Those of you who have followed our newsletter for some years know that we predicted the derivative-based banking crisis well before it happened. We saw it developing and repeatedly predicted a looming disaster. When the crash occurred, we explained the most egregious causes, one of which was the un-bank like speculative behavior of banking institutions. Leading up to the crash, they were acting more like wild speculators than sober lenders and traders of government bonds.
Banks are supposed to be conservative institutions that do prudent analysis of credit risk, make loans accordingly, and buy government bonds. In the initial years of the 21st century, the banks were far from prudent and conservative. They were gamblers, and when they lost, the taxpayer had to bail them out.
The door to such risky and adventuresome behavior was opened when Congress and President Clinton effectively repealed the Glass-Steagall Act of 1933, a law targeting the gambling behavior of banks that contributed to the Great Depression. By separating commercial banking from speculative activity and investment banking, Glass-Steagall served as an effective anti-depression tonic for decades. That changed after 1999, with the enactment of the Gramm-Leach-Bliley Act, that allowed a merger of investment banks (that engage in trading and issue securities) and commercial banks (that take deposits and make loans). Freed from restraint, elated bankers proceeded to lever up and gamble with depositor and shareholder money, and eventually with taxpayer money.
Initially, there were a few years of exceptional profits. But the bankers became blinded by greed, employed too much leverage, did too little research on their speculations, and, by 2007, were precariously teetering in the direction of collapse. A total wipe-out was narrowly averted at the last minute by emergency transfusions of massive taxpayer money in the form of loans and investments into many poorly-managed banks.
In short, in the few years after Glass-Steagall was torpedoed in favor of the Gramm-Leach-Bliley Act, the bank bubble built up and then blew up. The severe aftershocks are still being felt.
Unfortunately, the self-interest continue unabated. The banking sector is currently hard at work trying to stop implementation of the Volcker rule, a key provision in a needed financial overhaul legislation targeting the over-speculation madness. Named after the former Federal Reserve chairman, the provision seeks to bring back prudent risk-taking and less taxpayer liability to banking. A recent article in the Wall Street Journal explains the latest banking shenanigans. To read the article, click the following link: Volcker Rule Delay Is Likely
There are politicians financially supported by the banking industry. Their allegiance to their backers may trump national interest and result in the Volcker rule being delayed or ignored. If such tactics prevail, you can expect crisis after crisis ahead within the banking system, along with taxpayer bailouts, until such a rule is fully and finally implemented.
