Investigations after the 1929 stock market crash revealed widespread conflicts of interest and outright fraud in the activities of financial firms leading up to the crash, and the worst financial catastrophe the country has ever experienced, the Great Depression. It was clear that financial firms had become too big, too powerful, and too greedy.
To prevent it from ever happening again, in 1933 Congress passed the Glass-Steagall Act. It split up conflicting areas of financial activities, forcing financial firms to choose which one they would operate within, while divesting themselves of the others.
Savings banks could take in deposits from the public and make personal and home loans. Commercial banks could take in deposits from businesses and make business loans. Investment banks could raise capital for businesses by taking them public, arranging mergers and acquisitions and the like. Brokerage firms could provide a market for stocks after they had become public, brokering the trades of investors and trading for their own accounts. Mutual funds, then known as investment trusts, could invest in portfolios of stocks and sell their shares to investors.
It worked very well for 60 years – for the country – and for the financial firms, with each type of firm prospering.
But in the boom times of the late 1990s, savings banks, commercial banks and insurance companies began peering over the barriers at the profits being made by investment banks, brokerage firms, and mortgage brokers, and wanted in on that too.
So huge amounts were spent on lobbying by Wall Street firms, and sure enough the barriers began coming down, with Congress repealing the entire Glass Steagall Act in 1999.
That opened the flood gates to behaviour similar to what took place in the 1920’s leading up to the 1929 stock market bubble and subsequent crash.
Banks established or acquired brokerage firms, launched their own mutual funds, invested in and backed hedge funds, sliced and diced mortgages into derivatives and sold them as investments, while diving into proprietary trading for their own accounts in a big and reckless way.
And sure enough, the greed got seriously out of hand and then imploded, in fact twice, once with the bursting of the stock market bubble of 2000, and then even more seriously with the real estate and sub-prime mortgage bubble and resulting financial meltdown of 2008-2009.
As in the early 1930’s, congressional investigations were undertaken over the last few years. Once again it was similarly determined that banks had become way too big, their greed and conflicts of interest too dangerous to the economy.
Sweeping reforms were promised. Wall Street screamed bloody murder and lobbied heavily against every proposal.
The reinstatement of the Glass Steagall Act was debated. Although it had been proven to work well for many decades, it was beaten down.
A watered-down Dodd-Frank reform bill was eventually passed. The so-called Volcker Rule was adopted (which at least would limit proprietary trading by depository banks to no more than 3% of their Tier 1 capital).
But under pressure from Wall Street, regulators decided to delay implementing most of even the watered-down new regulations.
The game Wall Street was playing seemed obvious. Investors were mad as hell after the 2000-2002 bear market, and then the 2007-2009 bear, and weren’t going to take it anymore. They were demanding regulatory changes, and Congress and the regulators were going through the motions.
Meanwhile, through mergers and acquisitions that were part of the rescue efforts, the banks have become even bigger financial empires. Bank of America was encouraged to buy troubled Countrywide Financial, and brokerage firm Merrill Lynch. JP Morgan took over Washington Mutual. Wells Fargo took over trouble Wachovia. And so on.
But Wall Street was well aware of the short memories of investors. They knew that once the next bull market was underway investors would be focused on it and forget about the past.
So not only were they successful in having implementation of the watered-down Dodd-Frank regulations delayed, there are plans in Congress to attempt to repeal all or part of it after the elections.
However, this week came a wake-up call. Supposedly carefully managed and conservative JP Morgan Chase lost somewhere between $2 and $4 billion dollars last week on a derivatives trade that went bad.
Congress and regulators have been oddly quiet in reaction, since the news potentially throws a monkey wrench into their plans to scuttle even the Dodd-Frank financial regulations after the elections.
Come on people! Wall Street has been ranting for three years about the ‘excess regulations’ that were being proposed. The truth is that even the harshest of the proposals would be far short of the regulations that were in effect, and working very well, right up to the 1999 repeal of Glass Steagall.
Give the country a break. It can’t handle another financial meltdown.
And in 1929, again in 2000, and yet again in 2008, we’ve seen how those meltdowns are inevitable if the financial industry is left to its own devices.