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Most people only think about bank runs around the winter holidays when “It’s a Wonderful Life” plays incessantly on television and the protagonist is trying to save his small community bank from going under. Bank runs are an old-fashioned idea, the stuff of black and white movies and not the sort of issue we tend to think of as a problem for this century.
Since the advent of the Federal Deposit Insurance Corporation (FDIC) in 1933, our deposits are protected and we don’t need to worry about banks running out of money.
Or do we?
When banks are allowed to take bets on toxic debt or enter into complex derivatives transactions – essentially gambling with our taxpayer-insured deposits — we may be setting up our economy for another meltdown. Banks can and do lose huge sums of money on failed bets, as happened with several leading banks in the run up to the 2008 crash. These bad bets were part of what caused many financial institutions to fail; the failures set off the chain reaction of the economic crash. Instead of paying back depositors and simply allowing the banks to go under, the government chose to bail out some of them, leading to trillions in payouts under the Troubled Asset Relief Program (TARP) and other bank supports.
They say hindsight is 20-20, but our country’s leaders should have known better then to allow this gambling. For most of the last century, we had strong, clear protections against just that type of bank activity. President Franklin D. Roosevelt and Congress included a ban on riskier investment banking (read gambling) by FDIC-insured facilities when the system of federally-insured deposits went into effect in 1933. This ban between commercial and investment banking was called the Glass-Steagall Act, and it was rolled in with the Banking Act of 1933, which also created the FDIC.
This safety glass was in place for over 50 years and served the country well as we experienced overall stability in the financial industry. But banks desiring to engage in high-risk, high-profit transactions pressured Congress to break down the wall. The Glass-Steagall Act was repealed in 1999 through President Clinton’s signing of the Gramm-Leach-Bliley Act.
After Glass-Steagall’s repeal, commercial banks backed by FDIC guarantees borrowed cheap money and jumped full force into packaging debt, underwriting mortgages and growing their investment strategies. They took bigger risks than ever before, leading us straight to the crisis. Over-leveraged and under-capitalized, the banks’ gambling strategies blew up. More