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Globalization helped fuel the current financial crisis, and it
will undoubtedly be employed to help resolve it.
Charles R. Geisst is professor of finance at Manhattan
College. His many books include Wall Street: A History, and
he is the editor of the Encyclopedia of American Business
History.
I
n the decades following World War II, the idea of
globalization became more and more popular when
describing the future of the world economy. Some day,
markets for all sorts of goods and services would become
integrated and the benefits would be clear. The standard
of living would be raised everywhere as barriers to trade,
production, and capital fell. The goal was noteworthy
and has been partially realized. But recently it hit a major
bump in the road.
Globalization has many connotations. Originally,
it meant international ease of access. Barriers to trade
and investment eventually would disappear, and the
international flow of goods and services would increase.
Free trade and common markets were created to facilitate
the idea. A world without barriers would help distribute
wealth more evenly from the wealthy to the poor.
To date, only financial services have succeeded in
becoming truly global. Fast-moving financial markets,
aided by speed-of-light technology, have swept away
national boundaries in many cases, making international
investing effortless. Government restrictions have been
removed in most of the major financial centers, and
foreigners have been encouraged to invest. This has
opened a wide panorama of investment possibilities.
This phenomenon is not new. Since World War II,
many governments have loosened restrictions on their
currencies, and today the foreign exchange market is
the world’s largest, most liquid financial market, trading
around the clock. And there is no distinction made in it
because of those national peculiarities or restrictions for
Globalization and the U.S. Financial System
Charles R. Geisst
Speed-of-light technology makes international investing effortless.
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the major currencies. If governments allow their currencies
to trade freely, as most in developed countries, then a
dollar or a euro can trade in Hong Kong or Tokyo as easily
as it does in Dubai or New York.
CROSS-BORDER TRADING
Other financial markets quickly followed this
precedent. The government bond markets, corporate
bond markets, and the equities markets all started to
develop links based on new and faster technology. Forty
years ago, Gordon Moore, one of the founders of software
giant Intel, made his famous prediction (Moore’s Law)
that microchip capacity would double every two years.
New, faster chips were able to accommodate an increasing
number of financial transactions, and before long that
capacity spawned even more transactions. Soon, traders
were able to cross markets and national boundaries with
an ease that made the supporters of globalization in other
sections of the economy jealous. During the same time
period, manufacturers had been promoting the idea of the
universal car, without the same level of success.
Wall Street and the other major financial centers
prospered. Customers were able to obtain executions for
their stock trades with a speed unimaginable in the mid-
1990s. The NYSE (New York Stock Exchange) and the
NASDAQ (National Association of Securities Dealers
Automated Quotations) abandoned their old method of
quoting stock prices in fractions and adopted the decimal
system. Computers did not like fractions, nor did the old
method encourage trading at the speed of light. Customers
were now able to trade via computer in many major
markets as quickly as in their own home markets. True
cross-border trading was born, making financial services
the envy of other industries that long had dreamed of
globalization.
The results were astonishing. Volume on the NYSE
increased from a record 2 billion shares in 2001 to a
record 8 billion in 2008. Volume on the foreign exchange
markets was in the trillion-dollar equivalents on a daily
basis. The various bond markets were issuing more than
a trillion worth of new issues annually rather than the
billions recorded in previous record years. The value of
mergers and acquisitions equally ran into the trillions
annually. The volumes and the appetite for transactions
appeared endless.
A TRADITIONAL CYCLE
The U.S. economy traditionally had witnessed long
periods of prosperity before slowing down substantially,
usually brought to a temporary halt by an asset bubble
that finally ran out of hot air. The situation had been
replayed many times since 1793, when the first major
economic downturn was recorded in New York. Similar
problems were recorded at least eight times until 1929.
Each boom was followed by a bust, some more severe
than others. The post-1929 depression finally ushered in
far-reaching reforms of the banking system and securities
markets.
Until 1929, these recessions were called “panics.” The
term “depression” was used once or twice in the early 20th
century, but during the 1930s the term became associated
exclusively with that decade. The traditional cycle is still
in evidence. The recession of 2001 followed the dot-com
bust, and many of the day traders who had employed
the new computer technology retreated to the sidelines
much as their forebears had done in the 19th century. A
recession followed, temporarily slowing down the appetite
for speculative gains.
The 19th and the 21st centuries had more in
common than might have been imagined. After gaining
its independence from Britain, the United States had been
dependent on foreign capital for the first 120 years of
its existence. Until World War I, much of the American
infrastructure and industry had been financed with foreign
money, mostly in the form of bonds. Americans produced
most of the goods and services they needed, but capital
was always in short supply until the war changed the face
of geopolitics.
The situation remained unchanged until the late
1970s, when the position again was reversed. The U.S.
household savings ratio declined and foreign capital
poured into the country. Bonds were the favorite again,
but the equities markets also benefitted substantially.
Consumers, accounting for about two-thirds of the U.S.
gross domestic product since the 1920s, bought domestic
and foreign goods, while foreigners supplied the capital
necessary to finance the federal government and many
American industries. The situation persists today, with
about half the outstanding U.S. Treasury bonds in the
hands of the Chinese government alone.
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THE MORTGAGE BOOM
After the dot-com bust and the Enron and
WorldCom scandals, it appeared that Wall Street was due
to take a breather for lack of new ideas to fuel another
bubble. But it was a combination of cyclical trends that
reappeared and together fueled the greatest short-term
boom yet. Globalization, an influx of foreign capital,
and esoteric financial analytics combined with residential
housing to produce the most explosive — and potentially
destructive — boom/bust cycle ever witnessed in
American history.
The recent market bubble was created by the boom
in residential housing. Normally, housing follows stock
market booms but has not caused them. In the wake of
the dot-com bust and the post-September 11 trauma, the
situation became reversed. The home became the center
of many investors’ attention. First-time buyers abounded,
and many others clamored to refinance their existing
mortgages. The new thing was really an older thing
dressed up by modern finance.
This phenomenon was difficult to detect in its early
stages. All of the factors that converged to produce it
had been seen before. Many were well-known and timeproven
methods in finance. Securitization had been used
for several decades by the U.S.-related housing finance
agencies to convert pools of residential mortgages into
securities that were purchased by investors. This provided
even more available funds for the housing market at a time
that demand was very high after 2001. The new thing on
Wall Street became financing the “American Dream” —
the idea that everyone should own his
or her own home.
Demand for the securitized
bonds proved strong, so strong that
Wall Street securities houses began
cranking them out at increasingly fast
speed. Much of the demand came
from foreign investors — central
banks, banks, sovereign wealth
funds, and insurance companies —
all drawn by their attractive yields.
Dollars were being recycled by these
investors, especially central banks and
the sovereign wealth funds, from the
current account balances they were
accumulating with the United States.
The money left the United States as
Americans purchased imports from
foreign producers and found its way back as investments.
VICTIMS OF THEIR OWN SUCCESS
The mortgage boom began after 2001, and within
a couple of years it was in full stride. Demand remained
strong for mortgage-backed securities, and soon subprime
mortgages, credit default swaps, and other exotic collateral
based on derivatives became part of the asset backing. By
the late summer of 2007, as short-term interest rates rose
from historically low levels, cracks began to appear in
this collateral and asset values began to collapse, creating
the banking and insurance crises within months. In the
past, without the technology, the results would have taken
years.
The boom was aided immeasurably by the
deregulation of the U.S. financial markets in 1999,
officially culminating over two decades of a gradual easing
of once stringent rules. The new financial environment it
created allowed banks and investment banks to cohabit,
something that had not been allowed since 1933. When
they began to share the benefits of deregulation under
the same roof, older ideas of risk management began to
crumble in a greater quest for profit.
The credit market and collateral crisis marks the
end of the almost 40-year legacy of the federally related
housing agencies and all of the benefits they provided
since the social legislation passed during the 1960s. Wall
Street, the credit markets, and the U.S. housing industry
all were victims of their own success when the markets
The housing boom in the SiliconValley, California, before the dot-com asset bubble presaged the
mortgage crisis of 2008.
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collapsed in 2008. Greed, lack of regulatory oversight, and
the sophistication of structured finance, which created
many of these exotic financial instruments, all played a
role in the most recent setback for the markets and the
economy as a whole.
Most importantly, the crisis demonstrates the pitfalls
of deregulation and globalization. Unfortunately, the
appropriate skepticism that must accompany every
boom has been missing. Globalization helped fuel the
crisis and will undoubtedly be employed to help resolve
it. Deregulation will be swept aside in favor of more
stringent institutional controls on financial institutions
designed to prevent fraud and deceit. It took almost four
years after the market crash of 1929 to erect a regulatory
structure to separate different types of banks and establish
national securities laws. Moore’s Law suggests that it will
occur faster this time around. The forces that shaped
globalization will demand it.
The opinions expressed in this article do not necessarily reflect the views or
policies of the U.S. government.
Newspaper headline from the stock market crash of 1929.
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