Economics for Dummies
In trying to understand the economic meltdown of 2008 what we need to accept is a simple truth no single cause shall ever be found(1). Scholarly hairsplitting on the Great Depression of 1929 has not yet settled what caused it.The school of Milton Friedman and of Joseph Maynard Keynes have their adherents and their positions are deeply entrenched so any of these more or less expresses itself in the economic thinking of nations. Those who believe in a large role for the state in the economy believe it was mostly a failure of the free markets and those who believe in free markets believe it was mostly a failure of government that compounded the problem. This being the case one cannot rest assured a single cause made it happen. Such inexactness rules the market forces just as supply- demand can never match without pricing coming into the play. Thus there are many factors that caused the meltdown of 2008 or depression of 29..
One law was set in place as a result of the Depression of 29.
Glass- Steagall Law of 1933 divided banks into commercial and investment banking. This law resulted in Federal Deposit Insurance Corporation for insuring bank deposits.Rediscounting is a way of providing financing to a bank or other financial institution. Especially in the 1800s and early 1900s, banks made loans to their customers by “discounting” their customer’s notes.
Such a note is a paper document, in a specified form, in which the borrower promises to pay a certain amount at a specified, future date. For example, assume that a customer wants to borrow $1000 for one year. In exchange for giving him $1000 today, the bank might ask him to sign a note promising to pay $1100 one year from now. The bank is “discounting” the note by giving the customer less than the note’s $1100 face value. The extra $100 is the bank’s compensation for providing the $1000 to the customer before the note matures,The Federal Reserve System in turn provided financing to the bank by rediscounting this note by giving the bank $1050 in exchange for this note. This Federal Reserve System was the bugbear for certain financiers who vilified it as state intervening in the free market.
Why should these financiers castigate FRS if they were set in place to oversee an orderly transaction between supply and demand factions across the counter?
Naturally for those who wanted to take risks and self aggrandize the law was an obstacle. Gramm-Leach Bliley act of 1999 was enacted precisely to cut the ground from under the feet of FRS from effectively functioning. This was done to give unfair advantage to Citicorp a commercial bank holding company.
Citicorp-a commercial bank holding company merged with an insurance company in 1998 to form Citigroup, a corporation combining banking, securities and insurance services.This combination, announced in 1998, would have violated the Glass-Steagall Act and the Bank Holding Company act of 1956 by combining securities insurance and banking. The law was passed to legalize these mergers on a permanent basis.
Also note the curious fact: the Gramm-Leach-Bliley Act was passed in November 1999, repealing portions of the BHCA and the Glass-Steagall Act, allowing banks, brokerages, and insurance companies to merge, thus making the Citigroup/Traveler Group merger legal.Top Citigroup officials were allowed to review and approve drafts of the legislation before it was formally introduced.
Also noteworthy is this:After resigning as Treasury Secretary and while secretly in negotiations to head Citigroup, Robert Rubin helped broker the final deal to pass the bill. He later became one of three CEOs that headed up CitiCorp.
Was Citigroup for serving the nation or for serving the vested interests?
Two years ago (2007)Citigroup was worth $273bn. Now it is worth just 20bn. This loss was not incurred in the pursuit of giving service to the clients fairly and responsibly as was expected of a commercial bank according to its original avowed principles. In the climate of reaganomics and unfettered risk taking to give heavy profits to a chosen few, the CitiCorp outplayed itself. The citiCorp was in trouble It tried to cover its credit crisis by brazenly trying to do just the opposite:Citigroup suffered a significant setback at the end of September, when its deal to buy regional bank Wachovia was trumped by an offer from rival Wells Fargo.(If the deal had gone through, it would have given Citigroup billions in additional deposits, boosting investors’ confidence and possibly preventing the steep share price sell-off.)
It has been battered by the meltdown in sub-prime mortgages – made to people on low incomes or poor credit ratings.
Citi has lost heavily, and its share price has fallen from over $55 in 2006 to less than $4, on par with lows last seen in late November when the US Treasury announced a $45bn rescue plan accompanied by a $306bn guarantee for Citi’s most risky loans.
If the bank had been allowed to collapse, it could have caused financial havoc around the globe, seizing up fragile lending markets and causing untold losses among institutions holding debt and financial products backed by the company.
Citigroup’s operations stretch around the globe with 200 million personal bank accounts in more than 100 countries.
In 2007, the bank’s total revenues topped $159bn, not far off the GDP of Chile.
Citigroup itself as a unified institution is relatively new. It was formed in 1998 through the $140bn merger of the bank Citicorp and the financial conglomerate and insurance firm Travelers Group.
However, the history of the bank dates back to the earliest years of the United States, with the foundation of the City Bank of New York in 1812.
Ever since, the bank has played a central role in the financial history of the US.
By 1895 the National City Bank of New York, as it had become, was the largest bank in America.
In 1918 it was the first American bank with more than $1bn in assets, and by 1929 had become the world’s biggest commercial bank.
In 1955 the bank altered its name to the First National City Bank of New York, and then in 1976 became Citibank – while its holding company changed its name to Citicorp.
In the 1970s, the bank was one of the first to pioneer the use of ATM machines, and by the 1990s it had become the world’s largest issuer of credit cards and charge cards.
Through a series of big mergers, Citi then built itself into a financial giant – offering customers everything from personal bank accounts and credit cards, to investment banking and wealth management.
The idea behind these mergers, with banks such as Mexico’s Banamex and Poland’s Bank Handlowy, was to create a financial group which would be big enough to deal with any crisis.
However, critics say that crucially Citi failed to control its expenses, and as it grew it became unwieldy and unfocused.
The losses that Citigroup built up as as result of the credit crisis have exposed some of the bank’s problems that critics claim had been hidden by profits during the years of booming house prices.
Group profit soared from $17.8bn in 2003 to $21.5 billion in 2006.
But as the crisis intensified, Citigroup’s fall has been equally dramatic, culminating in the $8.29bn loss during the October to December quarter in 2008.
Without such a deal, Citigroup had few options but to go cap in hand to the US government.
Ack: wikipedia, BBC News16 January 2009 -tim bowler- business reporter/ citigroup)
(1)In relation to the 1929 downturn, historians emphasize structural factors like massive bank failures and the stock market crash, while economists (such as Barry Eichengreen, Milton Friedman and Peter Temin) point to monetary factors such as actions by the US Federal Reserve that contracted the money supply, and Britain’s decision to return to the Gold Standard at pre-World War I parities (US$4.86:£1).