How debt accumulated during the financial crisis still poses a threat to the banking system

7/25/2019 How debt accumulated during the financial crisis still poses a threat to the banking system

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How debt accumulated during the financial crisis still poses a threat to the banking system.

By Spencer Venable

May 201

!reface

The removal of the Glass-Steagall Act in 1999 marked the end of a period of financial

stability that began when it was put in place as part of the emergency Banking Act reforms of

19! The Glass-Steagall Act separated deposit taking banks from investment firms and


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effectively helped to protect the savings of millions of people for more than "# years! $hen the

act was fully removed after years of political lobbying from banks% financial markets &umped in

value with stocks hitting their highest valuations ever in history in the year '### (even more

e)treme than the peak of 19'9*% only to crash and lose more than +#, of their value in both

'###-#' and again in '##-#9! The second crash in '## set off the worst financial recession

since the Great .epression! The '## financial crisis led governments and central banks around

the world to enact a series of emergency policies that would increase the debt in the financial

system in the hopes of reflating economic growth! The result has been the weakest economic

recovery on record! Growth did not rebound as hoped for/ however% global debt levels e)panded

by nearly 0"# trillion to an all time high today! The risks of another financial crisis and ma&or

global recession have increased given poor global growth and a heavy debt burden that remains!

"able of contents

reface22222222222222222222222222222222222

Table of 3ontents2222222222222222222222222222222!

Background222222222222222222222222222222222!4

Significance2222222222222222222222222222222221


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Spencer Venable

5)perts2222222222222222222222222222222222!!!1"

6ole of 3ontrol!2222222222222222222222222222222!19

7ogic of 5vil22!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!'1

3ase Studies8

1! 3hina222222222222222222

22222222!!'4'! Australia22222222222222222

22222222!'9! 5ngland22222222222222222

22222222!!+

nternational :rgani;ations22222222222222222222222222!!!!

3anadian 3onnection22222222222222222222222222222!4'

Solutions22222222222222222222222222222222224 and lasted from 19'9 to 199!

n response% the ?S government passed The Banking Act of 19! This act helped to

protect the savings of millions and create financial stability for decades afterwards! t achieved

this in two key ways8 first it established the ta)payer funded @ederal .eposit nsurance

3orporation (@.3* which - in the event of a bank insolvency - insures deposits by up to

0'+#%### per customer% secondly by controlling the level of leverage and risk in the financial

system by separating securities sales firms from the commercial banks (The Glass-Steagall Act*

that were backed by the @.3 insurance! This division meant that @.3 backed banks could

only use customer deposits to make conventional mortgages and loans% but not for financial

speculation and trading activities that had a high risk of capital loss! Those firms wanting to

engage in speculative financial activities were reuired to do so risking their own capital at risk

of only personal bankruptcy!

These provisions helped to stabili;e the financial system into the early 19"#s until banks

began lobbying politicians to loosen the Glass Steagall divisions and allow them to e)pand once

more into investment underwriting and sales! @inally% in 1999 resident Bill 3linton signed the

Gramm-7each-Bliley Act which repealed the separation between banks and securities sales firms

and effectively allowed banks to use @.3 insured customer deposits for high risk activities!'

1"Unemployment Statistics during the Great Depression." Unemployment Statistics during theGreat Depression. N.p., n.d. Web. 13 ay !1#.

!"$istory o% Glass&Steagall 'ct."An Equal Say And An Equal Chance For All. N.p., n.d. Web. #ay !1#.


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n the 1" years since the Glass Steagall Act was repealed% the ?S has already e)perienced

two massive financial market declines% one in '###-# and another in '##-#9! Both events

triggered costly recessions! The collapse in '## has been called =The Great 6ecession> and

=The Great @inancial 3risis> (G@3* being the largest economic decline in world history ne)t to

The Great .epression!

Today% eight years after e)cessive debt levels and financial speculation triggered the

Great @inancial 3risis of '##% debt in the global banking system has increased by tens of

trillions of dollars% and the largest banks backed by @.3 insured deposits% represent an even

more concentrated risk to the economy! The five biggest financial institutions in the ?S have

been called =Too big to fail>% by financial regulators because allowing one of them to go

bankrupt would cause debilitating losses to customer deposits and the ta)payers who are backing

them via @.3 coverage! As we enter '#1"% the risk of the ne)t great financial crisis is arguably

larger than ever!

n the early 19'#s% wealthy families commonly hired independent financial advisors to

work directly for them in helping to manage their money and assets! These advisors were paid

by their clients alone and had a fiduciary duty to always place their clients best interests ahead

of everything else! @iduciary advisors (like lawyers and doctors* are by law prohibited from

taking advantage of their clientsCthey must not make any secret profits or operate with conflicts

of interest that ma)imi;e their own financial gain at the e)pense of their clients!


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Securities sales firms on the other hand were in the business of creating and selling

investment products! They saw great opportunity in convincing financial advisors to recommend

these products to their clients!

n the late 19'#s securities sales firms began merging with banks and buying up private

asset management and advisory practices with the goal of gaining a distribution channel for their

products! The trouble was that their products were high on fees for the investment banks and

low on protection for the clients! Those selling the products were brokers that collected rich

hidden commissions and incentives for getting their clients to buy them! ndependent fiduciary

advisors became increasingly replaced or turned into sales people! Deanwhile the investment

conglomerates made little attempt to inform clients of the mandate change from advising to

sales!

As more financial products like stocks and bonds were issued and sold% the more prices

increased% so did debt! nvestment firms discovered that their customers could buy a lot more

products if they were given investment or Emargin loans to purchase securities! As the value of

the assets purchased increased% the banks lent more money to borrowers so that they could buy

more and more securities! $ith more investor demand% banks were able to issue more bonds and

use the money to make consumer loans to their customers! 7ending standards dropped and credit

uality (the likelihood of being paid back* declined while capital risks for investors rose!

@inally% the debt bubble burst and in 19'9 stock and bond prices collapsed% with the .ow Fones

ndustrial Average (the # largest ?S company shares* dropping #, over the ne)t years!

3oulton, $arold Glenn. The Financial Organization of Society. (hicago, )*+ U o% (hicago, 1!1.-rint.


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$ith the amount of damage that the 3rash of 19'9 inflicted on the world economy and

the lives of families% in 19' the ?S Senate 3ommittee on Banking and 3urrency began a two-

year investigation as to the cause and who was responsible! n Fune of 194 it released its

conclusions in a94-page report that states(my underlining of key points*8

any of the e!ils that "ere disclosed at the hearings #efore the United States

Senate su#committee "ere inherent in the interrelationship of commercial #an$ing and

in!estment #an$ing% A great many of these e!ils "ere& ho"e!er& attri#uta#le to the utter

disregard #y officers and directors of commercial #an$s and in!estment affiliates of the

#asic o#ligations and standards rising out of the fiduciary relationship e'tending not only

to stoc$holders and depositors& #ut to persons see$ing financial accommodation or

ad!ice% The hearings disclosed& on the part of many #an$ers& a "oeful lac$ of regard for

the pu#lic interest and a proper conception of fiduciary responsi#ility% (ersonages upon

"hom the pu#lic relied for the guardianship of funds did not regard their position as

impregnated "ith trust& #ut rather as a means for personal gain% These custodians of

funds gam#led and speculated for their o"n account in the stoc$ of the #an$ing

institutions they "hich they dominated) participated in speculati!e transactions in the

capital stoc$ of their #an$ing institutions that directly conflicted "ith the interest of these

institutions "hich they "ere paid to ser!e)

*#orro"ed money from the #an$ing institutions either "ithout or "ith inadequate

collateral) procured the #an$s+ loans for other indi!iduals to effectuate the purposes of

these officers and directors) informed pri!ate companies to co!er up operations

conducted for their o"n pecuniary gain) a!ailed themsel!es as directors of pri!ate

corporations& of inside information & to aid them in transactions in the securities of these
http://www.senate.gov/artandhistory/history/common/investigations/pdf/Pecora_FinalReport.pdfhttp://www.senate.gov/artandhistory/history/common/investigations/pdf/Pecora_FinalReport.pdfhttp://www.senate.gov/artandhistory/history/common/investigations/pdf/Pecora_FinalReport.pdf


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corporations) caused to #e paid #y the #an$ing institutions to themsel!es e'cessi!e

compensation) had !oted to themsel!es participations in management funds and

su#stantial pensions& and resorted to de!ious means to a!oid the payment of their ,ust

Go!ernment ta'es%-

n the end the government implemented what it identified as three critical areas of reform8

The Securities Act of ./00 and the Securities E'change Act of ./01 ha!e !ested the

Securities and E'change Commission 2SEC3 ,urisdiction of the source of and traffic in

securities% The !igilant administration of these acts should materials a#ate& if not

eradicate& a#uses that ha!e caused much economic distress% The esta#lishment of an

honest and true securities mar$et is dependent upon the effecti!e enforcement of the

legislati!e mandates in these acts%

4n the field of #an$ing& three ma,or principles ha!e #een dealt "ith in recent legislation&

namely 2The 5an$ing Act of ./003& the separation of monetary policy from #an$ing& the

creation of deposit insurance 2FD4C3 and the separation of in!estment #an$ing and the

securities #usiness from commercial #an$ing 2Glass Steagall3%

These legislative changes helped to strengthen and protect the banking system for three

decades! owever% in the 19"#s the banks began lobbying the rules instated by the Glass

Steagall! @irst they lobbied 3ongress to allow them to enter sales of municipal bonds and they

slowly succeeded! n 19" the @ederal 6eserve Board who has oversight control on banks and

monetary policy removed section '# of the Glass Steagall Act! This allowed the banks to e)pand

into the securities business to ma)imum of +, of their profits! Then this spread and in Fanuary

199% the @ederal 6eserve allowed the reuests of F Dorgan% 3hase Danhattan% Bankers Trust


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and 3iticorp for unlimited dealing in debt and euity securiti;ation! Then in 199 Travelers

nvestment Bank was allowed to merge with 3itigroup and Glass Steagall was effectively ended

before being officially removed in 1999 by resident 3linton!4

Hine years after the official removal of the Glass Steagall Act% the Great @inancial 3risis

sparked a worldwide recession! This collapse began in the ?S mortgage and housing sector but

thanks to the international reach of the largest financial firms and globali;ation the collapse in

American housing stunted the growth of economies worldwide8 3hina% Australia and 5ngland are

all key e)amples that will be covered in detail later!

n September '#1#% the ?S Senates @inancial 3risis nuiry 3ommission held hearings

into cause of the '## market crash and who was responsible! n the end% the government

commission referred evidence of numerous violations of federal securities laws by investment

banks to the ?S .epartment of Fustice (.:F*! n response% the .:F spent the ne)t " years

negotiating &ust over 04# billion in faceless fines! A total of 1 large financial institutions% all

done without naming or holding one single e)ecutive or individual civilly or criminally liable for

admitted offences! Ho bank e)ecutives went to &ail in America!+

n truth% the 04# billion in fines were a tiny fraction of the hundreds of billions in profits

the crimes continue to generate for the biggest banks! The fines were an e)pense of doing

business paid for by ta)payers and shareholders like pension beneficiaries and mutual fund

"' /rie% $istory o% the Glass&Steagall 'ct."An Equal Say And An Equal Chance For All. N.p., n.d.Web. ay !1#.

0isinger, 2esse. "Why nly ne 4op /an5er Went to 2ail %or the 6inancial (risis." The 6e" 7or$Times. 4he Ne7 8or5 4imes, 3 ay !1. Web. # ay !1#.


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holders! Deanwhile% the actors and e)ecutives who profited most from the illicit acts were

allowed to retain all their pay and freedom to continue a lucrative career!

The '#1# @inancial 3risis nuiry identified many of the same factors and incentives

leading up to the '## market crash as had been noted leading up to 19'9! Banks being allowed

to work hand in hand with investment banks were enabled to make risky loans to people with

poor income and credit history by selling the loans off as securities to other investors! Since the

banks were cashing their money out and not holding on to collect the loan payments% they began

to care little about whether the people borrowing were a good credit risk! The investment sales

arms of the banks were making millions in commissions packaging the loans and then

recommending them as solid investments to pensions and mutual funds around the world! As

more people bought% more and more risky loans were made and the more cash flowed back into

the banks to make even more loans! As more people got loans% more were able to buy real estate

and the prices soared! This caused a sudden rise in housing values and with down payments on

loans reaching as low as ;ero people began leveraging money to purchase more housing creating

a surge in housing sales!


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This chart shows the volume of sales that rose very uickly leading up to the beginning of the

collapse in '##

money to purchase were left with homes that no one would purchases and large debts to the

bank! This also meant that banks were not recollecting a lot of the money they had given out

causing many of the large banks to become insolvent! @or fear of recreating the devastating

collapse of 19'9 the @5. (@ederal 6eserve* bailed out the banks allowing them to continue their

investment banking operations!"

A development that did come out of the Great 6ecession however was the creation of the .odd-

@rank $all Street 6eform and 3onsumer rotection Act ('#1#*! The stated purpose of the act

was to prevent banks from becoming too big to fail% putting an end to government bailouts with

ta)payers dollars% and creating organi;ations to watch over the banking sector% and enforce the

#"What )s 9uantitati:e asing;" The Economist. 4he conomist Ne7spaper, ar. !10. Web. ay !1#.


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rules! owever% the act failed to re-separate the @.3 backed commercial banks from their

investment sales divisions and there is much doubt as to whether or not the .odd - @rank Act

will truly help prevent the ne)t crash or at least stop the government from bailing the banks out

with ta)payers dollars! Dost of the participants% practices and incentives to create e)cessive debt

and leverage and risk remain embedded in the present financial system!

Significance

The @inancial system is used by nearly everyone in the world! The real economy% which is

made up of businesses and families% depend upon a stable and reliable financial system to

function! This means that widespread corruption and illegal actors can be catastrophic for the

lives of many! A clear division between savings deposits and financial speculation must be

reinstated! n the year 19 at the end of the Great .epression a total of 9### banks


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At the same time% households and companies in these countries misunderstood the rebound in

prices during '##-11 as a resumption of the economic boom that had been in place from '##-

#! They were encouraged to continue spending beyond their income and took on record

amounts of debt to buy things and spend on discretionary items! This has left them weaker

financially and less able to ride out the ne)t recession which lies somewhere ahead!

Since the '## recession% the world has increased the level of total debt by an estimated 0+!10?+ n. pag.


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e)ecutives in the finance industry! Although it is a common trend in most industries for people

who formerly worked in the trade to later regulate it% in the case of finance no-one is fully held

accountable for the =mistakes>! $hen the banks sell mortgage backed securities to their clients

and allow for the leveraging of debt to purchase more DBS (mortgage backed securities* the

S!5!3 (building inspector* allows it! $hen the markets reach a point of inflation where they

collapse (the collapse of the building* no one is held accountable% not by the public% the

organi;ationIs who regulate the system% not even by the criminal investigators and prosecutors

like the @B and the .epartment of Fustice!

A great e)ample of this was in '## when the Great 6ecession occurred! 5ven though it

was an acknowledged fact that the '## meltdown occurred largely due to the selling of

subprime loans on a large scale and making fraudulent representations to investors that the assets

were high uality% only one individual% high ranking bank employee went to &ail! Hone of the

e)ecutives who oversaw and profited the most off of these operations were held accountable!1 and that she has =many investments and is not aware of why this is of

importance>! owever% this caused a large commotion in the media who pushed the government

to make new rules to close the insider trading loop hole% this legislation is called the =Stock Act>

passed in '#1'! The Stock Act made it so the records of politicians purchasing and selling stocks

was available as part of the public record and could be monitored! owever% these files are kept

in the basement of a government building! Deaning that if the public wished to view this

information they first need access to the basement and then find the specific file in the +%###

files kept19!

1Gonglo%%, ar5. "Stoc5 'ct (hange 2ust 9uietly ade )t asier 6or 4op 6ederal mployees 4o)nside 4rade." The >uffington (ost. 4he$u%%ington-ost.com, n.d. Web. 13 ay !1#.


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)ase Studies

3hina

n the years leading up to the housing crash of '##% ?!S consumers increasingly

substituted stagnant household incomes with greater amounts of cheap debt! The banking

industrys use of new credit products (specifically mortgage-backed securities* helped reduce

risk to creditors from defaulting borrowers! The lowering of risk by pooling mortgages with

differing credit ratings made it possible to add another =tranche> level of credit uality into the

mi) called =sub-prime>! The ability to include lower credit uality debt in the creation of DBSs

(mortgage-backed securities* meant that an entirely new segment of ?!S consumers were now

able to access larger loan amounts% despite low incomes! This new group of consumers helped

push purchases of goods to new heights!


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!

The chart above illustrates the rapid increase in ?!S consumer household debt in relation

to household incomes% the rise is especially noticeable during the period 199 to '##9!

The chart above illustrates the dramatic rise in 3hinas e)ports to the ?!S to show the reciprocal

relationship to ?!S household debt levels!

!"(onsumers and the conomy, -art ))+ $ousehold Debt and the Wea5 U.S. Beco:ery." Federal=eser!e 5an$ of San Francisco. N.p., n.d. Web. 13 ay !1#.


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$ith 3hina being the worlds largest e)porter of ine)pensive goods to the ?!S% it saw a

large boom in their economy! Dore manufacturers opened up meaning many new &obs were also

made!

The increased amounts of American money in the 3hinese economy also accelerated the

growth of the middle class% prior the country only had two social classes! The upper class which

made up 11, of 3hinas population/ this group consisted of politicians% management of state-run

businesses owners with key political ties! The average income of this group was 044%### ?S. a

year! The second social class was much poorer than the first! This group was made up of the

middle and lower class! The reason for this is the difference between the two is simply not

enough to &ustify labeling them separately! The so called middle class made 09%### - 1"%###

?S. a year! $hile the lower class made 09%### or less ?S. a year! This shows the income

difference between upper and lower class is 0'%### ?S. whilst the difference between mid and

lower is only 0+###% really not enough to differentiate the two classes! The lower class was

employed mostly as factory line workers% farmers% and tradesmen!'1

3hinas class system remained segregated by a large gap between the two groups until

?!S demand triggered a wave of new factories and businesses to be made! Tradesmen were in

high demand as they were needed to build the infrastructure reuired to supply the boom!

Another factor that helped towards the growth of the middle class was that once pro&ects were

completed% it opened up positions for managers and other higher paying staff! This trend

continued until '## when the ?!S financial markets crashed% sending shock waves across the

!1"apping (hinaFs iddle (lass." c8insey 9 Company. N.p., n.d. Web. !3 'pr. !1#.


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globe! .emand for e)ports from 3hina fell dramatically and this led to &ob losses! The

unemployment rate &umped in 3hina as shown here!

n response to the '## financial crisis and related collapse in e)port demand% 3hina

initiated an enormous stimulus package valued at roughly 4 trillion Luan! The government

funded initiatives were uickly put in place to maintain economic output and political stability!

nfrastructure pro&ects took the form of transportation systems such as new high-speed trains%

airports% highways% dams and sewage plants! 7arge scale housing comple)es with commercial

and retail spaces were being built far and wide throughout the country! n some e)treme cases

entire cities were built!

The e)pectation (hope* was that the new buildings would become home to farmers and

rural workers migrating to the cities for higher paying &obs% it was also thought that the work

force building the pro&ects% would one day live in them! These e)pectations were never reali;ed

because the average 3hinese worker in '##" had an income of 4"1!"1 3hinese Luan (0


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?S. per suare foot/ far from the reach of anyone in the working class!''This left :rdos and

other massive cities like it to be abandoned% getting them the title of =Ghost Towns>! owever%

the development of more of these cities is still under way today! This is mainly because the

building pro&ects main intent never were (although claimed to be* to house the new upper middle

class! This is clear when we consider the price of housing was never in reach for the middle class

at anytime before during or after the '## crash! 5ven for the upper class with a annual salary of

044%### ?S.'they would be reuired to save all their income for '+ years to be able to afford a

1### suare foot apartment at 1%1## ?S. per suare foot in :rdos'4! $hat the government

wished to achieve was the creation of &obs to help stimulate their economy% and at this it was

successful! The unemployment rate which was still very high from the effects of the Great

6ecession nearly returned to the pre-crisis at the beginning of '##! The middle class now has

reconvened with the lower class as they have the same housing and can afford mostly the same

things! The only separation between the two is the middle has a slightly bigger paycheck!

.espite attempts to support the 3hinese economy with more unneeded infrastructure% 3hinese

leaders now say that the previous growth rates were unsustainable% setting new lower target of

"!+, to


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Australia

Fust as 3anada is the resource warehouse for America% the largest economy in the world!

Australia is the resource warehouse for 3hina% the second largest economy in the world! As the

creditOhousing boom took off in America during the year '##% 3hinese manufacturing soared

and Australias G. growth went along for the ride as shown in this chart since '##1!

The mining and energy sector created many well paying &obs which allowed Australian

consumers begin borrowing and spending accordingly! This ne)t chart of Australian household

debt to G. shows a #, increase in consumer debt levels between 199# and '#11!


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PHote the small looking bump that occurred around the Great .epression in the 19'#s - to #s

in reference to its current position in the '1st century - markets have inflated to four times their

position in the '#s and #s - !

As Americans e)perience mortgage backed securities created by the international

financial conglomerates subprime mortgages were issued on Australians as well! This debt


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shown in the chart above was encouraged by lack of government ta)ation on second properties

for Australians! This created above average inflation in real estate prices% with gains of more than

1#, a year in hot areas like Sydney% Delbourne and Brisbane as shown below!

3onsumer spending as a percentage G. in Australia is almost identical to 3anada at

+",!'+ As their home prices rapidly increased% Australians felt more wealthy and confident and

with increased confidence come rising levels of debt! @or a while strong income gains% driven by

the commodities boom helped them to afford their higher debt payments and increase spending!

This of course did not last! $hen international demand dried up in the American mortgage crisis

in '##A o% GD-?." Data. N.p., n.d. Web. !3 'pr.!1#.

!#ansbach, Bichard W., and @irsten *. 4aylor. "4he Global South."4ntroduction to Glo#al (olitics.*ondon+ Boutledge, !=. 1#


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3hina purchased ", of all Australian e)ports% mostly iron ore! ron ore makes up +


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The other ma&or buyer for Australian real estate was wealthy 3hinese investors who were taking

money out of 3hina and looking for diversified places to park it around the world! Australia was

a natural selection! Australian markets continued to increase as shown in this ne)t chart!

This chart shows the housing inde) in Australia from the 1#-'#14 (in red*% and shows the

temporary sell off in '## followed by the dramatic rebound in Australian realty prices after the

?S topped out in '##< (in blue*!

As the 3hinese stimulus spending ended in '#11% commodity prices began to fall once

more as shown in this chart of the 36B (3ommodities 6esearch Bureau* commodities inde)

199+ to '#1+!


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Australias economy began to weaken with commodity demand once more and &ob losses

began to spread! Because Australian households% business and government were more indebted

than ever before% loss of income has been very difficult to manage! @or a while% spending had

continued thanks to a lowering of lending standards similar to what happened in America in

'##+-#

'###s! As the population in the west is growing older they are spending less money! n addition

they are having to build up their savings and pay down still massive debt levels! This will take

several more years% and is likely to hold back consumption and demand for Americas e)ports!

At the same time% thanks to the government stimulus spending of 3hina and other countries

during '##-11% the world has record levels of commodity inventory already on hand in storage!

t will take several years to consume the products already on hand and this means the weak

demand for new products from Australia is likely to continue suppressing the countries income

&ust as the people struggle to pay back massive debts at home! This means the home prices at

record highs are likely to decline and cause rising loan defaults% bankruptcy and losses in the

finance and service sectors! This puts Australia at increased risk of a prolonged recession!


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5ngland

n '## the ?nited States brought in legislation called the Sarbane :)ley Bill which

reuired corporate e)ecutives and accountants to be held personally responsible for the financial

information reported in corporate financial statements! ndividuals were reuired to personally

sign reports that were issued to the public! This was implemented because in the tech bubble

collapse of '###-'## many financial statements of publicly traded corporations had been

misleading and incomplete% in many cases hiding debts as Eoff book assets!' Several high

profile companies like 5nron and $orldcom had gone bankrupt due to these hidden debts and

this resulted in massive layoffs in the economy and losses for investors!

Hot keen on the increased liability that Sarbane :)ley posed% large financial companies

looked for other options! Similar laws were not implemented in 5ngland and this attracted many

to move their operations to be based out of 7ondon% 5ngland! t also meant that debt

securiti;ation grew uickly in the ?K as it had done in the ?!S and Australia! ousehold debt

levels climbed and home price appreciation took off well above historical averages!

$hen the mortgage debt bubble burst in the ?S in '##


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n '##% the largest investment banks were bailed out by governments and their

respective central banks% this helped financial markets stabili;e! Although mortgage fraud was

acknowledged by the bankingOinvestment industry no one was arrested or prosecuted! The

finance sector paid some fines and returned to making debt products! As a ma&or finance capital%

the 3ity of 7ondon recovered uickly! ome prices rebounded% households went back to

borrowing helping the british economy recover!

@eeling as though they were wealthy% many British people began borrowing money

against their homes and buying properties in other parts of the world% particularly in 5urope as

countries like Spain! This caused a large boom in construction and related service &obs! owever%

it was over investment and it created a similar scenario that 3hina and Australia face with an

oversupply of housing and now cripplingly high levels of consumer debt!


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The Bank of 5ngland recently reported that outstanding household debtCincluding

mortgages and credit-card lendingChit a record Q1!+ trillion (0'!' trillion* in Hovember '#1+

and lending to households increased by !', over a year earlier% the largest rise since late '##!

:n average% ?K homes owed '"!+, of their annual income on loans and credit cards in the third

uarter of '#1+% the highest rate since '##!'9

How the ?!K is faced with having to correct their economy and this is no easy task!

owever the ?!Ks government released a plan outline in '#1+ outlining the steps they will be

taking to correct their economy! This plan involves focusing on the foundations of their economy

meaning the workforce and the nationIs productivity! They wish to achieve this by implementing

things like8 modern transportation% and world class digital infrastructure pushing their economy

towards a more tech based one! They also plan to cutcorporation ta) to 1 per cent in '#'#%

which would save businesses Q"!" billion a year resulting in less money to the government but

more to the people!#

,nternational -rganiations

@ederal 6eserves

!"$ousehold Debt /inge $its -recrisis *e:el as /rits Go ad %or Ne7 (ars." This 4s oney. N.p., n.d.Web. 13 ay !1#.

3"-roducti:ity -lan *aunched." GO?%U8. N.p., n.d. Web. 1 ay !1#.


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Spencer Venable

The @5. or ?S @ederal 6eserve was made in 1911%when the @ederal 6eserve Act was

put in place! The purpose of this act was to be a fail safe for the financial system if it were to

collapse! The @ederal 6eserve Act was made in response to the financial crisis that occurred in

19#

central bank of the ?nited States! Another attribute of the act was allowing the creation of both

public and private financial institutions! The act reuired a board of governors to watch over the

@5.% and it also is what started the creation of the @ederal 6eserve note which is the money used

today in America! The intent of the @5. is to create economic stability% keeping the G. roughly

the same! They do this by pumping money into the economy from the purchasing of stocks and

bonds! The stocksObonds are for the most part purchased with money the @5. printed! .ue to the

@5. being the creator of the worldIs benchmark currency they are the only HG: in the world

that is allowed to print it!

owever% the @5. is a HG: meaning a non-governmental organi;ation! This being said the

board of governors for the @5. are all chosen by the ?!S president and approved by the head of

senet! The current seven governors that sit on the @5.s board are8 Fanet 7! Lellen% Chair

(former 3hair of the $hite ouse 3ouncil of 5conomic Advisers*% Stanley @ischer% Vice

Chairman (former chief economist at $orld Bank*% .aniel K! Tarullo (former employ in the

Antitrust .ivision of the ?!S! .epartment of Fustice* % Ferome ! owell (prior partner of the

3arlyle Group* and 7ael Brainard (?nder Secretary of the Treasury for nternational Affairs*!

The other two members of the board are whoever currently hold the position of the Secretary of

the Treasury and the 3omptroller of the 3urrency! Fack 7ew former 3:: of 3itigroup currently

31"Becent De:elopments." 5oard of Go!ernors of the Federal =eser!e System. N.p., n.d. Web. 13ay !1#.


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Spencer Venable

holds the position of Secretary of the Treasury and Thomas F! 3urry prior 3ommissioner of

Banks for the 3ommonwealth of Dassachusetts% is the 3omptroller of the 3urrency'!The &ob of

these board members are to evaluate the different situations presented and decide the actions of

(in a completely unbiased manner* the @5.!

n '## large amounts of spending from the @5. was seen in response to the Great 6ecession!

Hot only did the @5. spend 1!< trillion dollars on the reinflation of the American banking

systems but large spending on international banking systems was seen! t was confirmed that a

total of 01" trillion dollars was spent by the @ed to bail out banks internationally during and after

the Great 6ecession! Sen! Bernie Sanders is uoted as saying =Ho agency of the ?nited States

government should be allowed to bailout a foreign bank or corporation without direct approval of

3ongress and the president!>! This statement is to say that 3ongress was unaware of the

spendings of the @ed% showing how distant from the government the organi;ation has become!

The spending of @5. helped banks R!5 (Ruantitative 5asing*% an unconventional monetary

policy in which a central bank purchases government securities or other securities from the

market in order to lower interest rates and increase the money supply4* regain stability all

around the world/ it allowed for them to continue to loan out money as they had been before the

near collapse! This is part of the reason why large amounts of inflation can be seen in countries

like 3anada and Australia! The correction that would of taken place in '## when the markets

3!"/oard embers." F=5@. N.p., n.d. Web. 13 ay !1#.

33For#es. 6orbes agaEine, n.d. Web. !3 'pr. !1#.

3"9uantitati:e asing De%inition." 4n!estopedia. N.p., 1! 'pr. !. Web. 13 ay !1#.


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Spencer Venable

crashed was stopped% therefore allowing them to reach record highs that will collapse

catastrophically when they do!

3@B (3onsumer @inancial rotection Bureau*

The 3@B was created as part of the .odd-@rank Act in '#11! As the .odd-@rank Act

was made for consumer protection the 3@B was labeled the =consumers watchdog>% regulating

the new rules and prosecuting those who dont adbi to them! The bureaus &urisdictions include8

banks% credit unions% securities firms% payday lenders% mortgage-servicing operations% foreclosure

relief services% and debt collectors! The 3@B has had many successful cases against law

breaking banks and other financial services! n '#1+ the 3@B cracked down on .iscover Bank

for overestimating the minimum amount due on borrowersI billing statements% misrepresenting

information that could have allowed borrowers to receive ta) benefits and called borrowers early

in the morning and late at night% =often e)cessively!> The company also% according to the 3@B%

failed to provide defaulted borrowers with legally reuired notices about their rights! .iscover

Bank lost the case and agreed to pay 1!+ million dollars to resolve the allegations put against

them!+

The organi;ation is very effective in the prosecution of law breaking financial companies%

acting as a police force in the financial world

The nternational Donetary @und (D@*

nternational Donetary @und was founded in 194+% it is an international organi;ation of N19

countries working to foster global monetary cooperation% secure financial stability% facilitate

international trade% promote high employment and sustainable economic growth% and reduce

30"(onsumer 6inancial -rotection /ureau." 4n!estopedia. N.p., != Sept. !1. Web. 13 ay !1#.


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Spencer Venable

poverty around the world!>!"3ountries put funds into a pool with promise of being able to

borrow money from the pool if they encounter balance of payments difficulties! The last public

update of the amount of money in the pool was in '#1# when they had S.6 4


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Spencer Venable

The chart below shows the year over year percentage change in 3anadian e)ports (in green* and

the price of the commodity inde) (in purple* from 19' to '#1+! 3anadas economy e)panded

strongly until '## when the ?!S housing bubble crashed and the global demand for

commodities fell!

3=

3="4ed (armichael Global acro." @ Canadas =ecession De#ate isses the (oint. N.p., n.d. Web.13 ay !1#.


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Spencer Venable

This chart shows the growth of 3anadas G. 19"+ to '#1+!

7ike Australias economy% 3anada bounced back uickly from the '## recession

because of our concentration in resources! Stimulus spending from 3hina and the ?S as well as


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Spencer Venable

low interest rates helped to revive G. and the willingness of 3anadians to borrow and spend!

The 3anadian housing market had been increasing strongly from '## to '##! t dipped in the

'## recession but rebounded uickly! n addition to 3anadians borrowing record levels of

household debt to upgrade their homes% hot areas like Jancouver and Toronto saw large inflows

of foreign investors from places like 3hina who were looking for assets to park money in outside

of the 3hinese markets and banking system! This led to a rapid increase in home prices in ma&or

cities and the national average! This attracted more investment into real estate construction in

3anada and led to strong &ob growth in that sector as shown in this chart of residential

investment and construction employment since 19


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Spencer Venable

6eal estate prices increased as shown in this 3anadian Hew ousing rice nde)! At the same

time% the government lowered lending standards to allow more people to enter the property

market! A conventional mortgage historically reuired a '+, down payment but during the

199#s it was lowered to 1#,! Then in '##" the national standards were lowered to

downpayments of ;ero and payback periods (amorti;ations* were increased to 4# years% from the

usual '+! This allowed people who could not have purchased housing on traditional rules in the

past to suddenly be able to ualify for mortgages! n the process% household debt leaped as

shown in this chart comparing '### with levels in '#14!


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Spencer Venable

.espite many people calling for a rebound in the price of oil% it has not recovered

significantly and is today still under 04# a barrel down more than "#, since '#14 4#! At the same

time% the world has the highest oil supplies on hand in more than # years% while the global

economy continues to grow at less than , a year in '#1" (compared with more than +, a year

during the credit bubble peak in '##


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Spencer Venable

Solutions

5fforts must be made to correct the removal of the Glass Steagall Act which was the

predecessor for the Great 6ecession% and a ma&or cause of economie failures around the world!

The division between deposit taking banks and investment sales firms should be reinstated to

bring back the stability that was seen from the years 19 to 1999!

3urrently ?S Senator 5li;abeth $arren and Fohn Dc3ain are attempting to bring back a

variation of the Glass Steagall Act called the '1st 3entury Glass Steagall Act! The bill is the old

Glass Steagall Act modified to fit modern times!

Iur ne7 !1st (entury Glass Steagall 'ct once again separates traditional ban5s %rom

ris5ier %inancial ser:ices. 'nd since ban5ing has become much more complicated since

the %irst bill 7as 7ritten in 133, 7eJ:e updated the la7 to include ne7 acti:ities and

lea:e no room %or regulatory interpretations that 7ater do7n the rules. I 1

- Elizabeth Warren

1"Support liEabeth WarrenFs 6irst /an5ing /ill." Eliza#eth


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Spencer Venable

A specific - and largest ad&ustment in the new bill to provide for the comple)ity of modern

finance firms% is the instatement of a gradual transition period for investment companies splitting

into two distinct entities!

I4he bill 7ill gi:e a %i:e&year transition period %or %inancial institutions to split their

business practices into distinct entities K shrin5ing their siEe, ta5ing an important step

to7ard ending I4oo /ig to 6ailL once and %or all, and minimiEing the ris5 o% %uture

bailouts.L !

- Elizabeth Warren

owever% they are having a difficult time gaining support! oliticians that receive significant

funding from banks are reluctant to support the cause! 3onflict of interest in this area are a hurdle

to effective regulation! eople who are employed as influential politicians (especially those that

regulate banking and finance* must be reuired to limit their connections with and funding from

banks - both directly or through family members! Additionally there should be a period of at

least five years reuired before a politician or regulator can take a &ob with a large financial firm!

t is common for employment contracts in private businesses to have periods of non-competition

when a person leaves a company so that they cannot go directly to working for a competitor!

Similar cooling off periods should be reuired of people moving between government and

regulatory &obs to the businesses they are overseeing! This is likely to make regulators more

!"Support liEabeth WarrenFs 6irst /an5ing /ill." Eliza#eth


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Spencer Venable

focused on doing their &ob effectively% rather than thinking about how they can use their

e)perience to make more money in the private sector!4

Secondly the rules around loaning money must be tightened/ high debt euals high risk! Ho

longer should people be able to take out mortgages with as little as #, down! f people were

forced to have a minimum of '+, down--as it was for conventional mortgages--then much more

stability would be seen because it would stop people from taking out e)cessive loans on

properties and other =investments>! Darket values would have a much harder time getting far

over valued and then crashing as people are much more careful with their capital when itIs '+,

their money compared to #,! t would also slow the amount of investments people are making

as it would take longer for them to save '+, of their purchase creating an overall more stable

environment!

7astly lenders should not be able to package off the bulk of their loans and sell the risk of

collection to investors! They should be reuired to maintain at least +#, of the loans on their

books! That way lenders maintain risk and this will make them more careful in who they are

making loans to as well as in what amounts! This would also help to control the uality and

uantity of loans in our banking system! And this will help make it more stable and less likely to

need ta)payer bailouts!

An e)ample of a country that has e)ecuted the proper steps to finding a solution is

celand! The history of celands financial system and its rapid growth is fascinating!

3"Warren, c(ain )ntroduce /ill to /ring /ac5 Glass&Steagall." The>ill. N.p., < 2uly !10. Web.13 ay !1#.


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Spencer Venable

n the year '## celand with only a few billion dollars and a population of ##%### set

out to become a ma&or finance center! Surprising to most% they came close to achieving this goal

during the years of global economic growth that are '## '##

?!S stock market managed to double its value while celand managed to multiply its stock

market values by a factor of nine! The few trillion dollars that the country started out with turned

into 014# trillion/ making this small country on the tundra into a financial powerhouse!

6eyk&avUks (the capital of celand* real estate value tripled% as did the average celandic familys

wealth! All of this new money was tied to the investment banking industry and increasing levels

of debt! Hearly every school began offering courses on economics and money/ celand was no

longer &ust a country it became like a hedge fund!

But as in other countries% lending standards deteriorated and loans were being given to

pretty much everyone who applied for one! $hen the '## global financial crisis and recession

hit celand% it hit them very hard! n total they e)perienced 1## billion dollars of banking losses%

which for a country the si;e of the state of Kentucky% was huge! t resulted in roughly 0#%###

of debt owed for every person in celand% including children44! Dore savings was also lost due to

an +, drop in the celandic stock market and foreign-currency speculations that many people

had been making! These are speculations made on the values of foreign currencies by a private

investor! n many cases% people in celand were borrowing funds in other currencies where

interest rates were lower! $hen the celand krona plunged in value% this made these loans much

larger and difficult to repay!

-erson, and Vanity 6air agaEine. "Wall Street on the 4undra." ?anity Fair. N.p., n.d. Web. 13 ay!1#.


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Spencer Venable

celand went from ;ero to hero and back to ;ero in an astonishing + years! $ith debts

amounting to +#, of their G!.! it appeared impossible! But it was what celand did in

response to its crisis% that truly set them apart from other countries!

A very distinguished professor from the ?niversity of 3hicago named 6obert V! Aliber4+

was invited to give a speech at the ?niversity of celand! Students% bankers and &ournalists sat in

to listen to the speech! .uring his speech he deconstructed the illusion the celandic people

seemed to have% in which they believed they had some sort of innate talent for high finance! e

described the celandic economy had all the signs to show a financial bubble of huge

proportions! After the speech when he was asked to predict the future% Aliber answered I give

you nine months. Your banks are dead. Your bankers are either stupid or greedy. And Ill bet they

are on planes trying to sell their assets right no!.> This caused much panic for the bankers in the

room and they tried with all their power to stop the speech from being published! owever%

Alibers words spread uickly starting the push towards correcting celandIs economy!

These words were also proven very true when the recession hit! The amount of money

that the banks needed to get out of debt was not obtainable by the government resulting in the

collapse of the banks! Although the failure to re-fund the banks was not intentional% it was

something that worked very well for them in the long run! The badly managed banks and their

e)ecutives went bust and the government bailed out families who owed money instead! After

'##9% celands economy (G.* recovered uicker than in other countries as shown below! f

0"Bobert M. 'liber."


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Spencer Venable

America were to have done the same in '##9% they might have also e)perienced a stronger

recovery in the real economy!

The government also reacted wisely to the foreclosing of celands banks! Hew rules were

applied to the governing of banks to create more structured and transparent systems! The banks

were taken over by the government and recapitali;ed with cash increased to 1", of all assets!4"

This insured a percentage of the money would be kept safely in the bank% and limited the amount

of loans that could be made with customer deposits! Although a disadvantage of this was celand

had to take on a tremendous amount of debt to pay for the funds they used to recapitali;e the

system!

$ith the government taking on this debt themselves and eliminating all non-government

owned banks their debt is controlled! $ith no HG: banks giving out loans the countryIs national

# "(rac5s in the (rust." The Economist. 4he conomist Ne7spaper, 13 Dec. !=. Web. 13 ay !1#.


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Spencer Venable

debt is controlled by the government! They prosecuted and imprisoned '9 people4

Documents

How debt accumulated during the financial crisis still poses a threat to the banking system