MONEY 1 - U.S. ECONOMY

THIS IS MY FIRST POST ON UNDERSTANDING MONEY TOOLS

Money! Money! Money! 

Let us take a look at a couple very important things that helped create and destroy finances in our country.  Of course, there are many to recall, but I am going to cover a few briefly here.  One is the Glass Steagall Act of 1933 that kept separate our institutions of brokerage, insurance, and commercial banking. 

A second is the Bretton Woods Agreement. In 1944 it put into place a functioning international system of rules and institutions to regulate international monetary policy, including the International Monetary Fund and World Bank. On August 15, 1971 the United States terminated the convertibility of the US dollar to gold, thus going off the gold standard, and went to a “fiat” currency.

Thirdly, we’ll discuss briefly the destruction of an old institution, the Savings and Loan industry, and how that came about.

The Glass Steagall Act was created during our “depression years” to keep separate the financial business of insurance, commercial banking and stock/bond brokerage.  Lack of regulations in the financial industries helped promote the Great Depression and the US tried to prevent the same from happening again.  Also, competition was welcomed.

An important part of the Act was the creation of the Federal Deposit Insurance Corporation, to insure deposits backed by the US Government.  The banks were to buy US Treasury’s so there was money in case of bank defaults and customers’ deposits in jeopardy. Up and above the guarantee of bank insurance was the US Government. In 2007-8 the FDIC went negative from bank deposits and the Government needed to step in.  One of the first major changes to the Act was in 1977 when banks’ holding companies could establish security affiliates/subsidiaries.

In 1978 mortgage backed securities entered the brokerage field, and foreign banks buying US banks put pressures to bear to be able to diversify. President Ronald Reagan was a proponent of deregulation and in 1982 mutual fund companies entered the investment field as “non-banks”. Major investment banking firms soon followed in offering mutual funds.  It is a worthy note here that Federal Reserve Chairman, Paul Volcker, was against this.  In 1987, Alan  Greenspan became head of the Federal Reserve and he believed in deregulations. With deregulations in the financial industry corruption escalated; junk bond sales to institutions from Charles Keating, Michael Millikan and others quickened the downfalls of “thrifts” and banks.  Mortgage derivatives and mortgage backed securities were sold to Savings and Loan Banks. 

These very complex structured mortgage backed securities developed in the early 1980s by Wall Street investment banking firms like Solomon Bros. could rarely be analyzed except by those who created the instrument and were sold to institutions, eventually taking down about 1/4 of the Savings and Loans.  At about this time interstate banking was permitted,  the large banks bought up many of the small and family owned banks, thus less regulation and competition. By 1995, with political pressure coming from the large banks and institutions Glass Steagall was about dead.  In 1998, Citicorp and Travelers Insurance merged. 

On November 12, 1999 the Gramm, Leach, Bliley Financial Modernization Act was signed into law putting the final “nail into the coffin” on the Glass Steagall Act.  One last comment here, when during the Clinton years and the undoing of the Glass Steagall Agreement banks could use depositor monies to invest for their own profitability.  If the investments turned out positively the banks made money, if the banks lost money through these investments, the Government’s FDIC bailed the banks out.  In 1933 the Glass Steagall Agreement authorized US Treasury notes to be issued not backed by the gold standard, but by the United States.

Another very important act impacting our money was the Bretton Woods Agreement of 1944. The US had been increasing its debt mainly from the Viet Nam War escalating during President Kennedy, even more during President Johnson and inherited by President Nixon. The US needed to pay  debts and needed to print money to do so beyond the backing of the gold supplies.  Therefore, on August 15, 1971 we went off the gold standard backing our United States currency and went with what is known as “fiat” currency, which concisely means that our currency is not backed by anything but the good faith and strong economy of the United States.

This was the end of the Bretton Woods Agreement. The printing of money and increase of US debt has been growing significantly since then, except for a couple of years at the end of the 1990s when we cut our defense budget, had a strong economy, and no expensive wars taking our dollars outside the country.

 Lastly, we will briefly talk about a lost industry that had been around for many years, the Savings and Loan business, sometimes referred to as “thrifts”.  These S&L’s were important players in the money industry as they dealt primarily with mortgage loans even though they lent money for cars and personal items. In August, 1979, Paul Volcker became Chairman of the Federal Reserve System.  Inflation was heading upward, primarily because of OPEC and the pass through of expensive oil, and oil is used for many products. 

To slow inflation Paul Volcker went against free market decision making and raised interest rates to very high levels crushing the home building, real estate industry and especially small business. When this happened people weren’t financing homes and thus Savings and Loans were not making enough loans to stay in business. The Tax Reform Act of 1986 had a major impact on investing, changing tax rates such as capital gains and knocking out tax favorable products such as partnerships, thus lowering values of assets.

Unsound lending practices were common with deregulations especially in real estate, and then mortgage derivatives took down many S&L’s when the Federal Government stepped in and forced S&L’s to sell the derivatives they carried on the books.  Sound familiar?  Happened again in 2003-2007 and collapsed many banking institutions around the world.

Next we will talk about stocks, bonds and your investing.