Six Steps to Hell: Our Descent into Today's Daunting Economic Inferno

How many steps are there to hell - seven, nine, ten, perhaps twelve? How about - at least six?

That’s my reading of Robert Weissman and James Donahue’s Sold Out: How Wall Street and Washington Betrayed America.

They describe how ALL of our Washington representatives, including the elected members of the legislative and executive branches; and the appointed regulatory authorities weakened a post-1930’s Depression regulatory system over the past thirty years. As a result, we may be retracing our steps to economic hell today.

The 20^th century regulatory system:

• Drew boundaries between regulated commercial banking and investment bank risk-taking;
• Forced disclosure of publicly relevant and accurate financial information;
• Established limits on the use of leverage;
• Contained the financial sector so that it remained subordinate to the real economy;
• Provided consumer with meaningful financial protection; and
• Enforced meaningful limits on banking concentration and size.

Step-by-step, these protections were ripped away. The dirty trail appears below.

1. Repeal of Glass-Steagall

The 1999 Financial Services Modernization Act repealed the Glass-Steagall Act of 1933, which prohibited commercial banks from offering investment banking and insurance services.

One-year prior, Citibank (C) had merged with the Travelers Group insurance company, (correctly) assuming that this would force the repeal of Glass-Steagall. This made it easier for the banks to invest into financial instruments such as CDO’s as well as credit default swaps, which rocked world markets in 2008.

2. Special Purpose Vehicles and Off-Balance Sheet Accounting

We’re not talking here about ATVs or SUVs. We’re talking SPEs (special purpose entities).

SPEs were off-balance-sheet financing vehicles that some banks used to hold securitized mortgages. This was permitted by FASB – the Financial Accounting Standards Board. SPEs' “off balance sheet” status limited – in theory – investors’ recourse to the affiliated bank, and – in practice – lowered the total amount of capital held in reserve against losses.

As the credit crisis developed, Citigroup (see #1, above) brought the off-balance-sheet assets back onto its books, as it collapsed the SPEs. This left the consolidated entity with insufficient capital. This helped make Citi the two-dollar stock that it is today.

3. The Executive Branch & Congress Reject Financial Derivative Regulation

Financial derivatives – what Warren Buffett called “weapons of mass financial destruction” - are unregulated. Thanks to derivatives, you and I now own a piece of AIG. Once a world financial leader with operations in more than 130 countries, AIG now operates under the “protection” and (somewhat lax, given this week’s bonus news) “supervision” of the US government.

The Commodity Futures Trading Commission (CFTC) has jurisdiction over futures, options and other derivatives connected to commodities. During the Clinton administration, the CFTC sought to regulate financial derivatives.

This effort was (in Weissman’s and Donahue’s words) “quashed” by the Treasury Secretary and the Fed Chairman. The then-Deputy Treasury Secretary (who is now the Director of the White House’s National Economic Council) said that CFTC’s proposal cast “a shadow of regulatory uncertainty over an otherwise thriving market.”

Congress joined the Executive’s battle to beat back the demons of regulatory oversight with the 2000 passage of the Commodities Futures Modernization Act (CFMA). CFMA exempted financial derivatives, including credit default swaps (such as that used by AIG, see above) from regulation.

4. The SEC’s Voluntary Regulatory Regime for Investment Banks

Since 1975, SEC rules required investment banks to maintain a debt-to-net-capital ratio of less than 12 to 1.

In 2004, however, the SEC permitted the big investment banks to develop their own net capital requirements in accordance with the investment banks’ own requests and international standards.

Investment banks used their new freedom to, for example:

• Raise their leverage ratios to “as high as 40 to 1”; and
• Thunder their herd into the arms of commercial banks

when the housing bubble popped. The former SEC Chairman “acknowledged that … voluntary regulation was a complete failure.”

5. Federal Preemption of State Consumer Protection Laws

The federal regulators “sat on their hands” and did not crack down on predatory lending abuses. According to Weissman and Donahue:

• Between 2002 and 2007, the Federal Reserve took three formal actions against subprime lenders; and
• Between 2004 and 2006, the Office of Comptroller of the Currency (which has authority over almost 1,800 banks) took three consumer-protection enforcement actions against banks.

As the former Attorney General and Governor of New York has recounted:

• In 2003, during the height of the predatory lending crisis, the Office of the Comptroller of the Currency invoked a clause from the 1863 National Bank Act to issue formal opinions preempting all state predatory lending laws, thereby rendering them inoperative. The OCC also promulgated new rules that prevented states from enforcing any of their own consumer protection laws against national banks.

6. Mega Merger Mania

Over the last twenty years, regulators permitted and approved an extraordinary number of bank mergers that would have pleased Alexander Hamilton and sickened Thomas Jefferson, were they both not dead. The resulting mega-banks are “too big to fail”, and apparently “too big to respond to appropriate adult supervision,” even if it had been tried.

While some (such as Weissman and Donahue) have argued that they should have been treated as public utilities with heightened regulation and risk control, the repeal of Glass-Steagall enabled these gigantic institutions to benefit from federal guarantees, even as they pursued reckless high-risk investments.

There is – of course - more. Weissman & Donahue’s seven-page Executive Summary (see link above) lists a total of twelve steps; and their 231-page report contains all of the hot little details. But that’s enough “stepping” for me – I am simply too damn tired.

Comments

[peterthepai...:]

the bullies in the playground never go away...

they get older and get themselves and their friends into positions of power and influence...

they plan and wait and scheme and weave...

the political good guys are weak and divided or al least not as prepared as the bullies...

we have been outmanouvered by these people and they have stolen the future prosperity of our countries...

look how powerless president obama is in the face of bonuses...

political leaders allover have been made to look ridiculous...

finance was made too complex for the politicians to understand...

a great simplification is needed...

compexity is the friend of the conspiritor....

keep it simple and transparent and shame the bullies

Mar 17 08:24 AM

[russ:]

Finally, an orderly presentation of the facts, without the political posturing and ideological crap of the Fox or CNBC networks. I would add that the repeal of Glass-Steagall did not cause the problem. The problem arose because of poor oversight and lack of regulation of the new compostion of the industry after that repeal. The root cause is the philosophy of the Saint Reagan worshipers that huge private businesses did not need regulation or constaints

Mar 17 08:36 AM

[BOBO101:]

For anybody that wants to understand how "capitalism" supposedly failed us should read this book. I will, if as Ira said, I can stand the stupidity.

Great summary.

Mar 17 09:31 AM

[William Cowie:]

Very good summary.

Notably absent (probably because it's hard to document) would be the big banks' lobbying efforts (read dollars) to pay off politicians to look the other way. It would not surprise me that Sandy Weill thumbed his nose at the laws knowing he had secured lawmakers' assent the old-fashioned American way: dollars. By the way, why isn't he in jail? He broke the law at the time, and today that's costing you and me more money than Madoff.

Mar 17 09:41 AM

[Pat Shuff:]

Most excellent, thank you. The skeletons in the closet are stacked to the ceiling in every room, on every level, both ends the Mall and spilling from the judiciary.
What dirty laundry can't be whitewashed has already been swept under the very lumpy rug, joining the previous debacles (i.e. S&Ls) of synonmous culpabilities. The failure of the role
of the Fourth Estate, the press, to tell this story in a sustained way that all can understand guarantees
that this is just another chapter. From a mass grave of skeletons stretching from DC to California the press can't seem to find a bone to pick from any of it. One arrives at some place beyond caring joining
everyone else, knowing or not. Thus consensus granting mandate, a trusted confidence in ignorance and amnesia.

Mar 17 10:40 AM

[ArkansasAngie:]

I'm with peterthepainter -- "keep it simple and transparent and shame the bullies".

There is fiduciary responsibility and there's gambling. Nothing wrong with gambling -- you just have tell people you're doing it ... or ... do it with your own money.

Until and unless they "fix" the financial system there will be no real recovery. And ... it's beginning to tick me off that these yahoos seem to think they can some how scam/skate by this mess.

I am worried and I am not happy!

Mar 17 12:05 PM

[CoinMiner:]

Very well laid out, IRA. This serves as a fine primer for those good folks who seek to gain understanding of the current quagmire. Though if I may, at the very center of Hades lies the fractional reserve banking system. Whether measured by the FRN or BIS, the underlying scam holds all other mini-scams - as detailed above - tethered to the mothership. Thanks for the article.

Mar 18 01:45 PM

[milkchaser:]

Not sure how Glass-Steagall repeal factored in. Still skeptical on that one.

Hindsight is 20-20. Where were the warnings before these problems became obvious?

Mar 18 08:42 PM