What, The Stove Is Still Hot?

One of the most potent political buzzwords used by Republicans to rally the troops is the term” regulation.” They hammer home the point that regulation is nothing but a left-wing plot to restrict our freedoms. Unfortunately, that does not include a woman’s right to control her body. Republicans have cast regulations as one of the significant threats to a society that respects the individual and their right to govern their lives. This stand for the rights of individuals sounds admirable, but this crusade against regulations has been a Trojan Horse for decades.

A well-functioning society requires a regulatory framework that is effective and dynamic. The goal of any regulation should be to promote stability and, ideally, address problems that stifle progress. Regulation should also be effective in mitigating bad acts and bad actors. If there is anything these past 20 years have shown us, there is no shortage of horrific actors.

Without question, at the top of this list of bad actors is the financial sector, a notorious repeat offender. If there were ever an industry that needed regulation and oversight, it would be the financial sector. Recently we saw headlines about the failures of First Republic Bank (FRB), Silicon Valley Bank (SVB), Signature Bank, and Silvergate Bank. Why did the banks fail? Republican politicians are saying the reason for this debacle is regulators. History has shown us that regulators may have played a role but are also convenient scapegoats.

The Great Depression of 1929

The Great Depression of 1929, to this date, has been the most catastrophic financial disaster in our country’s history. Historians and financial experts have cited various reasons for the collapse of the global financial system. Prominent among these factors were the stock market crash of 1929, overproduction and oversupply, counterproductive Federal Reserve policy (although the destructive die had already been cast), protectionist policies, and presidential paralysis Hoover believed in minimal governmental intervention. Another significant factor was the international commitment to the gold standard.

There is still an ongoing debate about the causes and relative importance of those causes for the Great Depression. Still, there’s a strong consensus that unbridled speculation ran rampant in the financial markets and contributed mightily to the Great Depression, which lasted approximately a decade. During this decade, unemployment exploded to 25 percent, the stock market lost more than 85 percent of its value, and half the banks in the United States collapsed.

The period before the Great Depression was called the “Roaring Twenties” for good reason. Total income in the United States more than doubled during that period, but the “Twenties” weren’t roaring for everyone. One-tenth of one percent of Americans had more income than 42 percent of Americans. The more things change, the more they remain the same. Gross Domestic Product was estimated to drop by 30 percent, and the Wholesale Price Index declined by 33 percent. This meant that businesses believed that demand would continue to increase, so they produced more, but consumers became unwilling and later unable to purchase manufactured goods. Then prices went into a downward freefall.

Much of the damage was due to the over-speculation of the financial sector, banks, and the stock market. Their behavior is inextricably linked. Banks made risky investments and loans to many companies in the stock market that would sell stock on the margin. (leveraged purchases). The returns initially were so enticing that many average citizens participated in this Wild Wild West atmosphere.

The Federal Reserve played a significant role in mishandling its response to the events leading to The Great Depression because the Federal Reserve members were at loggerheads on whether to feed the beast or starve it. However, I have a bigger problem: the U.S. Government and the Federal Reserve were working from a reactive instead of a proactive position. Regulatory regimes must be both.

The destruction caused by the Great Depression is directly responsible for the New Deal. The New Deal was a comprehensive combination of legislation, executive actions, and programs designed to help the nation recover from and prevent another financial catastrophe. Central to the new deal was the Emergency Banking Act of 1933 (EBA), also known as Glass-Steagall, signed into law by President Franklin D Roosevelt. Several pieces of this legislation were critical to our nation’s economic recovery.

The EBA was implemented to restore confidence in the U.S. banking system and create structures that would regulate the banking system, administer oversight, and safeguard the nation against another depression. First, to stabilize the banking system, the government temporarily closed banks to inspect them for financial stability. Then, after meeting specific criteria, the government reopened financially stable banks.

Two of the more consequential and enduring pieces of the legislation were the Federal Deposit Insurance Corporation (FDIC) creation. The FDIC insures consumer bank accounts deposits in case their FDIC-covered bank was to go bankrupt. The initial amount covered was 2,500 USD, which is now 250,000 USD. In the cases of Silicon Valley Bank and Signature Bank depositors, they raised the ceiling above 250,000 USD.

Glass-Steagall set up a wall of separation between sectors of the financial industry. Its primary goal was to prevent commercial banks from taking your hard-earned savings and engaging in underwriting and dealing securities. Banks did this with impunity leading up to the Great Depression,

Americans can be worse than the little boy or girl that you warn not to touch the stove because it will burn them, and they still touch the stove, except they usually don’t touch the stove again. We do.

Savings and Loan Crisis 1980

During the 1980s, there was the Savings and Loan Crisis. The Federal Home Loan Bank Act of 1932 created the Savings and Loan (S&L) system. It was designed to promote home ownership to the “working class.” The Act was constructed to pay lower-than-average deposit rates, but the trade-off was that mortgage rates were lower than average. This policy helped make homeownership accessible and was beneficial to many Americans.

Unfortunately, the decade of 1970s was a period of very little economic growth and high inflation. This combination of elements was coined stagflation by a British politician named Iain Macleod.

These economic conditions posed severe problems for Savings and Loan Banks because they lost depositors to banking institutions with much higher Rates of Return (ROR). S&Ls had a cap on their RORs. S&Ls pleaded with Congress to remove the low-interest restriction. So, in 1982, President Reagan and Congress decided to touch the hot stove again. Instead of taking measured steps to address the S&Ls problems, he signed the Garn-St. Germain Depository Institutions Act which eliminated the interest rate cap.

To exacerbate things, it also allowed banks to have up to 40 percent of their assets in commercial loans and 30 percent in consumer loans. State legislators made things worse by promoting banks’ investments in highly speculative real estate. This legislation was indeed a bipartisan fiasco.

Politically, Reagan and Republicans were engaged in a massive campaign to discredit the federal government and regulators. It never made sense how Reagan could cast the federal government as a nefarious threat to the American people yet be the categorical leader of that government.

In so many instances, the purpose of regulations is to protect people from organizations, entities, and individuals that have the power to do grave harm to the citizenry.

The organizations and individuals that make up the financial industry are perfect avatars.

For example, during the Savings & Loan Crisis, the value of S&L banks’ speculative real estate investments began to tank, and banks hid the truth about their financial status. They continued to value those properties at their original price. Even the law changes couldn’t keep 35 percent of the S&Ls solvent, and by 1987 the Federal Savings Loan Insurance Corporation was insolvent. Ultimately, this crisis cost 160 billion USD, of which taxpayers paid 132 billion USD. If only we could have adopted some measured regulations to address these problems. Eliminating the regulations we had in place was not the answer.

Despite the failures of deregulation in resolving the Savings and Loan Crisis, the deregulation movement gained momentum among policymakers and legislators. Advocates for deregulation of the financial sector came from the White House and the Halls of Congress, from Republicans and Democrats. Yet, disgustingly, while completely ignoring the devastating lessons of the Great Depression, various administrations and Congresses eliminated and slashed regulations designed to moderate the financial industry’s high-risk investment philosophy.

The Second Great Depression (Recession)

In 1999 President Bill Clinton signed the Financial Services Modernization Act of 1999, commonly known as Gramm-Leach-Bliley. This legislation brought about the most significant change in the regulatory framework established during the Great Depression. It eliminated the near impermeable walls created between commercial banking, investment banking, and insurance.

This change was a recipe for reckless investment and Ponzi scheme operations, leading to millions’ impoverishment. In straightforward terms, this legislation gave the financial industry the right to take individuals’ deposits, underwrite securities using those deposits and then insure themselves on any investment gamble they take. For banks and investors, this would be akin to going to a casino and being told that not only will we reimburse you for anything you lose by gambling, but we’ll also pay you interest on those losses.

In my opinion, this, more than anything else, played a significant role in the Great Recession.

Many try to blame it on borrowers that defaulted on their mortgages, but the terms of these loans were designed to fail. Banks and other financial institutions had no reservations about lending money to people who wanted something that could create generational wealth. That was the hook, and these prime mortgages with their overinflated values were then bundled and insured for values far outweighing the value of the original asset, your home. People in the financial industry were making bets on mortgage securities with a nearly nonexistent connection with the house.

During the Bush presidency, regulators were accomplices, turning a blind eye to these strategies and practices.

There is a term called rehypothecation, and it is the practice where “banks, brokers, or individuals use collateral they do not own to help finance assets. Your house was the asset, and it was repeatedly being used as collateral to create new loans. This act” creates a credit cycle that promotes profitability but increases default risk.” They could do this because the non-depository financial institutions (investment banks) were integrated with the depository system (commercial banks). Thank you, Ronald Reagan, Bill Clinton, and George W. Bush.

These bundled mortgages would then be passed from one party to the next like “hot potatoes.” When the final call was made on these mortgages (homeowners defaulting), neither banks nor insurers had sufficient capital to meet their obligations. In the meantime, many in the financial industry had already profited before the industry’s freefall.

In 2010, Congress enacted the Dodd-Frank Wall Street and Consumer Protection Act of 2010. This legislation responded to the 2008 financial crisis that caused the Great Recession. I believe it should be called the Second Great Depression. Two of the goals of this new legislation were to increase oversight of and accountability for financial institutions.

The legislation provided many oversight and enforcement changes to protect against another disaster. One primary objective was to identify those financial institutions that were so large that their downfall would lead to catastrophic harm to our country’s economy and, if you apply the “sneeze” metaphor, the rest of the world.

A focus was placed on those banks holding 50 billion USD or more in assets or any nonbank financial company supervised by the Federal Reserve. That came to a total of 38 institutions with total assets valued at approximately 31 trillion USD. Sarah Miller of fin.plaid.com does an excellent job summarizing the bill’s six significant provisions. They are:

The Volcker Rule
The Consumer Financial Protection Bureau
Capital and liquidity requirements
The Financial Stability Oversight Council (FSOC) and designations
Derivatives regulations
Too Big to Fail and Living Wills

https://fin.plaid.com/articles/major-provisions-of-the-wall-street-reform-and-consumer/amp/

Although there has been legitimate criticism of the legislation, the first ten years showed that the steps taken reined in much of the riverboat gambling of the financial industry. Moreover, these regulatory steps helped us survive and eventually thrive through the turmoil and human suffering caused by a global pandemic, startling job losses, and significant inflation.

Dodd-Frank Wall Street Reform and Consumer Protection Act

We finally furnished Federal regulators with some tools that constrained reckless behavior and held perpetrators accountable. To quote Michael Corleone (Al Pacino) from Godfather Part III, “Just when I thought I was out, they pulled me back in.” Just as we thought we had learned some critical lessons from previous financial calamities and brought stability and a measure of accountability to our financial sector, we had to go and touch the hot stove again.

During the financial crisis of 2008, even the notion of financial reform was anathema to Republicans, who fought tooth and nail to block any substantive reform legislation. Finally, their persistence paid off, and in May 2018, President Trump signed the Dodd-Frank Wall Street Reform and Consumer Protection Act. But, of course, just about anytime Republicans pass legislation, you can bet the bill’s objective is the opposite of its name. This new bill did the following:

It raises the Dodd-Frank threshold for regulatory standards from 50 billion USD to 250 billion USD. That means 25 of the 38 largest banks were no longer subject to more robust capital and liquidity rules. The exempted banks hold 3.5 trillion USD in assets, one-sixth of the assets in the banking sector. They also received 47 billion in TARP bailout funds.
Under the ruse of claiming to be concerned about regional banks, the legislation deregulates the U.S. holding companies of scandal plagues banks like Deutsche Bank and Credit Suisse.
The legislation lowers the loss-absorbing capital cushions State Street Corp and The Bank of New York Mellon Corp, two banks holding a combined 60 trillion in assets under custody and administration.
We have obliterated the oversight and reporting requirements for those 25 banks identified as posing a significant risk to our financial health.

In March 2023, four U.S. banks failed and caused a significant decline in global stock prices. The banks were Silicon Valley Bank (SVB), First Republic Bank (FRB), and Signature Bank, which accounted for 2.4% of all assets in the banking sector. Silvergate Bank was another notable bank failure. SVB, FRB, and Signature Bank had assets on their books of 209 billion, 229 billion, and 110 billion USD, respectively. The primary reasons for the closure of these three institutions have been mismanagement and excessive risk-taking.

One of the factors contributing to their demise is the untimely intervention by regulators, but Republicans are doing nothing but scapegoating. Their claims are also the epitome of hypocrisy. Their enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act exempted these three banks from heightened capital and liquidity requirements, more robust oversight, and increased reporting requirements. The 2018 legislation eviscerated many tools to prevent this situation, yet they want to cry that the crisis was due to lax regulators while implying they didn’t regulate enough.

The war against regulations has been waged by politicians armed with lies, fear tactics, and self-interest. Of course, there will always be ineffective regulations, which should be revised, replaced, and sometimes eliminated, but to think that a world that could exist with a minimalist regulatory framework is folly. I tell people that I am not an anti-capitalist. I’m just an adversary of mythical capitalism. You know, the one that is self-governing and self-correcting. Unfortunately, we continue to have the habit of unlearning past lessons and repeating avoidable suffering.

References

https://www.fdic.gov/bank/historical/bank/bfb2023.html

https://en.wikipedia.org/wiki/2023_banking_crisis#:~:text=Over%20the%20course%20of%20five,to%20prevent%20potential%20global%20contagion.

https://fin.plaid.com/articles/major-provisions-of-the-wall-street-reform-and-consumer/amp/

https://corpgov.law.harvard.edu/2010/07/07/summary-of-dodd-frank-financial-regulation-legislation/

https://www.statista.com/statistics/421697/financial-institutions-assets-usa/#:~:text=The%20total%20assets%20of%20financial,approximately%20135.4%20trillion%20U.S.%20dollars.

https://fin.plaid.com/articles/major-provisions-of-the-wall-street-reform-and-consumer/

https://obamawhitehouse.archives.gov/economy/middle-class/dodd-frank-wall-street-reform#:~:text=Separates%20“proprietary%20trading”%20from%20the,unrelated%20to%20serving%20their%20customers.

https://www.fdic.gov/bank/historical/sandl/

https://www.archives.gov/seattle/exhibit/picturing-the-century/great-depression.html

https://news.stanford.edu/2020/04/29/great-depression-demonstrated-indispensable-role-government/

https://www.loc.gov/classroom-materials/united-states-history-primary-source-timeline/great-depression-and-world-war-ii-1929-1945/overview/