By Nancy Spannaus
Oct. 13, 2019—If one is to take the actions of the Federal Reserve since Sept. 17 into account, the United States banking system (and perhaps the global one) has already entered into a new systemic crisis. The Fed is issuing tens of billions of dollars a day to the major U.S. banks, due to what is claimed to be problems in the repo market. (overnight repurchasing agreements) All the signs are that some major bank is in big trouble, thus demanding such bailouts to stay afloat. Yet, as Wall Street on Parade columnists Pam and Russ Martens put it in their column Sept. 27, Congress doesn’t even have enough interest to hold hearings about where this money, our government money, is going.
The top item on Congress’s agenda should be the reinstatement of FDR’s Glass-Steagall regulation, in order to protect the monies of companies and citizens in the commercial banks from the rampant speculation which the mega-banks are carrying out with cheap Federal money! We need a firewall to protect legitimate deposits and commercial activity.
When the Republicans controlled the House of Representatives, it was not surprising that no hearings were held on the Glass-Steagall legislation which had been introduced by Rep. Marcy Kaptur and Senator Elizabeth Warren. Now, almost a year into a Democratically-controlled House, will the Democratic leadership do any better?
Both the House and Senate Glass-Steagall bills lapsed with the opening of the 116th Congress in January. Rep. Kaptur has reintroduced her Return to Prudent Banking Act (H.R. 2176), and it now has 29 cosponsors. Senator Warren, when she issued her Plan to Rein in Wall Street in July, gave prominent attention to the need to reinstate Glass-Steagall; so far, she has not reintroduced her 21st Century Glass-Steagall Act.
The reckless speculation which led to the blowout of 2008-9 has ballooned to even larger proportions, and even the minimal restraints included in the Dodd-Frank bill have been whittled away by the Congress into almost nothing. I recommend following Wall Street on Parade for the blow-by-blow; the daily column features excellent intelligence on the financial criminality underway.
For a solution, we must turn to the principles of the Hamiltonian American System. Hamilton understood speculators to be the bane of a prosperous economy, and sought to rein them in. He was dedicated to a banking system that would support industry, agriculture, and commerce—the very opposite of the financialized mess which we have today. The first step in achieving such a system today is re-imposing Glass-Steagall, for reasons I elaborate below.
What was Glass-Steagall?
Glass Steagall was a bi-partisan, 37-page, populist, law signed by President Franklin Roosevelt in 1933, and actively promoted by powerful Wall Street bankers following the Crash of 1929 and closure of ALL banks. It worked by completely separating commercial banking, which is loan-making, from investment banking, that entails speculation. Throughout its 66-year history, Glass Steagall prevented ANY systemic banking collapse. Its dilution, and eventual repeal in 1999, led to the financial system collapse and Great Recession of 2008-09 that devastated the American economy, doubled the national debt, and took years from which to recover.
The Glass-Steagall Act prevented “the undue diversion of funds into speculative operations.” Speculation refers to the use of depositors’ money buy stocks, bonds, today’s derivatives, or businesses through underwriting, with the hope that their value will rise, but with the risk their value might also fall.
- Commercial banks, that take in deposits and make loans to small businesses and households, could not use depositors’ money to speculate. To further protect citizens’ savings, Glass-Steagall created the Federal Deposit Insurance Corporation, to insure bank deposits up to of $250,000 (today’s maximum) in the event that one or more individual banks might fail.
- Investment banks, that create and hold derivatives, buy and sell stocks and bonds, and underwrite large financial deals, had to be separated into an entirely separate bank, with no common boards of directors, shared deposits, etc. If those banks failed, there would be no government bailout.
- Commercial banks could purchase securities for their clients, but not for their own account (i.e. proprietary trading, the subject to today’s Volcker Rule) reducing even the appearance of betting.
Push to Deregulate Banks: In the 1980-90s, the wall between investment and commercial banking was dismantled, and banks were allowed to own brokerage firms and mutual funds, and act as both agent and principal in securities trading.
- In 1980, in the face of rising interest rates that reduced their profitability, Savings and Loans (S&Ls) were given permission to speculate, contributing to the failure of 1/3 of those institutions by the end of the decade, at a cost to taxpayers of $130 billion.
- In 1987, Greenspan allowed Bank Holding Company subsidiaries to deal in derivatives; the need for a $3.6 billion bailout of banks that had lent money to the hedge fund, Long Term Capital, followed a decade later.
- In 1999 Congress repealed Glass-Steagall. Commercial and investment banks merged and became Too Big to Fail Banks (TBTF).
- In 2000, Congress passed the Commodities Futures Modernization Act, deregulating derivatives.
- Thereafter, the issuance of derivatives (mostly mortgage backed securities associated with the housing bubble) soared, and banks and insurance companies competed to purchase them by increasing their leverage (or borrowing) from other banks. Thus, financial sector debt skyrocketed, from 25% of GDP to 125% of GDP between 1985 and 2008. And the interconnectedness-of-debt, and risk of systemic failure, rose alongside.
The Great Recession of 2008-09: The system began to crash in the fall of 2007, as home mortgage defaults, short sales, and falling house prices, caused Citigroup’s toxic financial paper to tank. By October 2008, 12 of the 13 most important banks were “at risk of immediate failure”, according to Federal Reserve Chair Ben Bernanke, and were bailed out. The myth that the crash was caused by the implosion of investment banks not subject to Glass-Steagall is UNTRUE. Citigroup, e.g., ultimately received $45 billion in taxpayer bailout, $340 billion in asset guarantees, and $2 trillion in near-zero percent Federal Reserve loans.
The recession’s impact on America was devastating: the economy contracted by 5.1%, 80.7 million jobs were shed, upwards of 10 million families lost their homes to foreclosure, the net worth of American households fell by 22%, the stock market lost 57% of its value, government debt doubled to $20 trillion (on account of low tax receipts and high unemployment claims), and the Federal Reserve, the Treasury, and the FDIC, spent an additional $5 trillion at public expense to keep the financial system afloat.
Today we are more vulnerable than ever: As of last year, the US banking system held an eye-watering $255 trillion in derivatives on the books of federally insured banks. Underlying these derivatives and stimulated by continued loose monetary policy from the Federal Reserve, new price bubbles have re-appeared in the housing market, stocks, bonds, and the US dollar. Derivatives and stocks bought on margin (or with leverage) continue to be financed through loans from other banks. A new bubble is the $14 trillion corporate debt — larger than the subprime mortgage bubble of 2007, according to a report by the International Monetary Fund. Corporate Debt to Earnings ratios are at near-record highs; and corporate defaults are building as the Federal Reserve progressively raises interest rates.
According to a 2015 report by the Office of Financial Research on the SYSTEMIC RISK imposed by US banks, the higher a bank’s leverage, the more prone it is to default under stress. And the greater its connectivity other banks, the greater is the risk the default will spread to other banks. That report identified five mega-banks with particularly high contagion index values — JPMorgan-Chase, Citigroup, Morgan Stanley, Bank of America, and Goldman Sachs. A default in any single one could bring the entire financial system down. And that would overwhelm the capacity of the FDIC to protect citizens’ deposits.
Added to the above, a “financialization” of America is crowding out the supply of money available to lend to America’s productive economy for real investment, thus slowing economic growth. The claim that the Dodd-Frank Act of 2010 has constrained the supply of money to lend is UNTRUE. JP Morgan-Chase, e.g., sits on $1.4 trillion in deposits, of which only $900 billion has been lent to the real sector. The rest has gone to speculate in derivatives and lending overseas, and more recently to buy back stock in order to boost CEO pay.
The recent rollback of Dodd-Frank bank regulations has only created more dangers. On May 24, 2018, President Trump signed S. 2155, the “Economic Growth, Regulatory Relief, and Consumer Protection Act,” into law. Sixteen Democrats, including Mark Warner (D) and Tim Kaine (D) of Virginia, had co-sponsored the bill in the Senate. Among other things, this Act purports to help small and medium banks by raising the threshold for “applying enhanced prudential standards from $50 billion to $250 billion.” The idea is flawed, however, for several reasons:
- The new threshold exempts 25 of the 38 biggest banks in the nation from enhanced capital and liquidity rules. These 25 banks hold $3.5 trillion, or 1/6 of the assets of the entire banking system, and received $47 billion in taxpayer bailouts in 2008.
- Moreover, among the 25 banks are U.S. holding companies of some of the most bankrupt, scandal-ridden foreign banks, including Deutsche Bank, BNP Paribas, UBS, and Credit Suisse. Deutsche Bank received $12 billion, and UBS received $5 billion, in U.S. taxpayer bailout in 2008. All 25 banks of these banks should therefore continue to be monitored on an enhanced basis as per pre-S.2155 law.
- The Act also exempts banks with less than $10 billion in assets from compliance with the Volcker Rule, which prohibits proprietary trading with a bank’s own funds. Just like the S&Ls that collapsed in the 1980s, these smaller banks can now engage in risky, speculative gambling – on hedge funds, derivatives, bitcoins, and other speculative ventures – with FDIC insured deposits.
- The Act does not fix systemic risks to community banks posed by the risky speculation of too-big-to-fail (TBTF) banks. Rather, the Act makes systemic risk worse, by weakening stress tests for regional AND larger banks, and reducing capital requirements for banks with over $50 billion in assets. In recognition of these risks, the National Association of Federally Insured Credit Unions recently called for the enactment of a 21st Century Glass-Steagall Act.
- Finally, S. 2155 removes the requirement of holding escrow accounts for home buyers with higher priced mortgages that fall below the $10 billion asset level. In addition, the Act exempts appraisal requirements for homes, including in rural areas, which could lead borrowers to purchase overpriced homes, with the result that they owe more than the homes are actually worth. The Financial Crisis Inquiry Commission, created by Congress following the 2008 crash to investigate its causes, cited a lack of escrow accounts, and appraisal fraud, as two major causes of the mortgage bubble and its subsequent demise.
The assessment of the Congressional Budget Office is that this Act increases the chances of another round of bank bailouts.
Indeed, this round of bailouts has already begun. During the 10 years after the height of the crisis, the Federal Reserve increased its balance sheet by $4.5 trillion in order to bail out the major banks, in policies like Quantitative Easing. In 2017, this policy began to be reversed, slowly but surely reducing the amount of paper it was holding. Interest rates were incrementally raised in tandem. Now, Quantitative Easing—a fancy word for bank bailouts—is back in all but name, as the danger of a new major crisis becomes clearer each day.
There is no substitute for restoring the Glass-Steagall Act. That legislation would completely separate commercial banking, which is loan-making, from investment banking that entails speculation. Under a Glass-Steagall regulatory environment, ALL commercial banks – including small and medium-sized ones – would be protected from Wall Street speculation, and the need for enhanced supervision would then be moot.