Platt Perspective on Business and Technology

Open markets, captive markets and the assumptions of supply and demand dynamics 13

Posted in macroeconomics by Timothy Platt on June 20, 2016

This is the thirteenth installment to a brief series on underlying assumptions as they arise and play out in economic systems, and in production and marketplace systems (see Macroeconomics and Business 2, postings 230 and loosely following for Parts 1-12.)

I began to more specifically discuss the Great Depression, and our more recent Great Recession in Part 11 and Part 12 respectively. And then I stated at the end of Part 12, that I would continue their closely connected lines of discussion here with a matching consideration of reform law initiatives that have been attempted, that would at least ideally prevent a next recurrence of these types of economic and sociopolitical challenge and disruption, and long-term.

My goal here is to focus on two historically significant case in point regulatory bills there, that were in fact successfully enacted in the United States, making their way through Congress and getting signed into law: the Glass-Steagall Act and the Dodd–Frank Wall Street Reform and Consumer Protection Act.

The Glass-Steagall Act was originally enacted into law on February 27, 1932, as a direct response to the Great Depression and what was known by then as to how it had arisen. It was passed with a set of specific shorter-term goals for enabling a more rapid economic recovery. One of the more important of them was its wide-ranging initiative for reining in and stopping a rampant pattern of deflation that had taken hold in the US economy, that was preventing growth and recovery. And a second, long-term consequential part of this law that fit that short-term recovery initiative was in how this new law expanded the ability of the US Federal Reserve System as initially created in 1913, to offer recovery loans to member banks, while also allowing it to issue both government bonds and commercial paper (unsecured promissory notes with a fixed maturity of no more than 270 days.) And a goal of both of these portions of this law and others that supported them, was to in effect rebuild and stabilize the overall banking system in the United States, where so many banking institutions had failed from loss of public trust and from ensuing bank runs.

On a longer-term perspective, the Glass-Steagall Act as initially passed also began a systematic process of limiting and even outlawing a range of banking and financial institution practices that had created ongoing and unsustainable risk, and both for those institutions and collectively for the entire economy. And this law was almost immediately expanded upon with the passage on June 16 of the Banking Act of 1933. Resistance and opposition in Congress made it necessary to develop and push through this overall legislative package in stages, with this entire step-by-step effort as enacted often collectively identified as the Glass-Steagall Act and as the Glass-Steagall Legislation.

This now expanded regulatory systems law established the Federal Deposit Insurance Corporation (FDIC), and federally mandated and supported banking service consumer protection. And it specifically outlawed some of the practices that had most egregiously led to the Great Depression, preventing banks for example from entering into lines of business that created investment vehicles (e.g. of the type that had just led so many bank holding companies to fail.)

And Glass-Steagall faced furious opposition, and while it was working its way through Congress, and after it was passed into law. And a great many vested interests that were certain they could do better, sought to water down and eliminate what they saw as its undue restrictions on how they could do business. The story of how this set of legislative initiatives came into law and then was brought into decline, and how it was ultimately unraveled is fascinating if disturbing. But to keep this posting within bounds for its length, I will simply offer two reference links to more fully detailed accounts of that: Glass-Steagall Legislation and the Decline of the Glass-Steagall Act. I will simply add here that ongoing efforts to chip away at this law were carried out and vigorously, from about 1935 until 1999 with the passage of the Gramm-Leach-Bliley Act, which formally ended several of Glass-Steagall’s key provisions – including fully ending the restrictions on activities that banks could enter into, for conflict of interest reasons and because of the historically verified risk potential that those mixed-business activities could create.

The Gramm-Leach-Bliley Act is generally viewed as having repealed Glass-Steagall, even if a variety of its provisions, such as the FDIC continue to exist, and with increased levels of coverage with higher maximum savings per account protected. For purposes of this posting and this series, I simply note that the majority of Glass-Steagall’s more protective restrictions that were intended to prevent the types of bad practices that led to the Great Depression, were killed off or so watered down as to be essentially meaningless. And many of the old practices that it sought to prevent were picked up on again and repeated by a new generation of banking and finance entrepreneurs that did not know of or remember the cautionary lessons of their industries’ and the overall economy’s past.

Granted, this generation of entrepreneurs came up with a few new due diligence and risk management challenges to economic stability of their own, and new twists on older ones. But bottom line, their failure to learn from the past and the removal of hard-fought law that was intended to enforce more prudent business practices, led to the Great Recession.

While the Great Recession was built in part on bad practices that began to be followed in earnest, from before the November 12, 1999 passage of Gramm-Leach-Bliley, I note the timeframe here as significant between the disillusion of Glass-Steagall’s last key provisions and protections, and the official, undeniably painful start of the Great Recession – less than ten years later.

And this brings me to the still smoking aftermath of the Great Recession as it took hold, and as voices rang out that this should never be allowed to happen again. This brings me to the negotiating and lobbying and news coverage and other pressures that led to the passage of the Dodd–Frank Wall Street Reform and Consumer Protection Act.

On the face of it, this piece of legislation was enacted as a new and updated version of the Glass-Steagall Act, or at least of its intent, that would address both old and long-standing risk and the business practices that lead to it, and new forms of risk that could not exist pre-internet for example when Glass-Steagall was first devised and passed into law. And exactly as happened with Glass-Steagall, voices of reaction and rejection arose and from the beginning – from before it could even move out of Congressional committee, to be voted upon by the full bodies of the House and Senate. And compromises were arrived at in what was included in the final law passed, between those who saw this initiative as not going far enough and those who saw it as going too far and as being overly restrictive. Glass-Steagall saw this same type of conflict play out in its final drafting and passage too.

The Dodd–Frank Wall Street Reform and Consumer Protection Act is a very lengthy and complex piece of legislature with 61 main provisions, each of which is complex and highly detailed in its own right. As such, I will not delve into the details of this law here, any more than I did here for the Glass-Steagall Act. I suggest a review of the Wikipedia link offered here in this posting where I show offer this law by name in link form, and this: US Securities and Exchange Commission resource for further details.

And I will simply add as a final note here, that a significant number of primarily self-proclaimed “ultra-conservative” Republicans, backed by and acting at the behest of some of the Republican Party’s biggest donors, have been fighting to roll back or even repeal what they see as excessively onerous provisions of this law too, and exactly as was done with Glass-Steagall.

I made note of one of the new iterations of the types of toxic investment “opportunity” in Part 12, that directly led to the housing market bubble and financial institution losses in the Great Recession, and that are arising again since the passage of Dodd-Frank: the now-named, brand new and no doubt exciting “bespoke collateralized debt opportunity (bespoke CDO)” and its more popular variant: the “bespoke tranche opportunity.” Lacking a working crystal ball, I can only guess, but I expect to see more new (but not really) investment opportunities like them, and a further eroding of Dodd–Frank on top of what is already being pushed for and achieved.

I fully expect to come back to this line of discussion in future postings to this blog, but I end this discussion here, for now. And as already noted in this series, I will turn to consider China in my next series installment, and its economics, and for its version of politically grounded economic friction (see Part 12 for a working definition and basic discussion of that term.)

Meanwhile, you can find this and related postings at Macroeconomics and Business and its Page 2 continuation.

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