“The credit system, which has its focal point in the allegedly national banks and the big money-lenders and usurers that surround them, is one enormous centralization and gives this class of parasites a fabulous power not only to decimate the industrial capitalists periodically but also to interfere in actual production in the most dangerous manner — and this crew know nothing of production and have nothing at all to do with it.” – Marx, Capital, volume 3, chapter 33
“The industrial revolution caused unspeakable misery both in England and in America. I do not think any student of economic history can doubt that the average happiness in England in the early nineteenth century was lower than it had been a hundred years earlier; and this was due almost entirely to scientific technique.” – Bertrand Russell, 1951
With the ongoing financial crisis, I found myself very lacking in my knowledge of economics and economic history. Likewise, I found those around me equally lacking. How are we to approach the great problems before us today if we don’t know where they stem from or the basic foundations of our modern system? I have received inquiries regarding Glass-Steagall, Bretton Woods and the gold standard theory… and I do not think I was able to answer them sufficiently.
I propose to cover a very brief history of economics in America, for my own benefit and hopefully for the benefit of others. I could of course start earlier or later — 1907 is more or less arbitrary — but I feel that any sooner is covering too much ground and any later would leave out some key parts of the past century. At some point, I hope to expand this to include the various labor movements of the twentieth century, as I believe they can be closely correlated.
I welcome, as always, any comments and suggestions. I am by no means an expert on this topic — I am literally learning as I type — and would welcome any corrections that may be needed. My hope is that together we can begin to grasp the financial issues of our day and be aware of the state of affairs should future crises arise.
1907-1913: The Federal Reserve is Born
The story of the Federal Reserve starts in 1907, when the Treasury had to bail out the “cabal” after a panic. The Panic of 1907, also known as the 1907 Bankers’ Panic, was a financial crisis that occurred when the New York Stock Exchange fell close to 50% from its peak the previous year. Panic occurred, as this was during a time of economic recession, and there were numerous runs on banks and trust companies. The 1907 panic eventually spread throughout the nation when many state and local banks and businesses entered into bankruptcy. Primary causes of the run include a retraction of market liquidity by a number of New York City banks and a loss of confidence among depositors, exacerbated by unregulated side bets at bucket shops.
The next big step was in 1908, with Republican Senator Nelson Aldrich. Congress formed a monetary commission led by the blue-chip Senator.
The Wall Street Journal ran a 14-part editorial on its front page in 1909, written by journalist Charles Conant, arguing the case for a central bank.
Aldrich, a close friend of the Rockefellers, held a private meeting in 1910 on Jekyll Island for ten days with some of America’s most prominent bankers. Such banks represented included J.P. Morgan, National City Bank of New York (owned by the Rockefellers), Kuhn, Loeb & Company, and the First National Bank of New York. Colonel Edward House was also present; House would become President Woodrow Wilson’s closest adviser and founder of the Council on Foreign Relations.
Together, these men constructed the “Aldrich Plan”, a banking bill that was crafted by the bankers for the bankers, without the knowledge of the Senate at large. Aldrich introduced the plan in 1911, calling for a central bank with fifteen supporting member banks. Prior to this, banks were largely independent of one another, giving local municipalities more control over their finances. Not surprisingly, this plan was supported by the American Bankers Association and much of Wall Street, as well as a majority of Republicans. The banking system would be a “private monopoly” with little government influence (although the government would be allowed to have a member on the board of directors).
Democrat William Jennings Bryan stood against the plan, fearing that its passage would ensure that bankers would “then be in complete control of everything through the control of our national finances.” Notably, Republican Senator Robert M. LaFollette (“Fighting Bob”) stood against Aldrich, as well.
While the Democrats largely opposed the Aldrich Plan, Democratic President Woodrow Wilson (elected in 1912) was mostly in favor of the proposal, and even critical Democrats admitted that a banking reform was needed to protect the country from financial and economic crisis. Wilson was able to get a modified bill approved by the Democrats (who wanted more government control of regional banks) by promising to pass anti-monopoly legislation in the near future. Senator Bryan also supported the revised bill, despite being openly opposed to its similar predecessor.
January 1913: Pujo Committee
In January 1913, the Pujo Committee of the House of Representatives released their findings that uncovered a system of interlocking directorates and other forms of influence centered around six major banks: J. P. Morgan, First National Bank of New York, National City Bank of New York, Lee, Higginson and Company, Kidder Peabody and Kuhn, Loeb. These names may sound familiar from the earlier Aldrich meeting. This was the purest form of banker control theory.
The findings of the committee inspired public support for ratification of the Sixteenth Amendment in 1913, passage of the Federal Reserve Act that same year, and passage of the Clayton Antitrust Act in 1914. House of Morgan partners blamed the April 1913 death of J.P. Morgan on the stress of testifying in the Pujo hearings, though other health factors were certainly involved.
December 1913: Federal Reserve Act
After months of debates, modifications and hearings, the Federal Reserve Act (as the revision of Aldrich’s plan was now called) passed on December 23, 1913. Much of Congress was on vacation at the time, making the vote very controversial. And President Wilson, the Act’s champion, would later turn against it after calling the act a “lasting benefit for the country”. Recognizing the power such a law gave to international bankers, he remarked, “I am a most unhappy man. I have unwittingly ruined my country. A great industrial nation is controlled by its system of credit. Our system of credit is concentrated. The growth of the nation, therefore, and all our activities are in the hands of a few men. We have come to be one of the worst ruled, one of the most completely controlled and dominated Governments in the civilized world.”
Frank Vanderlip, President of National City Bank, wrote, “Although the Aldrich Federal Reserve Plan was defeated when it bore the name Aldrich, nevertheless its essential points were all contained in the plan that was finally adopted.” Vanderlip had been on Jekyll Island in 1910, and was pleased with his new, increased power.
Bryan, like Wilson, also later regretted his support, saying, “The Federal Reserve Bank that should have been the farmer’s greatest protection has become his greatest foe.” Bryan had previously wanted a government-run central bank capable of printing paper money (rather than privately owned one). President Wilson was able to convince him, incorrectly, that by having a government official on the board of directors, the same goal would be accomplished.
1914: Gold Standard Ends
America was on gold from 1879-1914, a much shorter reign than the propaganda of modern goldbugs suggests.
1915: Warburg as Fed Chair
Wilson appointed German-born Paul Warburg, a director at Wells Fargo, to the Federal Reserve Chairmanship in 1915, the first man on the job. Warburg opposed his own appointment, having been a big player in Wall Street and thinking this would not be a popular decision. He reluctantly agreed to take the job in September 1914 after America entered World War I, as a sign of his patriotism. To this day, Warburg is the only Federal Reserve Chairman who was questioned by Congress before starting the position.
1928: Things are Looking Good
Economist and statistician Robert M. Davis wrote in June 1928, “American industry and business have reached that status of well-being where it no longer has to fear a recurrence of the radical spreads from prosperity to depression that formerly afflicted business and industry.”
1929: Wall Street Crashes
Federal Reserve member Paul Warburg warned on March 8, 1929, of the disaster threatened by wild stock speculation then rampant in the United States, foretelling a great crash. He was, sadly, not heeded.
Beginning in late October and going into November 1929, the stock market took a great tumble. (Interestingly, the big crashes of 1987 and 2008 were also in October.) What caused the crash is debated, but it marked the end of the “roaring twenties” when prosperity was at an all-time high. Between 1924 and 1929, the market’s value had increased to five times what it was. The crash also came just before the Great Depression of the 1930s (although there’s no definitive claim that the crash ignited the depression beyond the influence on reducing consumer buying).
The Dow Jones Industrial Average (DJIA) took years to recover from the initial crash. After gaining in 1930, it again plummeted in 1932… and it was not until 1954 — 25 years later — that the DJIA rose to the level it was before the 1929 crash.
Stocks fell as people pulled out of the market, causing insecurities to lead to further failures and insecurities. The Rockefeller family bought stock at the same time in order to persuade people that there was no reason to lose confidence, but their gamble did not pay off. In one week, the markets fell $30 billion — more than America had spent in all of World War I, and ten times the nation’s budget at the time ($3 billion). To say this was a shock to the system would be a gross understatement.
The crash would be investigated by the Pecora Commission and ultimately lead to the enactment of the Glass-Steagal Act (see below).
1930s: Great Depression
Following the stock market crash of 1929 came what is now known as the Great Depression, an economic low point that lasted worldwide throughout the 1930s and even into the 1940s in some regions. The depression is often connected to the stock market crash, and there is good reason to accept this view. Clearly a stock market crash, if not recovered from, is a lasting financial concern. What should be noted, however, is that the stock market was again strong in early 1930. What crippled the economy was the citizen’s lack of purchasing, causing prices to tumble and jobs to decline. This, coupled with an incredible drought crushing the agricultural sector, ground America to a halt. Other economists blame the inflation value of the dollar or the growing inequality between rich and poor. This last theory helped push through the New Deal.
During the depression, international trade was reduced by one half to two-thirds (see Smoot-Hawley, below), along with personal incomes, tax revenues, prices, and profits. Construction was by and large halted. Farming and rural areas suffered as crop prices fell by roughly sixty percent; farming, mining and logging suffered the most.
Secretary of the Treasury Andrew Mellon advised President Hoover to “shock” the economy: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate… That will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people.” Hoover rejected this, and started various progressive programs, foreshadowing Roosevelt’s plans. Hoover attempted to increase farm prices, expanded federal spending in public works (including dams), and started the Reconstruction Finance Corporation (RFC) which aided cities, banks and railroads, and continued as a major agency under the New Deal. For unemployment relief, he developed the Emergency Relief Agency (ERA) that operated until 1935.
John D. Rockefeller remained optimistic as the depression hit, saying, “These are days when many are discouraged. In the 93 years of my life, depressions have come and gone. Prosperity has always returned and will again.” One of the unfortunate consequences of the Great Depression was Germany’s turn to Adolf Hitler in order to solve their national problems. For better or worse, the Second World War (and more precisely the “war economy”) did, in fact, help get many countries out of financial ruin.
1930: Hawley-Smoot Tariff Act
The Hawley-Smoot Tariff Act, sometimes called Smoot-Hawley, was an act signed into law on June 17, 1930, that raised U.S. tariffs on over 20,000 imported goods to record levels. The act was pioneered by Senator Reed Smoot, a Republican from Utah, and Representative Willis C. Hawley, a Republican from Oregon. A petition was signed by 1028 economists in the United States asking President Hoover to veto the legislation. Automobile tycoon Henry Ford spent an evening at the White House trying to convince Hoover to veto the bill, calling it “an economic stupidity”. J. P. Morgan’s chief executive Thomas W. Lamont said he “almost went down on my knees to beg Herbert Hoover to veto the asinine Hawley-Smoot tariff.”
In retaliation, many other countries raised their tariff rates. This stymied international trade, and greatly bolstered the Great Depression. American imports from Europe declined from a 1929 high of $1,334 million to just $390 million in 1932, while U.S. exports to Europe fell from $2,341 million in 1929 to $784 million in 1932. Overall, world trade declined by some 66% between 1929 and 1934. Unemployment was at 7.8% in 1930 when the Smoot-Hawley tariff was passed, but it jumped to 16.3% in 1931, 24.9% in 1932, and 25.1% in 1933.
On December 10, 1930, a large crowd gathered at the Southern Boulevard branch of the Bank of United States in the Bronx seeking to withdraw their money, and started what is usually considered the bank run that started the Great Depression (though there had already been a wave of bank runs in the southeastern part of the US, at least as early as November 1930). The New York Times reported that the run was based on a false rumor spread by a small local merchant, a holder of stock in the bank, who claimed that the bank had refused to sell his stock.
1931: Spurious Equilibrium
1931: Keynes gave a lecture where he observed that an economy can come to rest at a “spurious equilibrium” with a low level of production and employment. This idea rejects a key idea of classical economics: supply can never exceed demand, and consequently the long-term unemployment of people and machines cannot happen.
1931: Gold Standard Crushed (Again)
The “gold standard” — the idea that all paper currency must be backed by gold — had been around for a long time. Though perhaps not as long as many assume. In America, there was no unofficial gold standard until 1873 and the official connection came as late as 1900. Not long after, other governments decided to decouple themselves.
England left the gold standard behind in September 1931. Japan, Sweden and the other Scandinavian countries also dropped gold in 1931. Other nations in Europe soon followed. Due to the first world war, England’s reserves were depleted and the three way exchange between goods, gold and paper currency left gold valuable while goods lost value. England could not remain competitive if they could not profit from their goods. America, which held much of the world’s gold, was not in such a predicament, but loosened its attachment to the gold standard to be in step with Europe. This detachment predictably left the world without an objective method in which to measure a nation’s wealth. Some degree of a return was initialized through the Bretton Woods system (see below).
The lack of a standard also left consumers at the mercy of the banks and the government. As Federal Reserve Chairman Alan Greenspan would later point out, “In the absence of the gold standard, there is no way to protect savings from confiscation through inflation.” If inflation increases faster than a worker’s hourly wage raises, he is essentially losing rather than gaining money.
March 1933: Bank Holiday and Emergency Act
The banking crisis came to an end with Roosevelt’s declaration of a bank holiday on March 4, 1933. Irving Fisher argued at the time that this state intervention prevented the otherwise inevitable bankruptcy of the US government.
The Emergency Banking Act was introduced on March 9, 1933, to a joint session of Congress and was passed the same evening amid an atmosphere of chaos and uncertainty as over 100 new Democratic members of Congress swept into power determined to take radical steps to address banking failures and other economic malaise. The EBA was one of Roosevelt’s first projects in the 100 days. The sense of urgency was such that the act was passed with only a single copy available on the floor and most legislators voted on it without reading it.
According to William L. Silber “The Emergency Banking Act of 1933, passed by Congress on March 9, 1933, four days after FDR declared a nationwide bank holiday, combined with the Federal Reserve’s commitment to supply unlimited amounts of currency to reopened banks, created de facto 100 percent deposit insurance. Much to everyone’s relief, when the institutions reopened for business on March 13, 1933 depositors stood in line to return their stashed cash to neighborhood banks. Within two weeks, Americans had redeposited more than half of the currency that they had squirreled away before the bank suspension.The stock market registered its approval as well. On March 15, 1933, the first day of trading after the extended closure, the New York Stock Exchange recorded the largest one-day percentage price increase ever. With the benefit of hindsight, the nationwide Bank Holiday and the Emergency Banking Act of March, 1933, ended the bank runs that had plagued the Great Depression.”
April 1933: Roosevelt and Gold
On April 5, 1933 President Roosevelt signed Executive Order 6102 making the private ownership of gold illegal, reducing the pressure on Federal Reserve gold. The order was “forbidding the Hoarding of Gold Coin, Gold Bullion, and Gold Certificates.” It required all persons to deliver on or before May 1, 1933 all gold coin, gold bullion, and gold certificates owned by them to the Federal Reserve. Violations were punishable by fine up to $10,000 or up to ten years in prison, or both. Exemptions were made for jewelers, artists, electricians and dentists. People turning in their gold were awarded $21 an ounce (the market value), and this measure ultimately kept deflation in check. According to Georgetown University history professor Michael Kazin, this move boosted the economy and probably aided Roosevelt in his 1936 presidential campaign.
President Gerald Ford would legalize the private ownership of gold on December 31, 1974.
June 1933: The Glass-Steagall Act
The Glass-Steagall Act (officially named the Banking Act of 1933) was passed on June 16, 1933, and introduced the separation of bank types according to their business (commercial and investment banking), and it founded the Federal Deposit Insurance Company for insuring bank deposits. This kept investment banks separate from other banks, to better protect the funds of each. The bill was sponsored by Democratic Senator Carter Glass, a former Secretary of the Treasury, and Democratic Congressman Henry B. Steagall, Chairman of the House Committee on Banking and Currency.
1933: Regulation Q
Besides having a catchy name, Regulation Q was also a powerful part of the Glass-Steagal Act that regulated interest rates in savings and checking accounts. Banks were forbidden from paying too much interest on savings accounts and forbidden altogether from providing interest on checking accounts.
While today there is still no interest paid on checking accounts, banks and other institutions have found ways around this restriction. The Monetary Control Act of 1980 removed the restriction on savings account interest rates, and both “Negotiable Order of Withdrawal accounts” and “money market accounts” were created to act in place of checking accounts, providing similar services without the name.
The importance of Regulation Q, or lack thereof, is debatable. Generally, though, I find it to be of little importance to the grand picture of the financial system.
June 1933: National Industrial Recovery Act
The National Industrial Recovery Act (NIRA), officially known as the Act of June 16, 1933 was an American statute which authorized the President of the United States to regulate industry and permit cartels and monopolies in an attempt to stimulate economic recovery, and established a national public works program.
Section 7(a) of the bill, which protected collective bargaining rights for unions, proved contentious (especially in the Senate), but both chambers eventually passed the legislation and President Roosevelt signed the bill into law on June 16, 1933. The Act had two main sections (or “titles”). Title I was devoted to industrial recovery, and authorized the promulgation of industrial codes of fair competition, guaranteed trade union rights, permitted the regulation of working standards, and regulated the price of certain refined petroleum products and their transportation. Title II established the Public Works Administration, outlined the projects and funding opportunities it could engage in, and funded the Act.
The Act was implemented by the National Recovery Administration (NRA) and the Public Works Administration (PWA). Very large numbers of regulations were generated under the authority granted to the NRA by the Act, which led to a significant loss of political support for Roosevelt and the New Deal. The NIRA was set to expire in June 1935, but in a major constitutional ruling the U.S. Supreme Court held Title I of the Act unconstitutional on May 27, 1935, in Schechter Poultry Corp. v. United States, 295 U.S. 495 (1935). The National Industrial Recovery Act is widely considered a policy failure, both in the 1930s and by historians today. Disputes over the reasons for this failure continue, however. Among the suggested causes are that the Act promoted economically harmful monopolies, that the Act lacked critical support from the business community, and that the Act was poorly administered. The Act encouraged union organizing, which led to significant labor unrest. The Act had no mechanisms for handling these problems, which led Congress to pass the National Labor Relations Act in 1935.
When Roosevelt signed this into law and declared, “No business which depends for existence on paying less than living wages to its workers has any right to continue in this country. By living wages I mean more than a bare subsistence level, I mean the wages of decent living.”
1934: The Securities Exchange Act
The Securities Exchange Act of 1934 regulates secondary trading between individuals and companies which are often unrelated to the original issuers of securities. Entities under the SEC’s authority include securities exchanges with physical trading floors such as the New York Stock Exchange (NYSE), self-regulatory organizations such as the National Association of Securities Dealers (NASD), the Municipal Securities Rulemaking Board (MSRB), online trading platforms such as NASDAQ and ATS, and any other persons (e.g., securities brokers) engaged in transactions for the accounts of others.
President Franklin D. Roosevelt appointed Joseph P. Kennedy, Sr., father of President John F. Kennedy, to serve as the first Chairman of the SEC, along with James M. Landis (one of the architects of the 1934 Act and other New Deal legislation) and Ferdinand Pecora (Chief Counsel to the United States Senate Committee on Banking and Currency during its investigation of Wall Street banking and stock brokerage practices). Kennedy was an ironic choice, considering he had made his fortune in the 1920s bootlegging and manipulating stocks. Other prominent SEC commissioners and chairmen include William O. Douglas (who went on to be a U.S. Supreme Court justice), Jerome Frank (one of the leaders of the legal realism movement) and William J. Casey (who would later head the Central Intelligence Agency under President Ronald Reagan).
Schechter Poultry Corp. v. United States
A.L.A. Schechter Poultry Corp. v. United States, 295 U.S. 495 (1935), was a decision on May 27, 1935 by the Supreme Court of the United States that invalidated regulations of the poultry industry according to the nondelegation doctrine and as an invalid use of Congress’ power under the commerce clause. Notably, this was a unanimous decision that declared unconstitutional the National Industrial Recovery Act, a main component of President Roosevelt’s New Deal.
Chief Justice Hughes wrote for a unanimous Court in invalidating the industrial “codes of fair competition” which the NIRA enabled the President to issue. The Court held that the codes violated the constitutional separation of powers as an impermissible delegation of legislative power to the executive branch. The Court also held that the NIRA provisions were in excess of congressional power under the Commerce Clause.
The Court distinguished between direct effects on interstate commerce, which Congress could lawfully regulate, and indirect, which were purely matters of state law. Though the raising and sale of poultry was an interstate industry, the Court found that the “stream of interstate commerce” had stopped in this case—Schechter’s slaughterhouses bought chickens almost exclusively from intrastate wholesalers and sold completely exclusively to intrastate buyers. Any interstate effect of Schechter was indirect, and therefore beyond federal reach.
Though many considered the NIRA a “dead statute” at this point in the New Deal scheme, the Court used its invalidation as an opportunity to affirm constitutional limits on congressional power, for fear that it could otherwise reach virtually anything that could be said to “affect” interstate commerce and intrude on many areas of legitimate state power.
Justice Cardozo’s concurring opinion clarified that a spectrum approach to direct and indirect effects is preferable to a strict dichotomy. Cardozo felt that in this case, Schechter was simply too small a player to be relevant to interstate commerce.
This traditional reading of the Commerce Clause was later disavowed by the Court, which, after West Coast Hotel Co. v. Parrish (1937) began to read congressional power more expansively in this area. However, more recent cases such as United States v. Lopez, 514 U.S. 549 (1995) perhaps signal a growing inclination in the Court to once again affirm limits on its scope.
1934: Cities in Dust
In March 1934, 37 of the 310 cities with populations over 30,000 were in default, as were three states. Around this same time, gold was set at $35 an ounce ($409 in 1998 money).
In 1936, T. N. Whitehead wrote, “Every advance of industry has so far been accompanied by a corresponding impoverishment in social living”. Industrialization, for all its good points, also leads to unsatisfying work, purposeless activity, class distinctions, class conflict and a disintegrating community life, according to Wilensky and Lebeaux. [Wilensky: 27]
1936-1937: Flint Sit-Down Strikes
The 1936–1937 Flint Sit-Down Strike changed the United Automobile Workers (UAW) from a collection of isolated locals on the fringes of the industry into a major labor union and led to the unionization of the domestic United States automobile industry.
1937: Why Do Firms Exist?
Ronald H. Coase asked in “The Nature of the Firm” why firms exist. Traditional wisdom says, “The normal economic system works itself.” In other words, supply and demand are equilibrated by the self-regulating mechanism of the price system. Firms, on the other hand, are “islands of conscious power in this ocean of unconscious cooperation like lumps of butter coagulating in a pail of buttermilk”. Furthermore, “the distinguishing mark of the firm is the supersession of the price mechanism.”
1937: Fort Knox
Most of the nation’s gold supply was moved to the new US Bullion Depository inside Fort Knox.
1938: Fannie Mae
The Federal National Mortgage Association (FNMA), colloquially known as Fannie Mae, was established in 1938 by amendments to the National Housing Act after the Great Depression as part of Franklin Delano Roosevelt’s New Deal. Fannie Mae was established in order to provide local banks with federal money to finance home mortgages in an attempt to raise levels of home ownership and the availability of affordable housing. Fannie Mae created a liquid secondary mortgage market and thereby made it possible for banks and other loan originators to issue more housing loans, primarily by buying Federal Housing Administration (FHA) insured mortgages. For the first thirty years following its inception, Fannie Mae held a monopoly over the secondary mortgage market.
1938: Fair Labor Standards Act
The Fair Labor Standards Act of 1938 (abbreviated as FLSA; also referred to as the Wages and Hours Bill) is a federal statute of the United States. It applies to employees engaged in interstate commerce or employed by an enterprise engaged in commerce or in the production of goods for commerce, unless the employer can claim an exemption from coverage. The FLSA established a national minimum wage, guaranteed ‘time-and-a-half’ for overtime in certain jobs, and prohibited most employment of minors in “oppressive child labor,” a term that is defined in the statute.
1941: Atlantic Charter
Prior to the Bretton Woods system (see below), and even prior to America’s entry into World War II (December 1941), President Franklin Roosevelt met with Prime Minister Winston Churchill in August 1941 to establish what was known as the Atlantic Charter. Roosevelt and Churchill agreed that the post-war world would need to have stronger interlocking economies, and this agreement helped strengthen trade between England and America. The leaders believed all nations had a right to free trade and a right to use the seaways equally without fear of attack.
The Atlantic Charter, along with Bretton Woods, set the stage for American hegemony from 1945 onward. While Europe was rebuilding, America was left largely unscathed (and less economically diminished, having entered the war much later). By freeing up trade, America was able to dump cheaper goods into the European system and was able to make large loans that would be paid back for years to come. While European nations had little desire to be indebted to American power and finance, they were left with little choice.
1944: Bretton Woods is Established
In July 1944, representatives from 44 countries met at the Mount Washington Hotel in Bretton Woods, New Hampshire and signed the Bretton Woods Agreement. As World War II was winding down, it became clear that an official system was necessary in order to conduct international transactions. Rules and procedures were set up, as well as the basic framework for the World Bank and the International Monetary Fund (IMF), which became operational in the following year.
With the American dollar as its foundation, the nations established a fixed exchange rate. Previously, the gold standard was the primary method to maintain equal exchange. By this point, however, Europe had largely left the gold standard behind (see above). With America’s dollar still being backed by gold (albeit with a value raised to $35 and ounce from $20), there was little visible change from the old system. As long as the dollar was backed by gold and gold maintained its steady value, exchange rates would be fair and strong.
Critics may ask: why the dollar? The strongest currency until World War II was the British pound, but the pound was severely depleted by 1944 due to wartime spending (again). In fact, the pound had become a “supplement” to gold, and not as closely linked to gold as the dollar by this point. The only other nation with strong gold reserves was the Soviet Union, but even though it was allied with America and England during the war, there was an underlying disagreement in their financial systems — which would erupt into the Cold War.
The Bretton Woods system — an expansion of the Atlantic Charter — was a reaction to the problems of the Great Depression, where a lack of a fixed exchange rate left countries unbalanced — depending on the value of a given currency, one nation could lend or borrow from another at a very uneven level, causing one nation to suffer while another prospered. By interlocking the monetary systems, such imbalances would, in theory, be eliminated.
Cordell Hull, the United States Secretary of State, even linked imbalances not just to Depression problems, but also to the root causes of the two world wars. According to Hull, “unhampered trade dovetailed with peace; high tariffs, trade barriers, and unfair economic competition, with war…if we could get a freer flow of trade…freer in the sense of fewer discriminations and obstructions…so that one country would not be deadly jealous of another and the living standards of all countries might rise, thereby eliminating the economic dissatisfaction that breeds war, we might have a reasonable chance of lasting peace.” With free trade on an equal footing, countries that felt “screwed” (such as Germany) would not feel obligated to go after more stable countries (such as England). Whether or not Hull was correct in his beliefs about war’s foundations is outside the scope of this article.
Worth noting is the basic assumption that countries in this system would operate on a capitalistic basis. In order for the system to work, all countries involved had to use similar economic systems. While some countries were more in favor of the free market (the United States) and others more in favor of tight regulation (France), all powers involved had an underlying belief in capitalism that united them financially. As stated above, this basic assumption left one of the most powerful nations — the Soviet Union, who attended the conference but did not sign on — outside of the new world order.
1946: The Employment Act
The Full Employment Bill of 1946 was introduced by Democratic Congressman Wright Patman. The bill mandated that the federal government do everything in its power to attain full employment for American citizens, which was established as a guaranteed right. The President would be required to submit an annual report on the economy (“the Economic Report of President”) along with the national budget. This new report must estimate the projected employment rate for the following fiscal year and must mandate policies to achieve full employment if such a level was not already achieved.
Opposition to the bill as it was worded was strong. Many felt that employment naturally fluctuated, so there was no need to involve the government when employment would naturally rise towards being full, just as it naturally fell at times. The principle of “free enterprise” favored a market with minimal government input.
A compromise bill, the Employment Act of 1946 (notice the missing word “Full”), no longer had the guarantee of full employment and did not require the government to get involved with spending. Wikipedia sum it up: “The final act was not so much a mandate as it was a set of suggestions.” President Truman signed the compromise bill into law on February 20, 1946.
1948-1954: The Marshall Plan
With Bretton Woods establishing the dollar as the international currency, one major problem emerged: the European countries affected by World War II had few dollars whereas the United States had many. Seemingly good for the United States, this greatly reduced international trade and flow of funds because there were no funds to be flowing.
The Marshall Plan was devised. For a decade following the Second World War, the United States gave billions in grants (not loans) to European countries to help them rebuild. This pumped dollars into Europe in order to get economies prospering and flowing again. The Plan also had a significant secondary purpose: funds pushed into pro-democracy areas helped set up a bulwark against the Soviet Union and the alleged growing threat of communism. In essence, America’s “rescue” of the European economy also aggravated the Cold War.
(Problems soon arose wherein the system of using the dollar as an anchor currency meant that America would constantly have to run a deficit in order to keep the system working. The technical aspects of this are a bit beyond my comprehension and I won’t pretend to tackle them here.)
By the end of 1952, the outstanding debt of the US Treasury totaled 61% of GDP.
July 1953: Clark Kerr
Clark Kerr, economics professor and the first Chancellor of the University of California at Berkeley, told Fortune magazine, “A society without strikes, without labor turnover, without business mortality is a society without independence of spirit, self-reliance, competitive urge.” Kerr believed in a “society of accommodated conflict, rather than universal collaboration” standing firm against “the all-embracing party of the Communists and the Fascists, the all-absorbing corporation of Elton Mayo, the all-absorbing union of Frank Tannenbaum, the all-absorbing church of T. S. Eliot.”
1956: Bank Holding Company Act
The Bank Holding Company Act of 1956 increased and improved regulation of “bank holding companies” (companies that own banks). One improvement was that a company could not become a bank owner unless approved by the Federal Reserve Board of Governors. Another was to prohibit a company from owning a bank in a different state than the company’s headquarters. This essentially kept banks localized and reduced the risk of monopoly.
Companies that owned banks were also restricted in their ownership of non-banks. This could be seen as reducing conflicts of interest.
The restrictions placed on these companies was lifted durin the Clinton Administration in the 1990s. The “interstate” restriction was lifted in 1994 through the Riegle-Neal Act, and the restriction on bank holding companies owning non-banks was repealed with Gramm-Leach-Bliley in 1999. For more on this latter act, see the relevant section below.
1964: Barry Goldwater
Barry Goldwater suggested that Social Security be made voluntary, and was considered out of his mind.
July 1966: Alan Greenspan Speaks!
A young Alan Greenspan published an article (“Gold and Economic Freedom”) in Ayn Rand’s Objectivist newsletter. He further called gold the ultimate weapon against inflation, a way for the “owners of wealth” to “protect” themselves against all “welfare statist” schemes to “confiscate the wealth of the productive members of society to support a wide variety of welfare schemes.” Greenspan has also written essays for Rand attacking antitrust and consumer protection laws.
1967: Milton Friedman
Milton Friedman gives a presidential address to the American Economic Association, arguing that if the authorities pushed unemployment below its natural rate, inflation would be inevitable. Friedman’s presidency was a sign that the economic profession had moved right from “Bastard Keynesianism” towards “sadomonetarism”.
March 1968: End of Gold
The outflow of gold from the US to London was so great that the floor of the Bank of England’s weighing room collapsed.
1968: Ginnie Mae
The Government National Mortgage Association (GNMA), or Ginnie Mae, was established in the United States in 1968 to promote home ownership. As a wholly owned government corporation within the Department of Housing and Urban Development (HUD), Ginnie Mae’s mission is to expand affordable housing in the U.S. by channeling global capital into the nation’s housing finance markets. The Ginnie Mae guarantee allows mortgage lenders to obtain a better price for their loans in the capital markets. Lenders then can use the proceeds to make new mortgage loans available to consumers. This also helps to lower financing costs and create opportunities for sustainable, affordable housing for families seeking home ownership.
1970: Freddie Mac
The Federal Home Loan Mortgage Corporation (FHLMC), known as Freddie Mac, was created in 1970 to expand the secondary market for mortgages in the US. Along with other GSEs, Freddie Mac buys mortgages on the secondary market, pools them, and sells them as a mortgage-backed security to investors on the open market. This secondary mortgage market increases the supply of money available for mortgage lending and increases the money available for new home purchases.
February 1971: NASDAQ
When the NASDAQ stock exchange began trading on February 8, 1971, it was the world’s first electronic stock market. At first, it was merely a computer bulletin board system and did not actually connect buyers and sellers. The NASDAQ helped lower the spread (the difference between the bid price and the ask price of the stock) but somewhat paradoxically was unpopular among brokerages because they made much of their money on the spread.
August 1971: The Nixon Shock
As part of the “Nixon Shock”, the United States took the dollar off the gold standard. Fed chair Arthur Burns cautioned, “Pravda would write that this was a sign of the collapse of capitalism.” In August 1971, Nixon closed the Treasury’s gold window, ending the sale of cheap gold.
1973: South Shore Bank
In 1973 the South Shore Bank of Chicago, the oldest and largest community development bank, attempted to relocate from 71st Street and Jeffery Boulevard in the economically declining South Shore to the Loop. At the time, one third of all apartment buildings in South Shore were tax-delinquent and in danger of abandonment by landlords. Angered by the bank’s racist lending practices, community banker-activists Milton Davis, James Fletcher, Mary Houghton, and Ron Grzywinski purchased the bank after successfully petitioning the federal Comptroller of the Currency to stop the move. Urban planner Stanley Hallett was a founding board member and was vice president of the bank’s holding company its first five years.
1973: Bretton Woods Collapses
Less than thirty years after its creation, Bretton Woods collapsed in 1973 after years of serious problems involving the link between gold and the dollar. Most disastrous was America’s involvement in the Vietnam War, and other countries’ failure to support the American military effort there. Gold was leaving the country at an accelerated rate and dollars were being printed in order to cover military costs, boosting inflation to new levels.
The dollar was no longer a reliable anchor currency, being “overvalued” while other currencies were “undervalued”, destroying exchange rates. From this point on the concept of a fixed exchange rate was more problematic and any connection to a gold standard was severed. The only thing keeping the dollar remotely strong was its link to the value of crude oil, an increasingly valuable commodity due to its limited supply and growing demand.
1975: Fixed Commissions
Fixed commissions were abolished, leading to the growth of discount brokers.
May 1, 1976: Kohlberg Kravis Roberts (KKR) is born. They focused on modest deals, smallish companies. The partners would approach a firm, persuade the managers to borrow a bunch of money, and jointly buy the firm. The firm was founded in by Jerome Kohlberg, Jr., and cousins Henry Kravis and George R. Roberts, all of whom had previously worked together at Bear Stearns, where they completed some of the earliest leveraged buyout transactions. Since its founding, KKR has completed a number of landmark transactions including the 1989 leveraged buyout of RJR Nabisco, which was the largest buyout in history to that point, as well as the 2007 buyout of TXU, which is currently the largest buyout completed to date.
1978: Airline Deregulation Act
The Airline Deregulation Act is a United States federal law introduced in the Senate as the “Air Transportation Regulatory Reform Act” by Howard Cannon (D-NV) on February 6, 1978 and signed into law by President Carter on October 24, 1978. The main purpose of the act was to remove government control over fares, routes and market entry (of new airlines) from commercial aviation. The Civil Aeronautics Board’s powers of regulation were to be phased out, eventually allowing passengers to be exposed to market forces in the airline industry. The Act, however, did not remove or diminish the FAA’s regulatory powers over all aspects of airline safety.
Since 1937, the federal Civil Aeronautics Board (CAB) had regulated all domestic interstate air transport routes as a public utility, setting fares, routes, and schedules. Airlines that flew only intrastate routes, however, were not regulated by the CAB. Those airlines were regulated by the governments of the states in which they operated. The CAB promoted air travel, for instance by generally attempting to hold fares down in the short-haul market, to be subsidized by higher fares in the long-haul market. The CAB also was obliged to ensure that the airlines had a reasonable rate of return.
The CAB earned a reputation for bureaucratic complacency; airlines were subject to lengthy delays when applying for new routes or fare changes, which were not often approved. World Airways applied to begin a low-fare New York City to Los Angeles route in 1967; the CAB studied the request for over six years only to dismiss it because the record was “stale.” Continental Airlines began service between Denver and San Diego after eight years only because a United States Court of Appeals ordered the CAB to approve the application.
In 1970-71 the Council of Economic Advisers in the Richard Nixon administration, along with the Antitrust Division of the Department of Justice and other agencies, proposed legislation which would diminish price collusion and entry barriers in rail and truck transportation. While this initiative was in process in the Gerald Ford administration, the United States Senate Judiciary Committee, which had jurisdiction over antitrust law, began hearings on airline deregulation in 1975. Senator Ted Kennedy took the lead in these hearings. This committee was deemed a more friendly forum than what likely would have been the more appropriate venue, the Aviation Subcommittee of the Commerce Committee. The Gerald Ford administration supported the Judiciary Committee initiative.
The 1973 oil crisis and stagflation radically changed the economic environment, as did technological advances such as the jumbo jet. Most of the major airlines, whose profits were virtually guaranteed, favored the rigid system. But passengers forced to pay escalating fares did not, nor communities which subsidized air service at ever-higher rates. Congress became concerned that air transport in the long run might follow the nation’s railroads into trouble; in 1970 the Penn Central Railroad had collapsed in what was then the largest bankruptcy in history, resulting in a huge taxpayer bailout in 1976.
Leading economists had argued for several decades that this sort of regulation led to inefficiency and higher costs. The Carter administration argued that the industry and its customers would benefit from new entrants, the end of price regulation and reduced control over routes and hub cities.
In 1977, President Jimmy Carter appointed Alfred E. Kahn, a professor of economics at Cornell University, to be chair of the CAB. A concerted push for the legislation had developed, drawing on leading economists, leading ‘think tanks’ in Washington, a civil society coalition advocating the reform (patterned on a coalition earlier developed for the truck-and-rail-reform efforts), the head of the regulatory agency, Senate leadership, the Carter administration, and even some in the airline industry. This coalition swiftly gained legislative results in 1978.
Dan McKinnon would be the last Chairman of the CAB and would oversee its final closure on January 1, 1985.
Exposure to competition led to heavy losses and conflicts with labor unions for a number of carriers. Between 1978 and mid-2001, nine major carriers (including Eastern, Midway, Braniff, Pan Am, Continental, America West Airlines, and TWA) and more than 100 smaller airlines went bankrupt or were liquidated—including most of the dozens of new airlines founded in deregulation’s aftermath. But these losses are more than compensated by the advantage to businesspeople and vacationing families, boosting the overall national economy. Supreme Court Justice Stephen Breyer later reflected on the deregulation, saying, “In 1974 the cheapest round-trip New York-Los Angeles flight (in inflation-adjusted dollars) that regulators would allow: $1,442. Today  one can fly that same route for $268.”
1978: Government Mandates Employment
Unemployment was rising in the early 1970s and inflation was reaching new heights… fear of a recession had come to America. To help solve this, a bill was proposed by Representative Augustus Hawkins and Senator Hubert Humphrey (called the Full Employment and Balanced Growth Act) and signed into law by President Jimmy Carter on October 27, 1978.
The Act takes somewhat of a bottom-up position on growing the economy and is considered “stronger” than the Employment Act on which it is based. The four goals of this act are (1) full employment, (2) growth in production, (3) price stability, and (4) balance of trade and budget. In theory, following these guidelines would keep job growth steady, inflation low and prices reasonable for the working family.
The Act was also pushing a liberal, or some may say socialist, economic agenda very slightly in its undertones. Its aims were very idealistic: unemployment was to drop to 3% for persons over age 20 by 1983. Likewise, by 1988, inflation rates were expected to be 0%.
While growth was expected to be in the “private sector”, the government was advised to create a “reservoir of public employment” if needed to meet its unemployment goals. Drawing from the Depression-era lesson that government work is an effective way to boost infrastructure and maintain lower unemployment, these jobs would be designed for lower skilled workers who would not otherwise be competitive in the open market. Discrimination on account of gender, religion, race, age, and even national origin was explicitly forbidden.
August 1979: Paul Volcker
Economist Paul Volcker becomes chair of the Federal Reserve, having been appointed by Carter, bringing the policies of monetarism with him. This was a ruse for driving up interest rates to unprecedentedly high levels to create a deep recession, to break inflation, and with it, to crush the last traces of labor militancy.
The Depository Institutions Deregulation and Monetary Control Act of 1980 was passed by a Democratic Congress and signed by Democratic president Jimmy Carter, before the Reagan years. This is not to say we cannot put blame on Reagan or the Republicans, but clearly not all the blame. The Act removed all interest rate ceilings and gave the Federal Reserve greater control over non-member banks.
More specifically: It forced all banks to abide by the Fed’s rules. It allowed banks to merge. It removed the power of the Federal Reserve Board of Governors under the Glass–Steagall Act and Regulation Q to set the interest rates of savings accounts. It raised the deposit insurance of US banks and credit unions from $40,000 to $100,000. It allowed credit unions and savings and loans to offer checkable deposits. Allowed institutions to charge any interest rates they choose. Required banks be charged Fed Float for use of funds received before clearing between depository institutions.
1980-1981: Reagan and the Gold Standard
Amid rampant inflation, Ronald Reagan (still campaigning at this point) called for a return to the gold standard. Gold prices hit new highs, reaching $850 an ounce in January 1980, but then crashed after Reagan stopped inflation by other means.
In 1981, he appointed a commission to study gold and monetary policy. The commission concluded that a return to the gold standard would not be “fruitful”. Republican Representative Ron Paul of Texas dissented.
1982: Monetarism Ends
The Fed’s monetarist policies end as the US economy falls apart and the financial system made horrible sounds.
1982-1991: The Savings and Loan Debacle
The biggest financial trouble of the 1980s and early 1990s involved the savings and loan institutions and their eventual bailout. Roughly $125 billion was paid by the American taxpayer between 1986 and 1996 in order to save the failing businesses — 747 in the United States had collapsed — which in turn likely led to the recession of the early 1990s. (The housing market was also affected. During the late 1980s, the number of new homes constructed per year had dropped to roughly half of its earlier pace despite no slowing in population growth.)
President Jimmy Carter had tried to help out savings and loan companies in the late 1970s, because due to fixed interest rates the institutions often found themselves losing money — people paying the same rate over a long period of time where the general interest rates sky-rocket would leave the S&Ls covering the unpaid interest. In the year he left office, 87% of all savings and loans institutions had lost money.
The Garn-St. Germain Act of 1982 tried to make S&Ls more competitive, using the method of giving the institutions more power and fewer restrictions. Garn-St. Germain Depository Institutions Act (enacted October 15, 1982) let thrifts get out of housing and into whatever they liked. It was an Act of Congress that deregulated savings and loan associations and allowed banks to provide adjustable-rate mortgage loans. The act was a contributing factor in the savings and loan crisis of the late 1980s. An important consumer change was to allow anyone to place real estate in their own trust without triggering the due-on-sale clause that allows lenders to foreclose on a current loan upon transfer to another. This greatly facilitates the use of trusts to pass property to heirs and minors. It may also protect the property of wealthy or risky owners against the possibility of future lawsuits or creditors, because the trust owns the property, not the individuals at risk. The bill states “… a lender may not exercise its option pursuant to a due-on-sale clause upon … a transfer into an inter vivos trust in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy in the property”.
As history has shown, giving businesses more power and less oversight has its flaws. The S&Ls originally were set up for savings accounts and mortgage loans (hence the simple name, “savings and loan”) but Garn-St. Germain opened up the realm of possibilities. Money could now be borrowed from the Federal Reserve, commercial loans could be made and credit cards could be issued. Another addition was the ability to take ownership in real estate.
This last change was a direct cause of the savings and loan crisis. After the Tax Reform Act of 1986 was passed, much real estate plummeted in value due to new rules denying investors the ability to use real estate holdings as a sort of tax shelter. With savings and loan institutions now invested in real estate (unlike other institutions that may have given out loans for property but not directly invested) they found many of their properties slipping in value and hurting the institutions as a whole. Rather than hurt individual land speculators, average investors who had money in savings and loans were now feeling the pinch through no fault of their own. L. William Seidman, former chairman of the FDIC declared, “The banking problems of the ’80s and ’90s came primarily, but not exclusively, from unsound real estate lending.” When savings and loans were given the power of other banks, they were not given the same restrictions… leading to deregulation and decreased ability to protect the average consumer.
An interesting note is the connection of the crisis to the Bush family. Neil Bush, son of then-Vice President Bush, was the director of Silverado Savings and Loan, which collapsed in 1988. This particular institution alone cost taxpayers $1.3 billion to bail out. Bush had fraudulently run the business, granting $100 million dollars in loans to his business partners. He was ultimately fined $50,000, a fraction of the money his friends were given.
Today, savings and loan institutions are a fraction of what they used to be. Between 1986 and 1995, the number institutions dropped from 3,234 to 1,645 (roughly 50%). People seeking mortgage loans also turned less to savings and loans — in 1975, 53% of such loans were through S&Ls, but only 30% were by 1990.
1983: CMOs Are Born
A collateralized mortgage obligation (CMO) is a type of financial debt vehicle that was first created in 1983 by the investment banks Salomon Brothers and First Boston for U.S. mortgage lender Freddie Mac. (The Salomon Brothers team was led by Gordon Taylor. The First Boston team was led by Dexter Senft).
Legally, a CMO is a special purpose entity that is wholly separate from the institution(s) that create it. The entity is the legal owner of a set of mortgages, called a pool. Investors in a CMO buy bonds issued by the CMO, and they receive payments according to a defined set of rules. With regard to terminology, the mortgages themselves are termed collateral, the bonds are tranches (also called classes), while the structure is the set of rules that dictates how money received from the collateral will be distributed. The legal entity, collateral, and structure are collectively referred to as the deal.
September 1985: Plaza Accord.
The governments of France, West Germany, Japan, the United States, and the United Kingdom, agreed to depreciate the U.S. dollar in relation to the Japanese yen and German Deutsche Mark by intervening in currency markets. The five governments signed the accord on September 22, 1985 at the Plaza Hotel in New York City.
1987: The Keating Five
During the savings and loan crisis, one of the more notable tales of corruption circles around a man named Charles Keating. Keating was the director of Lincoln Savings and Loan, which ultimately went under and cost taxpayers $2 billion. 23,000 investors were defrauded by Lincoln and elderly couples who had invested with Lincoln lost their life savings.
Prior to Lincoln’s collapse, five of Keating’s friends in the United States Senate lobbied on his behalf to keep the government from investigating him and shutting him down. Those five senators, who received a total of $1.3 million in contributions, were the following: Alan Cranston (D-CA), Dennis DeConcini (D-AZ), John Glenn (D-OH), John McCain (R-AZ), and Donald W. Riegle (D-MI). All five were eventually reprimanded by an ethics investigation.
John McCain, who was not ultimately fined or penalized, was criticized for “poor judgment” and McCain has called his involvement “the worst mistake of my life”. He further said: “The appearance of it was wrong. It’s a wrong appearance when a group of senators appear in a meeting with a group of regulators, because it conveys the impression of undue and improper influence. And it was the wrong thing to do.”
1987: Black Monday
October 19, 1987 saw the world’s stock market crash. In America, the Dow Jones Industrial Average went down 22.6%, and other nations were hit even harder. This was (and remains) the largest one-day percentage decline in stock market history, even greater than the stock market crash preceding the Great Depression. New Zealand, the nation most severely hit, saw its stocks fall a total of 60%, crushing their economy for years to come.
Black Monday can be viewed as a fluke and a reminder that market stability is largely a product of human reaction to perceived risks. In 1987, the stock market actually ended higher in December than it opened in January — meaning that despite the crash, the year was still viewed as a success. The exact causes are debatable, but it can be argued that fears of a decline led to the selling of stocks, creating an actual decline. In essence, stock markets run — at least in part — on a self-fulfilling prophecy: belief in a crash will lead to a crash whereas belief in strength will avert a crash.
1988: South Carolina v. Baker
A 1988 Supreme Court decision declared that interest on municipal debt could be taxed. The Supreme Court stated the Congress could tax interest income on municipal bonds if it so desired on the basis that tax exemption of municipal bonds is not protected by the Constitution. South Carolina v. Baker, 485 U.S. 505 (1988), is a case in which the Supreme Court of the United States ruled that section 310(b)(1) of the Tax Equity and Fiscal Responsibility Act of 1982 does not violate the Tenth Amendment to the United States Constitution. The Supreme Court also ruled that a nondiscriminatory federal tax on the interest earned on state bonds does not violate the intergovernmental tax immunity doctrine; this is the case which permitted the federal taxation of bonds issued by U. S. state governments. In this case, the Supreme Court stated that the contrary decision of the Court 1895 in the case of Pollock v. Farmers’ Loan & Trust Co. had been “effectively overruled by subsequent case law.”
January 1989: Roberto Mendoza
In January 1989, Roberto Mendoza, VP of M&A at Morgan Bank, made a speech: “We often read in the press of returns on equity of 800 to 900 percent over a two- or three-year period. Somehow the bias has taken hold that this is an excessive return, or that someone is being exploited. We believe that financial buyers are intelligently using the methodology that many strategic corporate buyers do not use, and that the returns are not excessive; in fact, they are very reasonable. The financial buyer is using leverage in a creative and intelligent manner.” Reasonable or not, such returns are not sustainable.
In July 1990, the early 1990s recession officially began.
Exhibiting their influence on the economy and American society, finance, insurance and real estate (FIRE) surpassed manufacturing’s contribution to GDP in 1991.
“No models can explain the types of patterns we are having. This is really a quite extraordinarily difficult type of environment,” said Alan Greenspan in reference to the recession in October 1992.
In February 1994, a sequence of tightenings by the Fed were announced, a frank attempt to steal some of the populist reformers’ thunder. This same year, the Federal Reserve began hiking interest rates, causing derivatives to blow up all over.
By 1995, the nation had 10,450 banks, 2152 thrifts (savings and loan), 7361 mutual funds, and over 12,500 credit unions. A study by Pearl Meyer and Partners Inc. found that CEOs of big firms earned 212 times what the average US worker did, compared with 44 times in 1965.
On May 9, 1995, Sophia Collier of Working Assets said on CNBC that 40% of S&P 500 stocks are “socially responsible”. This is hard to ascertain. Even Ben and Jerry’s has its slips, with its rainforest ice cream in support of indigenous Brazilians was found to not support them at all, and perhaps even exacerbate social inequity.
In August 1996, the SEC decided that Nasdaq dealers had “colluded to boost profits by harming customers”.
Brooksley Born, chairwoman of the Commodity Futures Trading Commission, sought to extend its regulatory reach into derivatives in 1998. She was overruled by Fed Chairman Alan Greenspan and Treasury Secretary Robert Rubin.
1999: Deregulation Hits Its Stride
Looking back on 1999, the financial bill (and later law) that stands out today is the Gramm-Leach-Bliley Act. While the Glass-Steagall Act prohibited a bank from offering investment, commercial banking, and insurance services (see above), this new Act repealed that decision, in order to provide banks and businesses with more flexibility to make them more competitive. However, with more flexibility comes greater chance of irresponsibility.
The law was actually proposed after certain banks (such as Citigroup) had gone ahead and violated the earlier rules. Rather than forbid them from playing within their boundaries, the politicians caved in to the interests of the financial sector. The reasoning from the banks was that this freedom provided a better service for its customers — they could make investments and savings in a single bank — ignoring the very reasons it had been banned in the first place.
While the bill was proposed by Republicans Phil Gramm, James Leach and Thomas Bliley, and was largely supported by only Republicans in Congress, pro-business Democrats were willing to compromise for a few minor concessions. President Bill Clinton, easily the most pro-business Democratic president to date, was more than happy to sign this into law.
Why this law, seemingly beneficial at the time, is looked back on unfavorably, is due largely to the subprime mortgage crisis of 2007 and the general financial crisis of 2008. Economists such as Robert Kuttner have criticized Gramm-Lech-Bliley as being a contributing factor. Economists Robert Ekelund and Mark Thornton argue that “in a world regulated by a gold standard, 100% reserve banking, and no FDIC deposit insurance” this law would make “perfect sense”, but under the current system it “amounts to corporate welfare for financial institutions and a moral hazard that will make taxpayers pay dearly”.
Also worth noting is that the chief architect of this bill, Phil Gramm, became Republican presidential nominee John McCain’s economic adviser in the 2008 elections at a time when his bill may have been responsible for some of the troubles on Wall Street.
2003: Senate Banking Committee
The Senate Banking Committee held hearings on derivatives in 2003. Fed Chairman Alan Greenspan said, “What we have found over the years in the marketplace is that derivatives have been an extraordinary useful vehicle to transfer risk from those who should not be taking it to those who are willing to and are capable of doing so. … We think it would be a mistake to more deeply regulate the contracts … It seems to be superfluous to constrain trading in some of the newer derivatives and other innovative financial contracts of the past decade …”
In early March 2003, billionaire investor Warren Buffett warned shareholders of Berkshire Hathaway to stay away from derivatives. In his letter Buffett compared the derivatives business to “hell… easy to enter and almost impossible to exit”, and predicted that it would take years to unwind the complex deals struck by its subsidiary General Re Securities. Buffett argued that such highly complex financial instruments were time bombs and “financial weapons of mass destruction” that could harm not only their buyers and sellers, but the whole economic system.
In September 2006, Nouriel Roubini saw the end of the real estate bubble: “When supply increases, prices fall: That’s been the trend for 110 years, since 1890. But since 1997, real home prices have increased by about 90 percent. There is no economic fundamental—real income, migration, interest rates, demographics—that can explain this. It means there was a speculative bubble. And now that bubble is bursting.” On September 7, he said America was following the patterns of other failed economies and would soon collapse.
2007-2009: Subprime Mortgage Loan Crisis, Financial Collapse
In April 2007, New Century Financial filed for Chapter 11 bankruptcy protection.
In June 2007, Bear Stearns, the 5th largest US investment bank, liquidated the assets in one of its hedge funds.
On March 17, 2008, JP Morgan Chase offered to acquire Bear Stearns at a price of $2 per share or $236 million. On March 24, 2008, that offer was raised to $10 per share or $1.1 billion in an effort to pacify angry shareholders. JPMorgan Chase completed its acquisition of Bear Stearns on May 30, 2008 at the renegotiated price of $10 per share. The U.S. Federal Reserve rewarded Bear Stearns’ shareholders in the deal by taking responsibility for $29 billion in toxic assets in Bear Stearns’ portfolio.
The endgame in Bank of America’s $4 billion takeover of Countrywide Financial began with a December 2007 phone call from Countrywide Chief Executive Angelo Mozilo to his Bank of America counterpart, Kenneth D. Lewis. And on January 11, 2008, Bank of America announced it had agreed to buy Countrywide for $4 billion in an all-stock transaction. The stock’s value settled at about $5½ per share following the announcement; it had been as low as $4.43 before the Bank of America deal was announced.
On July 11, 2008, citing liquidity concerns, IndyMac Bank was placed into conservatorship by the FDIC. A bridge bank, IndyMac Federal Bank, FSB, was established to assume control of IndyMac Bank’s assets and secured liabilities (such as insured deposit accounts), and the bridge bank was put into conservatorship under the control of the FDIC. The FDIC announced plans to reopen IndyMac Federal Bank, FSB on Monday July 14, 2008. Until then, depositors would have access their insured deposits through ATMs, their existing checks, and their existing debit cards. Telephone and Internet account access would also be restored on Monday, when the bank reopened. The FDIC guarantees the funds of all insured accounts up to $100,000, and has declared a special advance dividend to the roughly 10,000 depositors with funds in excess of the insured amount, guaranteeing 50% of any amounts in excess of $100,000. Yet, even with the pending sale of Indymac to IMB Management Holdings, an estimated 10,000 uninsured depositors of Indymac are still at a loss of over $270 million.
With $32B in assets, IndyMac Bank is one of the largest bank failures in American history, after the 1984 failure of Continental Illinois National Bank, with $40 billion of assets, and the 1988 failure of American Savings & Loan Association of Stockton, California, due to large losses in mortgage-backed securities. IndyMac Bancorp filed for Chapter 7 bankruptcy on July 31, 2008.
On September 7, the Bush Administration placed Fannie and Freddie into “conservatorship” of the Federal Housing Finance Agency. (This is a euphemism for “nationalization”.)
On Sunday, September 14, 2008, Bank of America announced it was in talks to purchase Merrill Lynch for $38.25 billion in stock. The Wall Street Journal reported later that day that Merrill Lynch was sold to Bank of America for 0.8595 shares of Bank of America common stock for each Merrill Lynch common share, or about $50 billion or $29 per share. This price represented a 70.1% premium over the September 12 closing price or a 38% premium over Merrill’s book value of $21 a share, but that also meant a discount of 61% from its September 2007 price. Congressional testimony by Bank of America CEO Kenneth Lewis, as well as internal emails released by the House Oversight Committee, indicate that Bank of America was threatened with the firings of the management and board of Bank of America as well as damaging the relationship between the bank and federal regulators, if Bank of America did not go through with the acquisition of Merrill Lynch.
The 158-year old Lehman Brothers collapsed on September 15, 2008, filing for Chapter 11 bankruptcy protection.
September 16, the Federal Reserve lent AIG $85 billion in exchange for a nearly 80% stake in its equity — the biggest cash injection into a private company by the federal government ever.
On September 25, 2008, the United States Office of Thrift Supervision (OTS) seized Washington Mutual Bank from Washington Mutual, Inc. and placed it into the receivership of the Federal Deposit Insurance Corporation (FDIC). The OTS took the action due to the withdrawal of $16.4 billion in deposits, during a 10-day bank run (amounting to 9% of the deposits it had held on June 30, 2008). The FDIC sold the banking subsidiaries (minus unsecured debt or equity claims) to JPMorgan Chase for $1.9 billion. All WaMu branches were rebranded as Chase branches by the end of 2009.
On September 29, the Dow Jones Industrial Average crashed, losing a record 777.68 points.
The Troubled Asset Relief Program, commonly referred to as TARP, is a program of the United States government to purchase assets and equity from financial institutions to strengthen its financial sector which was signed into law by U.S. President George W. Bush on October 3, 2008. The Treasury pumped $250 billion into the top nine banks on October 14, and bought minority shares.
Alan Greenspan testified before the Committee on Oversight and Government Reform on October 23. “I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms… I discovered a flaw in the model that I perceived is the critical functioning structure that defines how the world works.”
Chairman Henry Waxman pushed the former Fed chief to clarify his explanation. “In other words, you found that your view of the world, your ideology, was not right, it was not working,” Waxman said. “Absolutely, precisely,” Greenspan replied. “You know, that’s precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well.”
Henwood, Doug. Wall Street: How It Works and for Whom
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