Clinton and the "Act" that did us all in

There was an Act in the 1930s and there was another act in the 90s. Both cancelled each other out and in the process gave this world "The Recession". I am talking about the Glass-Steagall Act.

It was put in place to prevent the prodigal investors (investment banks) from getting their hands on an unlimited supply of depositor's money (commercial banks). Basically, financial transactions are driven by two parties with very distinct motivations:

A: The party that wants to lower their risk. They are in the business of lowering the risk on behalf of people who can't afford or don't want to take the risk. They want to conserve their wealth so that they can continue to do what they are good at. They may not make much of a return. 

B: The party that wants to take the risk and in the process expects a return on it. They are in the business of representing people who understand that there are no guarantees and they may end up losing more than they make. And that's fine by them.

Doesn't take an economist to see that it is extremely dangerous when the boundaries of A and B start to merge. The Glass-Steagall Act came up as a result of a market crash in 1933 and when it was finally put to sleep in '99 - it resulted in the mother of all crashes. But at least we didn't need a world war to come out of it :)

Soon after Citicorp became Citigroup (and started pumping cash in the relevant pockets), Clinton finally gave in and repealed the Act. A couple of years ago, I actually helped them (more like one brick in the Great Wall of China) sell off Smith Barney 10 years after they brought it under their infamous "umbrella". After getting rid of the Glass-Steagall Act, the conflict of interest was officially forgotten. The guy who who guards your money also insures your risks and takes a pile of additional risk (and huge pile lately). 

Now that I have the unmatched power of hindsight, I can say - it was only a matter of time. This happens to be one of the main (if not the biggest) reasons that brought us to the brink of financial ruin. 

9 comments:

  1. This comment has been removed by the author.

    ReplyDelete
  2. This comment has been removed by the author.

    ReplyDelete
  3. Some pretty useful comments on Linkedin. Follow the discussion over there: http://linkd.in/ftBdQl

    ReplyDelete
  4. Barbara Pape • Presidents sign or veto legislation. The real issue is who proposed it, who pushed it through the two houses of congress, and who lined their pockets??? And just a thought here, greed is what does us in...Do you really think the pensions and retirement funds were accidentally wiped? They were in fact, a target.

    ReplyDelete
  5. Doug Bevill • Good Article Tanmoy: In my view the repeal of the G-S Act was the most significant move that lead to our economic problems. Barbara is correct, its repeal was bipartisan; the Repub congress proposed it and Clinton signed it. It was the Cherry on top of Wall Street milk shake that had been under construction for over twenty years. However it was the most significant piece of post depression legislation to be repealed and there has been nothing done to curb Wall Street's behavior.

    ReplyDelete
  6. Good comments Barbara and Doug. Yes, I guess he did decide to veto it a couple of times and that's why the repeal didn't go through. But then it is difficult to be in power and not do these things, especially with the deep pockets these banks had. I think the $70bn merger of Citigroup was the turning point. That basically brought the idea of "we are smart, and we can handle the risk" home. Yes greed sort of became legal. They were sophisticated, educated and very experienced professionals making a lot of stupid mistakes (since they got away with it a few times).


    I used to work with a guy who was planning to retire from Citi in 2008. That never happened. Pretty sad.

    Keep reading and commenting, if you like what I write. It will encourage me to keep going :)


    Cheers,
    Tanmoy

    ReplyDelete
  7. Doug Bevill • Tanmoy this is good discussion: For years I have been a student a practitioner of economics especially as it relates to the construction industry. Glass - Steagall was just the final significant act perpetrated on the American people. The bubble began thirty years ago under Reagan and was bipartisan in nature; there is no valid Republican vs, Democrat argument here; it comes down to special interests and the lobbyist army's and it still continues. There is a considerable amount of sadness to go around; we are not in a real recovery, The economy is in very fragile shape; most states are are broke and cannot afford to pay for critical services such as eduction, etc; housing starts took another dip. At the end of 2006 there were 2.3 million housing starts per month, in February we barley cleared 460 thousand and applications for new housing permits were at a two year low, which mean starts will more than likely fall lower. This all due to the crash of 2008.

    ReplyDelete
  8. Barbara Pape • 


    To understand the real estate collapse you must look
    closely at what sub prime did. Not only did banks lend aggresively to
    borrowers
    who could not pay the loan back under the best of circumstances, the
    knowingly
    took the high risk paper and sold it golbally, pocketing huge fees and
    turning
    their backs on the paper trail and its implications. Too big to fail
    translated
    into too big to do anything about. And since the Federal government falls
    prey
    to lobbists and big money interests, the middle class and the "borrower"
    were
    kicked to the curb as real estate values plummetted.

    When Wall Street got into real estate it could have gone
    either way. After the bond market tanked in August/September 1998 Lehman,
    Merrill, Credit Suisse and the other "institutions" that were deep
    into huge profits from securitization needed another way to keep those fees
    coming. They had secured a larger and larger share of th elending market
    from
    traditional lenders (the local and regional banks) and so found alternative
    means. The means to their end was selling air. The lending continued
    depsite known risk, and the result undermined the entire real estate market
    from single family homes up to Class A commmercial and insitutional-quality
    assets.

    Doug is right. When you wipe out fifty years of hard work,
    and equity build up across the boards it does not come back in a news
    cycle. Given the way Wall Street works today (algorithims do not contribute
    to the GNP), and that we don't make much here in the USA anymore, without
    huge policy shifts, start ups, and a true high production green economy we
    will
    continue to fall away as a world economic leader and society. And
    that is very sad when you realize it is avoidable.


    Interstingly, when you research the Big Bank performance and see major players like Citibank walking away from failed investments,
    turning their collective back on debts without consequence it is clear theyare a problem to be solved not nutured.

    ReplyDelete
  9. Some more comments from the discussion on Linkedin - http://linkd.in/hd0zLo

    ReplyDelete