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The Demise of Glass Steagall

“Oh, yes, we have class warfare in America. My class is winning.”
                                                                           Warren Buffet

In our current financial crisis, the activity of significant lending by banks to those who wanted to own a home was followed by those banks selling off the mortgage loans to investors. This had two consequences: the banks no longer were responsible for their loans (the loans were not on their balance sheets); thus, the banks became incredibly irresponsible about whom they would loan money; and two, once the mortgages were sold, the investors bundled those loans, and, thus, no one was able to keep track of who’s got what and to whom. This bundling is called securitization.

Of course we can change this. We can regulate the banks. We used to do that . It was called the the 1933 Glass-Steagall Act and it prevented banks from being so irresponsible that they could sell mortgages. Over time the Glass-Steagall Act’s powers were eroded by both Republicans and Democrats. (Yes, the Democrats were also responsible, not everything can be blamed on Ronald Reagan.)

Not only did Congress eroded the Act so did the Federal Reserve Board which has regulatory jurisdiction over banking, but not the stock market. Therein lies the rub. The banks were increasingly losing profits to nonbanking institutions who were intruding on banking territory. Congress got so nervous that in 1994, when Congress was still under Democratic rule, Congress passed the Home Owners Equity Protection Act. It empowered the Federal Reserve board to make rules for mortgages even for institutions that were not banks.  (I say this in case you think it doesn’t matter which party wins – it does matter).

Wonderful! Except Mr. Greenspan, head of the Federal Reserve, did not enforce the regulation. Remember Mr. Greenspan, he believed in the power of the market to self-regulate. We didn’t need regulation.
Now we are at the point where most sensible people say – we need regulation, let’s figure out what that will be.  However, we have the Republicans saying we have too much regulation and since the minority is running the Senate, we could end up with no new regulation to address this financial crisis.  What a country!

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