Market and Politics PDF

A Short History of Financial Deregulation in the United States Glass-Steagall Act (1933): A law enacted during the Great Depression to separate commercial banking ( taking deposits and making loans) from investment banking ( trading and securities). This was meant to prevent banks from taking exces...

A Short History of Financial Deregulation in the United States Glass-Steagall Act (1933): A law enacted during the Great Depression to separate commercial banking ( taking deposits and making loans) from investment banking ( trading and securities). This was meant to prevent banks from taking excessive risks with depositors' money. Repeal of Glass-Steagall: Happened in 1999 with the Gramm-Leach-Bliley Act. IT allowed banks to combine commercial and investment activities again, which some argue contributed to the 2008 financial crisis. Background Summary: ​ Early financial regulation included caps on interest rates to protect borrowers ​ The Federal Reserve System was created in 1914 to stabilize the economy, control money supply, and prevent baking cruises ​ The Great Depression brough stricter regulations, such as the Glass-Steagall Act, Which separated banking activities and created deposition insurance to protect consumers This section highlights how regulation evolved to address past crises like the Great Depression. It shows the balancing act between controlling financial risk and fostering innovation Early regulation were reactive, responding to specific crises setting the stage for later deregulation efforts. Removing Interest Rate Ceilings ​ Regulation Q, in 1933, capped interest rates on saving accounts ​ In the 1970s, inflation made these caps problematic, leading to their removal under Depository Institutions Deregulation and Monetary Control Act of 1980. ​ Spurred growth of new financial produce like money market funds, which offered higher returns without restrictions The removal of interest rate ceilings encouraged competition among financial institutions but also led to riskier financial practices. This deregulation shifted the financial landscape, allowing innovative produce to thrive while increasing system risks. 3. Repealing Glass-Steagall Summary: ​ The Glass-Steagall Act prohibited banks from engaging in both commercial and investment banking. ​ By the 1980s and 1990s, banks lobbied to repeal it, arguing that it hindered their competitiveness in a global economy. ​ The Gramm-Leach-Bliley Act of 1999 repealed Glass-Steagall, allowing banks to diversify and merge. ​ Critics argue that this deregulation contributed to the 2008 financial crisis by enabling risky banking practices. Analysis: Repealing Glass-Steagall was a turning point, signifying a shift toward deregulation and greater consolidation in the banking industry. While it boosted the competitiveness of U.S. banks, it also blurred the lines between different types of banking activities, creating potential for conflicts of interest and systemic risks. 4. Hands-Off Regulation Summary: ​ The 1990s saw a surge in new financial instruments, particularly derivatives, which posed challenges for regulators. ​ Efforts to regulate derivatives were resisted by powerful financial interests and government officials. ​ The Commodity Futures Modernization Act of 2000 exempted derivatives from regulation, contributing to the buildup of systemic risks in the financial sector. Analysis: ​ This section underscores the risks of minimal regulation in complex financial markets. The hands-off approach enabled rapid innovation but also allowed hidden risks to accumulate, ultimately contributing to financial instability, as seen in the 2008 crisis. Derthick and Quirk chapter from Politics of Deregulation The Politics of Deregulation explores how and why significant deregulation occurred in the U.S. during the late 20th century. The article examines the roles of political leadership, independent regulatory commissions, and economic analysis in driving reforms. It highlights how deregulation was made possible by a combination of public support, expert advocacy, and institutional dynamics, while also addressing the challenges posed by interest groups and the fragmented U.S. political system. Role of Independent Regulatory Commissions: ​ Commissions like the Civil Aeronautics Board (CAB) and Interstate Commerce Commission (ICC) led reforms by using their broad statutory powers to bypass Congressional gridlock. Importance of Economic Analysis: ​ Economists provided evidence-based arguments for deregulation, showing how regulations created inefficiencies and raised costs without benefiting the public. Political Leadership and Timing: ​ Leaders like President Ford and Senator Kennedy prioritized deregulation when public and political conditions were favorable. Public Support and Symbolism: ​ Rhetoric like "cutting red tape" helped gain public backing by framing deregulation as a way to lower prices and reduce government interference. Challenges to Reform: ​ Industries and labor unions opposed deregulation, but fragmented organization and strong public support weakened their resistance. Examples of Deregulated Industries:  ​ Airlines: Lower fares and more competition. ​ Trucking: Competitive rates and routes. ​ Finance: Removal of interest rate caps but increased risks. Vietor article, “Regulation American Style,” The New Deal established government oversight in sectors like banking, transportation, and labor, addressing market failures and creating safety nets. 1. Historical Foundations of Regulation ​ Regulation began during the Progressive Era (early 20th century) to control the economic and political power of monopolies and large corporations. ​ The New Deal of the 1930s expanded regulation to address market failures and stabilize industries like finance, transportation, and labor during the Great Depression. 2. Criticism of Regulation in the 1970s ​ By the 1970s, regulation faced growing criticism for being inefficient, outdated, and burdensome, particularly in industries like transportation (airlines and trucking) and energy. ​ Overregulation was linked to rising costs, stifled innovation, and inflationary pressures, prompting calls for reform. 3. Shift to Deregulation ​ Deregulation emerged in the 1970s and 1980s to address inefficiencies and enhance global competitiveness. ​ Key sectors like airlines, trucking, telecommunications, and finance underwent significant deregulation, aiming to: ○​ Lower consumer costs. ○​ Foster competition and innovation. ○​ Reduce government interference in the economy. 4. Role of Consumer and Environmental Movements ​ Social movements in the 1960s and 1970s expanded the scope of regulation beyond economic issues to include environmental protection (e.g., Clean Air Act) and consumer safety. 5. Consequences of Deregulation ​ Positive Outcomes: ○​ Increased competition led to lower prices and greater innovation in many industries. ​ Negative Outcomes: ○​ Job losses due to industry restructuring.  ○​ Industry consolidation, which sometimes reduced competition over time. ○​ Financial instability caused by the removal of safeguards, such as interest rate caps. 6. Regulation in the 21st Century ​ The article suggests that deregulation created both opportunities and challenges. While it modernized industries and fostered competition, it also highlighted the need for balanced oversight to prevent systemic risks. Takeaways ​ Regulation in the U.S. evolved to address economic and social issues, but its rigid structure eventually faced backlash. ​ Deregulation brought economic benefits but exposed industries to new vulnerabilities, such as financial crises and market monopolization. ​ Balancing regulation and market freedom remains a central challenge for policymakers. KEY TAKEAWAYS Session 20 What is the difference between statutory law and common law? Statutory law is written and enacted by legislative bodies (e.g., Congress or state legislatures), while common law evolves from judicial decisions and precedents established by courts. How do courts determine common law? Courts determine common law by referencing precedents set by previous judicial decisions, interpreting them in the context of the current case, and adapting principles as necessary to fit new circumstances. Why are statutory laws and common laws different in different cities and states? Statutory laws differ because legislative bodies in different jurisdictions enact their own laws based on local needs and priorities. Common law varies because judicial decisions are influenced by precedents and interpretations specific to each jurisdiction. What can interest groups do if they disagree with the actions of a federal regulatory agency? Interest groups can file lawsuits to challenge the agency's actions, lobby Congress to amend the law governing the agency, or petition the agency directly for rule changes or reconsideration of decisions. Where does a federal regulatory agency get its authority to act? Federal regulatory agencies derive their authority from enabling statutes passed by Congress, which delegate specific powers and responsibilities to the agency. What two aspects of the actions of a federal regulatory agency can be challenged? The substance of the agency's decisions (whether they are lawful and reasonable) and the procedure used to make the decisions (whether they followed required legal processes) can be challenged. A few months ago, the Supreme Court changed its opinion from forty years ago regarding the power of federal regulatory agencies to make decisions. What was the change? The Supreme Court limited the deference previously given to agencies under the Chevron doctrine, asserting that courts should interpret statutes more strictly and not automatically defer to agency interpretations. What benefits do corporations have that sole proprietorships and partnerships lack? Corporations have limited liability for owners, perpetual existence, and easier access to capital markets, unlike sole proprietorships and partnerships where owners are personally liable, and the entity dissolves with the owner's departure or death. Companies that wanted to create local infrastructure in the first half of the nineteenth century were given the incentive to do so if they could capture the user fees. But what else did they did need before they would invest the money? They needed a corporate charter or legal approval from the government granting them the authority and exclusivity to build and operate the infrastructure. In what ways did communities benefit from the market providing infrastructure rather than having the government provide it? Communities benefited from private investment, innovation, and faster development without requiring significant public funding or taxation. What does it mean that corporate charters provided communities with desired infrastructure, but, in return, they had to be willing to accept potential monopoly pricing and political corruption? It means that while communities gained access to essential services like roads and railroads, they often faced higher prices due to monopolistic control and dealt with unethical practices, such as bribery or undue influence, as corporations sought to protect their interests. Session 21 1. Explain how the expansion of railroads and communication created a national market and what that meant for business in America in the 19th century The expansion of railroads and communication in the 19th century created a national market by connecting distant regions, enabling businesses to transport goods widely and efficiently, which led to larger-scale operations and heightened competition. 2. Understand the difference between horizontal combination and vertical integration Horizontal combination involves merging with competitors to dominate a market, while vertical integration means controlling all stages of production and distribution. 3. Understand what it meant to say that Carnegie Steel was a "fully integrated corporation" Carnegie Steel was fully integrated because it owned every step of the steel production process, from raw materials to finished products, ensuring efficiency and cost control. 4. Be able to explain the puzzle of prices and competition in late 19th century America The puzzle of prices and competition arose when intense competition lowered prices, but rising production costs squeezed profits, leading businesses to stabilize markets through coordination or mergers. 5. Understand why corporations went from competition to coordination to consolidation Corporations moved from competition to coordination to consolidation to end destructive price wars, stabilize markets, and achieve efficiency through large-scale operations. Session 22 1. Understand the history of merger waves in the United States Merger waves in the U.S. occurred during periods of economic change, such as industrialization, post-WWII expansion, and the 1980s financial boom, driven by growth, technology, and market consolidation. 2. Understand the evolution of antitrust law in the United States Antitrust law evolved with the Sherman Act (1890), the Clayton Act (1914), and the FTC Act (1914), strengthening rules against monopolies and unfair trade practices. 3. Understand how the Great Depression led to the "creation" of the federal government in the 1930s The Great Depression forced the federal government to intervene in the economy, creating jobs, stabilizing banks, and regulating industries. 4. Understand what federal agencies were created in the 1930s Agencies like the SEC (securities regulation), FDIC (bank deposit insurance), and Social Security Administration (social safety net) were established. 5. Understand the logic and ideology behind the creation of the new federal government The new federal government was based on Keynesian ideas, emphasizing regulation and public spending to stabilize the economy and protect citizens. 6. Understand why the form of industry regulation was so distinctive from other nations U.S. regulation focused on market competition rather than direct state ownership, differing from many nations' more centralized approaches. 7. Understand which industries were regulated and how they were regulated Industries like transportation, utilities, and banking were regulated through pricing controls, standards, and antitrust enforcement. 8. Understand the performance of regulated industries for nearly half a century Regulated industries achieved stability and consumer protection but often became inefficient and resistant to innovation. Session 23 1. Understand how the Great Depression led to the "creation" of the federal government in the 1930s The Great Depression expanded federal authority, creating programs and policies to stabilize the economy and reduce unemployment. 2. Understand what federal agencies were created in the 1930s Agencies like the SEC, FDIC, Social Security Administration, and FHA were created to regulate markets, protect consumers, and provide social safety nets. 3. Understand the logic and ideology behind the creation of the new federal government The new federal government was guided by Keynesian economics, emphasizing active intervention to address economic crises and protect citizens. 4. Understand why the form of industry regulation was so distinctive from other nations U.S. industry regulation emphasized preserving competition rather than state ownership, aligning with free-market ideals. 5. Understand which industries were regulated and how they were regulated Banking, transportation, utilities, and securities were regulated with price controls, safety standards, and market oversight to ensure stability and fairness. 6. Understand the vocabulary of economic regulation Key terms include price controls (setting price limits), monopoly power (market dominance), rate setting (regulated pricing for services), and antitrust laws (preventing anti-competitive behavior). Session 24 1. Understand how the experiences of the 1920s led to the New Deal Regulation—how did regulating radio set the stage for regulating telephones and how did the problems causing the stock market crash set the stage for finance regulation? Regulating radio through licensing and spectrum allocation established a precedent for managing public utilities like telephones, while the stock market crash revealed the need for financial transparency and oversight, leading to the SEC’s creation. 2. Understand the new vocabulary of economic regulation and how these infrastructure industries were regulated in terms of entry, product/service delivered, and price. Regulation involved entry controls (licensing and permits), service standards (ensuring quality and accessibility), and price setting (preventing overcharging or predatory pricing). 3. Understand how changing economic conditions in the United States in the 1960s and the 1970s led to the breakdown of regulation and deregulation in the 1970s and 1980s. Economic stagnation and inefficiencies in regulated industries prompted calls for deregulation to lower costs, enhance competition, and stimulate growth. 4. Understand how the new regulatory agencies determined entry into the new regulated industry structure. Regulatory agencies controlled entry by issuing licenses or certifications, ensuring new entrants met safety, quality, and market demand standards. Session 25 1. Understand the most important elements of financial deregulation, particularly repealing Glass-Steagall and the Commodity Futures Modernization Act of 2000. The repeal of Glass-Steagall allowed banks to combine commercial and investment activities, while the Commodity Futures Modernization Act exempted derivatives like credit default swaps (CDSs) from regulation. 2. Understand the key issues in the Great Recession/Financial Crisis of 2008, particularly the role of derivatives such as credit default swaps (CDSs) and collateralized debt obligations (CDOs). CDOs bundled risky mortgages into securities, while CDSs insured against their default; widespread defaults caused these instruments to collapse, triggering the financial crisis. 3. Understand what were the key areas of financial deregulation—removing interest rate ceilings, deregulating the savings and loan industry, repealing Glass-Steagall, and not regulating financial derivatives. Financial deregulation eliminated interest rate caps, loosened rules for savings and loans, allowed banking consolidations, and left derivatives like CDSs and CDOs unregulated. 4. Understand the relationship between financial deregulation and the Great Recession/Financial Crisis. Deregulation enabled risky financial practices, like unregulated derivatives and speculative banking, which amplified instability and contributed directly to the 2008 crisis. Session 26 1. Understand the concepts of derivatives and securitization Derivatives are financial contracts based on underlying assets, while securitization involves pooling assets like mortgages to create securities sold to investors. 2. Understand the two reasons that banks (like JP Morgan) wanted to get risk off of their books Banks offloaded risk to meet regulatory capital requirements and reduce exposure to potential losses. 3. Understand how JP Morgan got the risk for the Exxon loan off of its books JP Morgan used credit derivatives like credit default swaps (CDSs) to transfer the risk of the Exxon loan to third parties. 4. Understand the process of securitization of mortgages and how that differed from the traditional mortgage process before securitization In securitization, mortgages are bundled and sold as securities, unlike the traditional process where banks kept loans on their balance sheets. 5. Understand the difference between the trading of derivatives such as commodity futures and the trading of derivatives such as mortgage-backed securities and credit default swaps Commodity futures are standardized contracts traded on exchanges, while MBS and CDS derivatives are often complex, customized, and traded over the counter. 6. Understand why home mortgages, which had always been a safe investment, became so problematic Risky subprime loans and falling home prices led to widespread defaults, making mortgage-backed securities unstable. 7. Understand how the incentives for mortgage originators changed and why that could cause problems Mortgage originators prioritized selling loans to securitizers over ensuring borrowers could repay, leading to risky and predatory lending practices. 8. Understand what it meant for homes and banks to be underwater Homes were underwater when their market value fell below the mortgage owed; banks were underwater when liabilities exceeded assets. 9. Understand why financial risk can never be eliminated Risk can only be transferred or redistributed, and unforeseen events can always disrupt markets and expose vulnerabilities. Session 27 1. Understand the concepts of derivatives and securitization Derivatives are financial contracts whose value is derived from an underlying asset, while securitization pools assets like mortgages into tradable securities. 2. Understand the process of securitization of mortgages and how that differed from the traditional mortgage process before securitization Securitization sold mortgage risk to investors, unlike the traditional process where banks held loans and bore the risk of defaults. 3. Understand the difference between the trading of derivatives such as commodity futures and the trading of derivatives such as mortgage-backed securities and credit default swaps Commodity futures are standardized and traded on exchanges, while MBS and CDS derivatives are complex, customized, and traded privately. 4. Understand what Brooksley Born at the CFTC was trying to do about derivatives Brooksley Born sought to regulate the derivatives market to address its lack of transparency and growing systemic risks. 5. Understand why "everyone" opposed Born's efforts to discuss and, possibly, regulate derivatives Politicians, regulators, and Wall Street feared regulation would stifle innovation and profit, favoring self-regulation instead. 6. Understand what happened to the CFTC in the Commodity Futures Modernization Act of 2000 and what happened to the market for derivatives (MBSs and CDSs) between 2000 and the financial crisis The CFTC was stripped of regulatory authority over derivatives, leading to explosive growth in unregulated trading of MBSs and CDSs. 7. Understand what happened to the stock markets in the 1990s The 1990s saw a stock market boom driven by tech innovation and speculative investment, culminating in the dot-com bubble burst. 8. Understand the key elements of "financial intermediation" from the video Homeowners: Increased leverage by taking on mortgages larger than their home values, becoming underwater. Banks: Used high leverage to maximize profits but increased vulnerability to losses. Lehman Brothers: Risky behavior stemmed from reliance on securitization and speculative investments. Mortgage Securitization: Offloaded risk poorly, leading to systemic instability. Shadow Banking System: Depended on short-term loans and investor confidence, making it prone to collapses in crises. 9. Understand how falling housing prices led to the crashing down of the financial intermediaries and a credit crunch for the entire economy Falling home prices caused mortgage defaults, undermining securitized assets, which collapsed financial institutions and froze credit markets. 10. Understand what it meant for homes and banks to be underwater Homes were underwater when mortgage debt exceeded home value, and banks were underwater when liabilities outweighed assets. 11. Understand why financial risk can never be eliminated Financial risk is inherent due to market uncertainties and can only be transferred or redistributed, not removed entirely.