banks and their social function
Banks aren’t ordinary corporations. In addition to being private, for-profit organizations, they also carry out important social economic functions. They’re the primary instrument the government uses to carry out national money policy. Through letters of credit, they also underpin the workings of the international trade of multinational firms that is increasingly important for economic growth.
This is why the major banks are considered “too big to fail.”
US banks have been on the brink of failure twice during the past hundred years–in the late 1920s and in 2007-09. Both times this has been the result of rampant speculative financial market activity coupled with reckless lending, both driven by the search for earnings per share growth.
Glass-Steagall, and its repeal
In the 1930s, Washington enacted legislation, including the Glass-Steagall Act that barred the banks from non-banking activities (like brokerage, proprietary trading and investment banking). The new laws ushered in a period of relative stability for the banks that lasted until the late 1990s, when their intense lobbying succeeded in getting Glass-Steagall repealed.
(An aside: yes, the banks manufactured periodic crises through imprudent lending to emerging economies–the Walter Wriston-led binge of the 1970s being a prime example–but these were relatively tame in comparison.)
Less than ten years later, many big banks were broke. World trade had come to a standstill as manufacturers refused to accept banks’ guarantees that shipped merchandise would be paid for (the worry was that the guaranteeing bank would file for bankruptcy while the goods were en route, reducing the shipper to being an unsecured creditor). The deepest peacetime period of world economic decline since the Great Depression began.
This, in turn, spawned Dodd-Frank, the 21st century equivalent of Glass-Steagall.
repeal again? so soon?
While it took more than half a century for the memory of the Depression to fade enough for Congress to consider removing restrictions on bank activity, we’re now less than a decade away from the 2007-09 collapse.
Despite this, despite campaigning on an anti-establishment platform, and despite warning that Hillary Clinton should not be elected because she would be a creature of the big banks, during his first few days in office Donald Trump is proposing to restore to the big banks the tools of self-destruction they have wielded to devastating effect twice before.
I think you’re missing a big factor if the banking crisis – the requirement that banks make loans to questionable lenders in the name of affordable housing. This was foisted upon them by Congress and championed by the very Barney Frank for which the Dodd-Frank bill was named. The banks then packaged these bad loans together into debt instruments, which somehow got AAA ratings (since no one believed everyone would default on their loan at once), and were sold to eager fixed income buyers who were looking for something that paid better rates since the Federal Reserve had kept the interest rates at banks down for so long.
The banks also bought some of these debt instruments, then bought “insurance policies” from each other called collateralized debt obligations (CDOs)that were supposed to pay them if the debt investments failed, making them nearly risk free. The issue was that the same banks paid for these CDOs by selling the same CDOs to others, believing there was no way housing could decline in price, and therefore there was no way they would ever need to pay. In the end they formed a circular firing squad where everyone was owed a bunch of money but also were supposed to receive a bunch of money. I wonder if they had all simply forgiven each other’s CDOs if they would have found out that they were all essentially even.
Thanks for your comment. You’re right that the government wanted the banks to increase home mortgage lending, arguing that owning a home produced greater economic and social stability. But the banks were hardly innocent. They made tons of mortgage loans without any evidence of the borrower’s ability to repay (so-called liar’s loans). They browbeat the ratings agencies, pitting one against the other, into giving AAA ratings to terrible CDOs. Sometimes they even submitted one slate of securities to the ratings agencies and substituted inferior names in the actual product after getting the rating. Proprietary bank traders have also been indicted for trying to illegally manipulate all sorts of commodity markets–which I read as saying they were terrible traders, so the only way they could make money was to cheat.
I think there was lots of blame to go around. There were also the borrowers who bought way more house than they could afford because they figured they could just sell for a big profit before the balloon mortgage came due, and some who even bought several houses as “investments” with nothing down. Some then trashed the place on their way out since they thought it was unfair they were being tossed from a place on which they were no longer paying the mortgage, sometime having lived rent free for months, despite having had hundreds of thousands of dollars being forgiven. Probably the only innocent ones were those of us buying far less home than we could be qualified for who ended up paying for the losses of the big banks through our taxes.