A COSMIC SICK-JOKE
Bahía de Caráquez, Ecuador, Tuesday, 22 September 2008

Several major factors have fuelled the de-regulation of banking across the industrialised world. First, by the time Reagan arrived as president of the U.S.A., the post-WWII (re-)construction boom was largely over; businesses were no longer investing in new capacity. As a result big business was becoming increasingly liquid. Bank commercial loans to businesses dropped proportionately and bank lending margins tanked. Companies, on the other hand, were looking for a place to earn money on their cash.

Second, following the formation of OPEC, the oil-producing countries were earning seriously-enormous amounts of cash, which needed a safe place to park and, which had to earn a good return. The deposit-taking banks were initially overwhelmed by this flow of money, the more so since they were running out of profitable lending activities.

Third, funded pension funds in many industrialised countries had also by the last quarter of the 20th Century become huge pools of money in search of a return.


Fourth, investment banks had found ways of brokering and trading multifarious flows of money, which as a consequence by-passed lending banks altogether. “Debt instruments” (long-term bonds but also short-term and eventually medium-term notes issued by all manner and classes of credit risks including ‘junk’ class issuers) could be issued by any borrower with a rating, a business plan and the assistance (for a fee) of Merrill Lynch, Morgan Stanley, Lehman Brothers or some other similar investment or merchant bank. The newly-issued (primary) notes or those in secondary trading markets could be directed to institutional (e.g. insurance companies, mutual funds, pension funds) or private investors. The clever boots at the investment banking powerhouses went on to develop, first, trading pits for all of these instruments and, later, an astonishing array of completely new financial instruments, which purported to benefit issuers and investors alike, certainly benefited investment bankers hugely and even purported to be useful financial tools for cash-holders and investors. As mentioned, they were huge money-makers for the investment banks. The impact of such novelties was seldom grasped by regulatory authorities until there had been a meltdown or near-meltdown. And there were several such in the period after Reagan took office.

The banks respond

The commercial banks responded in several rational and parallel ways. First came the drive to diversify into and/or expand into still-very-profitable retail banking, i.e., banking activities for the ordinary individual customer. The reader will have witnessed this trend first hand over the last thirty years in the form of the increasing prevalence of ATMs, plenty of advertising for your banking business, issuing drives for new credit cards, internet banking and the like. These retail banking activities were hugely profitable and successful, but they require a level of scale that is only achievable with the broad geographical presence that old-time restrictive banking laws inhibited, designed as they were to protect small-town banks. One after one, these barriers were struck down or removed by business-friendly administrations at state and national levels (the first steps to de-regulation). This went largely unnoticed by the voters and taxpayers. A giant consolidation phase was as a result set in motion, however: small banks were merged or acquired and nationwide banking became the norm. Even huge state-wide banks like Bank of America have found themselves acquired and managed from a headquarters in North Carolina, surely about as far away from the big money centres like New York, Chicago or San Francisco as one could imagine.

In a second response, money-centre banks like Chase, Morgan, Bank of America and Citibank began to lobby heavily to be permitted to enter other financial activities, most notably insurance and investment banking, which latter sector had been infringing on their corporate business for years in the form of directly-issued financial obligations and, later, sexy financial instruments (see above). The lobbying led to the end of the Glass-Steagall Act and the construction of “Universalbanken” (retail and corporate lending as well as securities activities) along German lines - but of course, without the ‘stuffy’ and ‘heavy-handed’ German regulatory system.

Third, all of this took place to a background of economic thinking which was increasingly opposed to any government regulation whatsoever under the premise that all markets are self-regulating and any government ínterference’ is ipso facto bad for business, bad for the economy, bad for the individual and bad for society as a whole. The demise of the Glass Steagall Act was only a small step in the great scope of radical libertarian economic and political thinking that has left large parts of the economy with about as much regulation as a harbour fish market. ‘Unfettered markets’ became an article of faith that was to be sorely tested several times in the last forty years but has never lost its high priests, idols and acolytes. Despite evidence to the contrary therefore, ‘unfettered markets’ remains the dominant philosophy.

It should only take a few minutes, however, to recall major meltdowns of self-regulating markets. They have been frequent and have always caught the regulators, to the degree they still existed, by surprise. One of the most notorious was the indexed, computer-driven sell-off in October 1987 (Black Monday). This wiped out investor values and required the regulatory agencies to step in to close markets, supply the ‘players’ with plenty of liquidity and generally pull their nuts out of the fire.

Here’s another one you may recall: the Resolution Trust of the 1980s. Conservative savings & loan societies (‘thrifts’) successfully pleaded to be de-regulated so they could make more aggressive loans, especially in real estate. Mis-managed by their executives, it led to a real estate bubble and the collapse of large numbers of thrifts, the bill for which was however picked up in the trillions by the taxpayer, who remain even today and despite ‘unfettered market’ theologies the ultimate cleaner-upper. Since they are largely ignorant of economics and finance beyond simple chamber-maid calculations, most politicians are quick to sweep such disasters under the carpet. Conveniently the taxpayer only notices it in increments or in popular programmes that are no longer funded or even proposed.


Financial train wrecks

Eventually, the heavy hand of government regulation was removed. As globalisation proceeded apace there was nothing left but an orthodox belief that markets would always by their very nature avoid financial train wrecks. There was little discussion of just who or how many would be drowned before the financial ship bobbed up again or even, truth be told, if at all the ship could in fact come right-side-up on its own. Whenever it came to the crunch, the prospect that it would not was too much to contemplate and repeatedly, government has stepped in to protect bankers and “stabilise the system”. Since it (i.e., the government as the agent of the taxpayer) has long since stopped inspecting and licensing in any meaningful way, the taxpayer it now appears is always on the hook when there is a meltdown but his representatives have long ago removed any protective measures (auditing and licensing, for example). Profits are privatised in good times and losses nationalised in bad. Everyone of course tries this on in a free-for-all economy: the farmers, the miners, the hurricane victims, etc. But there issues are unlikely to knobble the whole economic and financial system.

Cosmic joke

It is a cruel and sick joke on us all however to see free-market priests like Fed Chairman Burnanke and Treasury Secretary Paulson so swiftly liquidating the till now strongly reiterated belief that government interference is in and of itself always bad.