 |
Printer Friendly View (with text zoom)
Library Home Street Smart Report Home BEING STREET SMART by Sy Harding My 2006 Wish for the U.S. Financial System! (Dec. 23, 2005) There used to be an impenetrable wall
between financial institutions and the types of products they could offer the
public. Savings banks took in deposits
primarily from individuals, and loaned the money out to individuals in the form
of home mortgages, auto, and personal loans. Commercial banks handled the
checking accounts and commercial loans of businesses. Investment banks handled
the intricacies of taking private businesses public, and raising additional
money for publicly traded companies through secondary stock offerings and the
like. Brokerage firms handled the transactions of investors trading stocks and
bonds with other investors. Mutual funds packaged diversified portfolios of
stocks and sold the shares of their portfolios to investors.
Mortgage companies sold and brokered real estate mortgages. Insurance
companies sold insurance. Investigations after the 1929 stock
market crash led to the Glass-Stegal Act which further separated commercial
banks from brokerage business, and banks involved in loans from banks involved
with investment banking. However, as the economy and stock
markets powered into high gear in the 1990s, envy between the separated areas of
the financial industry began to grow. Banks and insurance companies wanted to be
brokerage firms and mutual fund companies. Brokerage firms wanted to be banks
and mutual fund companies. They all wanted to be insurance companies. The financial industry is one of the
largest contributors to congressional lobbying efforts. So, just as the stock
market was powering into the most dangerous bubble since that of 1929, but also
the most profitable period ever for Wall Street, Congress repealed the
Glass-Segal Act. They left it in effect for 60 years, and then repealed it just
as the next investment bubble was forming. Great timing? So now we have one big fat and happy
financial industry. Banks, credit-card companies, insurance companies, brokerage
firms, mutual funds, and mortgage companies, have engaged in a frenzy of mergers
to get into each others businesses. Now your local bank, probably a branch
of a huge merged national bank, will provide your business with a loan, finance
your home mortgage and then package it with hundreds of others as an investment
product sold by brokerage firms and mutual funds, which it may also own. The
brokerage arm of your bank or insurance company will transact your stock trades,
sell you a mutual fund, one of their own or that of a competitor, and loan money
to your hedge fund so it can engage in leveraged derivatives transactions (which
are so complex that banks have trouble understanding where their risk lies). Chances are you can go to your
stock-broker's website, and take out a mortgage on your home, or a car loan,
using equity in your investment account as collateral. When you take out a
mortgage with a bank or mortgage company, or open a brokerage account, or a new
credit-card account, you're going to be inundated with sales pitches from
another arm of the bank or brokerage firm offering to sell you life, auto,
health or home insurance. With the relative safety of separated
structures no longer in place, just hope that the overall U.S. financial system
can hold together if one section of it comes under intense pressure.
We saw a glimpse of the risk in 1998,
when Long-Term Capital Management hedge-fund got itself on the wrong side of
highly leveraged Asian currency trades. Asian currencies collapsed with a fury
in 1998. Thanks to the intertwined relationships in the financial industry,
three major U.S. banks were not only lenders to the hedge fund, but were major
investors in it, and others, as well as having leveraged currency derivatives
positions of their own in their brokerage and investing divisions. They were on
the hook for major losses. Only the fast footwork of the Federal Reserve, which
feared a meltdown of the entire financial system, saved the situation. As the
stock market tumbled, the Fed organized a hurried conference call with members
of its Federal Open Market Committee, and quickly announced a surprise ½
percent cut in interest rates to stimulate the stock market and prevent its
collapse, while simultaneously calling major banks and brokerage firms into
emergency meetings, at which it forced them to share the losses and
provide capital that would allow an orderly liquidation of the hedge fund's
holdings rather than have them dumped on the market. It
was not the first greed-induced crisis. We need only look back to the late 1980s
and early 1990s, when the dramatic collapse of Savings & Loan institutions
(S&Ls), and commercial banks, also threatened a meltdown of the entire
financial system. S&Ls were deregulated in the early 1980s. By the mid-1980s they were loaning more money in overpriced real estate than they could cover in the event of falling prices. Rising short-term interest rates caught them in a bind of borrowing at high short-term rates, and lending at low long-term rates. The collapse came in the late 1980s, resulting in more than 1,000 S&L's going under, while in the banking sector more banks failed than at any time since the Great Depression of the 1930s. A total of 745 banks were taken over by the RTC. Some were closed, while healthy banks were forced by regulators to take in the others through mergers. The government bailout, which did avert a financial system meltdown, but just barely, cost taxpayers roughly $600 billion. With the entire financial industry now deregulated, and taking huge risks across several financial sub-sectors, not only in over-priced real estate again, but in sub-par mortgage and credit-card debt, hedge-fund loans, leveraged derivative investments of their own, investment banking deals, and who knows what else, while short-term interest rates are rising and long-term rates remain flat, my hope for 2006 is that the financial industry's greed does not again result in another financial system crisis. Back to the Top Library Home Street Smart Report Home Copyright © 2005, Asset Management Research Corp. |
 |
||||||
