The nation’s largest banks continue to engage in the same risky behavior that caused the recession, they receive unstated government subsidies that provide an unfair advantage, and they have proven that they are willing to throw out the law and regard for the greater good in the pursuit of the almighty dollar.
The Mortgage Crisis
The mortgage boom was fueled by low interest rates, skyrocketing home prices, and an influx of investor capital. Many banks had more capital to invest than customers to loan it to. This caused them to develop new programs that made borrowing easier, and it caused them to develop a dependence on mortgage brokers to find borrowers.
Mortgage brokers are paid a percentage on the loans they make and have no financial interest in the loan beyond that point. Many were not worried about their customer or the bank that was funding the loan. There only purpose was to get paid.
Due to the amount of business that banks had, much of the loan documentation was not thoroughly checked by the lending institution, or customers, mainly refi customers, got involved in high risk mortgages. Many people had bitten off more than they could chew, and simply walked away from their mortgage.
As defaults increased, real estate prices decreased and the money dried up.
Banks have always invested in real estate because they could make their money back off the sale of the property if the customer defaulted, but the banks had loaned too much. The homes were no longer worth what they had loaned out, and the crisis snowballed from there.
The Wall Street Crisis
The Glass-Stegall Act refers to four provisions of the Banking Act of 1933, which was sponsored by Senator Carter Glass (D-Virginia), and Representative Henry B. Steagall (D-Alabama).
Glass-Steagall placed limits on the dealings that commercial banks, banks that take deposits, could have with investment banks, those who deal primarily in securities trading.
Over the next 66 years, the protections of Glass-Steagall were eroded through actions by Congress and the Federal Reserve. Finally, it was repealed by the Gramm-Leach-Bliley Act of 1999.
This allowed the big banks to grow even bigger and that growth provided them with an unwritten government subsidy.
The big banks were so big that investors knew the federal government could not allow them to go under. Investors knew that if the big banks stumbled, the government would be forced to prop them up in order to save the economy. This protected the majority of their investment from loss.
In addition to that subsidy, commercial banks were at further advantage because they were able to use traditional bank deposits as cheap funding.
This unfair advantage allowed them to grow even more.
The problem is that banks pooled these mortgage loans and used them to back the securities, and when the housing market fell apart a chain reaction was set off. Mortgage backed securities became practically worthless, banks were unable to use them as leverage for short term funding and banks saw their available capital plummet.
Too big to fail is getting worse. In 1995, the balance sheets of the six largest banks were equal to 20% of the U.S Gross Domestic Product (GDP). At the time of the financial meltdown, the balance sheets of the six largest banks were roughly 66% of the GDP, and today their balance sheets are equal to 93% of the GDP.
A bipartisan group of four senators that includes Elizabeth Warren (D-Mass.) and John McCain (R-Ariz.) have introduced an updated version of the Glass-Steagall Act.
The New Glass-Steagall Act (NGSTA) would force banks that accept federally insured deposits to rely on traditional lending and would prevent them from dealing in securities, dealing swaps or operating hedge funds and private equity enterprises.
This is a necessary first step, but it does not go far enough.
Much of the crisis was caused by mortgage industry, which is included in the tradition lending practices that commercial banks would be limited to under the NGSTA.
We need to set the capital requirement of the banks at 10%.
Bank capital is the difference between the value of a bank’s assets and its liabilities. When the mortgage crisis set in, many banks were on the brink of solvency, others were bought out by larger banks, and many failed. The banks were unable to absorb the losses due to their lack of capital.
Increasing the capital requirement would increase their ability to absorb losses making the banks more stable and less of a threat to the economy. Of the six largest banks one has a capital ratio of 7.4%, the rest are below 5%.
Breaking the Law
In addition to their risky investments, the big banks have a history of breaking the law whenever it suits their purpose, which is to make more money. Over the last several years, they have been found guilty of manipulating foreign exchange rates, dealing with countries that they are prevented from dealing with by law (countries listed as rogue or terrorist regimes – Iran, Sudan, Libya, Burma, etc…), laundering money for drug lords and discriminating against black and Hispanic borrowers.
In other words, they are only interested in their bottom line, they are not worried about the economy, or the American people.
They do this because they know that if they get caught, they will be fined an amount that is usually less than they made by breaking the law and they will not face any significant jail-time. These penalties are a farce. It does not do any good to pass a law without a realistic punishment for these crimes because the law does not serve as a deterrent to committing the crime.
This needs to end. Anybody associated with the banks who is involved in or have knowledge of these crimes, and fail report them, should be faced with jail-time that fits the nature of their crime, just like anyone else who commits a crime.
If we take these steps, we can reduce the effect that individual bank stability plays in our economy, and lessen the chances of future economic instability. By decreasing the size of these banks, we will level the playing field, which will allow local banks to be more competitive, and honest competition is the best for all parties concerned.
We have two choices. We can continue to allow these behemoth banks to dictate economic policy to us, or we can take back our economy and force them to operate under rules that benefit all Americans, and not a chosen few.
Eleven part series on my 9-point economic plan:
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