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Too Big To Be Useful

Protests continue on Wall Street and around the nation calling for a vague program of reform.  Polls continue to show that the effort is popular, with opinion against Big Government even stronger than feeling against Big Business.  It seems that after many years we are beginning to develop the courage to make small plans once again.

At the heart of it all is 30 years of an applied theory, a history that appears to be discredited but never been properly repudiated.  As we move past the dogma of Supply-Side economics there is a lot more than government taxing and spending policy to clean up.  There are the banks whose turf is being occupied today, those that are beyond Too Big to Fail and well into Too Big to Understand and simply Too Big.  They got that way the same way our government did – by leaving common sense and history behind.

It’s been 12 years since the big financial bubble was in the process of collapsing for the first time.  Wall Street had a fabulous ride through the 1990s from “high tech” stocks that were largely retail outlets and services making use of the new connections promised by the internet and dramatic improvements in shipping.  The mania simply got ahead of itself, and by 1999 was clearly taking a bit of a pause.  That worried those who assumed the bubble was a desirable thing that should continue on forever.

The single guiding principle – supply side theory – told policy makers that if there was more investment money available the wonderful gains could continue forever.  This time it wasn’t a matter of tax or spending policy, but keeping the party going on Wall Street.  Freeing up banks, the argument went, would make even more money available for investment in the fabulous engine that created more and more wealth all the time.

Only one thing stood in the way.  Since 1933 it was illegal for ordinary banks, those that took deposits and made loans, to invest in securities like stocks.  Banks had to contend themselves with making loans to people and businesses with the money they made off of the interest from other loans.

That law was known as the Glass-Steagall Act, named after its two sponsors.

When it was passed in 1933, the separation of investment and ordinary banking was apparently obvious enough to not be controversial.  The Great Depression was well under way and the failure of banks propelled through every Main Street in the USofA as a general failure of everything.  A wall separating the two was simply a foregone conclusion – although other provisions of the act, such as deposit insurance (FDIC) took a lot more convincing.

Not so in 1999.  By then, the separation seemed antique and a serious impediment to perpetual wealth.  It was quietly repealed and then …  something very big happened.  Take a look at this chart that has been circulating around the ‘net (so I cannot give proper attribution!) showing the timelines for the creation of the largest banks – those that are truly “Too Big to Fail”:

Note that 1999 is the big turning point, the spot on the chart when many become one in quick succession.  Removing the wall between ordinary banking and investment banking created a grab for small banks and other institutions that had good cash flow – money in and out that could be leveraged into short-term borrowing that in turn was put into the stock market, derivatives, other complex investment instruments.

It was only a short step from the merger mania to the channeling of mortgages – the mainstay of many ordinary banks – into mortgage backed securities.  These are bonds with big cash flow behind them backed by ever-rising real estate that … well, we all know how this turned out.  Removing the separation between ordinary banks and investment banks fueled the mania that kept the party going right up until 2008, despite the fact that the rest of the economy was clearly in trouble from at least 2001.

There has been a call recently to re-instate this separation, and Glass-Steagall is being talked about more openly than it probably ever has.  Where its initial passage was not controversial, and its repeal also a forgone conclusion, it is now up for debate.  A bill to do this has not gotten far, languishing in the US House.

What are the demands of those who are fighting Too Big in many forms?  One of them must be to re-establish the provisions of Glass-Steagall – the wall between ordinary banks and investment banks.  Expect to hear a lot more about this in the near future as the excessive belief in supply-side theory – more money for investment is always good – is finally repudiated as the true origin of the massive credit bubble we’ve all experienced.

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33 thoughts on “Too Big To Be Useful

  1. My first attempt at a comment was eaten by the system! What I wanted to say was that I do not think anyone was paying attention to financial regulations in 1999 so it is hardly surprising that congress did this. But people are paying attention now and we need to act on that. You did a good job putting it all together and tying it to the belief that drives it all the time which is a big problem in politics even if no one will talk about it.

  2. Anna: Sorry ’bout that, doesn’t happen very often that I know of. But yes, I don’t think too many people were paying attention back then. To this day “Glass-Steagall” is a bit of a conversation killer. But I have to do what I can. It is all about a single political theory that has very much been proven wrong (at least in the far extreme where we tend to practice it).

  3. At least 3 years ago Thom Hartmann was railing on his radio show on the repeal of the Glass-Steagal Act–a lone voice in the wilderness. I bought into his argument at the time. He brought up the words of Senator Byron Dorgan (In part):
    “This bill will also, in my judgment, raise the likelihood of future massive taxpayer bailouts. It will fuel the consolidation and mergers in the banking and financial services industry at the expense of customers, farm businesses, family farmers, and others, and in some instances I think it inappropriately limits the ability of the banking and thrift institution regulators from monitoring activities between such institutions and their insurance or securities affiliates and subsidiaries raising significant safety and soundness consumer protection concerns.” (Byron Dorgan D-ND Senate Speech, 1999)

    • So someone was paying attention! I was at the time, too, but I don’t think I said anything that good. But Dorgan was 100% correct – and it’s time to fix it. I think as we plan on moving ahead we have to look at the total sum of the damage the supply-side arguments and all their weird derrivative effects had on our economy. It’s time to reject this nonsense all around.

      • Still – there are few calls for reinstating Glass-Steagal or enacting similar legislation, and with the current make-up of congress, 0% chance of such legislation to pass into law. 😦

  4. I thought that what populists object to is the bailing out of banks, the policy that might encourage too much risk taking. If that is a root of the problem, that’s where one would go. If banks are too big to be safe, then we should break up the banks.

    Joe Stiglitz the economist proposed nationalizing the banks. If the Occupy Wall Street people were smart they would advocate nationalizing the banks. This would would help focus our minds on what we need to do to further improve our financial system. I believe the supply of housing needs to be regulated. The private sector for the most part constructs housing. They continued to supply the housing for which there was financing available. They continued to do this until prices collapsed. It used to be that housing markets were regional things. So I want to know prevent housing oversuplly in Florida, California, Arizona and Nevada was able to affect the whole country. Also I know that European countries like the UK and Spain had housing bubbles, but they have different systems and policies in place. Supposedly Europeans businesses are less greedy than their American businesses. (That’s a joke.) What I know is that Minnesota had a lot of real estate exuberance around the 10,000 lakes. Some of the people who had bought or build cabins were hoping to sell them to finance their children’s college education. Also upper middle class people were building lake cabins for their retirement, hoping the achieve the 21st century American dream of owning two homes and having 2 SUVs, a boat, and personal watercraft.

    • Smithson: You have to stop reading my mind! One of the things I’m leading into is how the last 30 years or so have been about manipulating risk. Supply side, with its cheap money and implied bailout (which became real) as well as Black-Scholes-Merton, are all about personal benefit from investment with socialized risk. The use of the term “socialized” to describe offloading risk even when there are market forces involved may not suit some, but I can’t think of a better term for it. The point is that the investor has offloaded it to a larger population that may or may not understand what they have (esp given the lack of transparency around CDSs).

      The result was a Credit Bubble and an amazing concentration of wealth. What else could possibly happen? If we don’t change our attitude and get serious about risk / reward it will happen again. It’s obvious that this cannot continue.

      What I started with was the theory that became an attitude and an embedded policy in our politics that has to change. There’s also a specific course of action here, meaning there’s something for heart and arm and brain (you know it’s wrong, here’s the reason, and here’s what to do about it). But the bigger picture – Socialized Risk – is a bit harder to talk about. Wanted to start with a specific example to make the point more clear.

      But yes, we cannot afford Socialized Risk without Socialized Reward. If that means that we should talk about socializing banks, or at least regulating them as a public utility, then so be it. Those who would naturally object to these ideas have a position to fall back on – a more traditional view of risk / reward where BOTH are taken on by an investor or group of ’em.

      Either way, I’m OK with it. Better than the mess we have now.

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  6. I hope in time you will show up to Occupy at the People’s Plaza and check it out. (Or at least the St. Paul version when it pops up soon.) Whenever you do show up, it would be great if you did some teach-ins on subjects like the economy.

    • Chelsea: Sorry I was slow to see your post! Thank you, I would love to be part of a teach-in on economy and politics. We on the left naturally are wary of economics – it is the study of money, not the people and their efforts that make the true wealth of any nation. But we have to undersand what’s being done to us so we can get ahold of it and make it work for us for a change. Thank you, I am looking forward to the St Paul effort – act locally!

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