The Bankers Panic of 2008 -- New Regulation

In late 1999, the bulwark bank regulation of 1933, the Glass-Steagall Act -- the wall between investment banks and commercial banks -- was torn down. This was a great victory for creative bankers, who had found the wall irksome and restrictive.

However, this teardown reduced the stability of the financial system and opened the way for the Bankers Panic of 2008. Senator Carter Glass, who led in the creation of the Federal Reserve System in 1913, saw how the deposits of correspondent banks flowed to New York City where the big banks were tempted to speculate with the funds. He was determined to keep the investment-banking foxes out of the commercial-banking chicken coop. A wall was created around the banking system to separate investment banks and their assets from commercial banks.

When this wall came down in 1999 with the Financial Modernization (Gramm-Leach-Bliley) Act, it allowed banks and investment banks to join up through the bank holding company mechanism that had been created in 1956 with a cautious requirement that the Federal Reserve approve creation of a bank holding company. No bank holding company headquartered in one state could acquire a bank in another state. It generally prohibited a bank holding company from engaging in non-banking activities or acquiring voting securities of certain companies that are not banks.

What was outside the wall should have been brought under an expanded regulatory scope of the Federal Reserve or the SEC, or both. Back in 1999, the Economist Magazine wondered why the wall between banks and investment banks was taken down without U.S. financial regulatory reform. Two years before, the British consolidated their regulatory system. The reason for the persistence of the multiple financial regulatory authorities in Washington (and the states) was given as follows by John D. Hawke, Jr., Comptroller of the Currency, in a speech to the NY State Bankers Association in 2000: "Regulatory competition has stimulated innovation and efficiency. Competition keeps all of us on our toes, and provides incentives to add real value to our supervision. While the system unquestionably provides opportunities for regulatory arbitrage, there is little evidence that it has stimulated the competition in laxity that former Federal Reserve Chairman Arthur Burns discussed 30 years ago."

Today, competition in laxity and regulatory arbitrage seem good descriptions of what has occurred in financial markets since 1999, at an accelerating pace. The worst possible situation for an institution seeking to avoid regulation is a single regulator. A large number of regulators creates the impression for the consumer that the system is tightly controlled, while creating ample opportunity for innovators to do what they want. Could mortgage bankers have succeeded in processing so many subprime mortgages if borrowers weren't fooled by the paperwork into thinking that the process was under some kind of regulation? Could so many CDOs have been sold if investors in the United States and overseas weren't reassured by the many bank regulators and the SEC and the monoline insurers and the rating agencies that the securities they were buying were as advertised?

If we really want to modernize the American financial system, we need a single government entity in Washington to oversee it. This entity -- perhaps a Treasury-Fed-SEC Regulatory Commission -- might seek to impose and enforce capital adequacy requirements, proportional to risk, on all financial institutions and address issues such as moral hazard and disclosure across the entire range of players.

The Economist was right in 1999 to recommend that modernization of the American financial system be accompanied by regulatory reform. On March 19 ("What Went Wrong") the Economist now argues that the financial industry "is unlikely to grow as it did in the 1980s and 1990s. If finance is foolishly reregulated, it will fare even worse." This wobbly sentence needs to be parsed:
- Reregulation is not a good way of describing what is under consideration in Washington because reinstating Glass-Steagall is not a viable option.
- If the sentence means that any new regulations would be foolish, the Economist is pre-judging what the Congress might come up with. New regulations are going to happen.
- If the Economist means that new regulations should not be adopted if they are foolish, then who could argue with that?

Comments

[JacobSinger]

"If finance is foolishly reregulated, it will fare even worse."

I don't believe there's any mystery to this statement, and you will hear it from GOP/NeoCon pundits ad nauseum in the coming months. It is foolish to think vested interests will just roll over for new regulations without a fight.

Of course, the trick is to not be swayed by the words of those who have run this ship aground in the first place.

[ForRichardorPoorer]

some of the best regulation, is to let the risk takers, take the fall and not bail them out every time they F*** up. And, no adjustable rate loans without a 2% annual rate cap and a 5 or 6 % lifetime cap. period. end of discussion.

[mmckinl]

Time to fire the Fed and establish a Public Central Bank that creates our money without interest. Why should we pay interest on our own money?

[joebhed]

"Allow me to create the nation's money, and I care not who makes the laws."

[mmckinl]

Rothschild wasn't it ...

[outnow]

The Fed is using our money to bail out the financiers - the investment bankers - using the authority of the Federal Reserve Act of 1913. The traditionally regulated banking system was the commercial banks.

[mmckinl]

Actually it is illegal for the Federal Reserve to give out these lloans to non-members ... But they're doing it anyway, putting more debt on the publics' credit card of national debt. 600Billion and counting.

[mmckinl]

The Malthusian component of our economy is our banking system, more specifically 'debt based leveraged banking' misnamed by the Banks as 'fractional reserve banking'.

[Henry]

Do you remember the advent of the Department of Homeland Security with its chief Tom "Ducttape" Ridge?
A single regulatory authority is beyond amazingly stupid. (have you been paying attention)
How about... depoliticizing the appointments to the FED Treas FDIC and SEC? Big step in the right direction. Then there needs to be a small, yet penetrating, discussion about who the government is for: the people or big biziness. The exponents ot the trickle-down theory naively argue that big business should roll unregulated like a bull out of the pen, while deeper thinkers know (ither from experience or insight) that the bull who is not constrained by halter will do some damage.
Moody's and Standard & Poors need to be sued out of existence for their failures in this securitization mess as an example to the takers of the fee-based plots of negligence to scam America. The very fact that this does not happen will insure repeats of the same behavior in the same generation.

[WIpatriot]

I want to see the CEOs on TV telling everybody "I am not a crook."

[Novista]

Some people seem to think that there were no rules, no regulations, and no oversight.

In any case, Glass-Steagall in effect would have made no difference to Bear Stearns, eh?

Cast your mind back to last year when the SEC was investigation Countrywide's Mozilo. What happened to that? And last September, the FHEO Atlanta (I think) provided $51.1 Billion (yes, with a B) bailout to Countrywide. A short time later, Bank of America offered to buy Countrywide for $4 Billion. Eh!

Somewhere, I got lost between the Pledge, the Turn, and the Prestige ...

Meanwhile, those good GSEs with rules abounding, still got their greedy paws in shonky mortgages. And yes, there was retroactive oversight and they got fined. Tsk.

Cast your mind back to Enron -- even the SEC approved their bizarre accounting practices. And the ratings firms still advocated 'buy' two weeks before the demise. So, really, I am wondering if a little regulation and/or oversight doesn't work, how will more be better?

Glass-Steagall sounds good in theory., How would it help for financial firms who would follow the letter of the law and not the intent? Like, shell companies and interlocking directorates.

Catastrophes litter the roadway of history, despite government involvement. Bank of North America. Bank of the United States. Second Bank of the United States. Civil War greenbacks with a promise ... And then the coup de gras on Dec 23, 1913. There's a pledge for you. And any number of turns. And all we ever see is a prestige that is amateur-hour smoke & mirrors.

[dadw5boys]

The mortgage clearing house would have caught these bad loans when they were overvlaued.

[FreedomCorpse]

The SEC is a rubber stamper. On COMEX it is so highly manipulated by the money changers that it is obvious...but SEC just checks to see if Brittany is wearing underwear today.

[joebhed]

Let's look at the bright side here.
Mr. Tepper Marlin has presented a call for a very strong governmental action across broad areas of the entire financial services industry.
As usual, the Economist needs just as much parsing as the meaning of capitalism.
And for those tied to repeating the business cycle of deregulation once again, the TM scenario has broad appeal.
But I disagree.
There is no reason for the American people to accept the actions of the unregulated investment banks as something that might require a little slap on the wrist, while we increase some reporting requirements. Their actions have thrown the American economy into chaos, with a negative outlook.
There is a much bigger question here than the establishment of appropriate capital requirements amid the leveraging.
There are great potential benefits, and equal potential risks, associated with the use of the nation's money supply.
The basis of the entire fractional reserve system of banking is the deposits of the American people.
It is also the people of the United States of America who are responsible for all debts of the country that are payable in US dollars.
The creation of the money supply and its proper use are vital tools to ensure that the country can have the greatest potential benefit to its overall economy.
It seems hardly appropriate to turn that power back over to the same group who created the today's unregulated markets of finance that used illusory valuing methods to create this house of cards.
The right to create the nation's money ought to, and does, reside with the American people.
Acting, as we do, through our national government.
It is time to abolish the private Federal Reserve Bank, and create in its place a publicly-controlled, sovereign Central Bank of the United States of America.
This bank will ensure the priority use of the nation's money supply is to the betterment of the American depositors.
The major task ahead of us to re-establish the American economy is not properly vested with the private bankers who brought us to this lack of confidence in its methods and its instruments of finance.
The way to restore confidence is through the actions of the government, not as regulators, but as managers of the nation's money supply.
The basis of the American money system is the deposits of the American people.
How these deposits are used to better the nation's economy should be, and is, somebody's job.
It's time to transfer that job from the invisible-handed free marketeers to the people that we elect to run our national government.
We do get to vote.
We do get the government we deserve.
We need to replace the best government that money can buy.
When the government has the power of money, money does not have the power of government.
The Joint Committee on Currency and Monetary Policy.
It's your money.

[mmckinl]

Marlin - "British consolidated their regulatory system" And now British Banks are in trouble. Why?

Because as in America the British Banking System is in private hands and using 'debt based fractional banking', misnamed as 'fractional reserve banking'.

It is the same 'leveraged debt as asset' model that we use. That's right, when the bank takes your loan it pays out the money but then puts the loan on its' balance sheet as an asset that it can use to make even more loans! Thus the pyramid begins.

To put this power in private hands was strictly forbidden by our own Constitution, yet in 1913 that is just what happened and ever since we have been on a debt binge feeding the privately owned and operated Federal Reserve interest bearing notes that have been used to create money for their owners and members in the Federal reserve System.

It is not enough to consolidate the regulatory system. The Agency in charge must be a purely public agency. That solves half the problem.

The United States must begin printing its own money, not borrowing it from the Federal Reserve at interest. Why should we pay interest on our own money?

"I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs."

- Thomas Jefferson

[SamThornton]

Saving capitalism from its own excesses through government regulation that the players find odious seems to be a recurrent theme in our economic history.

What seems to emerge pretty clearly from that history is that the very worst judges of what works well are those in the business community. On that basis, we could probably profitably institute what might be called the Costanza Rule where for any regulatory recommendation made by a member of the business community, the legislature would enact exactly the opposite.

[Rule Of Law]

The Glass-Steagall Act and the creation of the FDIC were in direct opposition to the so called-Federal Reserve and the Depression it created for us to benefit the Financial titans of the time. This article seems to say that we must keep the Fed. That would only mean a continuation of the policies that have led us to this most recent Depression and a further indebtedness of future generations of Americans to this privately owned Bank.

The Fed must be destroyed! Return the power of money creation to the People through the Federal Government and place our dollars on a metal valued basis. There is no reason that we, the people, should have to pay interest on our own money, especially when the FED then gives it away to private investment banks like Morgan, but we end up paying for it.

[Clinton]

It should be clear by now that may involved aren't merely incompetent, they are corrupt as well. The only answer is government regulation. If laws are not enforced, it is better to have them off the books entirely.

[BARRISTER]

JAil them!!!!

[Clinton]

Second that.

[Halsey]

Third that!... the author writes:

In late 1999, the bulwark bank regulation of 1933, the Glass-Steagall Act -- the wall between investment banks and commercial banks -- was torn down. This was a great victory for creative bankers, who had found the wall irksome and restrictive."

I'd like to point out that this occurred under the beloved Bill CLINTON..who had more millionnaires in his cabinet that even W...my GAWD..his own Treasury secretary was the former CEO of friggn Goldman Sachs (they too may fail..in spite of their recent "good earnings"...let mE see their books!...)

in 1928...you and I could margin up to 90%...ergo..the crash..today..we have to put down 50%..and cover if equity falls below 35%...yet Bear Stearns, Lehman...Goldman..can and did leverage 90%...WTF? why do THEY play by different rules? oh yeah...Clinton LET them...

So...the neo-cons hate regulation..but...look where we are? people and entities CANNOT self govern...we've seen that so many times...(like Southwest flying planes with cracks?..tell me..who doesn't want a more powerful FAA~~~~!!!) And people in Colorado are getting salmonella from frigging DRINKING water!...YOU want no regulation? (I'm using the collective you)..

These white collar, millonnaire snake oil salesmen need to go to prison...only THAT "might" give us a few years before the next abuse.