There’s been a lot of talk about financial reform in bank news and how Wall Street will be expected to clean up its act after such a huge mess was made of the financial system nearly two years ago.
Lawmakers, bank regulators and Barack Obama’s administration have been meeting for weeks to discuss what changes need to be made to the financial system and how they can be combined into a Wall Street regulation bill. But what needs to occur seems to rest largely on what brought us to the financial crisis in the first place: a lack of proper regulation.
Wall Street and Its Regulation History
It has been nearly 100 years since lawmakers saw a need to create a Federal Reserve System. Getting its start in 1913 with the passage of the Federal Reserve Act, the Federal Reserve became the private central bank that would control the country’s funds by printing reserve notes and lending them with interest to the government to redistribute as money.
However, as the years passed, the role of the Federal Reserve expanded. Some changes that took place are still in existence today and helped to create structure to the financial system. These changes included requiring bank compliance with specific regulations set in place, as well as maintenance of a stable financial system.
One major reason for the Fed’s expansion was the financial problems of the 1930s and the Great Depression. At the same time, what we consider today to be Wall Street regulation history emerged and major changes took place including the Federal Home Loan Bank Act of 1932, the Banking Acts of 1933 and 1935, the Securities and Exchange Act of 1934 and the Federal Credit Union Act of 1934.
All of the legislation passed during this time was aimed at promoting stability in what were considered very unstable markets. So by setting operating standards, limiting branching, separating asset and liability markets, fixing prices and guaranteeing some deposits, lawmakers were able to gain order.
Between the 1960s and 1980s, changes were made to the financial regulations, however. Because they loosened up, interest rates increased and new competitors in the market were not subject to rate ceilings, allowing interest rates to climb to double-digit levels.
Over the next two decades, the debate over federal bank regulations became an ongoing battle. Some believed that banks needed strong regulations and others believed otherwise. However, something went very wrong in the 2000s and as a result, the United States was hit with the worst financial crisis since the Great Depression.
What Caused the Financial Crisis?
There are a number of factors that contributed to the financial crisis, but most of them had everything to do with mismanagement (and some argue, greed) on Wall Street.
It started largely with the amount of faith placed into the housing market. So many people purchasing subprime mortgages, so many investors purchasing securities backed by these mortgages and one insurer in particular guaranteeing that it could insure these securities if the individuals couldn’t pay their mortgages, resulted in a domino effect that no one could recover from.
First, Lehman Brothers suffered as fewer people were able to pay their highly-increased adjustable rate mortgages and the securities became incredibly risky. As these investments fell through, AIG realized that it didn’t have the money to back the securities as promised and was forced to file bankruptcy. As a result, AIG received a government bailout and scrutiny from the American public and Lehman Brothers failed as a company after over 150 years in business.
With these companies failing, Wall Street suffered immensely and the effects trickled through the rest of the economy. Before long, 140 banks were forced to close in 2009, millions of people lost their homes to foreclosure, many individuals lost their 401(k) investments, and major companies laid off hundreds of thousands of employees each week.
Some lawmakers argue that much of what occurred in 2008 could have been avoided if regulations had been set on Wall Street to disallow such rampant selling of homes to individuals with bad credit who realtors knew could not pay the mortgage payment when it increased.
Also, some say that that if AIG had not agreed to insure securities backed by these mortgages that were sure to default, it would not have faltered either. There were a lot of mistakes made along the way that could have been avoided. Lawmakers now hope that with Wall Street and banking regulation, a financial crisis will not happen again anytime soon.
What Proposals Are On Deck for Wall Street Reform?
After the financial crisis, lawmakers jumped to action to make sure that consumers are protected from future problems. Earlier this year, Senate Banking Committee Chairman Christopher Dodd (D-Conn) even released a financial reform draft for Congress to consider in an effort to make changes to the current system.
Now, it seems that they are more committed to getting the system in order. Here are some specifics of current legislation that is on the floor:
- Depositors will be better protected: The FDIC would create more guidelines for protecting customers. Also, a consumer financial protection regulator would be created to oversee policies related to bank deposits and payment products like overdraft and ATM fees.
- Banks required to increase capital: In order to safeguard against another bailout, banks would be required to increase capital requirements from about 4 percent of assets to between 6 and 8 percent. This would protect taxpayer funds if asset prices drop.
- Investment firms must be transparent: Investment advisors will be legally required to provide information on investment products that are best for their clients’ financial situations. Also, they will be responsible for disclosing conflicts of interest.
In addition to the main legislation on the floor, there have been some amendments proposed that could make some major changes to the state of our financial system.
One of the amendments on the table right now is to reinstate the Glass-Steagall Act, which was also known as the original Bank Act of 1933. If this act is reinstated, there will once again be separation between banks’ commercial and investment operations.
Some other key proposals and amendments on the table include making it clear that public funds cannot be used to bail out banks. Also, the size of banks would be limited and the Federal Reserve would be eligible for auditing upon request. The Obama administration supports the Glass-Steagall reinstatement, but opposes the other proposals. Here is a complete list of amendments on the table.
While there are bound to be plenty of disagreements about what’s best for Wall Street reform, one can only hope that the final changes made will benefit us all. Alan Greenspan was recently quoted as saying that another financial crisis could occur sooner than later. We can only hope that Wall Street reform will prove him wrong.
