Kuttner Ch. 5 Money Markets and the Corporation

Ø     How pure and efficient are the market for financial products? 

1.      Interest rates are manipulated by the Fed, not fluctuating freely according to supply and demand.

2.      Banks, investment houses, insurance and real estate development companies are heavily regulated to protect the $$ of the public.

3.      Because of the deregulatory trend beginning in late 1970s, the focus of financial markets has been more speculative.

4.      The reasons cited: a. allocative efficiency b. maximizing shareholder value. 

Ø     The argument

1.      Keynes: problems occur when “enterprise becomes a bubble on a whirlpool of speculation.” Short-term focus can be ruinous. (Tobin Tax).

2.     Efficient Market Hypothesis: stock market has as much information about industry as possible.

3.     Counter-argument to #2: 1987 stock market crash à lost almost 1/3 of its value à required increased regulation.

4.     Previous financial system was slow-moving, long-term – many of public’s funds invested by law in 30-year mortgages. Little volatility. Those days are over. Today’s financial markets turn over entire value many times in a year.

5.     Today, many small investors are unaware that their pension funds and savings are invested in highly leveraged, risky interest rate and exchange rate instruments without protection from government insurance. Entire California county (Orange County) went bankrupt after investing tax dollars in speculative derivative securities.  

Ø     Regulation History 

1.      Although most businesses want SEC regulation, the push by Republicans in Congress killed legislation in the 1990s that would have regulated the riskiest securities (derivatives).  Businesses recognize that capital should serve industry, rather than be subject to free-wheeling profit centers.

2.      Inflation in the 1970s served to create pressure for deregulation ~ disintermediation crisis. New financial institutions arose that skirted regulatory oversight. Laissez faire advocates praised the movement.

3.      NOW was the beginning of the new instruments that broke the barriers of regulation like Regulation Q (a restriction on the interest banks could offer depositers).  Regulation Q was finally repealed in late 1970s.

4.       The new Non-bank financial organizations were siphoning funds from the regulated sector. As a consequence, pressure to repeal Glass-Steagall. Corporations could act as lenders, banks could act as investors. 1981 Garn-St Germain Act allowed S&Ls to invest in risky assets even though their deposits still protected by FDIC.

5.      Congress and Reagan deregulated everything but deposit insurance. Glass-Steagall still stands because investment houses don’t want banks as competitors – otherwise Congress would long-ago repealed it.

6.      But banks can own subsidiaries such as real estate investment companies as long as there is a firewall between the gov. insured deposits and the speculative ventures of the subsidiary – this is illusionary.