Why Investment Banking Is Like Doing Drugs

Some background: In the wake of the 1929 stock market crash and the subsequent Great Depression, Congress was concerned that commercial banking operations and the payments system were incurring

Bankers prior to the establishment of the Federal Reserve would establish lines of credit with larger banks. In the event of a run, the smaller bank would draw on the line of credit. In times of panic, large numbers of depositors would demand to withdraw their money, and only the largest Wall Street banks, with millions of dollars in reserve, could guard against this. In the early twentieth century, people were running to withdraw all their cash from their accounts, this may seem dramatic, almost theatrical to people today. Nevertheless, to people living in an economically unstable society, they were an expected occurrence. The banks were independent rivals, the amount of currency in circulation was fixed, and there was no element of

In doing so, Bruner and Carr are better able to elucidate the ways in which individual actors caused the rapid decline of the American economy in late 1906. In this, Bruner and Carr begin the text by highlighting the influences and magnitude of the major players in the financial services sector in the early twentieth century. Perhaps the most notable of the those mentioned is that of J. Pierpont Morgan, the Wall Street Oligarch for which the contemporarily “too big to fail” financial services entity J.P Morgan-Chase is named. In highlighting these individuals and their over-inflated influence on the financial system, Bruner and Carr subtlety highlight one of the biggest problems facing the financial services sector during this time period—the lack of regulation. To further elucidate this point, the books opening chapter follows the interactions between J.P Morgan and his other colleagues in George F. Baker, president of the First National Bank of New York and James Stillman, president of New York’s National City Bank. Here, the text focuses on the ways in which they inconspicuously competed and colluded with each other to make their fortunes larger and more

According to Alan Reynolds, government policy could be the only possible cause to destabilize the economy. This can be seen in the Smoot- Hawley Tariff Act of 1930; the five point plan summarily stated the following: raise the cost of living, stop all help to the farm sector, urge foreign countries to pay higher trade tariffs, and hinder foreign debtors from paying U.S. foreign investors (Phalan). On another note, the stocks collapsed on October 28, 1929, or Black Thursday, when multiple members of the senate switched to the approving side of a calcium carbide tariff. Then, another tariff was forced upon Hoover, and the next day was Black Tuesday. Finally, on November 14, the senate postponed action on the Smoot-Hawley Tariff, which caused a rise in stocks. Yet, the stocks downturned in anticipation of Hoover’s veto on the act even though he ratified it. To clarify, each passing of tariffs caused a downward force on stock value (Reynolds). Moreover, overspeculation, purchasing high-risk stock, flourished as interest rates were artificially lowered (Etheredge). As aforementioned, this caused a false sense of security within the market. The market’s peak in August of 1929 caused by this over speculation ended in October, and the massive loss of monetary value wiped out bank deposits (“Stock Market Crash of 1929”). In expansion, banks had utilized deposits to invest in the market and create interest, yet the money was not secured by an agency such as the FDIC, or Federal Deposit Insurance Company. Therefore, bank runs occurred as citizens rushed to withdraw from their accounts. The cause of such an event spurred the ratification of the Glass-Steagall Act, or Banking Act of 1933, which created the FDIC (Pusey 1). In all, over speculation caused economic chaos, and actions on the Smoot-Hawley Tariff caused a downturn in stock.

Financial historians have disputed the rational for reforming the banking system in the US as a result of the 1920s banking crisis. Calomiris (2010) argue that there may have been political self-interest incentives as to why the Glass-Steagall Act was enacted. Firstly Steagall had bargaining power as Chairman of the banking committee in the House of Representatives. Second, the Pecora Hearings populist politicians including Henry Steagall advocated in favour of small banks contributing in making large bank disliked amongst the public. And finally deposit insurance was introduced as a temporary system allowing for easy approval in the Congress.

Investment banks use some of the money to invest in the stock market. If the stock market crashed, the bank would also crash and people would lose all their money. Furthermore, since brokers demanded investors repay their loans, investors were withdrawing savings from banks as well. This was happening on a mass scale, and banks did not have enough money to continue operating.

Shortly after the implementation of the original act in 1933, Senator Glass removed support for part of his own bill due to a study done in that same decade. The research concluded that securities underwritten by non-commercial banks suffered the same consequences as those wrote by commercial banks prior to 1933; thus causing unnecessary harm to an already strained market. His revision to Section 16, which prohibited commercial banks from trading in non-government securities, to once again have the ability to underwrite risky speculative securities. This amendment passed through the Senate, but was ultimately killed in the Congressional process due to a lack of support from President Roosevelt. Glass is not the only opposition the bill saw before it’s repel in 1999. Another adamant opponent to Glass-Steagall has been former President Bill Clinton. It was during this administration that Laurence H. Summers was appointed as Treasury Secretary. Summers then fought for deregulation of the financial safeguards set in place by Glass-Steagall and praised Congress when its replacement, the Gramm-Leach-Bliley Act, shifted through. Summer’s and Clinton’s criticism, however; is not without a solid standing or reason. The G-S Act allowed banks to face tougher competition from unregulated retail and consumer stores that began to offer a line

Even before FDR had taken his oath of office, the Glass-Steagall bill had been in the works. Representative Henry Steagall had proposed deposit insurance as a means of saving failed banks. This was not a new idea. Several states had initiated deposit insurance schemes in the 1920s, when bank failures were on the rise. During the depression, however, states lacked the capital resources to rescue their own state-chartered banks, to say nothing of the many smaller banks. Steagall realized that opposition to a federally insured deposit system would come from the large banks, which would resent parting with revenue for the sake of their weaker competitors. By the spring of 1933, however, even the major banks were willing to support this idea, rather

During the good times of the 1920s Americans did not share the wealth equally. Prior to 1929 the top .1% had the same income as the bottom 40%. Even though employment was high and big business was manufacturing an abundance amount of product, wages did not rise. However corporate wages increased some 62% and business owners kept the profits, not the American worker. This made it extremely difficult for the common worker to afford the items they were producing and allowed the business owners to live lavishly like celebrities they were hearing about on the radio. Despite never addressing the wealth gap the New Deal created The Glass-Steagall Act which prevented banks from trading in the stock market until its repeal in 1990. The FDIC also came of this law which

The Glass Steagall Act was passed on 1933, which is also known as The Banking Act to tighten regulation on the way banks did their business. This act was written as an emergency measure when about 5,000 banks failed during the Great Depression. Banks mostly failed because of the way they would invest with money. The act prohibits banks from investing money on investments that turn out to be risky. Banks could no longer sell securities or bonds. The act also created Federal Deposit Insurance Corporation (FDIC) to protect the deposits of individuals, which is still used to this date. The FDIC in this era insures your deposits in your bank up to $250,000. This gave the public confidence again to deposit their money in the bank. In 1933

The banking industry as a whole after the stock market crashed was going bankrupt due to not being able to carry the “bad debt” that was created from using customer money to buy stock. Because the banks were out of money, they were unable to cover customer withdrawals from their bank, causing many bank customers to lose all of their savings. With the uncertainty of the future of the banking industry, many people withdrew all of their savings, which caused more than 9,000 banks to close their doors and go out of business (Kelly). Due to the effects of the Great Depression, and the collapse of the banking industry, the government created regulations to prevent similar failure in the future. For Example, the SEC, (or Securities Exchange Commission), which regulates the sell and trade of stocks, bonds and other investments was created as a result of The Great Depression. The FDIC (or Federal Deposit Insurance Corporation), was created to insure bank accounts so that that the consumer would be protected if the bank were to go out of business (Kelly). The Great Depression's effect on the banking industry led to many useful changes to the banking industry and helped restore confidence in banks in the American people.

Since at least the 1980s, the financial industry wanted the repeal of Glass Steagall (Shanny). The Glass-Steagall Act of 1933 separated commercial and investment banking in the United States. This passed shortly after a series of bank failures and was supposed to restore confidence in the banking system by prohibiting banks from taking excessive risks. Concerned that commercial banking systems were incurring losses from speculative investments, specifically the stock market, they felt that completely prohibiting them from making these investments was the necessary measure to take. This meant that commercial banks were no longer allowed to deal in or underwrite securities, while investment banks were no longer

The banking and securities industries had regulations since the 1930s or earlier. The laws were there to help regulate and give depositors some security. For one reason or another, the law has been changed, updated or appealed. The Banking Act of 1933, known as the Glass–Steagall Act named after the Congressional sponsors: Senator Carter Glass, a former Treasury Secretary and Senator Henry Steagall (Heakal). The Glass-Steagall Act foresaw problems with banks over lending becoming involved in securities. The Federal Deposit Insurance Corporation (FDIC) came out of The Act of 1933 (Stammers). The Federal Deposit Insurance Corporation (FDIC) wanted banks held accountable to depositors and the federal government for their actions. The major part of this act was to keep banks and securities separate until 1999 Gramm-Leach-Biley Act (GLBA) (Heakal). The GLBA allowed banking and securities to mingle and compete in domestic and international markets.

The third reason given was the bad banking structure which was in place in the 20's and into the 30's. Banks at this time were run individually, thus, when a bank failed or went belly up because of aggregate deposits, it started a domino effect. In 1929 alone, 346 banks closed their doors, leaving people out in the cold, with no money, money which they had trusted in the hands of these banks. This of course left the people with a bad taste in their mouths, and caused them to stop putting money in banks, relying instead on the bottom side of their mattresses. The bad running of banks ties into corruption also. The men who ran banks, men like Charles E. Mitchell, were more interested in keeping the stock market boom going rather then the health of the banks which they ran. These men kept interest rates low and gave bad loans to people who mostly had no hope of ever paying back.

Investment banking dates all the way back to early America, during the Civil War to be exact. During the Civil War, Jay Cooke, a Philadelphia financier, established the first modern investment bank. Although this was the first “official” investment bank, there had been many private banks doing the same jobs. After the civil war these financial services evolved dramatically. Investment bankers started to influence client companies by sitting on finance committees or even on the board of directors for the companies themselves.