Today we remember our veterans. We remember those who served and continue to serve our great country, the United States of America. As I mentioned in my post yesterday, our country would not be what it is today without the bravery and courage of our veterans.
While we honor our veterans and thank them for preserving freedom at home and around the world, I want to start a series of posts on freedom and fairness in the American financial markets. Ever since fall of 2008, I have grown deeply concerned about the financial stability and health of our country. I think all of the veterans who served and currently serve around the world would probably agree that the strength of America lies not only in its presence in foreign countries, but in its stability and success here at home. The following is a brief history and analysis of the American financial system up through the year 2000. While we fight for freedom and equality around the world, it’s important to remember that we need to continue fighting for economic freedom and equality in America everyday.
After the Great Depression, the financial industry was tightly regulated. America, with assistance from WWII, enjoyed 40 years of prosperity following the worst economic period in American history. During this time, there was a strict divide between commercial banks and securities firms, also known as investment banks. This divide was created by the Glass-Steagall Act, which refers to four provisions of the U.S. Banking Act of 1933 (sections 16, 20, 21, and 32). Under this Act, commercial banks could not use customer deposits to invest in non-governmental securities for their banks or their customers, nor could they distribute or underwrite non-governmental securities. Similarly, investment banks, who handled stock and bond trading, were prevented from acting like commercial banks by accepting customer deposits.
Most commercial banks were local businesses that had deep ties to the community. Investment banks were typically small, private partnerships. These partnerships were capitalized by the partners themselves, and therefore, the partners had an incentive to watch their money very closely and they did not engage in reckless behavior.
This bifurcated arrangement started to change in the 1980s when many of the Wall Street banks went public and received an influx of stockholder dollars. Everyone in the industry started to get rich. In 1980, the average American salary was on par with the average salary on Wall Street. By 2008, the average salary exploded to nearly $100,000 on Wall Street per year, while everyone else in America was barely making $50,000 on average annually. This all occurred at a time when economists, academics, and politicians heralded the philosophy of “Reaganomics”, which led to significant deregulation of the financial industry.
As many who lived through the 1980s will remember, the Reagan administration deregulated Savings & Loan companies, permitting them to make risky investments with their depositors’ money. Consequently, many families lost their life savings and taxpayers were left footing the bill. In this crisis, however, numerous executives went to prison for their reckless, overly-risky, and criminal behavior. However, even this crisis could not stop the tidal wave of deregulation to come, this time from a Democratic administration.
The Clinton administration continued the deregulation of the financial industry, even after the Savings & Loan crisis of the 1980s. At this point in the 1990s, the power of the financial sector was in the hands of a few. Investment banks had grown so large that the small, private partnerships of yesteryears could no longer compete. The M.O. was to go public or perish. The Clinton administration not only watched all of this occur, but permitted one of the largest corporate mergers of all time, the combination of CITICORP and Travelers Group to form Citigroup, the largest financial services corporation in the world at the time. Even though there was a strong argument that this merger violated the previously mentioned Glass-Steagall Act, neither the Clinton administration, nor the Federal Reserve Chairman at the time, Alan Greenspan, said anything. Instead, the federal government gave Citigroup a year exemption to the law until Congress, with pressure from financial lobbyists, passed the Gramm-Leach-Bliley Act in 1999, overturning Glass-Steagall and paving the way for future mergers of commercial and investment banks.
The end of Glass-Steagall changed everything. Similar to the Savings & Loan crisis, now investment banks were able to speculate on depositors’ savings accounts. This would lead to multiple “bubbles” throughout the 2000s, including the internet, or “dot-com” bubble, and the real estate bubble. Without personal accountability to keep themselves in check, investment bankers and others throughout the financial services industry were free to engage in risky behavior for private gains at a public loss. There were numerous incidents of agency capture throughout the 1980s and 90s where regulators governed in the best interests of the financial industry instead of the public who would eventually have to subsidize its risky behavior. A glaring example of this is, Robert Rubin, who served as Bill Clinton’s Secretary of the Treasury from 1995-1999. He joined Citigroup in 1999 and would go on to make $126 million in cash and stock at the company over the next decade. This is just one of the many examples of the regulators “getting into bed” with the industry they’re supposed to be regulating.
It is not hard to wonder why a major recession would occur at the end of the 2000s with this type of nepotism, agency capture, and crony-capitalism. It is still shocking to think that some of the “smartest” people in the world would loosen the regulations put in place at the end of the Great Depression (i.e. Glass-Steagall), and then question why the market crashes. I guess it goes to the old saying that we never learn the lessons of history. A “free market” is not free when the rules are skewed in the favor of powerful minority stakeholders who continue to accrue private gains and expect the public, who has already lost in the market, to bail them out with tax dollars because the powerful minority is “too big to fail.”
Part 2 will discuss the the various bubbles that occurred throughout the late 1990s and early 2000s. It will also provide a precursor to the financial crash of 2008.
I hope everyone had a great Veteran’s Day.