan.

And so you see these universal banks, and so you imagine that these universal banks will exist. And then there will be what investment banks used to be, back in the days when I first started covering this stuff, smaller, boutiquey, you know, private consultants, advisers, helping companies raise money and figure out how to proceed financially.

JEFFREY BROWN: Professor Sylla, do you see a changing of the business model that -- and lessons that come out of past crises, as well?

RICHARD SYLLA: Yes, it's sort of paradoxical that, in the Great Depression of the 1930s, we decided that the solution to the problem was to break up universal banks, as Paul talked about, and to the Glass-Steagall Act, separated commercial from investment banking, and that was the model for the next 60 years.

But at the end of the 1990s, we repealed the Glass-Steagall Act and allowed huge organizations, like Citigroup and some of the others. And now the solution to this financial crisis is to fold the investment banks back in to the commercial banks. So there's a little bit of irony or paradox there.

The government's role

Paul Solman
NewsHour
But by and large, the secular trend, as they say, has been absolutely towards more and more deregulation. The market will out. Free market fundamentalism, people call it, creative destruction.

JEFFREY BROWN: Now, Paul, if we look at the regulatory side, the role of government, now, you've been reporting on this since the '70s. This issue of the relationship between Washington and Wall Street, regulation, deregulation, what you have seen develop over the last 30-some years?

PAUL SOLMAN: Thirty-some years this, Jeff, and -- unbroken deregulation, starting in the Carter administration, ratcheted up enormously in the Reagan administration, continuing, maybe plateauing a little bit in the first Bush administration, the Clinton administration, and then taking off again in the current Bush administration.

The idea that markets will reward winners, punish losers, and that's -- we've been the beacon for that in the world economy, our financial system doing that. We now have the curious situation in which we're not letting the losers be punished.

JEFFREY BROWN: But we've also seen times when the government steps in. We just heard Margaret's discussion talking about the RTC, savings and loan. You and I covered that a while back, and we've seen other examples.

PAUL SOLMAN: Yes, no, no, it's not -- I wouldn't say -- and that's why I said you saw less of it under Bush I. I mean, that was the example, that, in that era, no, there was more government intervention.

But by and large, the secular trend, as they say, has been absolutely towards more and more deregulation. The market will out. Free market fundamentalism, people call it, creative destruction.

But the destruction is not being allowed here, or at least it's being severely limited, as we become a country that bails out, you know, free-market institution after free-market institution, the freest market institutions you've got, the ones on Wall Street.

A 'holistic' approach to regulation

Richard Sylla
New York University
The SEC and the banking regulators need to understand that the system is much more of a network now and needs a more, shall we say, holistic approach to regulation.

JEFFREY BROWN: Well, Professor Sylla, you started this conversation talking about how regulators now are learning from -- well, going back to the Great Depression. What specific things are they looking at? What do you look at when you think about what should be done now?

RICHARD SYLLA: Well, I think we're -- the Depression teaches us that the result of a major financial crisis is going to be regulatory reform. In the depression of the '30s, we ended up getting the FDIC deposit insurance, the Securities and Exchange Commission, regulations to promote mutual funds, various changes.

And it's my impression that the same thing will happen not right away, but in the next couple of years, when we look back at this crisis. And, you know, Secretary Paulson outlined last spring, February or March, a set of guidelines for reforming our regulation. We really need to reform it, because it's sort of an early 20th-century regulatory system.

The problem with it is that we have these separate regulators looking at little bits and parts of the financial system, whereas we've developed a financial system that's one big network now. And we need regulation that looks at the whole system.

The example of institutions used to write mortgages and hold them. And in the last 30 years, we've taken those mortgages, securitized them, sold them to investors all over the world. It's a different system.

The SEC and the banking regulators need to understand that the system is much more of a network now and needs a more, shall we say, holistic approach to regulation.

America's economic position

Paul Solman
NewsHour
Suddenly, it looks like not only did we overstep, but we can't even sustain that system. We're going to close that system down. That would seem to me to be a huge, huge change in America's economic position in the world.

JEFFREY BROWN: Paul, one last issue, which is the global nature of all this, what we've all seen over the last decades is globalized markets and therefore now, globalized crises.

Based on what you have seen over these years and looking at what's happening now, is it potentially historic-making in the sense of how we think of New York, Wall Street, even the United States as the central component of this global system?

PAUL SOLMAN: Well, Edyard Deni [ph], the economist, uses the term Feddie, not Frannie -- not Fannie, not Freddie -- I'm getting it -- but Feddie. That is, the federal government is now the biggest -- Dick, you should comment on this -- this is the biggest taxpayer-owned bank in the world now, Feddie?

RICHARD SYLLA: Right. I mean, the government turns out to be the ultimate risk manager.

PAUL SOLMAN: Yes, and so that's a sea change. I mean, that is a huge change. The world has looked at us for years as the pioneers of financial engineering, and that's been one of America's competitive strengths in recent years, presumably.

Suddenly, it looks like not only did we overstep, but we can't even sustain that system. We're going to close that system down. That would seem to me to be a huge, huge change in America's economic position in the world.

JEFFREY BROWN: All right, Paul Solman and Richard Sylla, thanks both very much.

JIM LEHRER: Paul Solman addressed several of your questions this week on his online business desk. You can find it at PBS.org. As always, just scroll down when you get there and click on NewsHour Reports.