What really precipitated the subprime loan fraud, corrupt banking practices and the derivative markets was the November 12, 1999 repeal of the 1933 Glass Steagall Act.
https://www.thebalancemoney.com/glass-steagall-act-definition-purpose-and-repeal-3305850
The Glass-Steagall Act is a 1933 law that separated investment banking from
retail banking.1
Federal Reserve Bank of St. Louis. "
Banking Act of 1933 (Glass-Steagall Act)."
Investment banks organized the initial sales of stocks, called an initial public offering. They facilitated mergers and acquisitions. Many of them operated their own hedge funds. Retail banks took deposits, managed checking accounts, and made loans.
Purpose
Glass-Steagall sought to permanently end bank runs and the dangerous bank practices that created them. Congress passed Glass-Steagall to reform a system that allowed the failure of 4,000 banks during the Great Depression. It had debated the bill during 1932.2 It redirected bank funds from fueling stock speculation to building industrial capacity.
Since 1922, the stock market had gone up by almost 20% per year.9
History. "
What Caused the Stock Market Crash of 1929?"
Banks invested in the stocks. When the market crashed in 1929, depositors rushed to withdraw their funds. By March 8, they had withdrawn $1.78 billion in just four weeks. Others demanded gold in return for the money. The United States was still on the
gold standard, but the demand was so high that the Federal Reserve was running low on its gold deposits.10
bank run will put even sound banks out of business. Banks keep just one-tenth of their deposits on hand and lend out the rest. Most of the time, they only need 10% to fill depositors' demand.11 In a bank run, they must quickly find the cash.
On March 6, 1933, President Roosevelt declared a four-day bank holiday.12 On March 9, Congress passed the Emergency Banking Act. It allowed banks to reopen on March 13. Banks would no longer exchange dollars for gold. Instead, the Federal Reserve printed dollars to meet depositors' demand. The currency was based on the banks' paper assets. By March 15, most banks had reopened to find that the bank run was over.
Effect
Glass-Steagall restored confidence in the U.S. banking system. It increased trust by only allowing banks to use depositors' funds in safe investments. Its FDIC insurance program prevented further bank runs. Depositors knew that the government protected them from a failing bank.5
During the Reagan administration, the banking industry complained that the act restricted them too much. They said they couldn't compete with foreign financial firms that could offer higher returns. The U.S. banks could only invest in low-risk securities. They wanted to increase the return while lowering the overall risk for their customers by diversifying their business.14
Citigroup had begun merger talks with Travelers Insurance in anticipation of Glass-Steagall. In 1998, it announced the successful merger under a new company called Citigroup.15 Its move was audacious, given that it was technically illegal, but banks had been taking advantage of loopholes in Glass-Steagall.
Repeal
On November 12, 1999, President Clinton signed the Financial Services Modernization Act that repealed Glass-Steagall.16 Congress had passed the so-called Gramm-Leach-Bliley Act along party lines, led by a Republican vote in the Senate.17
The repeal of Glass-Steagall consolidated investment and retail banks through financial holding companies. The Federal Reserve supervised the new entities. For that reason, few banks took advantage of the Glass-Steagall repeal. Most Wall Street banks did not want the additional supervision and capital requirements.18
Those that did became
too big to fail. This required their bailout in 2008-2009 to avoid another depression.
