On Tuesday, Federal Reserve Chairman Ben Bernanke said “We must have a strategy that regulates the financial system as a whole, in a holistic way, not just its individual components,” during his speech to a committee on foreign relations. His call was for a complete overhaul of the regulatory systems to strengthen oversight of banks, mutual funds, and large financial institutions that could seriously damage our economy if those institutions collapsed. In the wake of our current recession, this has been a big topic of conversations with many ideas thrown around in order to prevent another financial crisis. In other words the fools in Washington D.C. want a fool proof system with absolute guarantees. Good luck.
First of all, anytime people are involved you will never have a fool proof system. A keen observation was made a long time ago by a wise person who said, “It is impossible to make anything fool-proof because fools are so ingenious.” I have read several articles and seen interviews with people who want a return of Glass-Steagall Act type policies, which they say would have prevented our current meltdown. The act was repealed in the 1990s with the passage of the Gramm-Leach-Bliley Act, allowing financial institutions broader diversification in the types of investments they offer.
The Glass-Steagall Act was created in 1933 in response to the Great Depression and gets its name from the two main sponsors of the legislation. Senator Carter Glass, a former Treasury secretary and the founder of the Federal Reserve System, and Henry Steagall, a House of Representatives member and chairman of the House Banking and Currency Committee, drafted and pushed to have this legislation passed. It created a separation of commercial banking and investment banking, by not allowing financial institutions to do both. Once enacted financial institutions had a year to decide if they were going to be one or the other. In the fallout of the Great Depression it was determined by many that large commercial banks became too greedy and speculative, and this act sought to tightly curb and control the activity of banks and investments by separating them, only allowing 10% of a commercial bank’s revenue to come from securities. Many in the financial industry saw this as too harsh a judgment, and Glass himself sought to repeal the act shortly after it’s passage claiming it was an overreaction to the crisis.
Inherent in the call to a return to the Glass-Steagall Act is a belief that the less diversified in financial services a bank is, the more stable and secure it will be. A review of the carnage in the financial industry shows quite the opposite. Financial institutions who were less diversified became the hardest hit, and the first dominoes to fall in our current crisis. For example Countrywide, which was strictly a mortgage lender, became the first casualty as its stock price plummeted. The next big calamity came when investment banking giant Bear Sterns literally imploded overnight, followed by yet another purely investment bank, Lehman Brothers. As far as banks are concerned, IndyMac, which had little to no investment services and existed purely as a deposit bank, failed and was seized by the FDIC. By late fall, another purely investment firm, Merrill Lynch, was the next to have serious trouble and topple.
While not immune to the crisis, the large commercial banks, who were diversified in many aspects of financial services, fared much better. JP Morgan Chase, for example, not only survived, but was able to limit the damage done by purchasing several failed financial institutions. The failed Bear Sterns was quickly acquired by JP Morgan Chase, as was Washington Mutual. Without a buyer, the FDIC would have been on the hook for insuring all of WaMu’s deposits taking a big bite out of the majority of the FDIC’s reserves, if not eliminating them entirely. A big sigh of relief was breathed by the FDIC when WaMu was bought so quickly, thus relieving the government institution of a very heavy burden. Subsequently, Bank of America, another institution very diversified in financial services, was able to absorb other failed institutions. They bought both Contrywide and Merrill Lynch. Yes they were bad deals. They paid too much for Countrywide, and they should have done a bit more due diligence on the Merrill purchase, before absorbing some of that mess. However, the point is that they had the size and the strength to do it, and again it saved the government from having to absorb that hit. Bank of America is currently struggling, but with all of the other failed institutions it puts a strain on the industry as a whole. If you have some weak supports on a bridge that crumble, it will increase the load and the strain on the strong ones that remain, eventually weakening those as well.
You may be tempted at this point to say, “What about Citigroup? They were a large commercial bank that was diversified and look at what happened to them.” They key there is was diversified. Citigroup sold Travelers Insurance to Met Life in 2003, and Smith Barney to Legg Mason shortly after. By the time they got pinched in this crisis they were far less diversified then they were at their height. Again, it seems the less diversified the financial institutions are, the more they have suffered. Examining the situation, a return to the Glass-Steagall policies just doesn’t add up.
A complete overhaul of our financial sector is not what is best for this country, nor is it needed. Yes, pass legislation to make sure banks don’t return to stated income programs. Yes the perpetrators should have done some underwriting to actually verify the income people said they made in order to qualify for their mortgages. However, a complete overhaul now would be just as big of an overreaction as Glass-Steagall was in 1933.
The problem lies in human behavior and habits driven by emotion. When the economy is good and the market is up, people behave as if the party is never going to end. This is what caused people to apply for low interest rate loans that would reset after a few years to a higher rate. They assumed they could always refinance before the reset to a higher rate into another loan just like it, then do it again and again. If the housing bubble never burst that probably would have been true, but history says all bubbles in the economy eventually burst, and the market corrects to a realistic level. Their response was an overreaction to an up market.
The other problem is that when the correction comes and the markets are down, people feel as if it will never get better. Then its all doom and gloom, and the sky is falling. An overreaction at this point is just as big a mistake, if not bigger. History shows that the market is up much more then its down. The up periods are farther up then the down periods are down, and the up markets tend to last a much longer time then down markets do. An overreaction that curbs our capitalistic society will hinder that cycle , further preventing the financial sector to recover into good times again. It is okay to make some minor adjustments, but a complete overhaul is ridiculous. Again, that is a knee jerk reaction to the current situation and not a well thought out long-term strategy. I would argue now is not the time to make such plans. It is never good to react while you are currently in a crisis. The best time to clearly think is when the market is somewhere in the middle.
Overall, capitalism is good. The wealth and relative high standard of living we all enjoy in this nation is evidence of that. There is nothing wrong with big business, big money, and big banks. They have enabled our country to prevail in times of war and threat. Pure grit and determination alone didn’t enable us to simultaneously defeat the Nazis and the Japanese in World War II. Both were very savvy, with well planed tactics and engineering. The simple truth is we out spent them, and out produced them. We cranked ships out faster than the German U boats could sink them. After Pearl Harbor we rebuilt and rearmed our Pacific fleet in record time. Technology that was outdated for us at the beginning of the War quickly became state of the art, far surpassing the abilities of our enemies’. We had a ton of production capability with a big checkbook to throw at the effort.
In the 1980s it was capitalism that defeated the Soviet Union. Yes Ronald Reagan had a high budget for defense, but it was still a fraction of our budget and very manageable. However, the Soviet Union had to spend a ridiculous percentage of it’s GNP in an attempt to just keep pace. They couldn’t do it because they weren’t capitalists. It broke them down, forcing a collapse. Their population started demanding certain things from their government, and became more and more discontent with their standard of living. How is that for a war? Not a single shot fired! Zero troops mobilized! All capitalism and big money. Don’t mess with a good thing. Money keeps a nation strong, people fed, and a military at the ready.
The people that want to overhaul our financial system want guarantees. Well grow up! There are no guarantees in life. I don’t care what system you want to put into place, what rules you want to enforce, or grand ideas you want to explore. None of them will ever produce a 100% guarantee. What we do have is a great track record. Look it up. Overall our markets spend much more time up then down. The historical data is everywhere on the web and trade publications. Difficult times will always come, and then they will go. The problem with enduring them is our general lack of savings. Most Americans spend more than they make, living on credit. That is another main contributor to our current problems. This would be much more manageable for people who learn how to save in the good times. Maybe that is what needs to change. That should be the lesson for this country through this financial crisis. This crisis is this nation’s margin call. We are not a nation of savers, we are a nation of spenders. Squirrels and ants know how to gather and store food in the abundant spring and summer seasons to last them through long cold winters. Take a cue from a lower life form.
I find the belief that our government is going to bring it’s financial expertise and prowess to the financial sector laughable! Is it really wise to leave money management in the hands of the government? When has the government ever demonstrated its ability to handle money? The current administration has a hard time finding people for federal positions that aren’t embroiled in tax problems! Who in the government would oversee this process exactly? That would have to fall into the hands of Timothy Geitner, the Treasury secretary who had unpaid taxes.
Lastly, I am not confortable havng a consortium of global financial officials revamping our financial rulebook. We are Americans and our government answers to us, not a conglomeration of 20 world financial powers. It is not recomended to give our sovereignty away to someone else’s say so. If they would like to compare notes and listen to some good ideas, fine. However, our nation is our nation. We shouldn’t leave our fiscal policies up to foreigners. Final say so on our financial policies belongs right here at home. Period. Let your senators and congressmen know how you feel about that! Until another nation can rival America’s financial power, I don’t think it is wise to take clues from someone else. We are the wealthiest, most powerful nation in history. Maybe others should be taking their cues from us, or does that make too much sense?
