By Melvin J. Howard
Banking and the Depression
Under the old or classical world view central bankers use more or less traditional techniques for exercising some control over the economy, and a large part of this is maintaining the confidence of the markets in the monetary system. So people that don’t have much money don’t factor into central bankers decisions very much. On the surface many might think that there is no relationship between the Federal Reserve and the poor to speak of. However this ignores the interconnectedness of everything and this is perhaps best considered within the context of the "Zero Sum Game" that I spoke about earlier.
As income and wealth gaps have widened few people have more money, and the majority of the people are getting less. Many of those that have accumulated lots of the money go looking for lots of places to invest it, so that it will make more. This has lead to an explosion in non-bank financial institutions and the use of corporate bonds in lending. Neither mechanism "creates money by printing it" because the players’ don’t have a banking license. But because the players have accumulated so much of the existing money they can become financiers themselves by lending out the piles of dough they’ve accumulated. Thus, according to Martin Mayer in the book "The Fed", only one fifth of commercial and industrial financing now comes from the banks. The rest comes from people and non-bank institutions that have accumulated lots of the existing money.
This has several implications. First the Feds powers over the market is getting more limited because there are so many non-bank financiers, so the Fed has to do whatever it can to please these non-bank markets and keep their confidence in the whole financial system alive. By necessity this means always pleasing the people that already have lots of money. Second, banks go looking all over the place for new people and entities to lend to since the domestic non-bank corporations abandoned them. This search has been a big part of banks overseas lending adventures and the phenomenal growth in lending to the sub-prime domestic markets over the past decade. This loan market has grown 300% from about 75 billion in 1993 to over a Trillion Dollars today. Previously the banks wouldn’t touch this market with a ten-foot pole, but in their search for new borrowers, especially at high yields, this was a huge growth area.
In past years the practice of redlining has been common amongst banks, whereby banks mark maps with a red marker for areas they would and wouldn’t lend to and these distinctions were often made along racial lines. These days a similar map marking process might be used to distinguish between prime and sub-prime markets that is, who gets access to credit on reasonable terms and who gets lumped into the sub-prime category which is where the exploitative terms of credit prevail.
Public concern over discriminatory practices in lending and the limited availability of credit in poorer neighbourhoods lead to the passing of the Community Reinvestment Act (CRA) in 1977, under which bank examiners are supposed to check banks record of meeting the credit needs of the entire community including low to middle income groups. This means that the Federal Reserve has some responsibility for this but, as already noted, the Fed is mostly concerned with monetary policy, which means making sure that people that have the most money keep confidence in the monetary system. So as Martin Mayer points out in "The Fed", "discrimination against low income people in lending operations was a subject guaranteed to be of no interest to the Federal Reserve System". And as Kenneth Thomas, a Wharton School lecturer on finance points out, "banks are always happy with the ratings given by the easiest CRA grader in the business", meaning that the Fed doesn’t take the CRA review of banks too seriously.
Mayer also notes in "The Fed" that "Both publicly and privately, the Fed has always refused to acknowledge the existence of discrimination in any part of the American banking system." Consistent with this observation the Fed has behaved rather anti-socially during the approval process for mergers and acquisitions with respect to complaints filed with it regarding unfair and exploitative lending practices. Basically it has ignored consumer complaints and public concerns. The American Banker daily paper reported, in reference to the Greenlining Coalitions request for a hearing on the takeovers of banks, that "Comparing the Feds approval to "Alice in Wonderland" where a verdict is reached before the trial, the SanFrancisco-based umbrella group for 37 religious, minority and ethnic organizations said the hastily crafted approval process would embarrass even an old style Banana Republic Regime". That same issue of American Banker contained another story about Citigroups alleged gag orders on ex-employees about abusive and fraudulent practices in its sub-prime lending unit. The relationships between the Fed and the big banks are all just too cozy for public comfort.
We should just note the interesting results of one of Mr Greenspans recent data analysis projects when he was Chairman. The June 4, 2001 edition of Business Week reported on a study commissioned by the Fed that found that 50% consumer spending in the year 2000 was attributable to the top 20% of income earners. Also, amazingly, 80% of directly held equity or stocks was attributable to the top 20% bracket. The conclusion of this study was that the economic boom of the middle to late 90s was almost entirely driven by the spending of the top 20% of earners, whose spending in turn was driven by confidence derived from an inflated equity market. Now that the markets are sliding this spending has stopped, we are sliding into recession, and layoffs are increasing in response to low company earnings. What then is a Federal Reserve Chairman to do? It seems his role is to keep the stock markets up and keep the top 20% - the speculator class - happy. So maybe its not just that the poor are irrelevant to the Feds decisions, but the irrelevancy may run as high as 80% of the American people! Not to mention the rest of the world. Remember the crash of 1929 Herbert Hoover was President at the time. In the subsequent depression neither his administration nor the Federal Reserve did very much to bring the country out of the depression back then. This helped to get FDR Franklin D. Roosevelt elected and he took office in 1933. FDR inauguration speech of 1933 where every man and his dog remembers but nobody seems to remember it now so lets go back where he took office.
"The only thing we have to fear is fear itself".
But how many people remember the other parts of the speech where FDR is talking about the bankers and the Wall Street?
Excerpts from FDR 1933 Speech:
" And yet our distress comes from no failure of substance. We are stricken by no plague of locusts. Compared with the perils which our forefathers conquered because they believed and were not afraid, we have still much to be thankful for. Nature still offers her bounty and human efforts have multiplied it. Plenty is at our doorstep, but a generous use of it languishes in the very sight of the supply.
Primarily this is because the rulers of the exchange of mankind's goods have failed, through their own stubbornness and their own incompetence, have admitted their failure, and abdicated. Practices of the unscrupulous money changers stand indicted in the court of public opinion, rejected by the hearts and minds of men.
True they have tried, but their efforts have been cast in the pattern of an outworn tradition. Faced by failure of credit they have proposed only the lending of more money. Stripped of the lure of profit by which to induce our people to follow their false leadership, they have resorted to exhortations, pleading tearfully for restored confidence. They only know the rules of a generation of self-seekers. They have no vision, and when there is no vision the people perish.
Yes, the money changers have fled from their high seats in the temple of our civilization. We may now restore that temple to the ancient truths. The measure of the restoration lies in the extent to which we apply social values more noble than mere monetary profit.
Happiness lies not in the mere possession of money; it lies in the joy of achievement, in the thrill of creative effort. The joy and the moral stimulation of work no longer must be forgotten in the mad chase of evanescent profits. These dark days, my friends, will be worth all they cost us if they teach us that our true destiny is not to be ministered unto but to minister to ourselves and to our fellow men.
Recognition of the falsity of material wealth as the standard of success goes hand in hand with the abandonment of the false belief that public office and high political position are to be valued only by the standards of pride of place and personal profit; and there must be an end to a conduct in banking and in business which too often has given to a sacred trust the likeness of callous and selfish wrongdoing. Small wonder that confidence languishes, for it thrives only on honesty, on honour, on the sacredness of obligations, on faithful protection, and on unselfish performance; without them it cannot live."
"And finally, in our progress toward a resumption of work we require two safeguards against a return of the evils of the old order; there must be a strict supervision of all banking and credits and investments; there must be an end to speculation with other people's money, and there must be provision for an adequate but sound currency."
And so the process for implementing regulation to provide checks and balances and bounds on the markets began. For it is only after such a collapse that Wall Street actually realize that their success in their own game does ultimately depend on the people's willingness to play in it. The regulatory blitz included all the landmark laws.
The 1933 Glass-Steagall Act built a wall between banks which are essentially the guardians of the publics money and the brokers and investment banks who are the primary speculators in the exchanges. This would prevent privileged bankers from gambling with other people's money to make profits for themselves. Glass-Steagall also separated these institutions from insurance companies who took on a completely different set of risks. To restore confidence in the banks and therefore rebuild the monetary system 1933 also 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 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 couldn’t do this. The separation of banks and other financial operations under Glass-Steagall also helped to prevent this undesirable risky behavior of banks. Good times always make us forget the bad times. Although I was not born yet when it comes to the crash of 1929 we should all remember what got us there in the first place.
