There is no calamity greater than lavish desires.
There is no greater guilt than discontentment.
And there is no greater disaster than greed.
Lao-tzu (604 BC - 531 BC)
The current economic meltdown is due to our inability to differentiate between our needs and greed and the various interest groups getting acts passed in congress.
The Glass-Steagall Act (GSA) was enacted in 1933 after the collapse of the stock markets in 1929 leading to the Great Depression. This was done to ensure that a clear distinction was made between commercial banking and Investment banking. Regulatory barriers were created and banks were given a limited period of time to choose their lines of business to prevent all sorts of conflict of interest. This also ensured that Banks would be limited in their ability use depositor’s money for underwriting issues.
One of the main reasons the GSA was passed was that it was felt that commercial banks had become too-speculative. In the period leading to 1929 the banks had become very greedy. They issued doubtful or unsound loans to companies in which the banks had invested and then encouraged clients to invest in that stock. (Does this ring a bell in the form of sub-prime mortgages?)
The GSA was further strengthened by the Federal Reserve Board in 1956. A new act stated that underwriting insurance was not a good banking practice and needed to be delinked from banking operations.
The GSA was a strong barrier to fiscal irresponsibility and excessive speculation. Somehow this important legislation was overturned by the Gramm-Leach-Bliley Act (GLBA). The full name was the Gramm-Leach-Bliley Financial Services Modernization Act, Pub. L. No. 106-102, 113 Stat. 1338 (November 12, 1999). This is an act of the United States Congress which repealed the Glass-Steagall Act.
The ostensible reason was to open competition among banks insurance companies and financial services companies. The distinction between commercial banks and brokerage firms has since thinned.
If in a country we have the executive wing acting as the judiciary and dispensing justice, we call it having “Kangaroo Courts”. The reason these are separate functions is to ensure proper checks and balances. The passing of the Gramm-Leach-Bliley Act blurred the distinction between commercial banks and Investment banks in a manner similar to the executive and judiciary in Kangaroo courts.
I would like to give a short story taken from the Panchtantra, a series of stories in the manner of Aesops Fables taught in India to drive home some wisdom. This particular story explains how excessive desire can be ruinous.
The Brahmin and the Pot of Flour
Long long ago there was a Brahmin, Rama Raju known for his miserliness. Every day he would save the flour earned from his begging in an earthen bowl. This he tied above his bed.
One day he returned home very tired and went to sleep and began dreaming. He dreamt that there was a famine in the country and that he had fetched a huge some of money from the sale of his flour. He used it to buy goats whose milk he sold at huge margins eventually having a large herd. From this he bought cows etc to become a very rich man. He then dreamt that he got a beautiful bride with whom he had kids. These kids who were very naughty would not listen to him. One day he to discipline them he picks up a cane and starts waving in the air.
In his now disturbed sleep the Brahmin actually picks up a cane and waves it and by chance hits the pot of flour which crashes onto the ground. The Brahmin wakes up to see his dreams shattered.
“Moral of the story, Castles built in air will come crashing down”.
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11 comments:
Its perhaps a bit early to apportion true blame, but I think the root cause is the infamous Greenspan put. The Fed kept rates too low too long in 2003/4 causing an asset bubble, principally in US housing. The banks were the cheerleaders, fanning the flames (pick your cliche) and probably pushed the bubble both higher & quicker than would have happened otherwise so the eventual bursting now is incredibly painful, rather than just a run-of-the-mill recession. As Susan said, perfect storm.
Brian Moretta
I like what Larry said about increasing competition. I think only a tiny part of Glass Steagall was removed by GLBA though. I am not an advocate for removing the rest of it.
I think you have to go back to the root causes which in my view were two fold. One was irresponsible behavior with mortgages and two was the creation of essentially unregulated derivitives. Those two are obviously linked together as we are now finding out.
Historically, mortgages were almost always retained in the state that originated them. However, courtesey of securitization, they have gone global. we have had similar problems 20-years ago withe the savings and loans but the States did not step up to the plate in the aftermath. We lost over 700 savings and loans way before GLBA.
They first derivatives were created in the early 1980's, again way before GLBA. So I don't see either GSA of GLBA as making much of a difference or being a root cause of any of the present nonsense.
The States missed the boat on mortgage broker regulation and they still don't seem to get it. And the SEC failed to recognize that the unregulated derivatives were a security worth regulating, dispite the banks comparing them to only accommodating loan committment agreements.
Something to think about; In the past six years, Stephanie Pomboy of Macromavens estimates 500% more credit has been created outside of the banking system than within it. This means that those financial products are essentially unregulated. How is this different from a country turning on its currency printing presses? One aspect deals with the “velocity of money”. When a country turns on its printing presses the currency is used immediately so the effects are felt relatively soon. However this newly created credit is essentially sequestered by the credit markets seizing up, so any effects will be delayed.
Louis Fors Hill Chairman of Rockwood Capital Management, Inc.
The current meltdown comes from a lack of financial oversight by Washington and the failure of the legislature (both parties, I am non-partisan) and the White House to control spending. The moves over the past few days have effectively doubled the national debt.
What ends up happening to you when you spend twice as much as you actually have? People quit lending to you. You are seeing the results of that happen to our country, just like it would happen to an individual.
You raise an interesting point about the legistation and that certainly deserves some thought. The issues of deregulation and banking consolidation started long before that. The theme of the Reagan Adminstration and then followed by the Republican Revolution was one let free markets reign, get rid of "costly" regulation. GLBA was just the culmination of a process that started 20 years year earlier.
That said, there are laws and regulations and oversight responsibilities of the governement that exist. A strong power of the Executive Branch is to choose which laws and regulations get enforced. The Bush Administration has been one of allowing free markets to do what they want, allow winners and loser, keep the regulations to a minium and spur economic growth.
Unfortunely part of what's happned is that in an effort to spur economic growth (tax cuts, reducing regulations, reducing interest rates, pumping money into the banking system and fiscal stimulus through deficit spending) led to unsustainable growth levels. Couple this with lack oversight allowing for imprudent investment decisions and you have a recipe for disaster.
What's tricky about this is that any one component by itself seems reasonable, however when you start looking at all of the part and the implications it is not suprising that what is happening now is happening.
One last point on the consolidation: By allowing a large number of financial service sector companies to merge or purchase each other, they created the systemic risk that we see and the created the problem of "too big to fail". It's ironic that the GLBA was meant to foster competition, when really it encouraged consolidation and reduced competition. If you're cynical you might just believe GLBA was a power play by large financial companies to get bigger, eliminate competition and collect higher fees.
Hope this helps.
Larry Boyer
Principal Economist at Freddie Mac
I want to add that "transparency" is not the answer here either, or at least the way it's commonly used as "disclosure". Investors in CDO's, Credit Default Swaps, etc had all of the information. It's just too much and too complicated. There's been a tremendous amount of financial instrument innovation and very little of it is based on hard, economic realities. Did you know you can actually buy another company's profits through a finacial instrument and put them on your books? How is that reasonable and how does that help you understand the true value of the company, if you're told about it?
Larry
I'm regaular reader of this blog, Sunil's article is really helpful in understanding the recent collapse of financial giants.
Yes,the meltdown is the result of all you mentioned and more--lack of fiscal discipline among corporates and their excessively sybaritic ways.
While allowing room for some plush perks and luxuries,they can also do their bit for the unfortunate millions of the world by helping the efforts of governments,non-governments,several aid agencies,individuals' actions and UN and its organs' work for an 'incusive growth'.
Yes,the meltdown is the result of all you mentioned and more--lack of fiscal discipline among corporates and their excessively sybaritic ways.
While allowing room for some plush perks and luxuries,they can also do their bit for the unfortunate millions of the world by helping the efforts of governments,non-governments,several aid agencies,individuals' actions and UN and its organs' work for an 'incusive growth'.
The answer lies in the question. The present financial crisis is a combination of misinetepreted legislation; and excessive greed (when actually all should have been fearful).
You would appreciate that money is a zero sum game; and if a cerain set of persons do not have it then another set of persons would have it. After all the bail out being asked for (a present total of $700 billion) is also money. And in this case if the finacial markets do not seem to have the money, then it is the government that seems to have it.
However, everyone knows that the two (the government and financial markets) have to exist alongside one another. If you look back a bit into the past, it is also normal when the goevrnments seek bail outs from the financial markets. So, in hindsight the present set of circumstances facing the financial markets were avoidable.
Akash Thadani
I also strongly disagree with the Senators who have come to the floor and declared that this crisis is a failure of the free markets. No, the root of this crisis is a failure of government. It comes from a failure of regulation and, most importantly, monetary policy. In the long term we certainly need to update our financial regulation to reflect the realities of our modern economy, but it is just plain wrong to blame failures of our regulations and regulators on the market I want to mention a few more failures of government that directly contributed to this mess. Federal regulations require the use of ratings from rating agencies that have proven to be wrong on the biggest financial failures of the last decade. The Community Reinvestment Act forces banks to make loans they would not otherwise make based on the credit history of the borrower. The Securities and Exchange Commission under former Chairman Donaldson failed to establish meaningful oversight and leverage restrictions for investment banks.Fannie Mae and Freddie Mac used the implied backing of the government to grow so large that their takeover by the government effectively doubled the national debt. And they were pushed by their executives and the Clinton Administration to loosen their lending standards and write the loans that drove the companies to the point of being bailed out by the taxpayers.Finally, the same individuals who have come to this building to ask for the latest bailout set the stage for the very panic they are using to justify the bailout.The financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.
So ... I've been buying American stocks. This is my personal account I'm talking about, in which I previously owned nothing but U.S. government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in U.S. equities.
Why?A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation's many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.Let me be clear on one point: I can't predict the short-term movements of the stock market. I haven't the faintest idea as to whether stocks will be higher or lower a month - or a year - from now.
Let me be clear what bought America down is pure greed of the Wall Street. Like Guju's in India
Ramesh Manghirmalani
The problems with our current 'crisis' actual go back to the U.S. Laws which were written in 1933, 1934 & 1940 (in another era) - Congress has simply failed to act to update these laws:
- $62 trillion credit-default swaps - 'largely unregulated', the NY Fed has taken the lead in organizing this market defining them in recent weeks as an insurance product and trying to clear them (through 'tear-ups' the last few months down to $54 trillion). The Bank for International Settlements cites the total outstanding notional amount of OTC derivatives at $596 trillion (12/ 2007) - $400 trillion are interest rate derivatives.
- $12 trillion of U.S. mortgages - 'failing non-prime', this July the Federal Reserve's issued new regulations for mortgage lenders: banning repayment penalties, prohibiting lenders from issuing loans to borrowers that cannot repay while requiring the verification of their incomes and assets, and requiring escrow accounts for property taxes and homeowner's insurance, as well as: actual appraisal of a home's value and good faith lending practices.
- Housing bill signed into law: creating the FHFA (Federal Housing Finance Agency, GSE's regulator) for Fannie Mae and Freddie Mac (increasing limits to $625,500 from $417,000), modernizes/authorizes the FHA to insure up to $300 billion in refinanced mortgages, creates an affordable housing trust fund and $15 billion of home buyer's tax credits (States can offer an additional $11 billion to refinance subprime loans while increasing down payments to 3.5% from 3%) and grants $3.9 billion to buy and rehabilitate foreclosed homes.
- FHFA (Federal Housing Finance Agency) places Fannie Mae (with Herb Allison of TIAA-CREF) and Freddie Mac (with David Moffett of U.S. Bancorp) into conservatorship - dividends on both the common and preferred shares will be eliminated. Interest and principal payments will continue to their companies' securitized bonds and subordinated debt. The Treasury will 'backstop' both agencies with up to $100 billion (each) of a special class of stock - the Treasury through senior preferred stock and warrants will own 79.9% of each agency. Their portfolios "shall not exceed $850 billion as of 12/31/09, and shall decline by 10% per year until they reach $250 billion" - Fannie's is $758 billion and Freddie's is $798 billion.
- $3.35 trillion of money market funds - 'uninsured', Paulson's Treasury using its authority protects US money market mutual funds in the past days with insurance (using a $50 billion fund) - as some of the $3.35 trillion of funds 'broke the buck'.
$2-3 trillion Hedge funds / naked-shorting - 'largely unregulated', now reporting of short-selling. Short selling by Hedge funds of $100 million must now report positions to the SEC. SEC issues rules for short sales requiring delivery of securities by the settlement date, effective Sep 18. SEC rescinds the 'tick test rule', repealed on July 6, 2007.
Emergency Economic Stabilization Act of 2008 (EESA) a $700 billion rescue of financial institutions by purchasing devalued mortgage-linked assets (Paulson's Treasury Dept. will administer the Troubled Asset Relief Program, or TARP) - protection and tax beaks for taxpayers (equity positions in the financial institutions participating), limits on executive's compensation, independent oversight and transparency, help to prevent home foreclosures (modifying troubled loans), raises FDIC to $250k from $100k and an insurance option into which banks would pay. Federal Reserve receives authority to pay interest on reserves and the SEC receives the power to change mark-to-market accounting rules.
The US Congress doesn't act until after the disaster - public concern/outrage will bring about new laws. Failing to write laws to cover the above mentioned areas caused the problems.
JC Brandon
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