Predicting The Financial Collapse

Dan Boylan
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Wednesday - April 07, 2010

Three banks stood on the main street of the small Michigan town where I grew up. In the mid-20th century, however, only one of them housed a bank. One of the other two served as city hall; the proprietor of the second sold hardware.

But all appeared bank-like - solid, gray, thick places you might want to put your money, as many residents of the area had in the early decades of the century. Then the Great Depression of the 1930s did them in.

It opened up commercial space in former bank buildings across America. In the awful winter of 1932-33, banks tottered in Nevada, Michigan, Maryland, Kentucky, Tennessee, New York, Illinois, Kansas, the District of Columbia - 38 state governors declared bank holidays to determine how secure the funds inside those secure-looking buildings really were. Many reopened, many did not.


Writes historian William Leuchtenburg: “People stood in long queues with satchels and paper bags to take gold and currency away from the banks to store in mattresses and old shoe boxes. It seemed safer to put your life’s savings in the attic than to trust the greatest financial institutions in the country.”

During the first 100 days of Franklin Roosevelt’s administration, the bank holiday was taken national. All banks closed for four days; again, many reopened, many did not. But during that same period of national crisis, Congress passed and FDR signed the Glass-Steagall Act. The legislation contained two important provisions: It separated commercial from investment banking and established the Federal Deposit Insurance Corporation. The latter still gives us all peace of mind.

Don’t get me wrong. “My bank,” Bank of Hawaii, is a very good bank, and I love those friendly tellers and loan officers and branch managers BOH advertises. And Forbes magazine has indeed called it the nation’s “best bank.” But what I like best about it is that the FDIC insures my deposits up to $250,000. That’s enough to cover me.

Sadly, the first-mentioned provision of the Glass-Steagall Act has not survived. In 1999, Congress passed and President William Clinton signed a law that once again allowed banks to mix their commercial and investment banking. That measure marked the acme of three decades of financial deregulation.

“Nadir” is a better word, and the depths to which deregulation and near criminality of the obscenely overpaid men who led and others who failed to regulate the American financial system are explored in Michael Lewis’s new book: The Big Short: Inside the Doomsday Machine.

It tells the story of a small, rump group of men who bet against Wall Street. They saw that sub-prime mortgages bundled into bonds and blithely marked double A or B were doomed. They discovered the future as early as 2005. In retrospect, it should have been obvious.

Mortgage lenders offered sub-prime mortgages to lower- and middle-class Americans at “teaser rates” for two years. Lenders knew full well that many of the mortgages they approved could not be paid back when market rates kicked in.

They didn’t care because they wouldn’t be holding the mortgages. They were selling them to investment banks, where they were bundled into bonds which, when those market rates took hold, saw mortgage default rates soar and solid, gray, thick financial institutions such as Lehman Brothers, Goldman Sachs, Deutsche Bank, Morgan Stanley, Citigroup, Freddie Mac, Fannie Mae and AIG begin to shake.

How did it happen? According to Lewis, because those who ran Wall Street didn’t understand the mortgage-backed securities they were buying and selling. All they knew was that they were making enormous profits and paying themselves outrageous salaries and bonuses. Lewis calls it a “Ponzi scheme” on an enormous scale.

The stock market went south in 2008, as did the American economy. So we, on the advice of men at Treasury and the Federal Reserve who came from Wall Street, bailed them out with 700 billion in taxpayer dollars.

three star

CORRECTION: Fellow Pearl City resident John Walsh took me to task last week for saying that conservative losses in presidential year 1964 had helped get the 1964 and 1965 civil rights bills through Congress. Asked Mr. Walsh, “If the election was held in November 1964 and the Civil Rights Act of 1964 was passed in June 1964, then how could Goldwater’s defeat lead to something that was already done?”

Good point. I erred - badly enough to make an American historian blush. But those new numbers did help with passage of the 1965 bill, Medicare and Medicaid - as argued by this now-scarlet faced historian and columnist.

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