Finance, Forex and Investments

After the Great Depression,commercial banks were barred from operating in the stock markets? Why was this done?

This is a question for my macro-economics course. I need help!

Public Comments

1. I actually addressed this quite a few times in my post history but in short, the USG learned that part of the problem (not the entire problem, but part of it, yet an important part) that caused the market crash of 1929 and subsequently downfall was that banks were in the business of underwriting securities. Basically banks were not only into banking, they were in the more risky stock market business. What happened is that in 1933, the Glass Steagall Act was passed. This Act forced banks to decide whether they were either going to be a broker (underwriter) or a bank but not both. Glass Steagall Act http://en.wikipedia.org/wiki/Glass-Steagall_Act Now here is the part you are going to call some members in your gov stupid: Certain major banks (Citibank) got greedy and saw how much money the broker dealers (brokerage firms) were making in selling, underwriting securities, especially during the later 1990's .com boom. Said and other bank institutions lobbied congress (gave hundreds of millions in campaign contributions) to repeal the 1933 Glass-Steagall, bit by bit over 25 years to the point where, under the Clinton Administration (1999), signed off a law that finally eliminates the Glass-Steagall. "After 12 attempts in 25 years, Congress finally repeals Glass-Steagall, rewarding financial companies for more than 20 years and $300 million worth of lobbying efforts. Supporters hail the change as the long-overdue demise of a Depression-era relic." http://www.pbs.org/wgbh/pages/frontline/shows/wallstreet/weill/demise.html The result allowed banks to get in the underwriting business again just like they did in the 1920's. It only took about 6-7 years to recreate the EXACT SAME PROBLEMS we had during the Great Depression, and bring them into our modern world. The death blow? Mortgage Backed Securities (MBS). http://www.sec.gov/answers/mortgagesecurities.htm (Banks underwrote MBS's in huge amounts) Collateralized Mortgage Obligations (CMOs). http://www.sec.gov/answers/tcmos.htm (Banks underwrote CMO's in huge amounts) Credit Default Swaps (CDS). http://en.wikipedia.org/wiki/Credit_default_swap (Banks/ Insurance Companies (example (AIG)/ Brokers (example LEH, BSC) underwrote CDS's in huge amounts). And is our gov or regulatory body seeking to reinstate the 1933 Glass-Steagall Act so this problem does not repeat again or is prolonged? Answer: No. Not even being discussed. What is being discussed? "short sale rules." http://online.wsj.com/article/BT-CO-20090408-713337.html FYI: Short sellers were not to blame for the 1929 and subsequent crashes, nor are they to claim for our current problems. That is the answer. If one is not sure or does not like the answer sure. One needs to just read up on the history using the links provided or do their own homework. http://en.wikipedia.org/wiki/Great_Depression edit..... I have to respectfully disagree with my fellow poster. To clarify I did state above that Glass-Steagall was "not the entire problem, but part of it, yet an important part;" and cited 3rd party links that have documented problems related to such as PBS. Other than understanding market and economic history of the Great Depression and the current credit crisis as it is so loosely dubbed, my fellow poster is not clear on how banks and underwriting had a huge role in this mess, plus poor FED policy (see post history about my FED comments), more. This is another topic, and I have addressed this in detail, in the past many times (see post history. add me to view). Worth reading/ watching: House Of Cards: The Mortgage Mess CBS 60 Minuets Video: http://www.cbsnews.com/video/watch/?id=3756665n Text: http://www.cbsnews.com/stories/2008/01/25/60minutes/main3752515.shtml This one is better: "House of Cards" (CNBC) http://www.cnbc.com/id/28892719
2. It's pretty simple. Investment banks make underwriting commitments. This forces them to buy shares if they can't sell them to other investors. Even if they can, they will wind up owning shares in order to make orderly markets. These equity holdings form a part of a bank's reserves. In the event that the value of these holdings decline, the bank's reserves could fall too low to maintain solvency. While it's fashionable to belabor the repeal of Glass-Steagall as a cause of current distress, there's no example of a bank that lately has fallen apart on account of its entry into the investment banking business and even less evidence of an investment bank that became distressed by entry into commercial or money center banking. More simply, it's a matter of lowering reserve requirements rather than the composition of the reserves.
3. This is my understanding based on reading a couple of books a while ago. In the 1920's there was a huge speculative bubble in the stock market. A lot of it was based on easy credit. The market kept going up, so people went "all in" and some even borrowed money to invest (they invested on margin). This made the market go up even more. It all turned into a big Ponzi scheme. The banks provided the margin money. The banks were happy to have a frothy overheated stock-market because they were making comissions all over the place, especially underwriting new share-listings. So the banks kind of had a conflict of interest. Lending out their depositors' money to speculators was keeping the market moving up, which helpied their investment banking business. When the bubble broke, the market fell, the speculators couldn't pay back their loans, the banks went bust, the depositors lost their money, companies couldn't borrow anymore, and after a time, there was 25% unemployment. The government basically decided that the banks had behaved irresponsibly. They had made a lot of loans that were risky in the long term, for the sake of short term gain. (sound familiar?) So you can view Glass Steagall as a way of taking some of the power to make mischief in the capital markets away from the banks, as well as limiting their power overall.