In 2008, Bear Sterns collapsed. A couple months after its quick-acquisition by JP Morgan, I was sitting on a bus at 4am driving towards Masada in Israel. I turned to my friend Max from Boston, an associate at Lehmann Brothers. I asked him what he thought about Bear Sterns. He shrugged and told me that he would "wait and see." Three months later, Lehmann filed for bankruptcy.
And, so it began. Bank of America bought out Merrill Lynch (forced acquisition, depending on who you are talking to), JP Morgan bought Washington Mutual, AIG tanked, Goldman Sachs tanked and the NYSE dropped precipitously, sending the Down-Jones Industrial average from a high of over 14,000 to just below 6,000 (this occurred over a number of months). Small banks failed, big banks went bust, investments flopped and "too-big-to-fail" entered into the political and social lexicon.
As is the tradition with many major financial emergencies, politicians and businessmen pointed fingers. Democrats blamed the Bush Admin and Alan Greenspan, citing deregulation of banks and the egregiously bad enforcement of regulations by the Securities and Exchange Commission. Republicans blamed the Clinton Admin for its mission to allow anyone with a pulse to get a home loan. And, populists blamed shady and high risk investments by big firms like Goldman Sachs and AIG.
They are all correct:
The Clinton Administration's policies that gave home loans to individuals with terrible credit was a driver of many of the foreclosures when the housing bubble burst. But, in his compromise with the Republican-led Congress, he signed the repeal of the Glass-Steagall Act. This allowed for the creation of the behemoths that became "too-big-to-fail" by removing the separation between Wall St banks and Depository banks. Add in a host of high risk home mortgages that were packaged as securities based on an idea of a "never-ending" rise in housing prices, and you have the right mix for financial collapse stew.
What should be emphasized about the banking and investment environment, post-financial collapse, is the 1999 repeal of the Glass-Steagall Act. The Act, passed in 1933, created the Federal Deposit Insurance Corporation (FDIC) and introduced bank reform measures to curb speculation. The Great Depression, caused by a combination of international monetary policy (see "Dollar Diplomacy") and high speculative financial policy (See "Buying on Margin c. 1920s), was the main driver for bank reform. During the 1980s, investment banks lobbied heavily to get the Act repealed. In 1987, arguments arose for preservation and repeal:
Preservation:
1. Conflicts of interest for granting credit - lending and investing would happen in the same place, an abuse the Act was created to curb
2. Depository banks have a lot of power because they control the people's money - they should be regulated
3. Investments banks could make risky moves, putting the people's money in jeopardy.
Repeal:
1. Banks are losing market share to securities firms
2. Conflicts of interest can be avoided by regulatory enforcement
3. Combination of commercial and investment banks would lead to diversification and a reduction in risk
For those who argued for preservation, it seems as if they had some sort of financial crystal ball. For those who argued for repeal, eating your words doesn't even cover it:
1. Banks are losing market share to securities firms
What Happened: Securities firms invested in the bundled high-risk mortgages that were backed by loans from banks. Once the housing market tanked, the defaults shot up. Banks were left with trillions (yes...trillions) in toxic investments, which the government was forced to buy out.
2. Conflicts of interest can be avoided by regulatory enforcement
What Happened: Government bodies responsible for overseeing financial markets (SEC) did a piss-poor job at enforcement where they took a complacent attitude towards high risk investments. Ponzi schemes like Bernie Madoff's showed that "regulatory enforcement" wasn't worth the paper it was written on.
3. Combination of commercial and investment banks would lead to diversification and a reduction in risk
What Happened: High risk, high return, highly insulated investments led to "too-big-to-fail" institutions to play Russian Roulette with people's deposits and long-term savings (401[k]s, Retirement Funds, etc). Now, imagine what it would be like if Social Security was privatized before this happened.
A major criticism of the TARP/Bank Bailout initiative was based on "dependence." (my characterization). When an financial institution makes a risky investment, like buying up sub-prime mortgage securities, and the investment fails, the institution will learn one of the major lessons of capitalism - learn from your mistakes. But, with the advent of "too-big-to-fail," the institution will never learn their lesson. If the consequences of allowing that institution to fail have such a detrimental effect on the global economy that it must be "bailed out" then policies that lead to such a status must be reviewed. Due to the lack of strong regulation in the financial market, coupled with the surety that a financial institution will be "bailed out," we will never learn from the mistakes of the financial crisis, and there will only be a continued proliferation of "too-big-to-fail."
A return to the Glass-Steagall Act may not be pertinent at this time. We have entered a post-Act era, and must accept the existence of "too-big-to-fail." It is in this environment that the Fed and the Private Sector have to dance a fine line between punishing institutions for risky investment and growing a recessed economy.
No comments:
Post a Comment