My OperaThe great Rape of the Working Class
Monday, November 3, 2008 10:42:42 PM
Don’t let the financial pundits or even presidential candidates try to tell you the current financial problem is complicated. It’s simple: banks with lax or barely-existent credit standards gave mortgages to millions of people who could not afford them and then sold those bad mortgages to financial institutions that bundled them into various kinds of securities instruments that they bought and sold to one another many times over, raking in big commissions on every sale.
When home owners began defaulting on the loans they orginally could never repay, money, in the form of mortgage payments, disappeared and the securities instruments became valueless, leaving the banks with more debt than assets. (It's hard to finance a takeover with a bunch of empty houses no one can afford to buy.)
Of course, there are other factors
During the Great Depression in the 1930s, Congress passed the Glass-Steagill Act which created the Federal Deposit Insurance Corporation (FDIC), the organization that insures commercial bank accounts up to $100,000. It also separated banks into two types: commercial banks (the ones most of us use for our checking and savings accounts and personal, auto and home loans) while allowing investment banks – Merrill Lynch, Lehman Brothers, Bear Stearns, etc. – to operate with fewer restrictions and therefore make riskier financial deals with potentially bigger returns.
The argument for preserving Glass-Steagall (as written in 1987):
1. Conflicts of interest characterize the granting of credit – lending – and the use of credit – investing – by the same entity, which led to abuses that originally produced the Act
2. Depository institutions possess enormous financial power, by virtue of their control of other people’s money; its extent must be limited to ensure soundness and competition in the market for funds, whether loans or investments.
3. Securities activities can be risky, leading to enormous losses. Such losses could threaten the integrity of deposits. In turn, the Government insures deposits and could be required to pay large sums if depository institutions were to collapse as the result of securities losses.
4. Depository institutions are supposed to be managed to limit risk. Their managers thus may not be conditioned to operate prudently in more speculative securities businesses. An example is the crash of real estate investment trusts sponsored by bank holding companies (in the 1970s and 1980s).
If you don’t count my mother who, in her old age, kept gold coins in tin cans around her house, Glass-Steagill restored confidence in the banks for our grandparents and parents, and it worked well for more than 60 years. By the time I was old enough for my own bank accounts, there was no question about their safety.
The argument against preserving the Act (as written in 1987):
1. Depository institutions will now operate in “deregulated” financial markets in which distinctions between loans, securities, and deposits are not well drawn. They are losing market shares to securities firms that are not so strictly regulated, and to foreign financial institutions operating without much restriction from the Act.
2. Conflicts of interest can be prevented by enforcing legislation against them, and by separating the lending and credit functions through forming distinctly separate subsidiaries of financial firms.
3. The securities activities that depository institutions are seeking are both low-risk by their very nature, and would reduce the total risk of organizations offering them – by diversification.
4. In much of the rest of the world, depository institutions operate simultaneously and successfully in both banking and securities markets. Lessons learned from their experience can be applied to our national financial structure and regulation.[12]
The repeal enabled commercial lenders such as Citigroup, the largest U.S. bank by assets, to underwrite and trade instruments such as mortgage-backed securities and collateralized debt obligations and establish so-called structured investment vehicles, or SIVs, that bought those securities. [13]
Then in 1999, President Clinton signed the Gramm-Leach-Bliley Act which repealed Glass-Steagill. (You remember former senator Phil Gramm, don’t you? He was Senator McCain’s top economic campaign advisor until a couple of months ago when Gramm accused Americans of being whiners.)
What Gramm’s Act did was allow investment and commercial banks to consolidate, blurring the financial lines between them, leading to the same kinds of abuses that produced the Glass-Steagill Act in the first place - abuses that have resulted in the financial troubles we have today.
Unless the winner of the November election pushes Congress for more bank regulation (repeal of Gramm-Leach-Bliley would be a good start), I’m thinking I trust a coffee can under the bed more than any bank for the time being.
There is no telling how many Americans have been wiped out, or close to it, this week. As bad as it is for younger people, they have two or three decades to recoup. Old people, like Mildred, retirees who rely on small investment portfolios to supplement Social Security and the man who wrote me two weeks ago, do not.
But don’t expect any help. There is bail-out money – borrowed from China – but only for banks, along with golden parachutes for their executives who created this train wreck. The rest of us are on our own.
When home owners began defaulting on the loans they orginally could never repay, money, in the form of mortgage payments, disappeared and the securities instruments became valueless, leaving the banks with more debt than assets. (It's hard to finance a takeover with a bunch of empty houses no one can afford to buy.)
Of course, there are other factors
During the Great Depression in the 1930s, Congress passed the Glass-Steagill Act which created the Federal Deposit Insurance Corporation (FDIC), the organization that insures commercial bank accounts up to $100,000. It also separated banks into two types: commercial banks (the ones most of us use for our checking and savings accounts and personal, auto and home loans) while allowing investment banks – Merrill Lynch, Lehman Brothers, Bear Stearns, etc. – to operate with fewer restrictions and therefore make riskier financial deals with potentially bigger returns.
The argument for preserving Glass-Steagall (as written in 1987):
1. Conflicts of interest characterize the granting of credit – lending – and the use of credit – investing – by the same entity, which led to abuses that originally produced the Act
2. Depository institutions possess enormous financial power, by virtue of their control of other people’s money; its extent must be limited to ensure soundness and competition in the market for funds, whether loans or investments.
3. Securities activities can be risky, leading to enormous losses. Such losses could threaten the integrity of deposits. In turn, the Government insures deposits and could be required to pay large sums if depository institutions were to collapse as the result of securities losses.
4. Depository institutions are supposed to be managed to limit risk. Their managers thus may not be conditioned to operate prudently in more speculative securities businesses. An example is the crash of real estate investment trusts sponsored by bank holding companies (in the 1970s and 1980s).
If you don’t count my mother who, in her old age, kept gold coins in tin cans around her house, Glass-Steagill restored confidence in the banks for our grandparents and parents, and it worked well for more than 60 years. By the time I was old enough for my own bank accounts, there was no question about their safety.
The argument against preserving the Act (as written in 1987):
1. Depository institutions will now operate in “deregulated” financial markets in which distinctions between loans, securities, and deposits are not well drawn. They are losing market shares to securities firms that are not so strictly regulated, and to foreign financial institutions operating without much restriction from the Act.
2. Conflicts of interest can be prevented by enforcing legislation against them, and by separating the lending and credit functions through forming distinctly separate subsidiaries of financial firms.
3. The securities activities that depository institutions are seeking are both low-risk by their very nature, and would reduce the total risk of organizations offering them – by diversification.
4. In much of the rest of the world, depository institutions operate simultaneously and successfully in both banking and securities markets. Lessons learned from their experience can be applied to our national financial structure and regulation.[12]
The repeal enabled commercial lenders such as Citigroup, the largest U.S. bank by assets, to underwrite and trade instruments such as mortgage-backed securities and collateralized debt obligations and establish so-called structured investment vehicles, or SIVs, that bought those securities. [13]
Then in 1999, President Clinton signed the Gramm-Leach-Bliley Act which repealed Glass-Steagill. (You remember former senator Phil Gramm, don’t you? He was Senator McCain’s top economic campaign advisor until a couple of months ago when Gramm accused Americans of being whiners.)
What Gramm’s Act did was allow investment and commercial banks to consolidate, blurring the financial lines between them, leading to the same kinds of abuses that produced the Glass-Steagill Act in the first place - abuses that have resulted in the financial troubles we have today.
Unless the winner of the November election pushes Congress for more bank regulation (repeal of Gramm-Leach-Bliley would be a good start), I’m thinking I trust a coffee can under the bed more than any bank for the time being.
There is no telling how many Americans have been wiped out, or close to it, this week. As bad as it is for younger people, they have two or three decades to recoup. Old people, like Mildred, retirees who rely on small investment portfolios to supplement Social Security and the man who wrote me two weeks ago, do not.
But don’t expect any help. There is bail-out money – borrowed from China – but only for banks, along with golden parachutes for their executives who created this train wreck. The rest of us are on our own.
