[corp-focus] Wall Street's Best Investment II: 12 Deregulatory Steps to Financial Meltdown
Fri, 06 Mar 2009 14:27:24 -0500
By Robert Weissman
March 6, 2009
What can $5 billion buy in Washington?
Quite a lot.
Over the 1998-2008 period, the financial sector spent more than $5
billion on U.S. federal campaign contributions and lobbying expenditures.
This extraordinary investment paid off fabulously. Congress and
executive agencies rolled back long-standing regulatory restraints,
refused to impose new regulations on rapidly evolving and mushrooming
areas of finance, and shunned calls to enforce rules still in place.
"Sold Out: How Wall Street and Washington Betrayed America," a report
released by Essential Information and the Consumer Education Foundation
(and which I co-authored), details a dozen crucial deregulatory moves
over the last decade -- each a direct response to heavy lobbying from
Wall Street and the broader financial sector, as the report details.
(The report is available at:.) Combined, these
deregulatory moves helped pave the way for the current financial meltdown.
Here are 12 deregulatory steps to financial meltdown:
1. The repeal of Glass-Steagall
The Financial Services Modernization Act of 1999 formally repealed the
Glass-Steagall Act of 1933 and related rules, which prohibited banks
from offering investment, commercial banking, and insurance services. In
1998, Citibank and Travelers Group merged on the expectation that
Glass-Steagall would be repealed. Then they set out, successfully, to
make it so. The subsequent result was the infusion of the investment
bank speculative culture into the world of commercial banking. The 1999
repeal of Glass-Steagall helped create the conditions in which banks
invested monies from checking and savings accounts into creative
financial instruments such as mortgage-backed securities and credit
default swaps, investment gambles that led many of the banks to ruin and
rocked the financial markets in 2008.
2. Off-the-books accounting for banks
Holding assets off the balance sheet generally allows companies to avoid
disclosing “toxic” or money-losing assets to investors in order to make
the company appear more valuable than it is. Accounting rules -- lobbied
for by big banks -- permitted the accounting fictions that continue to
obscure banks' actual condition.
3. CFTC blocked from regulating derivatives
Financial derivatives are unregulated. By all accounts this has been a
disaster, as Warren Buffett's warning that they represent "weapons of
mass financial destruction" has proven prescient -- they have amplified
the financial crisis far beyond the unavoidable troubles connected to
the popping of the housing bubble. During the Clinton administration,
the Commodity Futures Trading Commission (CFTC) sought to exert
regulatory control over financial derivatives, but the agency was
quashed by opposition from Robert Rubin and Fed Chair Alan Greenspan.
4. Formal financial derivative deregulation: the Commodities Futures
Modernization Act
The deregulation -- or non-regulation -- of financial derivatives was
sealed in 2000, with the Commodities Futures Modernization Act. Its
passage orchestrated by the industry-friendly Senator Phil Gramm, the
Act prohibits the CFTC from regulating financial derivatives.
5. SEC removes capital limits on investment banks and the voluntary
regulation regime
In 1975, the Securities and Exchange Commission (SEC) promulgated a rule
requiring investment banks to maintain a debt to-net capital ratio of
less than 15 to 1. In simpler terms, this limited the amount of borrowed
money the investment banks could use. In 2004, however, the SEC
succumbed to a push from the big investment banks -- led by Goldman
Sachs, and its then-chair, Henry Paulson -- and authorized investment
banks to develop net capital requirements based on their own risk
assessment models. With this new freedom, investment banks pushed ratios
to as high as 40 to 1. This super-leverage not only made the investment
banks more vulnerable when the housing bubble popped, it enabled the
banks to create a more tangled mess of derivative investments -- so that
their individual failures, or the potential of failure, became systemic
crises.
6. Basel II weakening of capital reserve requirements for banks
Rules adopted by global bank regulators -- known as Basel II, and
heavily influenced by the banks themselves -- would let commercial banks
rely on their own internal risk-assessment models (exactly the same
approach as the SEC took for investment banks). Luckily, technical
challenges and intra-industry disputes about Basel II have delayed
implementation -- hopefully permanently -- of the regulatory scheme.
7. No predatory lending enforcement
Even in a deregulated environment, the banking regulators retained
authority to crack down on predatory lending abuses. Such enforcement
activity would have protected homeowners, and lessened though not
prevented the current financial crisis. But the regulators sat on their
hands. The Federal Reserve took three formal actions against subprime
lenders from 2002 to 2007. The Office of Comptroller of the Currency,
which has authority over almost 1,800 banks, took three
consumer-protection enforcement actions from 2004 to 2006.
8. Federal preemption of state enforcement against predatory lending
When the states sought to fill the vacuum created by federal
non-enforcement of consumer protection laws against predatory lenders,
the Feds -- responding to commercial bank petitions -- jumped to
attention to stop them. The Office of the Comptroller of the Currency
and the Office of Thrift Supervision each prohibited states from
enforcing consumer protection rules against nationally chartered banks.
9. Blocking the courthouse doors: Assignee Liability Escape
Under the doctrine of “assignee liability,” anyone profiting from
predatory lending practices should be held financially accountable,
including Wall Street investors who bought bundles of mortgages (even if
the investors had no role in abuses committed by mortgage originators).
With some limited exceptions, however, assignee liability does not apply
to mortgage loans, however. Representative Bob Ney -- a great friend of
financial interests, and who subsequently went to prison in connection
with the Abramoff scandal -- worked hard, and successfully, to ensure
this effective immunity was maintained.
10. Fannie and Freddie enter subprime
At the peak of the housing boom, Fannie Mae and Freddie Mac were
dominant purchasers in the subprime secondary market. The
Government-Sponsored Enterprises were followers, not leaders, but they
did end up taking on substantial subprime assets -- at least $57
billion. The purchase of subprime assets was a break from prior
practice, justified by theories of expanded access to homeownership for
low-income families and rationalized by mathematical models allegedly
able to identify and assess risk to newer levels of precision. In fact,
the motivation was the for-profit nature of the institutions and their
particular executive incentive schemes. Massive lobbying -- including
especially but not only of Democratic friends of the institutions --
enabled them to divert from their traditional exclusive focus on prime
loans.
Fannie and Freddie are not responsible for the financial crisis. They
are responsible for their own demise, and the resultant massive taxpayer
liability.
11. Merger mania
The effective abandonment of antitrust and related regulatory principles
over the last two decades has enabled a remarkable concentration in the
banking sector, even in advance of recent moves to combine firms as a
means to preserve the functioning of the financial system. The megabanks
achieved too-big-to-fail status. While this should have meant they be
treated as public utilities requiring heightened regulation and risk
control, other deregulatory maneuvers (including repeal of
Glass-Steagall) enabled them to combine size, explicit and implicit
federal guarantees, and reckless high-risk investments.
12. Credit rating agency failure
With Wall Street packaging mortgage loans into pools of securitized
assets and then slicing them into tranches, the resultant financial
instruments were attractive to many buyers because they promised high
returns. But pension funds and other investors could only enter the game
if the securities were highly rated.
The credit rating agencies enabled these investors to enter the game, by
attaching high ratings to securities that actually were high risk -- as
subsequent events have revealed. The credit rating agencies have a bias
to offering favorable ratings to new instruments because of their
complex relationships with issuers, and their desire to maintain and
obtain other business dealings with issuers.
This institutional failure and conflict of interest might and should
have been forestalled by the SEC, but the Credit Rating Agencies Reform
Act of 2006 gave the SEC insufficient oversight authority. In fact, the
SEC must give an approval rating to credit ratings agencies if they are
adhering to their own standards -- even if the SEC knows those standards
to be flawed.
From a financial regulatory standpoint, what should be done going
forward? The first step is certainly to undo what Wall Street has
wrought. More in future columns on an affirmative agenda to restrain the
financial sector.
None of this will be easy, however. Wall Street may be disgraced, but it
is not prostrate. Financial sector lobbyists continue to roam the halls
of Congress, former Wall Street executives have high positions in the
Obama administration, and financial sector propagandists continue to
warn of the dangers of interfering with "financial innovation."
Robert Weissman is editor of the Washington, D.C.-based Multinational
Monitor, <http://www.multinationalmonitor.org> and director of Essential
Action <http://www.essentialaction.org>.
(c) Robert Weissman
This article is posted at:
<http://lists.essential.org/pipermail/corp-focus/2009/000312.html>.
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