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Goldman Sachs’s lobbying efforts

Posted By Russ Roberts On November 6, 2011 @ 4:49 pm In Financial Markets,Gambling with Other's $ | Comments Disabled

From 13 Bankers [1] by Simon Johnson and James Kwak (which I recently finished in preparation for an EconTalk interview with Johnson):

Since 1932, Section 13 of the Federal Reserve Act had given the Fed the power, in “unusual and exigent circumstances,” to make loans to anyone–but only if the collateral provided in exchange arose “out of actual commercial transactions.” This requirement specifically excluded investment securities, which meant that in a crisis, investment banks might not have any valid collateral with which to borrow from the Fed.

This danger worried the remarkably prescient executives at Goldman Sachs. At their suggestion, the “actual commercial transactions” requirement was dropped in a “miscellaneous provision” of the Federal Deposit Insurance Corporation Improvement Act of 1991, ensuring that the Fed could lend against any collateral in a time of crisis. This change gave the Fed the power to widen its protective umbrella to encompass investment banks, at the same time that those banks were increasing the riskiness of their operations by expanding their derivatives and proprietary trading businesses and taking on additional leverage. This seemingly minor change would be of crucial importance seventeen years later; when the housing bubble of the 2000s ended –and with it the seemingly unlimited supply of money flowing from novel and largely unregulated financial products–not only investment banks but a major insurance company would have to be rescued with government money.

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[1] 13 Bankers: http://www.amazon.com/13-Bankers-Takeover-Financial-Meltdown/dp/030747660X/ref=sr_1_1?ie=UTF8&qid=1320615911&sr=8-1/invisiblehear-20

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