In 1803, Lazare Carnot began the the study of entropy in thermodynamics, suggesting that natural processes become disorganized over time, leading to waste and inefficiency. So too, in economics does this now taken-for-granted law seem to be in clear effect: recession's end has thus far led to little change in the regulatory structure of the Fed and other responsible bodies. The notable exception is the bill now before the House which aims to severely curtail the role of the Fed. Opinions on the extent and type of reform necessary are vehement and divisive. Suffice it to say that the US regulatory framework is in need of major overhaul. But what will regulation of financial markets look like, and how effective can it be?
Past precedent points us to the lessons learned after the Depression, when most of the modern financial oversight was established. The Glass-Steagall Act of 1933 prohibited mergers between commercial banks, investment banks and insurance companies, thereby limiting the liability of any single entity to impose systemic risk to the financial system (although it was not passed solely to combat this problem). The Gram-Leach-Bliley Act passed in 1999 repealed this law, enabling mergers like that between Citibank and Traveler's Group to occur legally (though they merged beforehand and were given a temporary waiver until the law was passed) opening up the floodgates for institutions to become large enough that they could pose serious problems were a major crisis to occur. A moral hazard that (in the context of the worst financial crisis in US history) had previously been seen as an obvious problem had started to fall on deaf ears fifty years later.
Another piece of Depression-era legislation which saw its demise in the later part of the century was the Commodity Futures Exchange Act, which limited the number of speculators in commodities so as to avoid artificially induced price changes. Fourteen major financials were able to obtain exemptions and thus distort a market intended for farmers to hedge against sudden drops in demand for their goods, leading to the massive spike in oil prices seen last year. This dramatic increase, coupled with the real estate crisis, made for a deadly combination for the larger economy. There has been no subsequent reining-in of the commodities speculation market, and after the crash earlier this year a slow run-up in oil prices has ensued.
Both of these examples show a clear trend in US economic policy: anti-regulation fervor has culminated in the removal of important financial laws. As loopholes have widened, systemic risk increased to unsustainable levels and caused recession. Some of the measures taken to mitigate the crisis have already been made illegal, such as federal bailouts passed by the legislature (such matters are now the province of the FDIC), but most other reform projects still have loose timetables and fact-finding committees, not bills or recommendations. A consumer protection user is still hard-pressed for traction in Congress, where lobbyists and former financial workers abound. Public opinion will likely be the determining factor in who is regulated and for how long. But these examples from the past show a few areas where it might not hurt to take a long, hard look.
After attend the University of Texas Ki decided to live in Texas and work in the Austin real estate market. He built a website with a search for homes in the Austin MLS. There, anyone can look for Austin real estate online. His site also has information on mortgage rate trends.
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Financial Regulation: What Went Wrong?
27 comments • Ki Gray - Austin Real Estate • December 06 2009 02:30AMComments
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What went wrong indeed?
Want answers?? Follow the money.
Comodity trading has always been a volatile market and a risky proposition. Good makes you think post.
Thanks Ki. A great short story on what led us to some of this mess. And may continue to do so.
Great stuff, but just part of the story. We truly let Wall Street run wild in so many directions that we no longer know who has the money.
Great post. Having survived the S&L crisis in the 80's and repeated mergers of mortgage banking companies(affiliated with major banks and securities firms) in the 80's, 90's and millennium, I have felt for a long time that the impact of mergers on the economy was not being scrutinized and controlled to a level that was necessary. And if you look back historically during those periods, oil prices have preceded major downturns in the real estate market in all cases - this issue can not be separated from the problem. If one were to oversimplify the problem, and to a degree I feel I have a right to make this comment after juggling ever pending restructuring for my entire career, blatant arrogance is the true root of the problem IMO.
Well written.
That's a good example of dumb criminals vs smart criminals. The dumb ones ignore the laws. The smart ones get them changed to make their stealing legal.
Then we have the corrupt politician that take the bribes to destroy our economy. No political party has a corner on the corruption or is more to blame. They are all apart of it.
I personally don't see the need for political parties to tell us what to think or who to vote for. We should be a Nation of Free thinkers.
the reason for the anti-regulation is simple comporations in the pockets of the politicians does not take much figure it out
Hi Ki -- I heard a very interesting hour-long segment on this topic of the various bills from the depression forward and how each both positively and negatively impacted the economy over the decades up to the present. While there was a difference of opinion, the consensus (as I heard it) is markets are prone to excesses if left unchecked and left to their own devices.
Ki,
Unless the laws change, this could happen again. Nobody needs bankers to be gamblers.
While Candian Banks are taking credit for their wisdom going into the recession, all but one wanted to merge in the late 1980's. However, they were prevented by the Government. Otherwise, they'd be in the same mess as everybody else.
Brian
Brian pointed out a key fact here. Nobody wants bankers to be gamblers...except the bankers. They like the bonuses and glory of making millions a year. The rest of us paid the price for their folly. The sad part is they don't think they were wrong.
Nice post Ki... it should be mentioned the role that Citigroup and Robert Rupin had in the Gramm-Leach-Bliley Act...
Perhaps throwing in the ties that Goldman Sachs has with the Federal Reserve... maybe the massive amounts of political contributions given to some certain lawmakers from financial institutions.. etc.. etc..
What went wrong? Maybe Some certain lawmakers burying their head in the sand as far back as 2004 and saying everything was A-Ok.
As Lenn says above... follow the money...
Hi Ki, This is an extremely well written review of the situation. While it probably lacks a point here or there it clarifies at least part of how we got in this mess.
Great summary of the situation, thanks for you thought out post.
What if I were to tell you that the system is working as it was designed? You might want to read this book!
Very provacative post. I'm not one for heavy handed government oversight, but markets left unregulated will eventually run into trouble. Greed takes over and investors' time frame for ROI gets shorter. History repeats itself. We will get out of this bind and see another boom, then bust in the next twenty years. We can prevent untold misery by taking measures now to ensure fair and transparent markets. Not easy to do considering the millions of dollars flowing into the coffers of our legislators.
you ought to talk with Matt Heaton here on Active Rain.. and part of the reason for the more recent price run-up on oil would be the weakness of the dollar caused by the massive defidit spending...
I think that we are all going to be affected in the next few years by what the government and the banks/financial institutions have done.
Wow there were a lot of words without any bold type or cute graphics and photos, yet a lot of excellent information.
Greenspan said it best when he testified as to the flaw in his thinking. You can trust the financial industry to self regulate. He contended that his initial assumption was that these institutions would only take actions that would assure their ongoing existence. WRONG!
Greed and power unchecked will lead to self destruction and take a few billion with it!
For Everybody who Thinks More Regulation is the Solution,
Who's going to regulate the regulators? "Regulators" failed to catch Bernie Madoff years before his own implosion did himself in.
If these "Too Big To Fail" (LOL!) companies would have gone under like they should have... that would have been the ultimate regulation for greed and corruption.
But no... they were bailed out for their bad behavior by the very same people who said that everything was just fine in 2005 despite reports suggesting otherwise.
So... these same people are supposed to come up with even more regulations and be the regulators?
God Help Us All...
Thanks, Ki, for this. I appreciate it! I think the free market isn't such a bad idea. Whenever government gets involved (witness the idea to open up the credit markets in 1998 as proposed by Fannie Mae chief Franklin Raines and others in a meeting at the White House) things seem to go downhill. I say let the bastards fail. Sure, it might have been a rough ride for all of us. But my question is this: Would it necessarily have been any rougher than what we have gone through? I doubt it. And now the government has mortgaged our future and we're still not our of the hole. Thanks again for the post!
Regulation is necessary but is seen as "anti-capitalist" where money is invloved.
The country is built on "democratic" values, but what does this really mean? The majority rules? Who is the majority? Is capitalism and democracy possible at the same time?
And who are the regulators? Do they really know better? Who are they working for?
These are the issues...loopholes and all.
. . . And the banks want to get into the real estate business. Can you imagine that?
Ki,
We indeed need to revamp the regulatory framework to avoid repeat of this mess, but Wall Street is hard at work to water down anything meaningful being considered.
Didn't they tell us that if we don't learn from history, we're doomed to repeat it?
@ Paul in # 20: So, regulators did not catch Bernie Madoff. So... we need to do away with them ? Perhaps we didn't have enough regulators... and that's why Madoff got away with it.
@ Athina in # 22: Excellent questions ! I would love to see you write a blog post using these questions. And... democratic values ? The majority rules ? Sounds like it could turn into "mob rule" in some situations... which would mean that it obviously was NOT working.
And...your comment about the regulators, and do they really know better ? The big question... your last one... is WHO are the regulators working for ? Again... great comment.