The investment side of your Bank is sitting on a ton of bad loans to various Latin American nations. The loans used to look good: The rates were, of course, sky high. But with the world in recession, many of these same Latin American nations are just this side of defaulting. If they do default, it could be very bad for the Bank. Sure, the investment side of the Bank would suffer the most, but the defaults would also impact the profit-and-loss sheet of the Bank as a whole. Not good.
The solution? Whip up your stockbrokers —they work on the other side of the Bank—and get them to go sell these “dogs” to the hoi polloi. Gussy the bonds up good, put a fancy name on the package, and, hopefully, the public will love ‘em. You’ll not only get the bad debt off your balance sheets, you’ll get a broker’s fee from the suckers who saved your skin in the first place. Gooooood.
Or consider this:
The Big Bank—the commercial side of your Bank—financed the investment side’s pool operation in copper stocks. Your stockbrokers then went out and sold the public a million and a half shares of copper at $120 a share. It’s now selling for $5 and change.
Annnnh, you say. Stuff happens!
Indeed it did and pretty much exactly as I outlined—but in 1929, not 2009.
For most of the next 70 years, there was no chance of a repetition of these kinds of shenanigans. And why not? Two words: Glass-Steagall.
The Glass-Steagall Act of 1933 forced banks to choose between being investment banks or being commercial banks. No longer could they be both. No longer could this hand slip the money under the table and into that hand. Nor could the commercial bankers blithely send their customers scampering over to the next-door office to do their stockbrokerage business—after having provided them with margin loans. No, thanks to Glass-Steagall, the Big Bank holding companies of the Twenties were no more.
But then along came Phil Gramm, egged on by the Wall Street Journal crowd—abetted, too, by the Clinton Treasury Department (Read: Bob Rubin and Larry Summers, assisted by a young Tim Geithner)—and they changed everything. And not for the better. With the stroke of a pen on November 12, 1999, President William Jefferson Clinton signed into law the Gramm-Leach-Bliley Act, which, in effect, repealed Glass-Steagall.
Americans didn’t realize it at the time, but the world of 1920s finance—ginned-up deals, suckers ripe for the plucking, and nobody to regulate much of anything—had returned with a vengeance. The only real difference, needless to say, was the computer, which simply made the thing go faster. A regular Merry-Go-Round of Mad Money.
And no Glass-Steagall to stop it. (more…)