Deregulation--1987-1988 The rise of Alan Greenspan

 Here is the 3rd rough drat installment of my financial crisis/online poker piece. Obviously I have yet to get in to the online poker part. just as a reminder, this is a rough draft that needs corrections. Thank you for any feedback.



  The Savings and Loan crisis of the mid 80's was a fresh wound when the calls for deregulation started up again. Like previous financial crashes, the S&L debacle could have been a reminder that unrestricted behavior on the part of banks without supervision will most likely cause financial destruction on some level, but because the cleanup was done in an efficient manner compared to those catastrophes before, opponents of regulation could point to the inexperience of smaller institutions and their risky behavior that put them closer to the inevitable tipping point of insolvency. Large Wall Street S&Ls took financial hits as a result of the crisis, but came out on top having rid themselves of regional competition. This gave them clear site of a new target in the global financial sector and they had a relatively new weapon at their disposal in the form of the growing derivatives market. The $160 billion bailout of the S&L industry did little to slowdown the money churning lobbying effort of the large banks to seek further deregulation and in 1987 they had a new hero. On June 2nd, 1987, then President, Ronald Reagan nominated Alan Greenspan as the next Chairman of the Federal Reserve. Alan Greenspan was a staunch advocate of deregulation and was in favor of letting the market take care of itself, while his predecessor, Paul Volcker was against allowing barriers to be torn down that would allow large banks to become even larger.

The Treasury Department at that time, like Greenspan, was in favor of allowing banks to get bigger in order to better compete with financial institutions around the world, namely Europe and Japan. George D. Gould, Under Secretary of the Treasury, was reported in the New York Times as saying,

''If we are going to be competitive in a globalized financial-services world, we are going to have to change our views on the size of American institutions,'' Mr. Gould said. ''People are going to have to accept that some big American financial institutions will need more capital to be competitive.''

Those who sought out less restriction believed that as the financial products became more complicated, the competition for capital investments became unbalanced due to the lack of regulation in foreign markets. The United States no longer had the largest banks in the world which was what many on Wall Street were looking to regain. Gould cited more lenient restrictions on the part of foreign banks in areas of capital to asset ratio as well as their ability to offer a wider variety of underwriting services to go with the everyday banking that had put them ahead of their American counterparts. Asian countries were experiencing a higher than normal growth rate and Japan was in the midst of their own bubble with rising home prices, low interest rates, and easily obtained credit.

Hans Angermueller, vice chairman of Citicorp said, ''We have been the beneficiaries of living in a relatively insulated big economy, and only recently have we found out that the Japanese can make automobiles better than we do, We are discovering that the same thing may apply in the financial services area, and to meet that challenge, we need to get leaner, meaner and stronger. We don't do this by preserving the heartwarming idea that 14,000 banks are wonderful for our country.'' Greenspan is later reported as saying that given the current banking environment, ''I do not have a fear of undue concentration of banking powers.''

 The Congressional Research Service released a report in June of that year on the subject of commercial banks vs. investment banks, in which they reiterate the reasons for supporting Glass-Steagall,  citing "...the distinctions between loans, securities, and deposits are not well drawn."
Banks that would be able to issue securities and take deposits are in nature at odds within those activities. Securities have a larger risk associated with them and institutions that take deposits are intended to minimize risk.
 The report acknowledged how American banks were losing market share to their deregulated foreign competitors and it advocated for legislation that wold reduce the "conflicts of interest".
  "The securities activities that depository institutions are seeking are both low-risk by their very nature, and would reduce the total risk of organizations offering them by diversification."

 

  Later that summer, Congressmen, Charles Schumer wrote an Opinion piece in the New York Times speaking out against repealing Glass-Steagall and the possible negative effects of large Wall Street banks. Schumer responded explained that in his opinion, Japanese banks had grown because of a similar regulatory protection from outside competition. Schumer also cited the fact that American banks had seen more profit in the mid 80's than that of the their large foreign competitors and warned of the classic risky behavior  in financial markets.

 "The banks’ proposals also defy common sense. Given the chance to speculate, some institutions are going to gamble poorly. This in turn will undermine confidence in the whole banking system. The recent experience of the thrift industry reinforces this lesson." Schumer goes on to say, "A bailout of the much larger commercial banking sector, if it got into a similar problem, would make the recapitalization for thrifts seem insignificant...Today's bankers promise they will be more careful. But to accept their assurances runs counter to the simple principles of fairness and common sense."

 It seems that Schumer, who was an advocate for the Garn-St. Germain Act of 1982, had a bit of a turnaround in light of the rampant fraud and gambling of the Savings and Loan crisis.

 In mid October 1987, called Black Monday, global financial markets plummeted, starting in Hong Kong and quickly working west like a financial Tsunami through Europe and then the United States. There are many causes that have been cited for the sudden drop, with Program Trading being one of the most popular, in which computers conduct rapid executions of strategies based on inputs. Proponents of this explanation state that once the crash started, those who were holding portfolio insurance derivatives were forced to sell with each down tick movement, hauntingly reminiscent of the stock market crash of 1929.

Economist David Mullins was asked to head the Brady commission for the purpose of investigating the causes of Black Monday. The conclusion directed a great deal of blame on derivative traders and portfolio insurance. 2 years later Mullins was nominated to fill a vacancy for the Federal Reserve board of Governors under George W. Bush until he left to be a part of John Meriwether's hedge fund, Long Term Capital Management. Others attribute the cause to global monetary policies as well as the collapse of the US-European bond markets that had a ripple effect in other areas of the Global financial sector. The Dow Jones fell 508 points (22.61%) which became the largest one day percentage drop since 1916. By the end of the month world markets had fallen from 22% up to, in some cases, 45%. The DJIA did not reach its high of 1987 for another 2 years.

 Despite the tremor in the vastly intertwined global financial markets, Alan Greenspan continued to voice his opinion that Glass-Steagall should be repealed.
"Warning that banks will become the dinosaurs of financial services if the Depression-era law is not repealed, Greenspan said that the Fed believes banking can be tied to securities underwriting without subjecting federally insured deposits at banks to the risks inherent in the stock market."
"The risks can never be fully eliminated, but they can be sufficiently contained to be acceptable," Greenspan said.
In February 1988, the GAO released a statement, summarized by Charles Bowsher (Comptroller General of the US) answering the concerns raised by Congressmen Edward Markey, as to the possible outcomes with the repeal of Glass-Steagall. In the view of the GAO, the integration of the banking and security shows how the Glass-Steagall Act may be antiquated, yet the nature of financial innovation may not be entirely stable.
  It's  "...potentially dangerous because it has not allowed for the systematic consideration for the legal and regulatory structure needed to better reflect the realities of today's financial marketplace."

 The statement summarizes the supporting legislation needed in the opinion of the GAO in order to preserve the safety and soundness of the banking system as well as protecting the consumer’s interest.  Maintaining an adequate level of capital reserves in order to cushion against losses and keeping the bank holding structure in order to preserve liquidity are the classic problems in most cases of financial downturn. The GAO raises the question of how far should the Federal Reserve go in times of financial crisis. The report goes on to state that "Ultimately, the degree of comfort that one has with the repeal of Glass-Steagall depends on one's faith in the regulators' abilities to effectively oversee the newly allowed activities..."
This report reflects the concerns of a changing financial sector that, like technology, was growing no matter the obstacle. The underlying concern raised was how new legislation would better support and protect the changes of a diverse market place. The GAO warned of the possible confusion and complexities of a cutting edge investment area that could end in a crash much similar to 1929 despite its technological leaps. What many knew, unwilling to admit was that for all the changes the world had seen, ultimately human desire for riches may be it's undoing.