With the repeal of Glass-Steagall, big banks had no incentive to measure risk seriously
San Francisco, CA -- (SBWIRE) -- 08/23/2013 -- Thanks to the FDIC, big banks have a deal a gambler can only dream of. When they take big risks, they can win big and if they lose, the FDIC safety net and the taxpayer picks up the tab. Even if they bet the house and lose, they can count on a too-big-to-fail government bailout, where the taxpayer picks up the tab again.
High-risk investments by financial firms, according to the 2011 Financial Crisis Inquiry Commission (FCIC), were the main cause of the financial meltdown. “We conclude dramatic failures of corporate governance and risk management at many systemically important financial institutions were a key cause of this crisis…,” went the report. “Many of these institutions grew aggressively through poorly executed acquisition and integration strategies that made effective management more challenging. The CEO of Citigroup told the Commission that a $40 billion position in highly rated mortgage securities would ‘not in any way have excited my attention,’ and the co-head of Citigroup’s investment bank said he spent ‘a small fraction of one percent” determining the risk of these investments. Why should he? They are backed up by the federal government essentially. “Too often, risk management became risk justification.”
The repeal of Glass-Steagall in 1999 was the “fundamental change in these institutions” that led to this type of carefree mentality. In 1933, Glass-Steagall was enacted to correct the carefree mentality that led to the stock market crash of 1929 and the subsequent Great Depression. The law separated investment banks, not FDIC-insured, from commercial banks, insured but severely restricted in investment scope. Governed by the Federal Reserve Bank, commercial banks are restricted in the amount of risk they can take on in their investments.
In the late 1990s, Citicorp and Travelers Insurance wanted to merge but Glass-Steagall prevented the merger. Sandy Weill, the head of Travelers, and Citicorp CEO John Reed convinced President Bill Clinton, a majority of Congress and Treasury Secretary Robert Rubin to repeal Glass-Steagall. In less than a decade the “dramatic failures of corporate governance and risk management”, as the FCIC puts it, led to the financial meltdown.
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