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.