Bailout or Bust: Sould Companies too Big to Fail be Broken up?
Before I start I will confess that economics is not a field that has offered me much interest, but with our current economic environment where we have financial firms that are “Too Big to Fail” I have to take another look and ask myself is a Bank or other financial firm that is too big to let fail, too big to let exist?
Back when I was in High School it seemed that it was explained to me that we had laws that prevented these types of super firms from forming. I remember that back during the Great Depression that government did things like “Trust Busting” and braking up monopolies.
One law that was put in place during the Great Depression was known as the Banking Act of 1933 though commonly called the Second Glass-Steagall Act or just Glass-Steagall Act. This act provided a separation of bank types according to there business, and it prevented a commercial bank from merging with an investment bank, or with an insurance firm.
This law sould have prevented the formation of firms like AIG or City Group among others, but in 1999 congress passed the Gramm-Leach-Bliley (Named for the Bill’s key supporters in congress) Act which removed the separation of banking types, and allowed these super firms to develop.
The question before us now is what do we do with these super firms that have so pervaded our nation’s financial system that it would be devastating to us should we let them fail? Should they continue as the super firms that they are or sould we go back to the days of banking regulation, and trust busting and break them down into less dangerous entities?
What do you think?
Monopoly Money
Disclaimer: IANAB/EM (I Am Not A Banking/Econ Major)
The trouble is that ironically, the companies aren't really breaking any laws. There aren't trusts or monopolies, since there are dozens of players competing in the market (Citi, Wells Fargo, BoA, etc.) they're just really, really big.
It's their size that is causing the issue. Although there are side-effects from the banks' merging of investment and traditional banking, the real issue is bad investments, by the banks themselves and their consumer investment bank counterparts.
When you go to your local Wells Fargo branch, they'll give you .5% (or whatever) on your savings account. Based on the premise that you won't be pulling all of that money out, they use that money to loan to other customers for mortgages, etc for a higher interest rate then they're paying you. Nothing new to you I'm sure.
The thing is that until recently, mortgages were considered a pretty sound investment for a bank. They had a relatively low rate of default (compared to car or personal loans for example) and were guaranteed by the value of the property itself.
This created a secondary market in which other banks, especially investment banks, would effectively 'buy' the loan. Wells Fargo is happy to take a smaller cut of the interest now rather than wait for the interest payments to come in over time- and now the money is available for Wells Fargo to issue more mortgages. These investments were considered so safe that even the most conservative of mutual funds held a significant portion of their investments in "mortgage-backed securities."
But the banks made some bad decisions as to whom they should lend that money. A lot of bad decisions. The banks were passing out money to anyone who would take it, especially to the 'sub-prime' market, who would have normally be considered a bad risk. Banks would even (illegally) inflate the appraisal values of the home to help ensure the borrower would do business with the bank, they would even offer low rate Adjustable Rate Mortgages with absurdly low payments, assuring their customers that they would be able to refinance before the rate adjusted to the higher interest rate a few years later.
Then the bottom fell out. Those loans started adjusting, and people started defaulting. The houses weren't worth the amount of the loan, and banks had to eat the difference. And it was a big difference. Suddenly those mortgage-backed securities..weren't. Investors started loosing money in a big way. Not just here in the States, but elsewhere too. Americans weren't the only ones who invested in these securities, and the entire global economy soon took one giant crap in the punchbowl.
Hundreds of banks with millions of investors, all working on a global scale. It's the sheer size of these networks that caused the impact they did, and I can think of no amount of legislation that can change that.
But of course, it's just Sunday night, and I'm bored.
Any Econ or Banking majors should feel free to chip in.
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