You may be forgiven for believing that the federal deposit insurance was enacted by Congress as a way to protect consumers’ savings accounts. In a stunning sleight-of-hand, Congress has now turned that piece of consumer-protection legislation into an insurance umbrella to cover trading risks by the country’s largest banks.
The Purpose of the FDIC
In the 1920s and the 1930s, out-of-control stock market speculation ushered in the era of the Great Depression. The FDIC was created when widespread financial panic threatened to destabilize the financial system of the United States. It was set up in an attempt to win back the confidence of depositors as well as to alleviate the fears of the banking establishment that the public would make a run on the banks should another financial panic threaten the economy.
The New Rule
In a startling provision of the budget bill, Congress will now permit banks to protect their risky trades in derivatives using the same insurance umbrella that prevents customers from losing their bank deposits. In order to pull this off, parts of the Dodd-Frank financial reform act had to be dismantled.
This is tragic enough, but it gets worse. By repealing portions of the reform act, it now also opens up the possibility of the government offering banks more bailouts should their risky trades go awry. Despite everything the country has been through in the past few years, there will now be even less oversight of big banks indulging in risky behavior.
What this basically means is that Wall Street can once again enjoy the upside of high-risk derivative trading without paying for the downside should things not go as planned. After JP Morgan traders lost $6 bn in the London Whale trade, it led to a round of congressional hearings. If another fiasco of this magnitude were to happen again, the financial loss would have to be covered by….you guessed it: the taxpayers.
The Glass-Steagall Act and the Dodd-Frank Act
Before the Glass-Steagall act, there was no clear distinction made between a bank’s two primary sources of cash flow: lending out deposits and market speculation. The now defunct Glass-Steagall act separated the two banking activities. The Dodd-Frank act brought back a portion of that attempt to protect the consumer.
The purpose of the Dodd-Frank act was to prevent big banks, essentially, “banks too big to fail” and “too big to jail,” from putting the public on the hook for high-risk trades. It recognized that losses made from derivative trading could be severe enough to shake up the country’s financial system.
The new budget provision is the final revenge of JP Morgan, Citigroup, and other big banks. With the retraction of the rule: banks are again back in the business of playing dice with the American economy. They can once again take absurd risks in any kind of high-risk trading without a fear of financial loss should things go wrong.
How Derivatives Trading Derailed the US Economy In 2008
The reason why banks love the derivative business is because it is highly profitable. It is also almost entirely dominated by the five largest banks in the United States. Bank of America, Citigroup, Goldman Sachs, Morgan Stanley and JP Morgan control the lion’s share of the business–an astonishing 95% of it.
The financial crisis in 2008 occurred because of mortgage derivatives. Multibillion dollar insurance companies like AIG buckled under the weight of toxic derivative trades. The financial earthquake was strong enough to knock out legendary investment banks like Lehman Brothers and Bear Stearns. Merrill Lynch, brought to its knees, agreed to a Bank of America buyout to stay alive. Meanwhile, Morgan Stanley and Goldman Sachs had to restructure their corporation as commercial banks to gain the protection of the Feds.
A Brief History of Irrational Congressional Acts
Although the White House has issued a statement saying that it does not approve the provision, it is more of an apology than a serious attempt to reverse the absurdity of the situation.
Congress’s evisceration of the carefully thought-out safeguards built into the Dodd Frank Act is just one more example of the radical departure from representative democracy and the embrace of corporatocracy.
This is not the first time that Congress has made decisions that make no sense. For instance, when the Internet first rolled out and cyber crime showed up, Congress enacted a law to repress encryption technology. “In a case that began in 1993,” reports an article on computer crime laws in Frontline, “the U.S. State Department ruled that Daniel Bernstein, then a graduate student at the University of California at Berkeley, would have to register as an international weapons dealer if he wanted to post an encryption program online. The government feared encryption technology could be used to conceal illegal activity, so it restricted its export under the Int’l Traffic in Arms Regulations portion of the Arms Export Control Act.”
What do you think? How absurd–nay, criminally negligent–is allowing the big banks to get back in business doing the very thing that caused our economic troubles in the first place?