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Editorial | Economy in precarious position | Rich Elfers
It was October 1929 and the stock market had crashed. It was well known by the public at that time that some commercial banks had loaned money to stock speculators who had then gone to their stockbrokers and bought stocks on margin. That means they only put a small percentage of the cost of the stock down (say 10 percent) and promised to pay the balance when stock prices rose. Unfortunately for the stockbrokers, the speculators and the commercial banks, they couldn’t be repaid because the speculators had lost all their money with the crash.
Some average citizens began to make the connection that their life savings at the local bank might not be safe because of these loans to stock speculators. So, just to be safe, some people went to their banks to take their money out. Others saw people waiting in line outside the bank, so they began to be worried, too. They went to their banks and wanted their savings withdrawn. This fear set off a cascading series of bank runs and failures that spread across the nation in the years between 1930 and 1933.
To stop the panic, Franklin Roosevelt closed all the banks in the nation when he took office in March 1933 until the government could check their soundness. He had Congress pass what is called Federal Deposit Insurance (FDIC) to federally guarantee bank account deposits. We still have this today, with the government protecting up to $250,000 per account of our deposits.
Part of the FDIC Act was called Glass-Steagall and was passed in 1933 to separate commercial banks, where people kept their savings, from investment banks that are financial institutions that loaned money to people to buy stocks and bonds. This was meant to prevent the mistakes that caused the Great Depression of the 1930s. For 66 years, until 1999, this law functioned well, until with the push from Federal Reserve Chair Alan Greenspan, Secretary of the Treasury Robert Rubin, and some large financial institutions, the law was dropped.
I remember hearing about President Clinton signing the act that ended the Great Depression safeguard. Having taught about the causes of the Great Depression for more than 20 years at that time, I wondered what effect that decision would have upon the economy. We all found out in October 2008 when the economy went into a tailspin.
A new regulatory act was passed in 2010 called the Volcker Act, which is due to come into effect on July 12, 2012. It will seek to prevent some of the causes of the 2007-08 economic meltdown. But its chief weakness is that nothing equivalent to Glass-Steagall is part of that act. The end of Glass-Steagall in 1999 allowed financial institutions to grow “too large to fail.” The reason it wasn’t added is because lobbyists from financial institutions spent many millions of dollars successfully fighting against any such regulation. They had a lot to gain from blocking such a provision.
The problem that I see as the major issue is that when the government comes in to bail out corporations that are “too big to fail” it creates what economists call “moral hazard.” This means that since financial corporations now know that the government will bail them out as they did in 2008, they are less responsible with their investments. They are likely to get greedy again because there will be no consequences for them from their irresponsible actions.
Why might you care? My fear is that not having a Glass-Steagall type provision in place will lead to a repeat of the 2008 economic disaster. Unless Congress and the president act to reinstate a form of Glass-Steagall, we will see a repeat of the 2007-10 fiasco. Ignorance will not be bliss.
I recommend you go online and watch two Frontline videos. They’re free and all they will cost you is some time. They’re called “Frontline: The Warning” and “Frontline: Money, Power, and Wall Street.” To view them, type these titles into your search engine with quotes. The time you take to watch will help you understand how precarious a position we are in economically as a nation and that’s not even dealing with the Euro Zone crisis over Greece.