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Banking Reform Is Needed To Limit Economic Bubbles

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Some big banks that received huge federal government bailouts have been paying the money back, largely to escape the increased federal scrutiny of operations and restrictions on executive pay and bonuses that the government imposed. In December alone, Bank of America paid back $45 billion, CitiGroup agreed to repay $20 billion, and Wells Fargo Bank said it would redeem $25 billion of preferred stock issued to the U.S. Treasury to cover the bank’s “toxic” assets. So far, more than 50 of the 737 institutions that received funds have squared the books. Rather than signaling a turnaround of fortunes in the financial sector, the action seems to be setting the stage for pumping up yet another speculative bubble in the U.S. economy.

Banking Reform Is Needed To Limit Economic Bubbles
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The root causes of the current recession are buried in the Financial Services Modernization Act of 1999, passed by Congress and signed into law in a Faustian deal between the Clinton administration and Republicans. It essentially guts the Glass-Seagall Act of 1933, which, in response to the Great Depression, prohibited the integration of banking, insurance and stock trading into a single organization and separated riskier investment banking from traditional lending. Those combinations led to many bank failures in the 1930s.

“Too big to fail” is a phrase used as an excuse to bail out some financial organizations, but the FSMA law fostered the mergers and acquisitions that led to the creation of these behemoths, as well as the rise of the dangerous derivatives markets and the risky, non-banking activities that floored the economy.

The irresponsible, failing financial institutions should have stayed down; that is the risk of capitalism. The public now is stuck with their toxic assets, and some big financial institutions are going back to the practices that got them into trouble in the first place. The meaningful financial reform Congress should be fashioning to prevent such behavior seems unlikely as partisan politicians and special interests fight for short-term advantage.

The odd thing about economic bubbles is that people, investors and companies actually seek them out to get into the action early and recover from the damage caused by the previous bubble. The biggest action now is in the bailout bubble, potentially worth over $20 trillion. While relatively modest government investments in stimulus construction are having a positive impact on the economy, the bailout bubble may be the last stand for the U.S. If unfettered financial institutions again push the economy to the brink, there will be no government resources left to mobilize.

It seems people are doomed to learn the same lessons over and over: The drivers for enacting the Glass-Seagall Act in 1933 are the same as those for financial reform in 2010.


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