The high cost of cheap money

What is a bank? How does a bank work?

You’d think these would be obvious and easily answered questions, especially now that everyone with a byline is a five-minute expert on Silicon Valley Bank. (My editors just informed me of that The broadcast was an SVB customer and would like it noted for the sake of full disclosure, which it has now been.) But as usual, it’s a little more complicated than the politicians would have you believe.

For years, we’ve heard progressive (and sometimes right-wing populist) politicians and their media friends insist that the 2007-08 financial crisis could have been avoided if not for the 1999 repeal of the Glass-Steagall Act, a package of Depression-era banking regulations , which, among other things, created the FDIC. That claim is, and always has been, almost complete poppycock. Glass-Steagall regulated the affairs of commercial banks—that is, the kind of banks where ordinary people open checking and savings accounts, take out personal loans, etc. But the companies at the center of the 2007-08 financial crisis were a different kind of creature altogether: The were mostly pure investment banks, which are financial institutions that provide services to large corporate and institutional clients that do not have regular Joe depositors and whose activities are not insured by the FDIC, which does not insure investmentsonly deposit. Bear Stearns and Lehman Brothers were investment banks; AIG was an insurance company and a diversified financial conglomerate; Morgan Stanley and Goldman Sachs were investment banks that became commercial banks as part of the Federal Reserve’s stabilization efforts, and Goldman insists it never needed a bailout but would not forgo the offer of near-free federal money; etc. The repeal of Glass-Steagall meant that investment banks and commercial banks could enter into each other’s business to some extent, but it was not the major factor in the 2007-08 financial crisis. A number of FDIC-insured banks failed in those years — nearly 500 between 2008 and 2013, mostly small institutions you’ve never heard of, but not for reasons that would have been prevented by Glass-Steagall.

Almost no one in Washington really wants to understand these things — they want someone to blame and a political narrative that resolves such blame in a convincing way. Political stories are fairy tales, and fairy tales need villains. There was plenty of bad behavior, wishful thinking, short-sightedness, and self-dealing before the 2007-08 financial crisis, and plenty of bad policy decisions that contributed to it—starting in the 1930s and continuing under presidencies and Congresses controlled by both parties. But the basic true facts of the matter don’t provide much in the way of a satisfying moral high ground or a black-hat/white-hat narrative, because what happened is that a bunch of investors made a bunch of bad investment decisions that wouldn’t normally be such a big deal, except for the fact that so many of them for various political and business reasons had done same bad investment decision.

Leave a Reply

Scroll to Top
%d bloggers like this: