Underlying problems

The discussion of Thomas Jefferson's comments about money and banks in The Downey Patriot's New Year's edition is interesting but beside the point. (Letters to the Editor, 1/1/10)Going back to the 18th Century is not an option. Technology and the study of economics lead to a role for the Federal Reserve Bank that was quite successful by the end of the 20th century. At the time of its founding in 1917, the country had for decades been rocked about every seven years by one financial panic after another, and the goal was to set up a system that would stabilize the financial system. While clearly ineffective initially, after the great crash of 1929 and its massive bank failures, additional regulations were set up and enforced that kept banks small, separated bank lending from investment, and laid a basis for the Federal Reserve System to work. During this period, the idea of financial panics in boom/bust cycles became something taught in history classes, and by 1982 the leaders of the Fed had essentially achieved the goal of a country with relatively steady growth and expansion with minimal inflation. At the end of World War II, the paper dollar became the world's pre-eminent currency, and was a key element in the prosperity of the last half of the 20th century. Today, the paper dollar is mostly obsolete - most of the dollars in circulation are electronic. Going back to carrying gold around is simply not an option, and is unlikely to improve our economy. The U.S. had plenty of booms and busts while on the gold standard, and a long period of continuous prosperity while off of it. Attempting to back the dollar with gold would needlessly tie our nations (and the world's) finances to the fortunes of the mining industry, which is why that is the principal source of the PR funds that are trying to convince people to do just that. Sadly, there are a lot of people who don't recognize a good thing. At the end of 1999, Sen. Phil Gramm included a repeal of the Glass-Steagall Act in the Gramm-Leach-Bliley Financial Services Modernization Act, and President Clinton signed it. Together with two earlier financial deregulation bills, this completely removed the wall of separation between retail and commercial banks on the one hand, and investment banking and other financial services on the other, in the name of deregulation and modernization. The problem is that doing this pulled the rug out from under the Federal Reserve. Instead of making funds available to support the liquidity of institutions that were restricted to lending those funds out in support of commerce, funds made available by the Fed could now be diverted to investments - and to the most high-risk sorts of investments, derivatives. And it is not just diversion - as long as the same firms do both, it is impossible for the Fed to maintain liquidity in the financial markets without making the same cash available for speculation, at the discretion of bank management. No sooner did this happen than the investment bubbles started forming and popping, with three major bubbles during the last decade: tech, energy, and housing. If people can borrow money for practically nothing and use it to bet on commodities and derivatives, they will line up like pigs at a trough, bidding values up until they form a bubble, and eventually it will pop. This also explains what has happened to much of the money that bailed out the banks when their bets all came up snake eyes as the housing bubble popped in 2008. Instead of lending the bailout money on "main street" (for businesses and mortgages), they have put most of it back into their investment banking and derivatives casino, seeking higher and easier (but ultimately riskier) returns. Moreover, in order to save failing institutions, many of the remaining investment banks had to be merged into commercial banks, and vice versa. The problem is not the Federal Reserve System itself, but the repeal of Glass-Steagall. Those who would like a stable future in which America can resume leading the world should press their representatives and the White House to break up the too-big-to-fail banks. These banks would have failed without the bailout, and it is now time for the underlying problems of too-big-to-fail and diversion of Fed money from lending to be fixed. I am confident that if Thomas Jefferson had seen the economic history of the period from the Civil War through today, and had the opportunity to study modern economics, he would agree. - Matt Filler, Downey

********** Published: January 8, 2010 - Volume 8 - Issue 38

EventsEric Pierce