Saturday, March 05, 2011

The financial mess

For at least three years the country has been struggling with our financial collapse and its aftermath. Congress has passed laws, two Administrations arranged bail-outs, many books have been written (several reviewed here), and I have done many posts about the situation. And thus I am rather astonished that suddenly, over the last 48 hours, I finally had a revelation--I think--about exactly how our new, post-Clinton financial system operates, why it has made untold millions for men and women who are contributing very little to the rest of society, and why the Obama Administration made no serious effort to reform it. I do not have time to research the issue thoroughly myself, and my favorite financial expert friends are not readily available (I will refer each of them to this post for comment.) But I honestly think that I have figured it out.

As most of us have learned, the 1933 Glass-Steagall Act separated depository banking and commercial banking on the one hand from investment banking on the other. Investment banking was a relatively small part of the banking system even in the 1960s--I paid close attention to my Economics 1 class in 1965-6, and I don't recall it ever even being mentioned. And crucially, the Federal Reserve had nothing to do with investment banking at all. It lent money to depository banks and commercial banks, which in turn lent it out to customers--customers in the business world who needed money to finance their operations, and consumers, who wanted, for example, to take out a mortgage on their house. Those were relatively low-profit investments which had to be watched carefully. Meanwhile, as far as I can tell, investment banks had to put together deals financed by other people's money.

As we all know, that kind of loan is now a relatively small part, it seems, of our banking industry, especially, of course, for Citibank, Goldman Sachs, and the other giants. Instead, they invest enormous amounts of money in securities of all kinds--many of which, of course, turned out during the crash to be worthless--as well as in commodities, hedge funds, and heaven knows what else. And--and this is the critical point--since the repeal of Glass-Steagall, they can, as I understand it, now borrow money from the Federal Reserve, whose rates have been at historically low levels for most the last decade--coincidentally (?) the period following the repeal of Glass-Steagall. And that is how the banking world has become almost entirely disconnected from the rest of the economy. It's essentially a game of monopoly in which loans at 1% interest take the place the $200 you collect for passing Go. In such a system, it's easy to bid up the price of both stocks and commodities like oil, even in hard economic times like these--and that is what has happened since 2009. And a rise of just 5% in the price of such assets obviously translates into huge profits and bonuses.

One can read in the business pages, and confirm from any small businessman one happens to know, that today's banks are refusing to lend money to commercial customers. Why should they when safer, more profitable alternatives are available? The wisdom of Glass-Steagall has become painfully obvious: commercial and consumer lending is hard work, requiring a lot of careful analysis and not guaranteeing any huge profits--but it absolutely essential to a functioning economy. Glass-Steagall forced thousands of institutions to undertake it, because they were forbidden from doing anything else. In the Depression both Hoover and Roosevelt actually created some new financial institutions such as the Reconstruction Finance Corporation to make loans that banks would not make. That was what we needed in 2009, but no one apparently suggested to President Obama that he go that route.

I do not have the expertise to parse out the real implications of our new system. We now know that it can lead to catastrophic financial failure, but we don't know if it can lead to anything else. Suddenly, however, it seems to me that the focus on bailouts was misplaced. The Fed should not be blamed mainly for saving the system, which had to be done (albeit not necessarily on such generous terms for the banks.) It should be blamed for its new function of financing a continuous speculative orgy that serves no useful social purpose.

On a completely different front, it has occurred to me recently that we are now seeing the effects of the shrinking of print media over the last half-century. I remember in the 1970s when newspapers, apparently for economic reasons, went from 8 columns to six, which meant 25% fewer stories on the front page. Meanwhile, of course, budgets have been cut, newspapers have been dying, and Sunday sections have shrunk. I feel I have seen the impact of this lately, especially since the outbreak of revolts all over the Middle East, which are soaking up so much news space that the crises in Washington, in Wisconsin and in other states are getting much too litte coverage even in papers like the New York Times. We are faced with a really critical budget deal, but it is hard to find much of anything written about the talks that are going on. We will find in years to come whether either the public or our leadership is still sufficiently well informed to handle the problems we face.


Gerald Meaders said...

Excellent remarks.

Many thanks. I am finally finishing up Lewis' The Big Short, and it contains some illuminating insights on how the Wall Street finance industry was changed, and greatly enlarged, by creation and proliferation of debt obligations, especially the mortgage backed debt obligations which were then packaged further for gambling purposes.

This coincidentally was a topic Lewis had actually touched on in his early book, Liar's Poker; great stuff, and also a must read.

all the best,

Cliff said...

"It should be blamed for its new function of financing a continuous speculative orgy that serves no useful social purpose."

Investment used to mean placing hard earned money into hands of entreprenuers so they could build products or provide needed services. Get loans to expand business and provide opportunities to more Americans. God, do I feel like such a fool for believing that this is the way to make money in this society. (half -snark)

I feel beaten down by this economy. I tried really hard to adapt to the economic realities, but now I understand, it is impossible for those with moderate means to ever work our way out of this.

There's no money for innovation, all investments are in the churning of the markets with other peoples' money and raking off the top in the form of fees and interest. The fix is in, it always has been.

You have illuminated what I have known all along, but couldn't see the reason. Investment in our new global economy is no longer about innovation and creation of products for the marketplace. It is all about churning bubbles into the market with other peoples' money and skimming the profit right off the top. Its a closed loop system for those with the connections.

Combine this system of economic strip mining of our wealth, with multi-national corporations which, not who, (they are not freakin' people) take our jobs and merge third world living standards with first world technology are destroying what our parents and grandparents built over generations.

Russell Means was right when he said that we are all indians now.

Gerald Meaders said...


Attached seems to be a discussion I received, in an email today, of the issue you have raised here, re borrowing from the Fed by investment banks.

All the best,

PJ Cats said...

Dear Mr. Kaiser,

Thank you for your post. I really appreciate the way you allow intuition, experience and feeling into your stream of thoughts, and the way you share these with us. So many scholars limit themselves to executing their trick (especially economists - and that's not even science), thus eschewing the full portent of their humanity, so to speak.
On topic: I saw some great graphics at the motherjones website (, which show all the more the way the system is rigged. By now, the whole thing is quite extensively charted. It seems to me that the very many are completely 'enslaved' (that is not the 'mot juste' here, but it's as close as I can think of) by the very few. One can sum it up in just two words: 'class' (in the marxist sense, surely) and 'privilege'. As commenter Cliff put it: 'it's a closed loop system for those with the connections'. I'd just replace the words 'those with the connections' with 'those who are in'. As Cliff sees very rightly, chances are small he'll ever be 'in'. Neither will I, or you, for that matter.
All said, it rather reminds one of the situation in France, just prior to the French Revolution, doesn't it? You may have said that somewhere, it hangs vaguely in my mind... somehow it all seems to add up to a rather explosive situation; comparing the USA to the Weimar Republic, the economic circumstances to the eve of the French Revolution and the balance of power in the world to, let's say, about 1914. Not to speak of jingoism, religious fanaticism (including populist demagogues and economic ideologues) and general confusion due to information overload and social incoherence.
Some interesting times we're living in...

Anonymous said...

Apparently, there is Tea Party in France too.

Marine Le Pen poll rating shock for French politics
Marine Le Pen became National Front leader in January

An opinion poll suggesting far-right leader Marine
Le Pen could win the first round of next year's
presidential election has caused a shock in France.

tructor man said...

"The Fourth Turning" is disturbing, maybe because we're alreasy in it? Did it start with 9/11, or with the housing crash & financial meltdown of 2008-09? (Are we there yet?).
Will it be a new Renaissance or Ameggedon?
Tructor man

Cliff said...

"All said, it rather reminds one of the situation in France, just prior to the French Revolution, doesn't it? You may have said that somewhere, it hangs vaguely in my mind..."

Me too. I read somewhere that the young Tunisian gentleman who immolated himself as an act of protest was indeed a college educated (computer science) person who was refused a permit to open a vegetable stand.

I am a college (MS) educated white male approaching 50 years old and I haven't been able to find a decent job since I was layed off over 5 years ago after working for the same company for over 14 years. I tried the self employment thing and it worked for about 3 years, then I started to do night janitor work to make ends meet.

Now my hours have been cut to one or two hours a week and my meager savings are getting used up quickly. I don't see anything positive for me on the horizon, nothing to really live for other than survival and a hope to not be a burden on my family in the future.

I thought I could work my way out of any situation, take any job, do what I need to do to survive. But I don't know now, the jobs just aren't out there, unless you possess some kind of special skill set or know someone.

Without prosperity, there is no liberty. Something's gotta give eventually.

elinor said...

Excellent documentary recently released titled INSIDE JOB about this same subject...I highly recommend it.