Comparing 1928/1929 with 2004/2005
Between 1928 and Aug 1929 (2004 and 2005) the Fed targeted speculators in the stock market (mortgage/securitization) in an effort to halt excessive speculation, they certainly succeeded! Between 1929 and 1931(2006 and 2007) 5 of 6 financial institutions that failed were non regulated financial institutions.
For the next 18 months (depending on when you date the crisis to) the Government said the problem was confidence. When they finally began to address the problem, close to a change in Presidency, they first banned short sales (yes, both times) and then passed a rushed bank solvency bill that failed (yes, both times). Banks and the business classes continued to hoard partly out of uncertainty about the tax policies of the incoming Administration.
When FDR came to office he immediately closed the banks and only allowed the healthy ones to reopen. He then used the RFC in a manner different than his predecessor to finally get it right – unfortunately FDR tax policies kept us weak through the beginning of WWII. This Admin has, as announced yesterday, allowed the sick to get sicker, failed to do anything close to a real bank cleansing and is now proposing increased taxes on the business class.
Systemic risk regulators are only needed where they allow institutions to become systemically risky! For over 70 years we had banks that didn’t become systemically risky. I would propose that the concentration limits on deposits worked (in a world in which banks were deposit funded) in preventing systemic risks among banks. The systemic risk grew because as banks transitioned from deposit funding to capital markets funding we did not create any comparable rule to the deposit concentration rule. This allowed certain banks to become concentrated in being funded by, funding and intermediating in the capital markets.
The Fed is a liquidity regulator (a very good one) but it has no real skills in regulating credit risk (it had wanted to get rid of the leverage ratio and had it been successful all banks would be imperiled). It can’t work as a reputational risk regulator and it is unclear if anyone has the skills to oversee systemic operational risk.
Instead of a systemic risk regulator we should modernize the concentration rules to include deposit concentration limits and market concentration limits. It was leverage, not profitability, that allowed the big buys to get so big.
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February 27th, 2009 at 10:47 am
Josh- Interesting take. The 70 year span in which you say that the banks were not allowed to become systemically risky did however include the S&L busts of the 1980′s. Between 1985 and 1996, I think there were about 747 thrifts that were shuttered. Many of the S&L’s were caught up in the same real estate speculation and so it seems that they had become systemically risky. When real estate prices fell, the thrifts were all caught at the same time.
February 27th, 2009 at 10:58 am
There was systemic risk, there were not unmanageable and systemically risky institutions. Remember from 1987 to 2007 the Fed regularly pointed out that they had learned a lot from LTCM and, they claimed, ‘any institution could be wound down with manageable consequences. It is just a matter of time and liquidity’. I a short period, because of concentration of capital market funding, we now have claims of ‘too big to fail’.
February 27th, 2009 at 11:21 am
Great Depression Quotes 1929 vs 2008: Have We Learned Anything?
http://www.chartingstocks.net/2009/02/great-depression-quotes-1929-vs-2008-have-we-learned-anything/
a similiar, though different, take on the meme..
February 27th, 2009 at 1:01 pm
What was done this time was the same thing that was done pre 1929. Interest rates were artificially lowered until everyone was drunk on easy credit. Then credit was curtailed and the Fed cranked up interest rates sharply which off-footed the whole economy and caused a huge stumble. Viola! Cheap labor, cheap equities and cheap property
February 27th, 2009 at 7:19 pm
WOW! The parallels are truly amazing.
Generational forgetfulness and learning yet to occur.
The Savings and Loan thing of the late 80s and early 90s was exactly the same, except it was more contained to idiots believing real estate limited partnerships were a good thing. Ooops. Not nearly enough people went to jail over that one, which is still being handled in class action suits.
It was confined. Major banks were not major players. There was still enough seasoned corporate management in place to know better.
This time, the geniuses that knew it all knew very little. But they were geniuses by virtue of their position. And we all get to pay.
March 1st, 2009 at 7:34 am
“I would propose that the concentration limits on deposits worked (in a world in which banks were deposit funded) in preventing systemic risks among banks. The systemic risk grew because as banks transitioned from deposit funding to capital markets funding we did not create any comparable rule to the deposit concentration rule.”
dead on.
“too big to fail” must be appropriately addressed: let nothing become too big & let everthing be allowed to fail. Both must be addressed. The start of regulatory list follows:
Also, reimpose Glass-Steagal to split bank/insurer solvency from WS solvency, subject CDS’s to an insurable interest requirement and subject their writers to over-collateralization, turn the the rating agencies into regulated public utlities with a very well-paid staff, mandate “skin in the game” for loan/mortgage originators, require F&F prime conforming loan rules on loans in non-F&F MBS’s except for size req. on jumbos, get rid of off-balance-sheet, mark-to-market at least quarterly rather than annually and strengthen MTM on Tier 3, outlaw CDOs and tranched CMO’s for their opacity–pure pass-through MBS would be the only mortg. securitization, outlaw/eliminate products and/or their uses for regulatory arbitrage, keep ban on uptick rule (rule is irrelevant other than as an excuse to dismiss market valuations) but prosecute fully naked shorts.