On Thursday, Secretary Mnuchin and Sen. Warren got into a down-and-dirty on who wants what in terms of Glass-Steagall reform.  With each claiming ownership of the “21st-Century Glass-Steagall” moniker, it’s no wonder that each thought the other wildly wrong.  I’ve also been asked a lot about our forecast for structural reform when the “Glass-Steagall 2.0” label gets stuck on our analyses.  The Wall Street Journal on Thursday did a great job of showing why both the Trump Administration and Sen. Warren throw Messrs. Glass and Steagall around with such abandon, noting also why Federal Financial Analytics has said what we have in our reports.  Politics of course can crowd out content, so here’s a primer on how commercial and investment banking can be divided without anyone ever breaking up a big U.S. banking company.

The key is the phrase “banking company.”  It’s important to differentiate “Glass-Steagall” thinking into what may be done in a bank and what may be done in affiliation with the bank (either through a subsidiary of the bank or in a subsidiary of the bank holding company that owns the bank).  Back in the 1930s, this was relatively simple because BHCs weren’t even invented until 1956.  Now, not so much.

Mr. Mnuchin and Sen. Warren battled over whether the Trump Administration renounced its reform pledge because Sen. Warren believes a new Glass-Steagall must bar both activity and affiliation contact between a commercial bank and investment-banking or all the other activities she thinks are in a no-go zone.  Mr. Mnuchin countered that the 1933 Act was aimed not at barring activities or affiliations, but rather at preventing the conflicts of interest that were then seen as a cause of the Great Depression.  As a result, it’s not the activity per se, but how it’s done in relation to all the others.

Between these two points of view lies a tremendous difference in whether U.S. banks are “broken up” as Sen. Warren wants or restructured as Mr. Mnuchin intends.  The Warren break-up plan is in the McCain-Warren bill with the 21st-century appellation.  Essentially bringing U.S. banks back to the beginning, it would bar anything prohibited in 1933 and therefore force most banks (not just big ones) to tear themselves into permissible and impermissible pieces. 

As I’ve said before, like this or not (which I don’t), it’s a practical impossibility.  Starting in 1986, the banking agencies have allowed all sorts of securities services into the nooks and crannies of banking charters.  Separating these embedded now-traditional activities from “banking” is as practical as pulling chocolate chips out of ice cream to ensure that only pure vanilla remains.

The Hoenig plan is similar to McCain-Warren in that it tries to pull at least some of the chips out of the ice cream, doing so by targeting those big enough for ready identification – i.e., those with specific regulatory charters.  It is not as ambitious as McCain-Warren in that it not only does not seek completely pure-vanilla banking, but also that a parent holding company could own both a traditional bank and a wide array of non-commercial financial services operations.  

Together with the Trump plan, we call this approach “FHC-heavy” to signify that the financial holding companies authorized by the Gramm-Leach-Bliley Act would continue under new standards that – with or without new law – would put selected activities at more or less distance from traditional banking under more or less stringent prudential standards.  In short, McCain-Warren is a pure activities-based redesign, while the Hoenig plan addresses some activities and critical aspects of the parent company’s structure.

The Trump plan as far as one can tell so far will be purely structure based.  That is, it will not limit activities in banks or parent companies, but it will alter the terms on which insured depositories may relate to their parent companies in ways designed to insulate the insured depository.  It is for this reason that Mr. Munchin has been surprisingly supportive of the Volcker Rule – but only for the bank, not for its parent or the parent’s subsidiaries.

In a subsequent FedFin report, we will go through these options to identify industry winners and losers and – far more importantly – resulting financial-system stability, liquidity, and intermediation capacity.  Think for example about the ability of a bank to fund its non-traditional affiliates.  In McCain-Warren, it can’t do so because it doesn’t have any non-traditional affiliates.  Under the Hoenig plan, significant restrictions apply that would take the Section 23A and 23B inter-affiliate transaction limits and make them strict enough to prevent transfer of the benefits of FDIC insurance and Fed access.  We don’t know yet how the Administration plan will treat this question, although the Wall Street Journal story above suggests it would not be all that different from the Hoenig approach.

What likely will be different – very different – is the Trump treatment of capital requirements.  Mr. Hoenig wants a ten percent leverage requirement (LR) for the banking operation in his new-style FHCs along with a ten percent LR for the parent FHC.  He also wants an eight percent LR for the non-traditional banking company in this corporate structure. 

We don’t know what Secretary Mnuchin wants, but I’ll bet buckets that there won’t be a ten percent LR and also that the parent FHC might have no regulatory capital standard at all.  After all, if the insured depository and its related activities in a subsidiary BHC are insulated from non-traditional activities, why not let the non-traditional ones fight fire with fire from “shadow banks?”

A plan along the lines described above would do President Trump’s “big number” on Dodd-Frank, track Glass-Steagall’s intent as Mr. Mnuchin described it on Thursday, and target tough rules only at complex, large banks.  It isn’t anything like what Sen. Warren calls a 21st-Century Glass-Steagall, but it would make a mighty difference.