Changes to the US banking industry review

Module 4 discusses the changes to the US banking industry that occurred during the 1990s and into the early 2000s. These were the first major changes in decades. The prior major change was the introduction of the Glass-Steagall Act in the 1930s, and the changes discussed in the module essentially undid much of that act.

One of the key elements in Glass-Steagall was the separation of investment banking and commercial banking activities (Heakal, 2015). One of the reasons for this separation was that investment banking was inherently more speculative, and there was a recognition following the 1929 stock market crash that even if investment banking suffered significant volatility, the nation’s economy relies on having a stable commercial banking environment. Olson (2002) noted that the 1999 Gramm-Leach-Billey Act basically dismantled Glass Steagall.

One of the other key things that Glass Steagall prevented was investment bank speculation in commercial activities, such as residential real estate. The backdrop to this study is that after Gramm-Leach-Billey, investment banks began to seek out commercial banking income, not as much by buying commercial banks, but by creating investment funds in real estate. The commercial banking and real estate markets were completely unprepared for this influx of capital, and by Olson (2002) so was the Federal Reserve. A radical change in residential real estate markets occurred, and the outcome was basically that a lot of speculative money went into real estate, new investment vehicles were created and sold, but the market did not fully understand these vehicles or their risk.

There are certainly other factors –bond rating agencies also did not effectively convey the risk of these vehicles – but this was a major cause of the financial implosion in 2007-2009. These investments grew rapidly because of low interest rates that made housing affordable for many, but ultimately the risks of these products were revealed, and this created chaos not just in residential real estate but for any institution, government or investor holding a significant amount of these products in their portfolio.

The first three modules look at different aspects of the financial system. The first module is interesting in that it covers buyer behavior in terms of payments, in particular the adoption of new payment formats. As we shift from a cash society, to one where card payment is common, there are all these emerging new payment forms and these are changing the way that consumers behave because they lower barriers to making transactions.

Module 2 talks about banking regulations, going back to the creation of the Federal Reserve, Glass-Steagall, and eventually Gramm-Leach-Billey, and Dodd-Frank. One of the key roles of regulation is to ensure investor and consumer confidence in the banking system, but there seems to always be this tug between doing that and allowing banks to pursue innovation and new profit opportunities. There is a case discussion about United Federal Credit Union, as a different sort of retail banking model, owned by the members instead of shareholders, and how the credit union has had to evolve to meet the needs of its owner/customers.

Module 3 discusses the role of money in our economy, and in particular things like inflation that can devalue the role of money. It is important to contain inflation in order to preserve people’s wealth – inflation is a key factor in individual investment decisions, although there are certainly other factors as well.

All of these elements go into what our banking system looks like, and how we as individual interact with the banking system, in our daily lives. This is valuable information because it informs us of why banking regulation and banking issues are important – the different ways that they can affect us.

Module 4 Class Discussion

Part 1:

I am certainly concerned about the possibility of inflation. The large amounts of stimulus, especially the successive rounds of quantitative easing, were intended to kickstart the economy. With a lower cost of capital, firms would be more willing to take risk. However, just because an American firm has easy access to capital does not mean that they will spend that money in the United States. Capital moves around the world fairly freely, which means that a company can borrow in the US and then invest overseas. American companies are some of the most international anywhere, so this is a real possibility – that these companies will pursue growth where they find it, not necessarily in the US.

Because of that, I see risk in pumping too much money into the US financial system right now. It may not help with unemployment as much as is desired, which means there might be a lot more quantitative easing, lasting for several years. I feel that this could tip into the realm of too much stimulus, which would create inflationary pressure.

Further, if there are weak impacts on unemployment, the Fed will be hesitant to raise rates in order to address that inflationary pressure. It seems reasonable that they would fear harming employment, even at a time when there is clear inflationary pressure. So while the Fed has the tools that it needs to manage the economy, there may be political implications that make it hesitant to wield the full force of these tools. Instead, the Fed might continue to pump money into the economy for longer than it should, if faced with a choice between inflation and unemployment. So there is a need for this new money to be focused, more in terms of fiscal policy, than to simply come from monetary policy, where the Fed cannot actually control how it is used.

References

CFtech.com (1998). Understanding how Glass-Steagall Act impacts investment banking and the role of commercial banks. CFTech.com. Retrieved October 28, 2017 from http://www.cftech.com/index.php/the-brainbank-archive/special-reports/404-understanding-how-glass-steagall-act-impacts-investment-banking-and-the-role-of-commercial-banks

Heakall, R. (2015) What was the Glass-Steagall Act? Investopedia. Retrieved October 28, 2017 from http://www.investopedia.com/articles/03/071603.asp

Olson, (2002) Remarks by Governor Olson. Federal Reserve Bank of St. Louis. Retrieved October 28, 2017 from http://www.investopedia.com/articles/03/071603.asp

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