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The Glass-Steagall Act

Glass-Steagall Act

Glass-Steagall Act

With recent computer glitches chipping away at investor’s confidence in the market, a repeat of the stock market crash of 1929 becomes a real fear. Investors such as Efraim Landa must continue to exercise caution in their investments. Effi Enterprises is a consulting business which offers counsel to emerging businesses and entrepreneurs regarding financial investments and how to increase the value of the company. They offer marketing strategies and assist in helping businesses get started with brokers, divestiture strategies, capital sources and IPOs. Because Effi Enterprises helps businesses create value it is important to stay up to date on various aspects of the market and note how changes can affect business on every level. One of the acts that helped shape the market as we know it today was the Glass-Steagall Act.

The Glass-Steagall Act (GSA) brought about a separation between commercial banking activities and the investment markets. This was due to the fact that most agreed that too much commercial bank involvement in market activities was behind the stock market crash of 1929. According to Congress banks were taking too large of risks with their depositors’ money. The GSA continued as established until it was repealed in 1999.

Just before the depression most feel that commercial banks were too careless in their investing practices. They did a lot of investing of their assets and became greedy by taking larger risks hoping to gain even larger financial rewards. The objectives of banking itself became somewhat blurred and many loans were made into companies that the bank had invested in. They encouraged their clients to invest in the same stocks. Many feel that this mismanagement of funds caused the stock market crash. Henry Steagall was chairman of the House Banking and Currency Committee and seated in the House of Representatives at the time. Senator Carter Glass founded the US Federal Reserve System. Steagall supported Glass after they added an amendment which would allow bank deposit insurance for the first time.

The GSA was in response to financial crisis and set up a sort of regulatory firewall between investment banks and other commercial activities. Banks were allowed a one year time frame in which to decide whether they wanted to specialize in investment banking or commercial banking. The Act allowed only 10 percent of the income for commercial banks to come from securities; but one exception was allowed in which commercial banks were allowed to underwrite government issued bonds. JP Morgan and other financial giants were forced to cut the services they provided which cut their income drastically as well. The goal of the GSA was to prevent banks from using deposits if an underwriting job failed. Many in the financial community felt like the GSA was too harsh and glass even moved for a repeal right after the Act passed claiming himself that it was an overreaction.

The Federal Reserve Board is the US bank regulator implemented the GSA but in 1956 Congress decided to regulate another bank sector. To keep any specific financial corporation from gaining too much power, they extended the GSA by adding the Bank Holding Company Act to create a wall between banking and insurance companies. This stopped banks from being able to underwrite insurance companies even though they could sell insurance.

There have been many debates over whether these restrictions were the healthiest option for the industry or not. Many felt like banks should be allowed to diversify to reduce risks and that the GSA restrictions had the adverse effect and made the banking industry riskier instead of safer. After the Enron market mistakes banks are more likely to be transparent and less likely of making risky or unsound decisions regarding investment procedures. Reputation is a key component in the market today and this in itself motivates banks to regulate their own activities.

In November, 1999, congress repealed the GSA and eliminated the restrictions prohibiting affiliations between investment and commercial banks. The Gramm-Leach-Bliley Act allows banks to engage in a wider range of services which include underwriting. The intent of the GSA was to prevent deposits from being lost if there were investment failures, the repeal and establishment of the Gramm-Leach-Bliley Act demonstrates that many times attempts to regulate can end up with adverse effects.

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The LIBOR Scandal

LIBOR

LIBOR

LIBOR has an influence on interest rates around the world; but recently there have been some questions raised about the rigging of interest rates. Barclays already had to pay over $45 million in fines and it looks like there may be many more fines, and possibly lawsuits to come. Many say that regulators should impose more fines on some of the other 16 banks that are members of the British Bankers Association in hopes that there will never be a repeat.

LIBOR is the London Interbank Offered Rate which is the rate which these 16 banks charge one another for short term deposits and loans. This rate becomes a benchmark for interest rates set worldwide. It influences literally hundreds of trillions of dollars. LIBOR has an influence on various financial contracts corporate loans such as those managed by companies such as Effi Enterprises, interest rate swaps and floating rate mortgages.

Presently, there is much talk about criminal charges and possible jail terms for those involved. Asia, Europe, Canada and the US are investigating what looks like a huge picture of deceit and avarice. Banks must submit their data to be used in calculating the LIBOR; but in order to hide their own institution’s financial problems, or to boost profits for traders, they have submitted falsified data. Remember, that the LIBOR influences interest rates around the world so the repercussions of these devious acts are felt worldwide. Because it affects interest rates, investment firms like Effi Enterprises have been affected by the lowered benchmark.

Lawsuits are pending but as they are pursued they can mean global financial disaster. Municipal governments and investment firms purchased bonds or have entered into financial contracts which were based on LIBOR. They are now asking for compensation from the banks since they intentionally manipulated the benchmark. If the suits take place as it is assumed they will we are talking about potentially tens of billions of dollars that will have to be paid out.

Just so we understand how large of an impact this could have let’s say that LIBOR was only 0.1 percent off for one year. In that time the incongruity on the $300 trillion of swaps could easily mean that the rates were off by up to about $300 billion. This is just one type of contract; it doesn’t even take into account all the other types of contracts or any punitive damages that might be sought. It’s big enough the entire banking system could be crippled.

One suggested option would be for the banks to set up a compensation fund for the victims of LIBOR so that all the banks could pool resources to pay out. An administrator would need to be independent but he could generate a transparent formula which could estimate and calculate the damages that have been done. If the banks at least attempt to right the wrong clients might be more willing to settle instead of pursuing litigation which would be much more costly.

Of course this would take much cooperation among these banks. They would need to decide how much LIBOR had been skewed because of the misreports. Then they would also have to decide how much of the financial liability each bank should be responsible for. Government involvement could help to expedite the process. There may be more regulations set by governments which could help improve the bank’s transparency. Had they maintained transparency this would have never happened in the first place. Perhaps this is a lesson for all of those who deal with financial institutions. Consumers and businesses can benefit from open and honest transparency.