Loan Crisis Throws New Light on Investment Banks
This is the VOA Special English Economics Report.
Investment banks have long played a part in the financial system. But the recent crisis over securities based on risky home loans has brought them new attention.
Investment banks handle stocks, bonds and other securities. They underwrite new offerings. That means they take the risk of buying the securities and reselling them to the public. They also provide business advice and market research, and deal in existing securities.
Investment bankers have structured some newer securities in highly complex ways. Their value could be tied to lists of stocks or prices of goods or, as the world now knows, groups of risky home loans.
These mortgage-backed securities were sold to investors worldwide as a way to spread the risk. But as more and more loans went bad, the market collapsed.
Before the nineteen thirties, the United States had no separation between traditional banking and investment banking activities. Bank holding companies could own other financial companies that would underwrite new stocks. They would also provide stockbroker services for the public. People often bought shares with money borrowed from the banks.
Then, in nineteen twenty-nine, the stock market crashed. Between nineteen thirty and nineteen thirty-three almost ten thousand banks failed.
Congress passed a banking act in nineteen thirty-three known as the Glass-Steagall Act. It banned commercial banks from buying and selling securities; their job was to pay interest on savings and lend to borrowers.
This ban remained until nineteen ninety-nine. That year the Gramm-Leach-Bliley Act permitted commercial banks to deal in securities and sell insurance. They can again own investment companies that underwrite securities.
Many banks now regret that they got involved with high-risk mortgage securities. The collapse last month of the nation's fifth largest investment bank, Bear Stearns, showed the risks. The International Monetary Fund says total losses related to American subprime mortgages could reach almost one trillion dollars.
On March seventeenth, the Federal Reserve started offering loans to investment banks, as it does for other banks. The program will continue for at least six months. The central bank used a power described in section thirteen of the Federal Reserve Act. But this power has not been used since the law was updated in nineteen thirty-two.
And that's the VOA Special English Economics Report, written by Mario Ritter. I'm Steve Ember.