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What Financial History Can Teach Advisors

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In their ambitious new book “Genealogy of American Finance,” historians Robert E. Wright and Richard Sylla trace the histories of the 50 largest financial institutions in the United States. The lavishly illustrated book’s narratives and detailed “family trees” trace the evolution of a variety of financial companies from their institutional ancestors.

Wright holds the Nef Family Chair of Political Economy at Augustana College in Sioux Falls, South Dakota, and Sylla is the Henry Kaufman Professor of the History of Financial Institutions and Markets and Professor of Economics at New York University.

As Research’s in-house financial history buff, I eagerly plowed into an advance copy I received from the Museum of American Finance, which co-published the book with Columbia University Press. (Disclosure: I have done some writing for the museum’s magazine, Financial History.) To explore how the book and financial history overall relate to the concerns of financial advisors, I contacted the authors for email interviews, which appear in slightly abridged and edited form below.

Research: Your book “Genealogy of American Finance” delves into a long history of financial institutions merging with and acquiring each other. Will such transformations be similarly common in the financial sector’s future?

Wright: Mergers likely will always be with us here in the U.S. but they will wax and wane in importance. Mergers tend to come in “waves” associated with regulatory changes and/or macroeconomic shocks. An example of the first was loosening intrastate branching restrictions and of the latter the Panic of 2008. Local or regional shocks, from natural disasters or other causes, will injure small banks, the more unlucky and poorly managed of which regulators will force to merge with bigger banks. Technological change could also induce a merger wave, though it could also potentially spur spinoffs, breakups and other types of downsizing by reducing economies of scale or scope.

Sylla: I would not expect more mergers of the very largest banks/financial holding companies [FHCs], which have been identified or pilloried as being too big to fail, and also with some concerns that they are too big to manage. In fact, some of them (e.g., Citi, General Electric) are slimming down on their own, and others may follow as a result of Dodd-Frank and other regulatory moves that may saddle the biggest banks/FHCs with higher capital requirements than other institutions have. But some of the smaller institutions among our 50 might undertake mergers, perhaps with others in the top 50.

Are there some lessons a financial advisor could take from this genealogy that might improve his or her job performance and career prospects?

Wright: Bigger banks are not necessarily better banks in terms of financial performance or behavior. Some mergers have solid economic foundations but others contain holes that are papered over to aid specific interests like CEOs more intent on building empires, or increasing their bonuses, than in building long-term shareholder wealth. Banks that perform well financially but behave badly are the most likely targets of regulatory reforms (e.g., higher penalties for rule breaking) so financial advisors should understand the ultimate sources of bank profitability before making recommendations, especially to clients with social as well as financial goals.

Sylla: Despite the problems we have seen at some of the largest banks/FHCs, a good many on our list are pretty well-managed institutions, and so a financial advisor could well study them and direct clients to them if they operate in the client’s part of the country.

Do some financial institutions or individuals have historical reputations that you think are much different (either better or worse) than what they deserve?

Wright: J.P. Morgan, the person, was not as powerful or evil as typically depicted. Investment bankers like him provided valuable governance and monitoring services on behalf of investors.

Alexander Hamilton was not an anti-democratic plutocrat as many historians claim. I’ll let Dick elaborate as he has been working on Hamilton for many years.

Sylla: Yes, and both better and worse than they deserve. The left/liberal/populist end of the political spectrum has been suspicious of large financial institutions and concentrated financial power throughout American history, ever since Jefferson in the 1790s expressed grave misgivings about Hamilton’s Bank of the United States, and Jackson in the 1830s vetoed Congress’s bill to re-charter the second Bank of the United States. In the late 19th and early 20th centuries J.P. Morgan and others were similarly castigated for constituting a “Money Trust” and supposedly controlling the economy. Bankers were again pilloried during the 1930s—in the Pecora hearings and in some of the New Deal’s financial reforms. And now again, in the wake of the crisis of 2007–2009 we are seeing bankers and banks under clouds of suspicions and fines for misbehaving.

In my view, some of this is deserved; banks have misbehaved recently and in the past. But I also think that banks and capital markets have played crucial roles in the growth of the American economy, which has been spectacular, over the past 225 years. The two Banks of the United States early in our history were fine economic and financial institutions, but they had political problems (adverted to above). J.P. Morgan placed his partners on corporate boards not to control the economy but to exercise due diligence—he had underwritten and sold corporate securities and he thought he owed it to his clients who bought those securities to keep an eye on those companies on behalf of his clients and his own reputation. Banks do need to be supervised and regulated, but if we push the supervision and regulation too far, it could interfere with economic performance. We need to balance the need for regulation to promote financial stability with the desirability of having an innovative financial system and economy.

Does the subject of financial history get as much attention as it ought to from financial professionals? How about from the general public?

Wright: Financial professionals, policymakers, and the general public do not pay enough attention to financial historians when times are good. When times are bad, the stock of financial historians does increase but then it is too late to do much good. We were much in demand in 2008–9 as journalists, policymakers, investors, and voters tried to wrap their heads around the financial crisis but it would have been better for everyone if they had paid attention to us in 2002–7! Ken Snowden, for example, had shown that six previous mortgage securitization schemes had blown up between the Civil War and World War II. While his historical analysis did not conclusively “prove” that trouble loomed (the past can never be used to predict the future with certainty because the past rhymes rather than repeats) it should have set off more alarm bells, as it did for our colleague at NYU-Stern (where I taught from 2003–9), Nouriel Roubini, one of the few economists to make accurate predictions of the impending disaster.

Studying financial history, all forms of the past for that matter, can help to create good, old-fashioned judgment, the “soft” skills that help financiers like Henry Kaufman to discern the difference between junk mathematical models and the real deal.

Sylla: Most financial professionals pay too little attention to financial history, which ought to instruct them. In the wake of the recent crisis, a good number of them became more interested in financial history for the perspectives it shed on what had happened, and some even advocated more study of it. The CFA Institute has been studying ways of adding more financial history to its educational programs for finance professionals. But as the crisis fades in memory, finance professionals talk less and less about history’s importance. Its cautionary lessons might interfere with taking the next big risk to make the next fast buck. One of the great lessons of financial history is that a lot of finance professionals over the decades and centuries never learn, and so they repeat the mistakes of the past.

The general public ought to learn more financial history to protect themselves from short-sighted finance professionals!