Did we learn anything from the crash of 1929?
By Melvin J. Howard
The Depression brought with it numerous regulatory decisions that stayed with us for a long time. Here are a sample of four major areas and the status of them today:
Utilities Regulation: In 1935 the Public Utilities Holding Company Act or PUHCA was introduced to provide national supervision of the gas and electricity utilities in order to prevent their excesses of the 1920s. In the twenties big utilities had been buying up smaller ones, hiking up consumer prices, expanding into unrelated businesses, loading up on debt, hiding losses from investors, and milking their subsidiaries and affiliates to prop up their own earnings. Sound familiar? Many people have reminded us of this law in the aftermath of the Enron collapse and Enron's various exemptions from it amidst recent recommendations by everyone from the Senate Banking Committee to the SEC to have this law repealed.
Exchange and Accounting Regulation:
The Securities and Exchange Commission (or SEC) was established in 1934 under the Securities Exchange Act. During the 1920s there was effectively no Federal oversight of the securities markets, and with the market rising in the 1920s, and banks more than willing to lend for stock speculation, this created a recipe for disaster. The SEC was created to oversee market players in the securities markets and to require truthful quarterly reporting from publicly traded companies what happened? This is in part due to conflicts of interest rife throughout the financial world but also due the sheer complexity of financial transactions available to all companies and the absence of regulation on the most risky of financial transactions.
The Social Security Act:
Before the Depression there was no federal safety net for unemployed, disabled or retired persons. As often happens today the safety net was usually picked up by various charities and religious organizations. But this safety net collapsed during the Depression because of the collapse in confidence in the financial system. By necessity and through public pressure that had built up over the years the Social Security Act was born in 1935 and provided for old-age and unemployment benefits. Today, of course, this depression era safeguard is under attack with financial companies pushing for its privatization.
The Heart of the Financial System:
Finally the big one the regulation of the system that stands at the heart of the entire financial infrastructure the banking system. The big act affecting the banks and securities dealers was the Glass - Steagall Act of 1933 that brought radical changes and better supervision to the banking industry. This act separated deposit banks, where depositors expect to safely park their money, from more speculative players such as securities dealers and investment banks that could make depositors' money disappear through gambling and that is what exactly happened in the 1920s. The Federal Depository Insurance Corporation or FDIC was set up in 1933 to provide insurance on depositors' funds in the event of bank failure. This was necessary to restore confidence in the foundations of the monetary system - the banks - that had just seen run after run, failure after failure, and depositors had seen their money disappear right before their very eyes.
Interestingly various controls and regulations were put on the Savings and Loans institutions. This was all to be undone through the Ronald Reagan administration in the 1980s. As we now know the undoing of these regulatory checks and balances precipitated in the Savings and Loans debacle of the 1980s that could have brought down the world financial system, except that the US taxpayer saved the day with a high priced bailout. To restore confidence in the banks and therefore rebuild the monetary system 1933 saw the birth of federal deposit insurance under the FDIC or the Federal Depository Insurance Corporation. This insurance would guarantee that depositors would get all or most of their money back in the case of bank insolvency. It was realized that this insurance created a moral hazard for banks. Because deposits were backed by the Federal Government banks they had more of an incentive to take more risks. They could get more deposits by promising a higher return to depositors. With this money they could invest in riskier higher return assets to get higher profits and the depositors wouldn't be too worried about this because they knew there was federal insurance on their deposits. This realization brought in a law that forbade paying interest on checking accounts so that banks couldnt do this. The separation of banks and other financial operations under Glass-Steagall also helped to prevent this undesirable risky behavior of banks.
These regulations of banking are the heart and soul of the financial system. Federal Insurance means backed by the US taxpayer. With the repeal of Glass-Steagall protections in 1999 nobody seamed to have remembered the lessons of the 1980s, let alone the lessons of the 1920s! Now we are here in 2008 smack dab in another change in regulation. The Fed is about to get sweeping new powers to reign in wall street and the mortgage industry to streamline oversight will this be enough? The law of Qunatumnomics suggests that the universe is at a constant change it is inevitable. So back to my original question will this be enough. No it will never be enough there will be new and fancy financial instruments and new market participants. What we can do is understand change and adapt to that change. My theory of Quantumnomics is a start in understanding that change. So back to school and sign up for science and physics this with your MBA should get you a head start.
