Best of the Week
Most Popular
1. US Housing Market Real Estate Crash The Next Shoe To Drop – Part II - Chris_Vermeulen
2.The Coronavirus Greatest Economic Depression in History? - Nadeem_Walayat
3.US Real Estate Housing Market Crash Is The Next Shoe To Drop - Chris_Vermeulen
4.Coronavirus Stock Market Trend Implications and AI Mega-trend Stocks Buying Levels - Nadeem_Walayat
5. Are Coronavirus Death Statistics Exaggerated? Worse than Seasonal Flu or Not?- Nadeem_Walayat
6.Coronavirus Stock Market Trend Implications, Global Recession and AI Stocks Buying Levels - Nadeem_Walayat
7.US Fourth Turning Accelerating Towards Debt Climax - James_Quinn
8.Dow Stock Market Trend Analysis and Forecast - Nadeem_Walayat
9.Britain's FAKE Coronavirus Death Statistics Exposed - Nadeem_Walayat
10.Commodity Markets Crash Catastrophe Charts - Rambus_Chartology
Last 7 days
Johnson & Johnson (JNJ) Big Pharma Stock for Machine Learning Life Extension Investing - 2nd Jul 20
All Eyes on Markets to Get a Refreshed Outlook - 2nd Jul 20
The Darkening Clouds on the Stock Market S&P 500 Horizon - 2nd Jul 20
US Fourth Turning Reaches Boiling Point as America Bends its Knee - 2nd Jul 20
After 2nd Quarter Economic Carnage, the Quest for Philippine Recovery - 2nd Jul 20
Gold Completes Another Washout Rotation – Here We Go - 2nd Jul 20
Roosevelt 2.0 and ‘here, hold my beer' - 2nd Jul 20
U.S. Dollar: When Almost Everyone Is Bearish... - 1st Jul 20
Politicians Prepare New Money Drops as US Dollar Weakens - 1st Jul 20
Gold Stocks Still Undervalued - 1st Jul 20
High Premiums in Physical Gold Market: Scam or Supply Crisis? - 1st Jul 20
US Stock Markets Enter Parabolic Price Move - 1st Jul 20
In The Year 2025 If Fiat Currency Can Survive - 30th Jun 20
Gold Likes the IMF Predicting a Deeper Recession - 30th Jun 20
Silver Is Still Cheap For Now - 30th Jun 20
More Stock Market Selling Ahead - 30th Jun 20
Trending Ecommerce Sites in 2020 - 30th Jun 20
Stock Market S&P 500 Approaching the Precipice - 29th Jun 20
APPLE Tech Stock for Investing to Profit from the Machine Learning Mega trend - 29th Jun 20
Student / Gamer Custom System Build June 2020 Proving Impossible - Overclockers UK - 29th Jun 20
US Dollar with Ney and Gann Angles - 29th Jun 20
Europe's Banking Sector: When (and Why) the Rout Really Began - 29th Jun 20
Will People Accept Rampant Inflation? Hell, No! - 29th Jun 20
Gold & Silver Begin The Move To New All-Time Highs - 29th Jun 20
US Stock Market Enters Parabolic Price Move – Be Prepared - 29th Jun 20
Meet BlackRock, the New Great Vampire Squid - 28th Jun 20
Stock Market S&P 500 Approaching a Defining Moment - 28th Jun 20
U.S. Long Bond: Let's Review the "Upward Point of Exhaustion" - 27th Jun 20
Gold, Copper and Silver are Must-own Metals - 27th Jun 20
Why People Have Always Held Gold - 27th Jun 20
Crude Oil Price Meets Key Resistance - 27th Jun 20
INTEL x86 Chip Giant Stock Targets Artificial Intelligence and Quantum Computing for 2020's Growth - 25th Jun 20
Gold’s Long-term Turning Point is Here - 25th Jun 20
Hainan’s ASEAN Future and Dark Clouds Over Hong Kong - 25th Jun 20
Silver Price Trend Analysis - 24th Jun 20
A Stealth Stocks Double Dip or Bear Market Has Started - 24th Jun 20
Trillion-dollar US infrastructure plan will draw in plenty of metal - 24th Jun 20
WARNING: The U.S. Banking System ISN’T as Strong as Advertised - 24th Jun 20
All That Glitters When the World Jitters is Probably Gold - 24th Jun 20
Making Sense of Crude Oil Price Narrow Trading Range - 23rd Jun 20
Elon Musk Mocks Nikola Motors as “Dumb.” Is He Right? - 23rd Jun 20
MICROSOFT Transforming from PC Software to Cloud Services AI, Deep Learning Giant - 23rd Jun 20
Stock Market Decline Resumes - 22nd Jun 20
Excellent Silver Seasonal Buying Opportunity Lies Directly Ahead - 22nd Jun 20
Where is the US Dollar trend headed ? - 22nd Jun 20
Most Shoppers have Stopped Following Supermarket Arrows, is Coughing the New Racism? - 22nd Jun 20

Market Oracle FREE Newsletter

AI Stocks 2020-2035 15 Year Trend Forecast

How Deregulation Fueled the Financial Crisis

Stock-Markets / Credit Crisis 2008 Jan 13, 2009 - 12:46 PM GMT

By: Money_Morning

Stock-Markets

Best Financial Markets Analysis ArticleShah Gilani writes: No one person is responsible for the credit crisis, the failure of investment banks, the insolvency of commercial banks world-wide, the implosion of the world's stock markets, or for leading us to the precipice of another great depression.

The truth is there were many.


Fundamental and pragmatic banking regulations, which arose from the devastating financial collapses of the Great Depression , for decades strengthened U.S. banks and capital markets, making them the twin engines of American growth and the envy of the world.

The systematic dismantling of those same regulations by greedy bankers began in earnest in 1980, peaked in 1999, and finally climaxed with an insane Securities and Exchange Commission ruling in April 2004, a final decision that paved the way for the implosion of everything regulation was designed to protect.

Just how did we get here?

Wall Street bankers, their exorbitantly well-paid lobbying army of former congressmen and former regulators, their greatly contributed-to sitting legislators and, most egregiously, the self-righteous and still mega-rich “former” Street executives have systematically eviscerated the muscle and bones from the regulatory bodies charged with protecting us from banks' self-destructive greed. An inordinately powerful group of executive insiders from the once-deeply respected House of Goldman Sachs ( GS ) have served as U.S. Treasury secretaries and in innumerable other administrative capacities.

A Reflection on Reform

The Depository Institutions Deregulation and Monetary Control Act of 1980 , signed into law by President Jimmy Carter , was the first major reform of the U.S. banking system since the Great Depression.

While touted as a boon to consumers, the law was actually a gold mine for bankers. Among other requirements and banker “gifts” the 1980 Act's provisions:

  • Lowered the mandatory reserve requirements banks keep in non-interest bearing accounts at U.S. Federal Reserve banks.
  • Established a five-member committee, the Depository Institutions Deregulation Committee , to phase out federal interest rate ceilings on deposit accounts over a six-year period.
  • Increased Federal Deposit Insurance Corp . (FDIC) coverage from $40,000 to $100,000.
  • Allowed depository institutions, including savings and loans and other thrift institutions, access to the Federal Reserve Discount Window for credit advances.
  • And pre-empted state usury laws that limited the rates lenders could charge on residential mortgage loans.

In 1980, in a virtual landslide, Ronald Reagan was elected and grabbed the conservative mantle. A year later, the shock troops of the heralded Reagan Revolution launched their attack and embarked on a massive, systematic de-regulatory campaign.  President Reagan's first treasury secretary, former Merrill Lynch & Co. Chief Executive Officer Donald T. Regan , became chairman of the Depository Institutions Deregulation Committee.

In a burst of deregulatory bravado in 1982, Treasury Secretary Regan ushered through the Garn-St. Germain Depository Institutions Act . Key provisions of the Act ultimately coalesced with Treasury Secretary Regan's protection of the lucrative “ brokered deposits ” business, in which Merrill was a major player, and paved the way for the future collapse of the savings and loan industry.

Some of the provisions in that 1982 Act would later be blamed for thousands of bank failures. The provisions permitted the following:

  • Allowed savings and loans to make commercial, corporate, business or agricultural loans of up to 10% of their assets.
  • Authorized a capital assistance program - the “Net Worth Certificate Program” - for dangerously undercapitalized banks, under which the Federal Savings and Loan Insurance Corp . (FSLIC) and the FDIC would purchase capital instruments called “Net Worth Certificates” from savings institutions with net worth/asset ratios of less than 3.0%, and would theoretically later redeem the certificates as these shaky banks regained financial health.
  • And, most frighteningly, raised the allowable ceiling on direct investments by savings institutions in nonresidential real estate from 20% to 40% of assets.

The history of S&L greed and fraud - which resulted from brokered deposits and deregulation - wasn't forgotten by legislators. But it was steamrolled by bankers pursuing an even greater unshackling of the regulations that constrained their ambitions.

Shattered Glass

The ultimate prize was to be the undoing of the Glass-Steagall Act of 1933 . Glass-Steagall, officially known as the Banking Act of 1933, mandated the separation of banks according to the types of business they conducted. Investment banks, whose securities related activities resulted in relatively large risks, were to be separate from commercial banks, whose depositors needed greater protection. The Act created deposit insurance and the government wasn't about to allow taxpayer-backed insurance of commercial bank deposits to be exposed to securities related risks. It was a prudent and sensible separation. Bankers tried for years to undermine and overturn Glass-Steagall, but it took time.

In 1987, Alan Greenspan replaced Paul A. Volcker - the stalwart Federal Reserve Board chairman, national inflation-fighting hero and active proponent of Glass-Steagall (and now economic confidant of President-elect Obama).

In its twilight days, the Reagan administration was determined to further fertilize the seeds of deregulation and Greenspan's Ayn Rand -inspired “objectivist,” free-market philosophies would be the perfect embodiment of the deregulatory movement.

Securitization Enters the Scene

A year later - in 1988 - two very quiet revolutions sprouted that would ultimately hand bankers twin throttles to rain terror on us all.

That year, the Basel Accord established international risk-based capital requirements for deposit-taking commercial banks. In a byproduct of the calculations of what constituted mortgage-related risk (by nature of the loans' long maturities and illiquidity) lenders should be expected to set aside substantial reserves; however, marketable securities that could theoretically be sold easily would not require significant reserves.

To obviate the need for such reserves, and to free up the money for more-productive pursuits, banks made a wholesale shift from originating and holding mortgages to packaging them and holding mortgage assets in a now-securitized form. Not inconsequentially, this would lead to a disconnect between asset-quality considerations and asset-liquidity considerations.

Meanwhile, over at the U.S. Commodities Futures Trading Commission (CFTC), the appointment of free-market disciple Wendy Gramm, wife of U.S. Sen. Phil Gramm , R-Tex., as chairperson, would result in her successful 1989 and 1993 exemption of swaps and derivatives from all regulation.

These actions would not be inconsequential in the aforementioned reign of terror that was still to come.

In 1993, with her agenda accomplished, Wendy Gramm resigned from her CFTC post to take a seat on the Enron Corp. board as a member of its audit committee. We all know what happened there. Enron's fraud and implosion became the poster child for deregulation run amok and ultimately helped spawn Sarbanes-Oxley legislation, which has its own issues .

The constant flow of money to lobbyists and into legislators' campaign coffers was paying off for the banking interests. The Fed, under Chairman Greenspan, was methodically deconstructing the foundation of Glass-Steagall. The final breaching of the wall occurred in 1998, when Citibank was bought by Travelers. The deal married Citibank, a commercial bank, with Travelers' Solomon, Smith Barney investment bank and the Travelers insurance business.

There was only one problem: The deal was clearly illegal in light of Glass-Steagall and the Bank Holding Company Act of 1956 . However, a legal loophole in the 1956 BHC Act gave the new Citicorp a five-year window to change the landscape, or the deal would have to be unwound. If aggressively flouting existing laws to pursue a personal agenda isn't a perfect example of bankers' hubris and greed, then maybe I've just got it all wrong.

Phil Gramm - the fire breathing free-marketer, Texas senator, and chairman of the U.S. Senate Committee on Banking, Housing and Urban Affairs - rode to the rescue, propelled by a sea of more than $300 million in lobbying and campaign contributions. In 1999, in the ultimate proof that money is power, U.S. President Bill Clinton signed into law the Gramm-Leach-Bliley Financial Services Modernization Act , at once doing away with Glass-Steagall and the 1956 BHC Act, and crowning Citigroup Inc. ( C ) as the new “King of the Hill.”

From his position of power, Sen. Gramm consistently leveraged his Ph.D in economics and free-market ideology to espouse the virtues of subprime lending, where he famously once stated: “I look at subprime lending and I see the American Dream in action.”

If helping struggling borrowers pursue their homeownership dreams was such a noble cause, it might have been incumbent upon the senator to not block legislation advocating the curtailment of predatory lending practices. From 1989 through 2002, federal records show that Sen. Gramm was the top recipient of contributions from commercial banks and among the top five recipients of campaign contributions from Wall Street. [Click here to read "How Subprime Borrowing Fueled the Credit Crisis."]

 Since moving on from the Senate in 2002 to mega-universal Swiss banking giant UBS AG ( UBS ), where he serves as an investment banker and lobbyist, Gramm makes no apologies. “The markets have worked better than you might have thought,” he has been quoted as saying. “There is this idea afloat that if you had more regulation you would have fewer mistakes. I don't see any evidence in our history or anybody else's to substantiate that.”

The “New” Math

On April 28, 2004, in a fitting and perhaps flagrant final act of eviscerating prudent regulation, the SEC ruled that investment banks may essentially determine their own net capital. The insanity of that allowance is only surpassed by the fact that the SEC allowed the change because it was simultaneously demanding greater scrutiny of the books and records of what were the holding companies of investment banks and all their affiliates.

The tragedy is that the SEC never used its new powers to examine the banks. The idea was that Consolidated Supervised Entities (CSEs) could use internal models to determine risk and compliance with net capital requirements. In reality, what the investment banks did was essentially re-cast hybrid capital instruments, subordinated debt, deferred tax returns and securities with no ready market into “healthy” capital assets against which they reduced reserve requirements for net capital calculations and increased their leverage to as much as 30:1.  [Click here to read "How Wall Street Manufactures Financial Services Products," an insider's look at how greed on Wall Street results in unscrupulous investment instruments]

When the meltdown came the leverage and concentration of bad assets quickly resulted in the shotgun marriage of insolvent Bear Stearns Cos. to JP Morgan Chase & Co. ( JPM ), the bankruptcy of Lehman Brothers Holding ( LEHMQ ), the sale of Merrill Lynch to Bank of America Corp . ( BAC ), and the rushed acceptance of applications by Goldman and Morgan Stanley ( MS ) to convert to Bank Holding Companies so they could feed at the taxpayer bailout trough and feast on the Fed's new Smörgåsbord of liquidity handouts. There are no more CSEs (the SEC announced an end to that program in September). The old investment bank model is dead.

The motivation for bankers to undermine and inhibit prudent regulation is inherent in banker compensation incentives. The September 1993 Journal of Financial Research sums up the problem on compensation by concluding: “Firm characteristics that influence managerial compensation include leverage (as a measure of observable risk) market-to-book ratio of assets, size and shareholder return. Evidence suggests that Bank Holding Companies may be exploiting the deposit insurance mechanism because leverage is a significant factor in our results for incentive-based components of compensation. Our results strongly support the view that fundamental shifts in business activities of Bank Holding Companies have influenced their compensation strategies”.

No one would tempt an alcoholic by putting one in charge of a liquor store and neither would anyone put a fox in charge of a henhouse. So why are greedy bankers being allowed to rewrite banking regulations to enrich themselves while leveraging taxpayers, destroying trillions of dollars of hard-earned savings and sinking us into a potential depression?

Until transparency sheds light on the backroom dealers and influence peddlers that aligned with Wall Street against Main Street, we will continue to be held hostage to the same greed and avarice that manifests itself in too many human beings who actually have the power to execute their personal agendas.
This is the story of how we got here. Where we are is actually even scarier than authorities are willing to admit. In the second article in this three-part series later this week, I will be the unfortunate bearer of the news of where “here” actually is.

[ Editor's Note : Money Morning Contributing Editor Shah Gilani, a retired hedge-fund manager and noted expert on the global financial crisis, will host a post-Inauguration " Web summit " that talks about the pending regime change in Washington and what it means for investors in the coming months.

The Jan. 22 session - entitled " The Regime Change in Washington Triggers War on Wall Street " - is free of charge to investors who register in advance. It will start at 7 p.m. EST.

Those who tune in can expect to get candid insights not available on your favorite cable-TV finance show or in the business section of your local newspaper.
"Wall Street doubletalk got us into this crisis; I hear more excuses than straight talk. Most of the dialogue is noise," said Gilani, the editor of the " Trigger Event Strategist " and a commentator who is known for his deep connections inside the investment-banking world of Wall Street. "The truth may be difficult to swallow, but without hearing it, there's not much hope for finding the right way out of the maze."

Gilani will show investors how to interpret recent moves by lawmakers and their cronies to unlock the credit markets, and what's really behind the recent machinations taking place in the power alleys of Wall Street and in the halls of government down on Capitol Hill. With this insight, investors will be able to proactively strengthen their investing portfolios in the face of an escalating credit crisis and deteriorating financial markets - whose ripple effects are only now manifesting themselves in Europe, India and other markets abroad. Investors should sign up early; those who do will be able to also submit questions in advance for Gilani's consideration. Click here for more information, including instructions on how to sign up for the free web summit. ]

By Shah Gilani
Contributing Editor

Money Morning/The Money Map Report

©2009 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investment advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or 72 hours after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules