The Markets
To borrow a word
from the legendary Gomer Pyle: G-o-l-l-y!
In 1955, just
five years before The Andy Griffith Show
became a big hit, William McChesney Martin, Jr., then Chairman of the Board of
Governors of the Federal Reserve System, made an often-quoted speech in which
he said, “The Federal Reserve, as one writer put it, after the recent increase
in the discount rate, is in the position of the chaperone who has ordered the
punch bowl removed just when the party was really warming up.”
Last week, Fed Chairman Ben Bernanke didn’t confiscate the punch. He simply modified the recipe by adding a lower proof of spirits when he announced the Fed would begin to taper its bond buying program. Starting in January, the Fed will spend $10 billion a month less on bonds (the amount will be evenly split between Treasuries and mortgage-backed securities). Taking away the punch bowl would have entailed ending all bond purchases and increasing the discount rate. The Fed has indicated it will not change the discount rate for some time.
After an initial
dip on the news of impending tapering, many markets around the world moved
higher. The Dow Jones Industrial Average and the Standard & Poor’s 500
Indices pushed to record highs. Britain’s FTSE 100, Germany's Dax, and France's
CAC indices all pushed higher on Wednesday, as did Japan’s Nikkei 225 Index. In
the bond market, U.S. Treasury yields rose and then fell on the day of the announcement.
The beginning of
the end of quantitative easing wasn’t the only news that drove markets higher
last week. On Friday, the U.S. Commerce Department reported that U.S. gross
domestic product (GDP) – a measure of our nation’s productivity – accelerated
faster than originally thought during the third quarter. The reasons for the
upward revision were increased consumer and business spending.
Life may have
been simpler in fictional Mayberry R.F.D. – and they certainly had fewer
choices as consumers – but economics and the responsibilities of the Federal
Reserve weren’t any less complicated.
in the EARLY
DAYS OF BANKING IN THE wild west, there weren’t too many rules
about what banks could and couldn’t do. According to The New York Times, in the early1900s:
“…Commercial
banks established security affiliates that floated bond issues and underwrote
corporate stock issues. (In underwriting, a bank guarantees to furnish a
definite sum of money by a definite date to a business or government entity in
return for an issue of bonds or stock.) The expansion of commercial banks into securities
underwriting was substantial until the 1929 stock market crash and the
subsequent Depression.”
After the crash,
thousands of banks failed.
In 1933, Congress
passed the Glass-Steagall Act (a.k.a. the Banking Act). The Act defined the
difference between commercial and investment banking activities. Commercial
banks primarily took deposits and made loans while investment banks helped companies
issue stock and invested in securities. The Act prohibited commercial banks
from participating in investment banking activities. It also created the
Federal Deposit Insurance Corporation (FDIC) whose job was to protect
commercial banks’ clients’ deposits up to a certain amount.
In 1999, after
years of financial prosperity, Congress changed its mind and passed the
Gramm-Leach-Bliley Act (GLBA) which effectively repealed the parts of
Glass-Steagall that prevented commercial banks from participating in investment
banking activities. Some believe the change in rules played a significant role
in the global credit crisis during which commercial banks suffered billions of
dollars in losses because of their investment banking activities.
In 2010, the
Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in response
to the global credit crisis and subsequent government bailout. The 953-page
Volcker Rule is part of the Act and was passed by regulators in December of
this year. It establishes a set of rules that are intended to prevent FDIC-insured
banks from making risky bets with customers’ deposits. In particular, banks
that rely on taxpayer guarantees are largely prohibited from proprietary
trading and hedge fund investments. We’ll know more when regulators decide how
the rules will apply and who will enforce them.
George Bernard
Shaw said, “We are made wise not by the recollection of our past, but by the responsibility
for our future.” Let’s hope when it comes to U.S. banking law, he proves to be
right.
Weekly Focus – Think
About It
“As a child my family's menu
consisted of two choices: take it or leave it.”
--Buddy Hackett, American comedian
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