[Anonymous]

I was just watching a documentary “Inside Job” about the financial crisis of 2008. It emphasizes deregulation as playing a major part in causing the crisis especially Glass-Steagall.

Some has said that Glass-Steagall is a red herring but Didn’t the repeal of Glass-Steagall have a negative effect because it allowed deposit insurance to cover higher risk activities and thus increased moral hazard?

It sure seems so since in 1933 banks would have to suffer the consequences on their own if they made loans beyond what prudence would counsel.

[jmherbener]

Here are a few pieces on the partial repeal of Glass-Steagall:

https://wiki.mises.org/wiki/Glass-Steagall_Act

https://mises.org/library/does-it-make-sense-resurrect-glass-steagall-act

https://mises.org/library/insuring-deposits-ensuring-insolvency

https://mises.org/library/separation-commercial-and-investment-banking-morgans-vs-rockefellers

http://www.forbes.com/sites/objectivist/2012/11/12/why-the-glass-steagall-myth-persists/#f79087c2b67a

http://tomwoods.com/blog/the-glass-steagall-myth-revisited/

Tom Woods points out that the headline-grabbing failures of the downturn were unaffected by the repeal. They either remained pure investment banks or failed because of commercial loan portfolios, or they were not banks at all.

[johnwinters91]

What is the practical difference between banks dealing/underwriting in securities and them just buying them for themselves?

The Act prohibits banks from dealing and underwriting securities, but allows them to purchase and sell them for investment purposes. How is this not just a semantical difference involving legal gymnastics?

I’m not asking that question suggestively, I’m just curios what the significant differences are.

Also, did the artificial supply of credit cause an increase in derivative speculation? Was there more risk taken in derivatives than historically occurred leading up to the bust?

Thanks again for your time.

[johnwinters91]

What is the practical difference between banks dealing/underwriting in securities and them just buying them for themselves?

The Act prohibits banks from dealing and underwriting securities, but allows them to purchase and sell them for investment purposes. How is this not just a semantical difference involving legal gymnastics?

I’m not asking that question suggestively, I’m just curious what the significant differences are.

Also, did the artificial supply of credit cause an increase in derivative speculation? Was there more risk taken in derivatives than historically occurred leading up to the bust?

Thanks again for your time.

[jmherbener]

Yes, the credit creation stimulated derivative use. Banks created mortgages out of thin air and lent them to subprime borrowers. They then sold the mortgages to Fannie Mae and Freddie Mac who securitized them. Because Fannie and Freddie had implicit government guarantees, banks bought MBS and used derivatives to hedge their downside potential. As the credit expansion extended to riskier and riskier projects, Credit Default Swaps use expanded.

https://www.cmegroup.com/education/files/growth-through-risk-management.pdf

The growth in derivatives began after the tighter regulation of the Monetary Control Act of 1980. The volatility during the period called the “Great Moderation” from the early 1980s through the 1990s was reduced in part because of the continuing expansion of derivative markets on the basis of rapid and steady monetary inflation and credit expansion.

https://fraser.stlouisfed.org/docs/publications/frbnyreview/pages/1990-1994/67192_1990-1994.pdf

Commercial banks have more stringent regulations on the securities they can hold and underwrite.

http://www.frbsf.org/economic-research/publications/economic-letter/1997/march/cracking-the-glass-steagall-barriers/

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