Banks will destroy themselves if we don't stop them.

     "The Trump transition team has started to explore pathways to dramatically shrink, consolidate or even eliminate the top bank watchdogs in Washington." 

 The Wall Street Journal, Friday, Dec. 13, 2024

     “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing."

     Chuck Prince, Citigroup CEO, July 2007

The stock of Citibank and JPMorgan jumped 11% on news that Trump won. Morgan Stanley rose 12%, and Goldman Sachs rose 16%. Yippie skippy! The strict teacher with regular homework has been fired, and the new teacher is a soft touch.

Trump's victory means banks will enter a new era of relaxed oversight and regulation. It might mean fewer rules protecting bank customers, maybe even the end of the Consumer Financial Protection Bureau. It might stop the bank stress tests, relax rules on loan quality, and end the demand to increase capital reserves.

Banks are fragile because they are leveraged. Modern economies are an interconnected web of trust and mutual payments. That is why when banks fail, they get bailed out by governments. If a bank closes, customers of that bank may lose their ability to pay their bills. The people who were expecting payment from that bank's customers don't get paid. That means a third group of victims don't get paid. And so on downstream. Bank failures are contagious.

Citigroup's -- now Citibank -- stock price collapsed when the music stopped. But it didn't quite die.

We did not experience the worst of that in the Great Financial Crisis of 2008 because banks like Citigroup were not allowed to fail. They got bailed out. Chuck Prince's Citigroup -- my employer at the time -- got an emergency bailout of $476 billion, plus guarantees and backstops.

Why were banks syndicating and holding pools of very bad mortgages? They had to keep up with the competition.  Lax supervision of banks, mortgage-creators and syndicators, Fannie Mae, Freddy Mac, and the credit ratings agencies combined to create a giant honey-pot profit center for the financial system. They sold garbage loans to naive pension funds. Had any bank bowed out of this risky-but-legal profit center, then its profitability would look bad compared to its peers. Bank executives had "career risk." They had to keep up with the Joneses.  

Career risk still exists. Banks will play to the highest edge of what is legal, so long as the financial system perks along and, as Chuck Prince allegorized, the music is playing. If it all comes to grief, bank executives aren't imprisoned. They are bailed out by the guarantor -- the American taxpayer.

The solution to the public being held hostage by risk-taking bankers is bank regulation. Of course, banks fight it. They want free competition -- as long as the good-times music plays.

I will give a sports analogy: the face-mask rule. If tackling people by grabbing face masks were legal, then every team would need to do it as a matter of course. Otherwise they would lose games. Their players would be subject to easier tackles and broken necks, while their opponents were not. So football leagues created a strictly-enforced rule prohibiting everyone from grabbing face masks. No coach is fired because his team underperforms in the "opponents' broken necks" statistic.

Football needs the face-mask rule. Banks need capital requirement rules.

I don't know from where the next problem of systemic risk will come. In my career as a financial advisor, I saw it from "program trading" in 1987. I saw it in irrational exuberance for internet stocks in the late 1990s. I saw it from jets flying into buildings in lower Manhattan in 2001. I saw it from poorly regulated "derivatives" in mortgage loans and from bad mortgage loans themselves in 2004-2007. It is always something.

I would guess cryptocurrencies will be the trigger this time. It is the current irresistible honey-pot of easy money, and banks will fall behind if they don't listen to the music and join in. But if it isn't crypto, it will be something else.

Banks don't want regulations, but they need them. Taxpayers should demand them. Bankers won't pay the price of failure. (Chuck Prince walked away with about $40 million.) We will. 

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