On the campaign trails of 2008, something remarkable happened. Only months from election day, the financial markets that we knew, collapsed under its own weight. The collapse was similar to seeing a dam start to leak. The dam seems unbreakable but that tiny leak slowly grows larger and the surrounding wall begins to weaken. This continues until the entire structural integrity of the dam is compromised and collapse is eminent. To the untrained eye, the collapse seems like a sudden event. However, we know that the damage took place over time and was a gradual process. The initial collapse of financial institutions during the summer of 2008, was not the tiny leak on the dam. The initial collapse was when the wall surrounding the leak began to give way. It served to expedite the collapse.
The leak began almost a decade prior to the collapse. The leak began when our government failed to look at the long term possibilities of removing the Glass-Steagall provision from financial institutions. Suddenly the safeguards that had been in place since the Great Depression, were now gone. The line between being a commercial bank, an insurance company and an investment bank was erased. Companies could now become a hybrid of the three financial institutions. Under Glass-Steagall, consumers would go to a commercial bank to deposit into checking and saving accounts. If they wished to invest their money, they would go to an investment firm. And finally if the consumer wanted to purchase life insurance they would go to an insurance firm. Gramm-Leach-Bliley Act (GLBA) basically replaced Glass-Steagall and allowed the three fields to be merged into large institutions. In the mid-90’s, Citicorp, a commercial bank, merged with Travelers Group, an insurance firm, and created a new organization that housed commercial, securities and insurance institutions. The new conglomerate, Citigroup, served as an umbrella company of the different financial institutions.
Traditionally, a commercial bank will take your deposits and use a portion to issue out loans. The loan repayments is where the profit is made. The fee’s associated with commercial banks also serve as an avenue for profits. The GLBA allowed the commercial banks to use the money to invest in the stock markets. The GLBA also allowed lending institutions to reward lending officers for issuing loans with high interest rates or for loans that were in penalty. Whether in finance or in any other aspect of life, if you remove restrictions, it won’t be long until a few people come in and try to take advantage of the system. That is what eventually happened to the financial markets.
The collapse occurred when the stock markets began to trend down. All these financial institutions had large sums of money in the market and when that fell, their margins fell. People who had taken out bad loans or had fallen to predatory lending, were now unable to pay the loans because jobs were beginning to shrink. Less and less money was being fed into the banks while the banks were trying to find money to back the deposits of its customers. If a bank has $400,000 worth of customer deposits, the bank needs to at least have that amount in reserve in the event customers wish to access their funds. However, with the markets falling, the banks were losing money on their investments and were unable to make enough to offset the losses in loan repayments. The banks had grown too large and was unable to slow the hemorrhaging of money.
That is where the taxpayers come in. Wall Street, and all the banks associated with it, came to Congress and asked for help. Initially our elected officials stood up for us and declined. However, the financial lobbyists won out and convinced Congress on the need for a bail out. The banks argued that money was needed to back deposits and that if money was given, they would then be able to begin lending. The money was instead taken and used to cover losses and to this day the lending market lags. Along the way, various legislators have attempted to impose new regulations on the financial markets and to recoup the money paid to the banks. However, each attempt has met with intense opposition by the financial lobbyists.
However, now it seems that financial regulations are poised to come. We are at a time when elections are looming in November. It become difficult for a politician to return home and tell constituents that they have done nothing to hold the banks accountable. This pressure will hopefully lead to strict restrictions on bank operations. There are many suggestions as to how to proceed with reform. One great idea has been to create an independent agency that will monitor the actions of the Federal Reserve and will investigate lending practices to see if they are predatory lending practices still being used. This agency would be a watch dog for consumers.
The importance of reform can’t be stressed enough. We should not turn our backs and hope that people do the right thing. We need to take a stand and tell Wall Street that we will be watching them and that they will never again be able to make mistakes without consequence. Pressure your elected official and implore that they support strong financial reform. The future generations need a country that is not continually bailing out the banks.