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TIME TO REVISIT GLASS-STEAGALL? PDF Print E-mail

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Return of the Jedi?
In the 1930s J.P. Morgan experienced huge losses on the firm's investment in railroad bonds.  At the time, many railroads were strapped for cash and considered extremely risky investments.  The losses on its railroad bonds eventually eroded J.P. Morgan's capital position.  In an effort to raise capital, the company then hawked stock in initial public offerings (IPOs) to the public of which J.P. Morgan earned investment banking fees for.  The fees earned from underwriting the IPOs were then used to sure of its capital base from loan losses to the railroads.  Many of these IPOs were for companies with dismal business prospects and some speculated that the companies raising capital would not have been deemed worthy had Morgan's own firm been on stronger financial footing.  Morgan had effectively pulled off one of the first "Jedi Mind Tricks:" (i) hawk risky investments to the public, and (ii) take the huge fees from underwriting such securities to improve your own capital base.  Of course, many of the companies failed post-IPO and the public was outraged that Morgan had betrayed its trust.  

 

Glass-Steagall Act 

Congress and the Senate soon after enacted the Glass-Steagal Act which separated commercial banks and investment banks.  The logic was that investment banks which engaged in riskier lines of business were also exposed to huge potential losses.  That said, the government wanted to (i) protect bank depositors from potential volative losses experienced by investment banks and (ii) to reduce the temptation of investment banks to bilk the public to recoup those losses.  After years of lobbying efforts by both commercial banks and investment banks, Glass-Steagall was repealed in 1999 by a Republican-led Congress.  The popular argument for its repeal was that "The era of Glass-Steagall was over 60 years ago.  Times have changed." 

Today

During the current economic meltdown, investment banks and commercial banks have earned huge fees and bonuses from investments in mortgage-backed securities, credit default swaps and private equity loans.  When those investments did not pay off, certain firms have gone bankrupt or faced near-bankruptcy.  Those who were able to stave off bankruptcy did so through TARP funds provided by taxpayers, with the argument being that certain firms were too big to fail, and we ran the risk of becoming a third world country if government did not offer bailout funds.  In recent weeks, President Obama has called for more oversight and transparency as it pertains to the financial services industry.  The solution may be to (i) reinstitue Glass-Steagall, separating investment banks and commercial banks and (ii) strongly enforce Sarbanes-Oxley which forces companies to attest that their financial statements are true and accurate. 

Below is the link to the article where President Obama calls for Wall Street reform.  The arguments he makes are almost identical to those made by Congress, and the public, in the 1930's.  

http://news.moneycentral.msn.com/provider/providerarticle.aspx?feed=OBR&date=20090225&id=9643657

Where to Purchase Shock Exchange's New Book

SHOCK EXCHANGE How Inner-City Kids From Brooklyn Predicted the Great Recession and the Pain Ahead is out on:

Amazon (Kindle) www.clicky.me/kindleedition

Kobo ( http://www.kobobooks.com/ebook/Shock-Exchange-How-Inner-City/book-pXAKPUIoTUaLwNQhQF0sVA/page1.html )

Itunes: www.clicky.me/itunes

eBookPie: www.clicky.me/ebookpie

Copia ( http://www.thecopia.com/catalog/search.html?key=isbn%3A9780615678788&x=0&y=0 )

Baker and Taylor ( http://www.baker-taylor.com )

Gardners Books ( http://gardners.com/gardners/StockSearch.aspx )

Barnes & Noble (NOOK) [OPEN]

 

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