The financial sector of the United States is controlled by Congress and the White House, but surprising they have limited power to impose financial regulations on bankers and financiers, which helped to cause U.S. panics or recessions. 13 Bankers describes the increase of financial power and the effects on our economic stability. During the past three decades, a small number of banks became enormously large and profitable. Then these banks used their power to reform the political atmosphere to their advantages. In the late 1990s, the conventional belief in Washington, D.C. was that if Wall Street does well so do Americans. This thought process resulted in excessive risk-taking, creating an enormous "bubble" which leads to a disastrous financial crisis and recession.
The strategy to decrease the power of Wall Street is to divide up the big banks and having strict regulations on bank's size to prevent dominating the market. In the past, America has had this problem before in different forms such as, Thomas Jefferson's campaign against the First Bank of the United States to Teddy Roosevelt busting up trusts, and the 1930s banking regulations established by Franklin Delano Roosevelt. 13 Bankers details the current recession, how we got there, and what the future holds.
Another act of Congress blocked regulation of derivatives in the Commodity Futures Modernization Act of 2000. This blocking caused the derivatives market to grow to over $680 trillion in face value and over $20 trillion in market value by 2008. The 2008 financial crisis strengthened the most powerful banks such as, JPMorganChase, Bank of America, Wells Fargo, Goldman Sachs, and Citigroup. The current situation could possibly lead to another financial crisis, which will exchange wealth from taxpayers to the financial sector unless the powerful banks are broken up.
The Jefferson-Hamilton argument over the Bank of the United States was whether to have an agricultural based economy or an industrial nation. Hamilton's ideas on basic economics was right, but neither two predicted the intensity of the Industrial Revolution. Jefferson's main concern was that U.S. public policy was a political matter, not an economic one. The renewal of the Second Bank of the United States was vetoed by Andrew Jackson in 1832 because he was afraid political interests would overrun financial interests. Now that the U.S. no longer had a central bank, the United States economic development was susceptible to financial crises, such as the one in 1907; which then led to the Federal Reserve Act of 1913. American's economic speculation along with antiregulatory policies are the main causes of the Great Depression. But Franklin D. Roosevelt's New Deal legislation created a safe banking system that was successful.
Financial crises in foreign countries in the 1990s caused overconfidence in the U.S. In the late 1990s, economist Larry Summers was believed the U.S. was able to avoid any such crises. Crises are typically caused by political problems, along with corrupt use of wealth, conglomeration among oligarchs, with increased growth which causes a new crisis. The best solution to economic problems is to not have close relationships between economics and politics that corrupt the natural economic environment and allow money to be swindled.
The U.S. economy began to turn into a financial economy in the 1980s, compared to the safer banking practices, "from 1945 to 1973,real GDP (adjusted for inflation) grew at an average annual growth rate of 4.0 percent, and American corporations grew; prospered, and expanded throughout the world" (64). At the time the financial industry was permitted to work under lesser constraints. This was caused by high inflation, the beginning of college finance, and deregulatory trends. The Reagan administration increased securitized mortgages, arbitrage trading, and derivatives, and the Black-Scholes Model gave banks a new way to figure out the value of derivatives and hedges. Derivatives are established in one market and try to offset price changes in a different market while trying to minimize exposure to risk. The modern derivatives model began with interest rate swaps by Salomon Brothers in 1981. Now, risk became a product that could be bought and sold. After that credit default swaps became popular, beginning in the early 1990s by Bankers Trust and were used by J.P. Morgan in the late 1990s. The definition of a credit default swap is to have insurance on debt which reduces default risk and in turn can lower banks' capital requirements, thus allowing more funds for lending. "But because there is no requirement that the buyer of a credit default swap own the debt in question, these derivatives are also handy way to gamble on the chances of any company defaulting on its debts (similar to buying insurance on your neighbor's house); this quality made them a new type of security that could be minted in infinite quantities and traded, providing another source of profit for derivative dealers" (82). Commercial and investment banks merged together causing the financial industry to experience large growth during the 1990s.
During the 1980s there were signs that a savings and loan problem could happen, but during the 1990s deregulations were instated that had been successful since the 1930s. Lobbyist paid large contributions to financial companies to influence the regulatory committees to deregulate which would supposedly result in profitability. Bill Clinton passed deregulation law and the past Chairman of the Federal Reserve, Alan Greenspan agreed with ideology because of his beliefs. With the deregulations and profitability the financer's had a positive image as being innovative. Even though there were skeptics of deregulation, no one believed the system could fail. The financers' eventually knew financial innovation can not always be perfect. In the 1990s subprime mortgages, lending, banking, and finance led to an optimistic view in popular culture.
Wall Street had power over Washington, D.C. during the mid-1990s because of the development of asset-backed structured products created by J.P. Morgan. These asset-backed structures are called collateralized debt obligations (CDOs). In the 2000s, Wall Street sold assets and securities based on subprime mortgage loans. The large availability of these loans and easy access led to the housing bubble. To make the matter worse the financial powers used their strength to repeal the Glass-Steagall Act in1999 which increased deregulation again. Once capital requirements were reduced, banks were able to maximize their leverage. The efforts to regulate mortgage lending was successfully resisted by the Office of the Comptroller of the Currency ruling that federal regulations preempted state efforts to constrain subprime lending. Fannie Mae and Freddie Mac also contributed to the crisis by increasing the amount of money flowing into the securitization sector. The Federal Reserve decided to keep interest rates low even though there were indications of fraud. With so many moral hazards being abused financiers hoped the government would provide a fall back plan. In 1991, Goldman Sachs successfully won the removal of the requirement by the Federal Reserve Act that lending in unusual circumstances had to have collateral that came from actual commercial transactions. This deregulation furthered the severity of the financial crisis.
On Oct. 13, 2008, nine major banks were given bailout money that has no interest payments or a payback period. Many people thought this would be the end of Wall Street, but luckily it was not. All of the deregulations and so called innovations in the financial system caused the beginning of the recession. When Bear Stearns went bankrupt in March 2008, the crisis continued with the Lehman Brothers collapsing in September 2008. The financial system became even more susceptible to collapse from withdrawals on money market funds. On September 18, 2008, Paulson and Bernanke went to Congress to try to fix the financial problem but there was resistance to their proposal which resulted caused a stock market collapse. Money was committed to banks and AIG, and the FDIC was supposed to insure up to $1.5 trillion in new bank debt. Never in the United States history had such a large amount of taxpayer money been used to save banks from bankruptcy that they saw coming and did nothing about. The government had two options to try to remedy the problem; write a blank check to the banks, or take control of the banks. The government decided the best decision was to provide sufficient loans to help prevent a financial crisis. "Effectively, the government's strategy was to bail the banks out of their problems by helping them make large profits, juiced by reduced competition and cheap money, to plug the ever-widening hole created by their toxic assets" (172). The total cost of all the bail out money is almost impossible to add up because the different types of support that was given. These bailouts prevented a mass bankruptcy but did not create a stable financial market. The government chose to leave the banks under the same management, which made the government have no real way to regulate the banks in the future. The supporters of government takeover of banks believed it would have been the best option in terms of the economy, politics, and morality. After this failure the big banks grew even larger; Bank of America, JPMorgan Chase, and Wells Fargo. All these banks gave big bonuses, even though the economy was still declining and million of jobs were lost and governments were hurt from the decline in tax revenues, and the national debt increased.
The best solution is changing the rules, regulations, and laws of the financial system. Obama's proposed reforms lack support and strength and Wall Street will always fight against stricter regulations on financial sectors. The theory of regulation is that economic decisions are made by rational people.
Institutions too big to fail should not be allowed, but the better regulation approach is inefficient and needs further improvement; a break up of overly large organizations would help improve the economy. The goal should be to change the conventional thought about large banks as being safe and secure. This thought may not exist today, but this can change over time.
In conclusion, only one period of time over the past two centuries, (1930s- 1970's), was government regulation sufficient in regulating Wall Street and bankers. Ronald Reagan brought back the efficient-market hypothesis with his faith in laissez-faire. Reagan believed that no government oversight is necessary because markets correct themselves, so his administration allowed regulations to be decrease or canceled. The efficient-market hypothesis does not work because markets are not self-correcting. When bankers at the largest institutions go unchecked they cannot stop themselves from taking excessive speculation risks with others money until they inevitably crash the system. The Obama administration is seeking to regulation laws and has no easy solution to the problem. The responses of the Bush and Obama administrations to the crisis by bailing out the largest banks with free money, without fixing the real problem demonstrates the political power of Wall Street. The largest banks have become too powerful and are considered too big to fail, and with no consequences to change their behavior in the future will lead to more panics and crises. This patch only created the resources for another financial crisis, government bailout, and in increase in our national debt.
