Joe Six-Packīs Guide to the Ongoing Financial Crisis
James Mullin
April 28, 2008
Part I:
A Sobering Look at Banking Regulation: 1929 1999
What I donīt know about economics would fill a library, but even a semi-literate Iowan like me should be able to do some online research, mix in a little plagiarism, and tell a simple story.
When asked why he robbed banks, Willie Sutton famously said: "Thatīs where the money is." We need to start with banks for the same reason.
Prior to the stock market crash of 1929, banks had an enormous amount of money to lend, but large corporations were already satisfying their capital needs in the stock and bond markets. Many enterprising bankers then turned to individuals who were speculating in the stock market and loaned them money.
During this time, an investor who wanted to buy $10,000 in stocks only needed to come up 10 per cent, or $1,000, in cash. Loans and margin buying fueled the purchase of stocks and drove up prices.
Of course, the bankers were speculating in the stock market themselves. And while those investments were risky enough, bankers compounded the risk by loaning their depositors' money to the same companies in which they were invested. How ingenious!
When the Dow Jones Industrial Average went from 386 to 220, regulators panicked, the Federal Reserve cut back the money supply, (whatever that means) and a recession and a stock panic turned into a major depression.
Steel production dwindled to 12% of capacity, and the unemployment rate hit 25%. By 1933 the Dow Jones was at 41, and 11,000 banks had failed. When these banks closed, millions of Americans lost all the money they had deposited. Is it any wonder that they saw bankers as the main culprits in the financial crash?
After Franklin D. Roosevelt assumed the presidency in 1933, two knowledgeable Members of Congress, U.S. Senator Carter Glass, (D-VA) and Congressman Henry Steagall, (D-Ala) introduced The Glass Steagall Act to reform the banking system.
It set up a firewall between commercial banks and investment (corporate securities) banks because the volatile mixture of the two had contributed mightily to the speculative frenzy in the stock markets.
The Act also established the Federal Deposit Insurance Corporation (FDIC), which allowed ordinary Americans to put their money in accounts that were both federally insured and fully detached from more speculative investments like stocks.
The Glass-Steagall Act was the Roosevelt Administration's most important response to the nation's financial and economic collapse. In a sense, it is the New Deal.
The Securities and Exchange Commission (SEC) was established in 1934 to regulate the stock and securities markets. Together with Glass-Steagall, it kept commercial and investment banks apart for several decades.
Still, it wasnīt long before bankers, speculators, and regulators began chafing under the restrictions of Glass-Steagall. They wanted cross-ownership of commercial banks, investment banks, insurance companies and brokerage houses. More mergers and acquisitions!
In the 1960s, commercial banks began using their enormous wealth to lobby Congress, pleading that they be allowed to enter the municipal bond market.
In the 1970s, some brokerage firms began encroaching on commercial bank territory by offering money-market accounts that paid interest, allowed check-writing, and offered credit or debit cards.
In 1987, the Federal Reserve Board was ready to respond to the outraged cries of the financiers. When Citicorp, J.P. Morgan and Bankers Trust strongly advocated loosening Glass-Steagall restrictions, the Board overrode the opposition of Chairman Paul Volcker, and voted 3-2 to allow banks to underwrite municipal revenue bonds, and mortgage-backed securities.
Volcker was replaced that same year by Alan Greenspan, a former director of J.P. Morgan and a proponent of banking deregulation.
In 1997, the Federal Reserve declared that the risks of commercial banks underwriting stocks and bonds had proven to be "manageable," and henceforth banks would have the right to acquire securities firms outright. The Glass-Steagall Act was turned into an empty shell.
Before the end of the year, a new financial reality was evident. Bankers Trust bought the investment bank of Alex Brown and Co., making it the first U.S. bank to acquire a securities firm. Then Travelers Insurance acquired Solomon Brothers investment bank for $9 billion.
On April 6, 1998, the biggest corporate merger in history took place, when Travelers Insurance (Salomon Smith Barney) and Citicorp (the parent of Citibank) announce a $70 billion stock swap creating Citigroup Inc., the world's largest financial services company.
In May, 1998, the House of Representatives passed legislation by a vote of 214 to 213 that allowed the merging of banks, securities firms, and insurance companies into huge financial conglomerates. Glass and Steagall moaned loudly and rolled over in their graves.
The finance, insurance, and real estate industries won the mother of all jackpots because they spent more than $200 million on lobbying, and another $150 million in political donations during the 1997-98 election cycle. (Frontline: "The Long Demise of Glass-Steagall")
Naturally, their campaign contributions were targeted to members of Congressional banking committees and others with direct jurisdiction over financial services legislation.
In 1999, Congress passed the Gramm-Leach-Bliley Act, which repealed the now defanged and defeated Glass-Steagall Act. For financiers and bankers it was time to bid a long-overdue good-bye to a Depression-era relic. For others, it was the end of the New Deal regulation of banks, and a ticket to the unknown.
It has not quite been ten years since Glass Steagall was euthanized, and already a new kind of financial crisis is bringing bank losses and "write-downs" into the tens of billions of dollars with no end in sight.
Oh yes, there are calls for renewed bank regulation, but the genie of free-market capitalism is out of the bottle for good. To paraphrase Mark Twain, it will go around the world seven times before regulation can put its pants on.
Continued in Part II: "The World as We Donīt Know It"
A Sobering Look at Banking Regulation: 1929 1999
What I donīt know about economics would fill a library, but even a semi-literate Iowan like me should be able to do some online research, mix in a little plagiarism, and tell a simple story.
When asked why he robbed banks, Willie Sutton famously said: "Thatīs where the money is." We need to start with banks for the same reason.
Prior to the stock market crash of 1929, banks had an enormous amount of money to lend, but large corporations were already satisfying their capital needs in the stock and bond markets. Many enterprising bankers then turned to individuals who were speculating in the stock market and loaned them money.
During this time, an investor who wanted to buy $10,000 in stocks only needed to come up 10 per cent, or $1,000, in cash. Loans and margin buying fueled the purchase of stocks and drove up prices.
Of course, the bankers were speculating in the stock market themselves. And while those investments were risky enough, bankers compounded the risk by loaning their depositors' money to the same companies in which they were invested. How ingenious!
When the Dow Jones Industrial Average went from 386 to 220, regulators panicked, the Federal Reserve cut back the money supply, (whatever that means) and a recession and a stock panic turned into a major depression.
Steel production dwindled to 12% of capacity, and the unemployment rate hit 25%. By 1933 the Dow Jones was at 41, and 11,000 banks had failed. When these banks closed, millions of Americans lost all the money they had deposited. Is it any wonder that they saw bankers as the main culprits in the financial crash?
After Franklin D. Roosevelt assumed the presidency in 1933, two knowledgeable Members of Congress, U.S. Senator Carter Glass, (D-VA) and Congressman Henry Steagall, (D-Ala) introduced The Glass Steagall Act to reform the banking system.
It set up a firewall between commercial banks and investment (corporate securities) banks because the volatile mixture of the two had contributed mightily to the speculative frenzy in the stock markets.
The Act also established the Federal Deposit Insurance Corporation (FDIC), which allowed ordinary Americans to put their money in accounts that were both federally insured and fully detached from more speculative investments like stocks.
The Glass-Steagall Act was the Roosevelt Administration's most important response to the nation's financial and economic collapse. In a sense, it is the New Deal.
The Securities and Exchange Commission (SEC) was established in 1934 to regulate the stock and securities markets. Together with Glass-Steagall, it kept commercial and investment banks apart for several decades.
Still, it wasnīt long before bankers, speculators, and regulators began chafing under the restrictions of Glass-Steagall. They wanted cross-ownership of commercial banks, investment banks, insurance companies and brokerage houses. More mergers and acquisitions!
In the 1960s, commercial banks began using their enormous wealth to lobby Congress, pleading that they be allowed to enter the municipal bond market.
In the 1970s, some brokerage firms began encroaching on commercial bank territory by offering money-market accounts that paid interest, allowed check-writing, and offered credit or debit cards.
In 1987, the Federal Reserve Board was ready to respond to the outraged cries of the financiers. When Citicorp, J.P. Morgan and Bankers Trust strongly advocated loosening Glass-Steagall restrictions, the Board overrode the opposition of Chairman Paul Volcker, and voted 3-2 to allow banks to underwrite municipal revenue bonds, and mortgage-backed securities.
Volcker was replaced that same year by Alan Greenspan, a former director of J.P. Morgan and a proponent of banking deregulation.
In 1997, the Federal Reserve declared that the risks of commercial banks underwriting stocks and bonds had proven to be "manageable," and henceforth banks would have the right to acquire securities firms outright. The Glass-Steagall Act was turned into an empty shell.
Before the end of the year, a new financial reality was evident. Bankers Trust bought the investment bank of Alex Brown and Co., making it the first U.S. bank to acquire a securities firm. Then Travelers Insurance acquired Solomon Brothers investment bank for $9 billion.
On April 6, 1998, the biggest corporate merger in history took place, when Travelers Insurance (Salomon Smith Barney) and Citicorp (the parent of Citibank) announce a $70 billion stock swap creating Citigroup Inc., the world's largest financial services company.
In May, 1998, the House of Representatives passed legislation by a vote of 214 to 213 that allowed the merging of banks, securities firms, and insurance companies into huge financial conglomerates. Glass and Steagall moaned loudly and rolled over in their graves.
The finance, insurance, and real estate industries won the mother of all jackpots because they spent more than $200 million on lobbying, and another $150 million in political donations during the 1997-98 election cycle. (Frontline: "The Long Demise of Glass-Steagall")
Naturally, their campaign contributions were targeted to members of Congressional banking committees and others with direct jurisdiction over financial services legislation.
In 1999, Congress passed the Gramm-Leach-Bliley Act, which repealed the now defanged and defeated Glass-Steagall Act. For financiers and bankers it was time to bid a long-overdue good-bye to a Depression-era relic. For others, it was the end of the New Deal regulation of banks, and a ticket to the unknown.
It has not quite been ten years since Glass Steagall was euthanized, and already a new kind of financial crisis is bringing bank losses and "write-downs" into the tens of billions of dollars with no end in sight.
Oh yes, there are calls for renewed bank regulation, but the genie of free-market capitalism is out of the bottle for good. To paraphrase Mark Twain, it will go around the world seven times before regulation can put its pants on.
Continued in Part II: "The World as We Donīt Know It"
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