Bidness History 101

Not that I expect anyone to actually read this....


Here's how our economy went over the cliff:  Historically banking was a fairly mundane business.  Banks paid depositors a small percentage interest, charged borrowers a higher rate of interest, and the gap in the middle was their profit.  They matched up those who had an excess of money (depositors) with those who needed money (borrowers).  It was called 3-6-3 banking...they paid depositors 3%, charged borrowers 6%, and were on the golf course by 3pm.  Every small town had their own bank and everyone knew the banker and the banker knew all the townspeople.  They knew who was a good credit risk and who wasn't.  They thought long term, hopeing to help you start and grow a business and become your banker for life.  Banking was NOT a "get rich quick" profession.


Occasionally they strayed and began bankrolling speculators in exchange for higher returns for themselves, but things usually ended badly.  (Think:  The Great Depression)  After that fiasco the government passed all kinds of new laws hopeing to prevent a recurrence, the big one being the Glass-Steagall Act.  It said commercial banks (the ones where you put your paycheck) were given FDIC protection, but were limited to the very mundane types of banking ONLY (see above).  Investment banks such as Goldman Sachs, Bear Stearns, etc were NOT given FDIC protection, but were allowed to gamble with their "investors" money with the hope of hitting a home run....higher risks, higher returns.  Brokerage firms could buy and sell securities, but could not do what commercial or investment banks could.  These firewalls kept our financial system out of serious trouble for the next 50 years.


With the wave of deregulation begun by Jimmy Carter and Ronald Reagan these various types of financial service companies began eyeing and envying the others.  The firewalls began to spring leaks.  Commercial banks wanted to be able to gamble like the investment banks hopeing for a home run for themselves.  The investment banks thought if they had the HUGE piles of depositor's money to play with like the commercial banks did they could before long own the world.  With individual investors, mutual funds, and pension funds, etc, seeing the potential for nice returns on Wall Street, the volume of stocks traded went from a few million to eventually several billion a day.  And remember, brokerages are paid by the number of shares traded, NOT whether the market goes up or down.  The banks wanted some of that, too.


Little by little they were allowed to stray a bit farther from their roots.  The small town banks were largely bought up by the regional "downtown" banks, who were in turn absorbed by the "money center" banks such as Citi and Bank of America.  Their power became enormous and they learned how to exchange "campaign contributions" for Washington favor.  Finally, in 1999, Congress passed the Gramm-Leach-Bliley Act which killed off Glass-Steagall.  The firewalls were removed.  Banking became a highly desirable "get-rich-quick" profession.  Banks became less focused on helping their neighbors establish and grow businesses and more focused on devising new products to sell (such as "derivatives") which could generate almost unimaginable profits for their stockholders and immense commissions for themselves.  There was little reason to make "prudent" loans (well, they had to look prudent at least long enough to sell them) as the risk was passed on to those who eventually bought these new financial products.  


Greed ruled.  And then the wheels came off.  Some other time I'll explain what happened next.


S


NOTE:  I would welcome any feedback correcting this post if I have gotten something wrong.  Factual constructive criticism would be appreciated.