When Glass-Steagall, the long-standing government legislation that maintained the separation from banks and freely investing financial institutions, was lifted in the waning year of the Clinton administration, it opened a decade of uncontrolled, high-leveraged investments. It was primarily responsible for the high-risk leveraged breakdown that led to the worldwide financial collapse in mid-September 2008.
In effect, it allowed commercial banks to “invade” the high-risk investment markets with customers’ holdings, while putting such broad financial institutions as Goldman-Sachs into the banking business. In effect, it opened the doors of wheeling and dealing so wide as to cause an over-leveraged crash that came close to creating a global depression. It further exposed most commercial banks and many financial brokerage firms to an increasing financial disaster, now known as the Great Recession of 2008-2011.
Some of the root causes of this implosion, such as mortgages for low-income buyers who could ill afford them, are still available due to pseudo-governmental banks Fannie Mae and Freddie Mac. This post-crisis legislation, policed by the Federal Reserve, has led the U.S. banking system into the strongest reserve position it has ever been forced to practice. With the Fed taking on the almost worthless bank-held mortgage-backed derivatives, it cleansed their loan capabilities of this worthless paper, while the Federal Reserve gave it a price tag. The Fed, in turn, increased its balance sheet from $1 trillion to a current $4.2 trillion.
While the Glass-Steagall Act removal allowed financial institutions to take on banking privileges, and banks got actively involved in the investment business, the post-crisis Dodd-Frank legislation has newly restrained commercial banks from using customer accounts to make risk-loaded investments.
With the Federal Reserve Board becoming more active in making sure that commercial banks stay within legislative limits, this has strengthened the U.S. banking system’s safety level to an all-time high. And with the U.S. public supporting these actions with an overall savings rate of near 5%, a rate not seen in decades, the United States’ overall financial institutional safety net is in a far stronger position now than during the recession.
Energy sector bankruptcies
While the global oil glut combines with a daily production maximum of 10 million barrels of oil by Saudi Arabia, Russia and the United States, the massive bank loans that put most fracking shales into business are increasingly endangered by the continuation of unacceptable oil price costs.
At this stage of the loan crisis, all types of loans, amounting to 50% of all commercial/industrial debts outstanding, are affected to some extent. This is causing banks to stop lending on new loan requests, while attempting to sell off existing loans at whatever discounts it takes to get rid of them.
This pullback is severely reducing the influx of money to small- and medium-sized shale exploration companies, and will likely curtail much of the production emanating from marginal exploration concerns.
While such major oil producers as Exxon/Mobil, Conoco Phillips and Chevron will keep their “oars in the fracking water,” expect a growing majority of marginal startups to be out of business soon, barring a return to prices double those existent at the end of the first quarter of 2016.
The impact on major commercial banks will likely be in the low single-digit percentage range, as a component of too many loans outstanding. They will, therefore, not be adversely affected by outstanding loans as are those shale drillers, who are overwhelmed with repayment problems.
But what is now transpiring from the current financial energy crisis is the severity of cutbacks in both oil and natural gas accelerating in the second half of 2016.
Even under the best of circumstances in the rise of oil prices, and the beginning of natural gas shipments for worldwide export, the current reduction of fossil fuels (coal, oil, and natural gas) will cause only limited inventory shrinkage while demand will be starting to pick up at the time of lessening supply.
If past experience is any indicator, the last quarter of 2016 might see an 180° upward turn of the January drop to a low of $26 per daily barrel, which occurred right after the first of the year.
If the superimposition of an as yet undefined geopolitical development causes an even greater price reversal than currently expected, more dire supply/demand inversion, and consequently higher prices, remain a distinct possibility.
The value of gold
Since the mythical value of gold traces back to the ancient kingdom of King Croesus, the shiny metal has been regarded as a value indicator supreme, especially at times of economic troubles or overall world instability.
Even in modern times, gold has maintained its unique supremacy in the world’s most advanced instrument of comprehensive economic sophistication. The price of gold per ounce was set in the $35-per-ounce price range in the mid-1930s by President Franklin D. Roosevelt, during the midst of the nation’s overall economic depression.
It fell upon President Richard M. Nixon, in the early 1970s, to unleash gold per ounce from previous price restraints, allowing the world market of supply and demand to be the final judge of pricing. This brought about a wide range of up and down prices, depending on supply/demand and economic instability.
But at the present time, as the world supply of basic commodities (including gold, silver and platinum) have hit a long-term slump, gold seems to have generated buying interest in major emerging nations — China, India and Indonesia — far beyond the need for conversion to jewelry and other adornments.
While gold has historically developed a life of its own as a base of possession, signifying undisputed wealth, it has taken on a reverse position in the world’s developed nations. They are more interested in the possession of real estate, stocks and bonds, and lately possession of the more advanced methods of transportation and technology. Gold is increasingly considered by them as a minor supplement.
But as the lure of gold has found new interest, primarily in the fast-rising nations of Southeast Asia, it is resisting the downward track of such commodities as fossil fuels (coal, oil and natural gas), copper, iron ore, nickel, etc.
While the world’s banks still retain the lion’s share of gold reserves, the ownership of gold is increasingly seen universally as a symbol of economic stability at a time when the world is in a state of flux.
This article was originally titled “Dodd-Frank fortifies banks” in the July 2016 print edition of Plumbing & Mechanical.