We at Better Banking Law have enjoyed the columns of Steven Davidoff Solomon, law professor at Cal-Berkeley, which have appeared periodically in the New York Times. For example, a fine piece was published just two days ago: "Public Companies See Gold in California".
However, the column published in the Times on September 13th, titled "Fed Proposes Ban on Merchant Banking, a Practice With Little Risk", was not well thought out and surprisingly one sided. It chided the Fed’s proposal and was written mostly from the perspective of the Too Big To Fail commercial banks, their lobbyists and law firms. He states that the Fed’s proposed ban is another step back to the Glass-Steagall Act, but neglects to mention that the Banking Act of 1933 (Glass-Steagall) created Federal Deposit Insurance in addition to separating commercial banking from investment banking. And that is why only Federally Insured commercial banks (not investment banks) were prohibited from engaging in merchant banking.
A couple of paragraphs later he states that these merchant banking limitations ended in 1999 with the Gramm-Leach-Bliley Act which ended Glass-Steagall, but neglected to note that the other section of Glass-Steagall, which created Federal Deposit Insurance, remains very much intact. He further states that the removal of this merchant banking stricture was uncontroversial at the time. The question is why would permitting Federally Insured bank holding companies to combine banking and commerce, an obvious conflict, not be controversial?
He follows these statements by quoting a trade group for bank holding companies and a law firm that represents commercial banks as being opposed to the Fed’s proposal. Their positions are predictable, but why not also quote sources that are concerned about future taxpayer bailouts of Too Big To Fail Banks, and thus supportive of the Fed’s proposal?
He then states the following:
"The reason for the industry’s exasperation is easy to see. Merchant banking is simply the practice of buying operating companies. The risk to a bank holding company is twofold. First, the bank could lose its money — as with any investment. Or second, it could be held liable for the debts of that company."
However, there is a third risk and that is potential conflicts. Does the bank holding company, which owns an operating company, favor it by extending loans on more beneficial terms over other companies it does not own? Furthermore, won't objective lending standards sometime be compromised in support of the bank's own investment?
The professor also shows concern that, under the Fed's proposal, an operating company may not benefit because a Federally Insured bank would not be an eligible investor. However, the Federal Reserve must certainly have weighed that issue in reaching its decision and one must wonder how in the world so much merchant bank financing was accomplished from 1933-1999, when Federally Insured banks were prohibited from making such investments. The nation did fine without them and there are many more eligible investors today, both individual and institutional, without resorting to funds from taxpayer supported Federally Insured banks.
The foregoing are some of Better Banking Law’s observations regarding Mr. Solomon’s September 13th column. The following is another response to his piece by Saule T. Omarova, a Cornell law professor, which appeared on the New York Times Dealbook website on September 19th, titled "Real Risks in Big Banks’ ‘Merchant Banking’ Activities". We at Better Banking Law find it compelling:
