Banking Crisis and Regulations

In 1929 the one of the major problem in the USA was that the banks gamble with the money that they had in the form of deposits because they had huge amount of money to be made in the stock market. They put their money in the stocks, the stocks crashed, they lost all the money and did not have money to pay back their depositors and bankruptcy is declared. In this scenario the whole money of depositors was wiped-out but banks did not lose anything. In its response Glass-Steagall Act prevented banks from investing in stock markets and gambling with money of depositors. Also there was a maximum interest rate which means that banks could not compete with each other. More interest rate means that banks have to earn more money in order to pay so they will be o=more inclined to take risks which they did not want to take. All of these all were made to prevent competition in the banking industry. So, each bank was prevented to operate only in one state out of 50 states. Finally there was Federal Deposit Insurance that states that if banks did collapse and lose the money then the depositors will receive the money from government. As a result of this until 1980’s there were very few bank failures because these law worked. But in 1980’s these law were repealed and then bank failures again started to happen.

Macroeconomics of today is the direct result of the things that happen in USA and in Europe so history is very crucial. It means that learning only formulas, calculus and differential equation and apply it in economics does not make any sense. Today’s theories are devised in very special, concrete and specific scenario to solve any particular problem which came in US in 20th century and now studying these theories is out of context. Now idea that these theories are science is the problem itself because if it’s a science then it is universally invariant but it is not. Macroeconomics fiscal and monetary policy does not work in Pakistan in the same way as it works in USA. Same policy would have different effect in USA and Pakistan. So we have to study everything within its own historical context.