DCX2

Leverage 101: The Real Cause of the Financial Crisis

unregulatedleverage.or... has a nice piece that follows along with this quite well.

Here's my solution to the financial crisis...

1) Somehow cover the short-term credit "freeze". Short-term "crisis" solved.
2) Next, detox the debts by helping families refinance mortgages, or have the government buy foreclosed property and re-sell it...basically, get money flowing again so these debts aren't worthless. Medium-term crisis solved.
3) Slowly deleverage financial institutions. Some European banks are leveraged 30:1 (UBS is even 60:1!). Long-term crisis solved.
4) Create rules and regulations. Examples are small excise taxes on trades to discourage speculation. Reasonable limits on CEO compensation, so that we can fire a CEO who caused the company to lose jobs without having to give them millions of dollars for screwing up. The point is that we should encourage wise, long-term investments, not short-term greed.

Who Will Be the Next Treasury Secretary?

Gramm-Leach-Bliley did not increase competition; it set off a wave of mergers. It created a situation where investment banks would bring down the commercial bank it merged with (for example, Citibank).

It also screwed with risk assessment, because the lender is not going to vet themselves. No commercial bank would have bought investments off of a separate company if they knew the investments were backed with subprime loans; by keeping it "in the family", these subprime loans flew under the risk radar.

Further, Gramm's actual claim to fame is the Commodity Futures Modernization Act, which made swaps unregulated. This created the Enron Loophole, as well as opening up the Credit Default Swaps market to grow from <$1t to $62t in less than a decade. (note; this is greater than world GDP at $60t)