Deregulation: a Major Cause for the Financial Crisis of 2008
A major cause for the financial crisis of 2008? Professor E. Slavai Geoffrey Delbaere August 2013 “When you can create something out of nothing, it is very difficult to resist” Lee Hsien Loong (Prime Minister of Singapore) Introduction On September 15th 2008 the investment bank Lehman Brothers was declared bankrupt. That same month AIG, the world’s largest insurance company, also collapsed. These two events led to a global financial crisis which cost 30 million people their Jobs and doubled the national debt of the USA. It also caused to largest ingle point drop on the stock market in history.
Today we can realize that this crisis was not an accident, it was caused by an out of control industry. Since the start of the 1980’s the financial sector of the USA has risen through the skies. This has led to a series of increasingly severe crises which have caused more and more damage. But this has also led to the fact that the industry has made more and more money. The question that a lot of experts have asked themselves is: What was the impact of deregulation on this latest financial crisis? Along with the boom of the financial ector since the 1980’s, a lot of measures have been taken to deregulate the financial markets.
In my paper I wish to analyze the impact of those measures. A lot of people see this deregulation as the major cause, but a deep study also shows other causes that are more hidden for the public. First I will explain the chain of events that led to this deregulation. After that I will discuss how big the impact was of this deregulation on the financial crisis in 2008. 1) The process leading up to deregulation After the crash of 1929, the US economy experienced 40 years of growth without a ingle crisis. This was due to a lot of regulation.
In 1933 Congress approved the Glass-Steagall Act, or the Banking act, which prohibited commercial banks to speculate with investors’ money. This act arranged a limitation in the affiliation between commercial and investment banks. Until the 1980’s investments banks were very small partnerships. In 1972 the investment bank Morgan Stanley had 110 employees, 1 office and a capital of 12 million dollars. Today, this same bank has 50000 employees, offices around the world and a capital of several billions. In the eginning of the 1980’s, the financial industry exploded because these investment banks went public.
The capital and profits of these banks went way up and people on Wall Street were getting very rich. In 1981 President Reagan set the first step in CEO of Meryll Linch, Donald Regan, as his treasury secretary. This set Wall Street and the president in an eye to eye position, which is a very dangerous liaison. This can be seen as the start of a 30 year period of massive financial deregulation. In 1982 Reagan approved the deregulation of savings and loans companies. This allowed hese companies to make risky investments with their depositors money.
At the end of the decade this decision led to a crisis which cost 124 billion dollars and a lot of people their life savings. A lot of these savings and loans companies had to declare bankruptcy. Because of this crisis, a lot of people went to Jail for fraud and mismanagement of their companies. One of these people was Charles Keating. Before he went to Jail, in 1985, he started realizing that federal regulators were starting to investigate him. He decided to hire Alan Greenspan, a skilled economist. Greenspan publicly said that he supported the methods that Keating was using.
This same Greenspan later became the Chairman of the US Central Bank during the Reagan, Clinton and Bush administration. This can be seen as the second step in bringing Wall Street en politics in the eye to eye position. Alan Greenspan made sure that these three presidents continued to support this upcoming deregulation. Thanks to Greenspan Wall Street started to capture the political system. By the late 1990’s Wall Street was made out of a few gigantic firms. These firms were so large that one ailure could threaten the whole system. The Clinton administration (and Greenspan) helped these firms to get even bigger.
In 1998 Citicorp and Travelers merged to form Citigroup. This merger created the largest financial services company in the world. This was a huge step towards deregulation because it violated the Glass- Steagall act. This means that this merger was actually illegal but Alan Greenspan said nothing, the Federal Reserve gave the merger an exemption for a year. The year after this merger, Congress accepted the Gramm-Leach-Bliley act, also called the Citigroup elief act. This act overthrew the Glass-Steagall act and made way for future big mergers.
At that point in time banks started to realize that the bigger they became, the higher the whole financial system is dependent on their survival. Through this way they understood that if their business would go bad, they would be bailed out by the government. This cleared the way for some very risky investments. At the end of the 1990’s the USA was struck by yet another crisis: the dotcom bubble. The big investment banks had put a lot of money in internet stocks. This crash led to a loss of trillion dollars. Investment banks had promoted internet companies they know would fail.
Stock analysts were being paid on how much business they brought in. This means they wanted to sell as much as they possibly could. The Securities and Exchange Commission (SEC), which was created during the Great Depression of 1929 to regulate investment banking, did nothing. This deregulation and advance in technology led to the explosion of very complex financial products: derivatives. Using these derivatives, bankers could now gamble on virtually everything (e. g. oil prices, ankruptcy of a company, weather,… ) At the end of the 1990’s these derivatives were a 50 billion dollar unregulated market. ;/