The government propping up banks, insuring deposits via the FDIC, insuring huge trades via the Federal Reserve, and passing legislation written by the banks ensures that things like this can happen. It isn’t natural to take these risks, nor could it have happened without the complicity of the law:
It is a common contention that regulation caused the market crash in 2008, particularly Glass-Steagle’s half-repeal by way of the Gramm-Leach-Bliley Act (115 regulatory bodies oversaw the circumstances that caused the crisis, yet that was still not enough for some people. Perhaps a 116th will make it all safe!). This is half true – but Gramm-Leach-Bliley is not to blame, Glass-Steagle’s remnants are. You see, the problem was not lack of to regulation, but government regulation and intervention in the first place. Gramm-Leach-Bliley repealed half of Glass-Steagle, the half that required the wall between investment and savings banks. This is what is commonly pointed to as the reason the bubble was inflated and ended up popping, as banks could use poorly-rated mortgages, bundle them, and invest them as securities. But it did not allow them to monetize debt as never before, fractional reserve banking is built on that principle. It did not create the credit default swap scheme, which was already in place. It did not allow for the poor rating of mortgage-backed securities (that was encouraged by other government regulation like the Community Reinvestment Act), nor did it change the fact that these could be traded by private investors, banks or no banks. All of the links to the puzzle are government-created, not artifacts that would arise out of a free market.
That part of the Glass-Steagle Act that was not repealed? It gave FDIC insurance for all bank accounts, meaning that if your bank account’s value went under because of a run on the bank or the bank lost it due to risky behavior, it would be insured from loss. Where the FDIC might not be good enough, Federal Reserve backing was given to the banks in case of emergency.. By law, risk was significantly encouraged. What bank would, if it could go under and destroy itself and so many people’s money by taking huge risks, gamble like they did? No. Glass-Steagle was the problem; it is not the solution. It privatized profits and ensured losses would be taken on by the government.
There is more. The Community Reinvestment Act. Freddie and Fannie. Low interest rates peddled by the Federal Reserve. Moral hazard of the above. Banks being “too big to fail” and getting there with the aid of government ensuring their oligopoly. The fact that banks wrote all of the relevant laws that led to the collapse. In a free market, these problems would not exist. The housing crisis would never have come to fruition, because natural limits would be in place and ensure no one was gambling money knowing that they would be paid back. It wasn’t Glass-Steagle. That is not nearly root enough of a problem…
- Canada has no Glass-Steagle, and their economy escaped the moral hazard-fueled crisis.
- Another perspective.]