The GLBA’s [Gramm-Leach-Bliley] “repeal” of a portion of the Glass-Steagall Act of 1933 is said to have somehow contributed to the current financial meltdown. Nonsense.
Adopted early in the New Deal, the Glass-Steagall Act separated investment and commercial banking. It prohibited commercial banks from underwriting or dealing in securities, and from affiliating with firms that engaged principally in that business. The GLBA repealed only the second of these provisions, allowing banks and securities firms to be affiliated under the same holding company. Thus J.P. Morgan Chase was able to acquire Bear Stearns, and Bank of America could acquire Merrill Lynch. Nevertheless, banks themselves were and still are prohibited from underwriting or dealing in securities.
Allowing banks and securities firms to affiliate under the same holding company has had no effect on the current financial crisis. None of the investment banks that have gotten into trouble — Bear, Lehman, Merrill, Goldman or Morgan Stanley — were affiliated with commercial banks. And none of the banks that have major securities affiliates — Citibank, Bank of America, and J.P. Morgan Chase, to name a few — are among the banks that have thus far encountered serious financial problems. Indeed, the ability of these banks to diversify into nonbanking activities has been a source of their strength.
Most important, the banks that have succumbed to financial problems — Wachovia, Washington Mutual and IndyMac, among others — got into trouble by investing in bad mortgages or mortgage-backed securities, not because of the securities activities of an affiliated securities firm. Federal Reserve regulations significantly restrict transactions between banks and their affiliates.
Posts Tagged ‘failout’
Another Article on How GBL Did Not Cause the Meltdown
October 17, 2008Fannie, Freddie, Worldcom, Enron…
October 2, 2008From Hotair, via Taxpayers for Truth
Wolf: On the Suspension of Mark to Market
October 2, 2008Leon H. Wolf of Redstate:
One of the items in the proposed bailout that a number of Republicans seem to be insisting on is either a suspension or outright end to mandatory mark to market accounting rules. It is supposed by many people that this will somehow aid the unfreezing of the credit markets and/or provide liquidity to the market. Count me among those who are not so sanguine about the long-term prospects of suspending MTM; in fact, I suspect that it may make the situation worse.
In the very, very short term, the suspension of MTM may help certain companies who have built in balance sheet triggers in contracts, credit agreements, or corporate charters and/or bylaws to avoid immediate catastrophic consequences. But as a systemic matter, the suspension of MTM would seem to inject more uncertainty into the market, which is frankly the very last thing the market needs right during the middle of a crisis of confidence.
To review, the accounting fiascos of 1999-2002 that brought us mandatory MTM accounting taught us that traditional accounting methods make it easier for a company – through “aggressive” accounting – to appear solvent for much longer than the company actually is solvent. Everyone in the lending world remembers this. To further review, a large part of the genesis of the current crisis is a widespread fear that certain assets are toxic, and that it’s impossible to identify the toxic assets from the good ones. So… I guess we’re supposed to assume that allowing a change of accounting rules which leads the credit markets to believe that companies might be (but no way to tell for sure) faking solvency is a good thing?
If we suspend MTM in the current climate, what exactly is supposed to happen? Will companies hire accountants to come in and hastily rewrite their accounting books? If they do, will any lender actually extend them credit without forcing them to crack open the old MTM books instead? And if they can’t force that, will they lend at all? Like I said, the market will go from widespread uncertainty about certain classes assets to having widespread uncertainty about every company, especially in these uncertain times. I fear that this may make the credit markets freeze even tighter than they are, even if we inject a bunch of liquidity into the system.
Interesting take as I have hear mixed things on both sides about mark to market
WSJ: Bill Educates Barack
October 1, 2008From today’s WSJ:
A running cliché of the political left and the press corps these days is that our current financial problems all flow from Congress’s 1999 decision to repeal the Glass-Steagall Act of 1933 that separated commercial and investment banking. Barack Obama has been selling this line every day. Bill Clinton signed that “deregulation” bill into law, and he knows better.
In BusinessWeek.com, Maria Bartiromo reports that she asked the former President last week whether he regretted signing that legislation. Mr. Clinton’s reply: “No, because it wasn’t a complete deregulation at all. We still have heavy regulations and insurance on bank deposits, requirements on banks for capital and for disclosure. I thought at the time that it might lead to more stable investments and a reduced pressure on Wall Street to produce quarterly profits that were always bigger than the previous quarter.
“But I have really thought about this a lot. I don’t see that signing that bill had anything to do with the current crisis. Indeed, one of the things that has helped stabilize the current situation as much as it has is the purchase of Merrill Lynch by Bank of America, which was much smoother than it would have been if I hadn’t signed that bill.”
One of the writers of that legislation was then-Senator Phil Gramm, who is now advising John McCain, and who Mr. Obama described last week as “the architect in the United States Senate of the deregulatory steps that helped cause this mess.” Ms. Bartiromo asked Mr. Clinton if he felt Mr. Gramm had sold him “a bill of goods”?
Mr. Clinton: “Not on this bill I don’t think he did. You know, Phil Gramm and I disagreed on a lot of things, but he can’t possibly be wrong about everything. On the Glass-Steagall thing, like I said, if you could demonstrate to me that it was a mistake, I’d be glad to look at the evidence.
“But I can’t blame [the Republicans]. This wasn’t something they forced me into. I really believed that given the level of oversight of banks and their ability to have more patient capital, if you made it possible for [commercial banks] to go into the investment banking business as Continental European investment banks could always do, that it might give us a more stable source of long-term investment.”
We agree that Mr. Clinton isn’t wrong about everything. The Gramm-Leach-Bliley Act passed the Senate on a 90-8 vote, including 38 Democrats and such notable Obama supporters as Chuck Schumer, John Kerry, Chris Dodd, John Edwards, Dick Durbin, Tom Daschle — oh, and Joe Biden. Mr. Schumer was especially fulsome in his endorsement.
As for the sins of “deregulation” more broadly, this is a political fairy tale. The least regulated of our financial institutions — hedge funds — have posed the least systemic risks in the current panic. The big investment banks that got into the most trouble could have made the same mortgage investments before 1999 as they did afterwards. One of their problems was that Lehman Brothers and Bear Stearns weren’t diversified enough. They prospered for years through direct lending and high leverage via the likes of asset-backed securities without accepting commercial deposits. But when the panic hit, this meant they lacked an adequate capital cushion to absorb losses.
Meanwhile, commercial banks that had heavier capital requirements were struggling to compete with the Wall Street giants throughout the 1990s. Some of the deposit-taking banks that were allowed to diversify after 1999, such as J.P. Morgan and Bank of America, are now in a stronger position to withstand the current turmoil. They have been able to help stabilize the financial system through acquisitions of Bear Stearns, Washington Mutual, Merrill Lynch and Countrywide Financial.
Mr. Obama’s “deregulation” trope may be good politics, but it’s bad history and is dangerous if he really believes it. The U.S. is going to need a stable, innovative financial system after this panic ends, and we won’t get that if Mr. Obama and his media chorus think the answer is to return to Depression-era rules amid global financial competition. Perhaps the Senator should ask the former President for a briefing.
Liberal friends of mine point to “deregulation” and the GLB as th reason for our financial crisis. The article makes a great point about the lack of regulation in hedge funds and the success they have had.
Bush to Speak at 8:45
September 30, 2008MIchelle Malkin is reporting this morning.
This got me thinking. Perhaps this isn’t McCain’s moment to shine, but Bush’s. The man is a leader and has shown deftness and skill at putting the nation at ease. We all remember his bullhorn speech from ground zero. I can’t remember a time when he was so inspiring. A strong Bush showing can raise his approval and work to benefit the party.
Financial Crisis in Bullet Points
September 30, 2008Found this linked from Redstate. It is pretty much a verbal distillation of what went wrong. From the adam smith blog:
- Anti-redlining laws in the US, passed in 1977 and strengthened in 1995, forced lenders to give mortgages to people they knew might not be able to afford repayments. People who haven’t had a full-time job in years were lent six figure sums.
- In order to manage the risk this exposed them too, lenders packaged these sub-prime mortgages up with other ones and traded them as derivatives (collateral debt obligations, or CDOs).
- People start to default on mortgages, but because the CDOs are so opaque, no one knows how much liability they, or others, are exposed to. So the banks stop lending to each other and the credit crunch begins.
- Now the banks which have overextended themselves – lending far more money than they have in deposits, and relying on being able to borrow cheaply to finance their business model – are in serious trouble. Ultimately, it’s a cash flow problem.
- Word gets out and Britain witnesses the first run on a bank in over 100 years. Confidence evaporates on both sides of the Atlantic. Share prices plummet, as one bank after another is infected. Investment banks, which do not take deposits and therefore rely most heavily on the ability to borrow, are hardest hit.
- Two possible policy responses emerge. One, motivated by the idea of moral hazard, says that banks must be allowed to fail. If government bails them out, they’ll behave even more riskily in future. Plus, why should the taxpayers fund a welfare state for bankers? The other school of thought stems from the idea of systemic risk, that allowing banks to collapse would endanger the entire financial system (and, by extension, the capitalist economy).
- Fears about systemic risk win out. Governments intervene to try and restore confidence. In the US, the Bush administration attempts to buy up all the bad debt, aiming to get banks lending to each other again.
- This what happens when a bubble bursts. For years, the availability of cheap consumer goods from emerging economies like India and China kept down inflation. This meant governments and central banks thought they could flood the market with liquidity (i.e. cheap credit) and get away with it. They couldn’t. With too much money chasing too few goods, an asset bubble built up. House prices, in particular, were hugely over-inflated. It got worse after 9/11 when, facing an economic downturn, the US and the UK both pumped even more liquidity into the market. With breathtaking arrogance, politicians claimed to have abolished the economic cycle. In reality, they had simply swapped an immediate and relatively minor readjustment for a much harder landing several years down the line.