VOICES FROM THE INDUSTRY: Looking back in history to understand this mess

September 29, 2008

Where is the stock market headed next? It may help to look where it has been. My clients may have grown tired of hearing how the bull market of the 1990s mirrored the Roaring Twenties-maybe because they knew what came after the Roaring Twenties? You remember the history books and your parents talking about the Great Depression.

The more articles you read concerning the recent market turmoil, the more this phrase appears: "Worst (fill in blank) since the Great Depression."

Could this recent market turmoil have been avoided? And, who is to blame for this mess? I have heard these questions a lot over the past few weeks. Yes, it could have been avoided, and the list of culprits is long, yet distinguished.

It's too easy to just blame greed. After all, a certain amount of greed is good. Hubris is at the top of my blame list.

Before I explain why I think hubris is to blame. Here are few quotes from news articles that you should recognize:

"American consumers and businesses relied on cheap credit... This fuelled strong short-term growth but created consumer and commercial debt."

"Businesses began to fail as construction work and factory orders plunged... Massive layoffs occurred."

"Banks which had financed this debt began to fail as debtors defaulted on debt... Bank failures led to the loss of billions of dollars in assets."

"With future profits looking poor, capital investment and construction slowed or completely ceased. In the face of bad loans and worsening prospects, banks built up their capital reserves and made fewer loans, which intensified deflationary pressures."

Even though the above quotes could be talking about today's market turmoil, they were all taken from pages describing the 1930s depression. Now stay seated and don't panic. I am not saying that we will go into another depression. Only pointing out some similarities between then and now in order to explain the hubris-is-toblame point of view.

Are we smarter today?

How can today's elected officials not be smarter than those elected in the 1920s and '30s? After all, it is their primary career today in comparison to people who just wanted to give back to society back then.

The Glass-Steagall Act was enacted during the Great Depression. It protected bank depositors from the additional risks associated with security transactions. The act was dismantled in 1999. More on that hubris move in a moment.

Consequently, the distinction between commercial banks and brokerage firms has blurred; many banks own brokerage firms and provide investment services.

The Glass-Steagall Act was enacted in 1933 after the stock market crash of 1929 and the ensuing banking crisis and Great Depression.

On the day it was signed, along with the National Industrial Recovery Act, President Franklin D. Roosevelt called the package "the most important and farreaching legislation ever enacted by the American Congress."

The idea behind Glass-Steagall, named for the two lawmakers who wrote it, was that confidence in America's financial house could best be restored if bankers and brokers stayed in separate rooms. Confidence in America's financial house sounds eerily familiar?

The bill that ultimately repealed the act was introduced in the Senate by Phil Gramm (R-Tex.) and in the House of Representatives by James Leach (R-Iowa) in 1999. The final bill, creating the Financial Services Modernization Act of 1999, was signed into law by President Clinton on Nov. 12, 1999.

The repeal enabled commercial lenders to underwrite and trade instruments such as mortgage-backed securities and collateralized debt obligations, and establish socalled structured investment vehicles, or SIVs, that bought those securities.

Blame to go around

Now I am not putting the entire blame on the doorstep of Phil Gramm and James Leach. Former Chairman of the Federal Reserve Alan Greenspan lowered interest rates to historic lows and left them there far too long.

Between 2000 and 2005, 40 percent of all U.S. economic growth came from the housing market, while the other 60 percent came from consumer spending. When the housing market stopped growing, actually popped by Ben Bernanke, our economy only had one direction it could go.

Consumer spending then came grinding to a stop, or at least diverted to the gas pump.

The stock market's gains since the repeal of Glass-Steagall have been pocketed by the Wall Street firms who lobbied for its repeal. Now we learn that their losses will be taken on the government's balance sheet. Actually, it will probably be kept off the balance sheet, but we taxpayers will still foot the bill.

We have successfully let capitalism work as long as there are profits and have socialized any losses. You as an individual investor must learn to work within this new free market system.

Coan is managing partner with Wealth Planning & Management LLC a fee-only registered investment advisor, and author of "Asset Protection and Wealth Preservation." Views expressed here are the writer's.
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