Since 1792 when our government got into financial problems and credit markets froze, there had been a financial crisis about every 15 or 20 years for about 140 years until the one culminating in the Great Depression during the 1930s.
As a result, in 1932 and 1933 there were 3 pieces of legislation passed:
- The Glass-Steagall Act that separated commercial/community banks from Wall Street and investment banks
- The FDIC which insures bank accounts
- And SEC regulations that a.) subjected Wall Street traders to strong incentives to avoid fraud, b.) kept key financial institutions from taking on too much risk, and c.) subjected trades to an important requirement of publicity – each time a financial instrument was bought or sold, the market itself received information about the perceived value of the instrument.
Because of those regulations, we went nearly 50 years with no bank failures and no panics.
In 1956, the Bank Holding Company Act is passed, extending the restrictions on banks, including that bank holding companies that own two or more banks cannot engage in non-banking activity and cannot buy banks in another state.
In the 1960’s the regulatory climate began to change. Banks start lobbying Congress to allow them to ender the municipal bond market and a lobbying subculture springs up around Glass-Steagall.
In the 1970’s some brokerage firms begin encroaching on banking territory by offering money-market accounts that pay interest, allow check writing and offer credit and debit cards.
In Dec. 1986, the Federal Reserve Board reinterprets Section 20 of the Glass-Steagall Act which bars commercial banks from being engaged principally in securities business. It decides that banks can have up to 5% of gross revenues from investment banking business. This is the first time the Fed re-interprets Section 20 to allow some previously prohibited activities. In the Spring of 1987 the Federal Reserve Board votes 3-2 in favor of easing regulations, overriding the opposition of Chairman Paul Volcker. The vote comes after the Board hears proposals from Citicorp, JP Morgan and Bankers Trust advocating allowing banks to handle several underwriting businesses including commercial paper, municipal revenue bonds and mortgage-backed securities. The bankers argue that since 1933 there were three “outside checks” on the industry, “a very effective SEC”, knowledgeable investors and “very sophisticated” rating agencies. Volcker is opposed, as it boils down to the issue of two different cultures – a culture of risk in the securities industry and a culture of protection of deposits in the banking industry. The Fed agrees with the banks however and also raises the limit from 5% to 10% of gross revenues. The Board believes the new reading of Section 20 will increase competition and lead to greater convenience and increased efficiency. In August 1987, Alan Greenspan (formerly a director of JP Morgan and a proponent of banking deregulation) becomes chairman of the Federal Reserve Board. He favors greater deregulation to help U.S. Banks compete with big foreign institutions.
In January 1989 the Fed approves an application by the big banks to expand the Glass-Steagall loophole to include dealing in debt and equity securities in addition to municipal securities and commercial paper. This marks a large expansion of the activities considered permissible under Section 20.
In December 1996 the Fed issues a precedent-shattering decision permitting bank holding companies to own investment bank affiliates with up to 25% of their business in securities underwriting. This expansion of Secion20 effectively renders Glass-Steagall obsolete.
In 1997 Bankers Trust (now owned by Deutsche Bank) buys the investment bank Alex. Brown & Co, thereby becoming the first U.S. bank to acquire a securities firm. Later that fall, Travelers Insurance Co acquires the Salomon Brothers investment bank. Salomon then merges with the Travelers-owned Smith Barney brokerage firm to become Salomon Smith Barney.
In 1998 Travelers proposes a merger with Citicorp which becomes the biggest corporate merger in history and the world’s largest financial services company. This was the birth of Citigroup, Inc. They quietly lobby banking regulators and government officials. The Fed gives its approval to the merger on Sept. 23.
Back in 1980, close to 100% of financial instruments traded in the market were subject to the “New Deal” exchange based regulatory regime. However, during this time, a new class of financial instruments, known as derivatives, was born. Derivatives are assets whose value is derived from something else. A derivative can pay you if the price of gold falls below $1,000 or if the temperature in San Diego rises above 100 degrees. A derivative is basically a bet entered into by two or more parties.
At first, derivatives were a very small portion of the market. However, technology made it possible for this market to explode until the industry fixed on a particularly rich and ultimately disastrous vein of home mortgages and developed a whole series of assets backed by real estate mortgages.
As it was growing, the debate raged over how to regulate it but through a series of steps they were ultimately totally exempted from regulation. In Jan of 1993 the departing chair of the Commodity Futures Trading Commission (Wendy Gramm) signed an order exempting most over the counter derivatives from federal regulation. (A few months later she was named a director of Enron, which was an active trader of natural gas and electricity derivatives.) By the end of 1994, all anti-derivatives legislation had been killed in Congress. This campaign was not just legislative, the SEC was told by members of Congress to lay off. When the SEC chairman, Arthur Levitt tried to introduce tougher conflict-of-interest rules for the accounting industry, Senator Phil Gramm, Senate Banking Chair threatened to cut the SEC’s budget. Finally, in 1999 President Clinton signed the law that abolished the Glass-Steagall Act, thereby confirming the deregulation already effected by bank regulators.
Now, the new head of the CFTC, Brooksley Born, felt that because derivatives functioned much likes “futures contracts” the CFTC should regulate them. She drafted a release to this effect in May 1999 and sent it to other relevant federal agencies. Every banker in Washington complained about it and following Wall Street’s urging, Treasury Secretary Robert Rubin (a former co-chairman of Goldman Sachs who days after the repeal of Glass-Steagall accepts a top job at Citigroup), Larry Summers and Alan Greenspan all berated her. She persisted and Greenspan, Summers and Rubin announced they would seek legislation to stop her and her CFTC. Shortly thereafter she resigned and the following year, Congress overwhelmingly passed the Commodities Futures Modernization Act, which expressly forbade the CFTC from regulating derivatives and expressly exempted derivatives from any other state law. The markets shifted to the lowest-cost, least-regulated havens.
From 1999 to 2008 the financial sector spent $2.7 billion in reported federal lobbying expenses and individuals and PACs in the sector made more than $1 billion in campaign contributions. As the money flowed the appetite for deregulation grew. But Congressman Jim Leach from Iowa who was the leading Republican on the House Banking Committee in 1994 was convinced that the derivatives market produced systemic risk to the economy. After the savings-and-loan crisis of the late 1980’s and early 1990’s he issued a report that called for strong regulation of derivatives. It was criticized by many in the industry and largely ignored. What made him so different from his colleagues is that he did not receive financial support from Wall Street because he refused to accept contributions from political action committees.
By 2008, 90% of the financial instruments traded in the market were exempted from regulations. We had flipped from a presumptively public market of exchange to a market where only insiders knew anything real about how the market worked or what the assets were worth. That was great for the insiders but awful for the rest of us.
Banks were encouraged to take more risks to get greater returns and due to the history of being bailed out by the federal government as “too big to fail”. They didn’t think they would need to bear the losses because government would step in. So in a way, it becomes a story of both too little and too much regulation. Too little, since by relaxing regulatory constraints the banks were more vulnerable to competition, which forced them to take more risk. Too much, since the implicit guarantee of a bailout encouraged the banks to be complacent about asset-price inflation. The combination, as we now know, was deadly for us. The surviving banks are now stronger than ever.
There were plenty of warning signs along the way that should have alerted us.
In the late 1980’s there was the Savings and Loan Crisis, which was the failure of about 747 out of the 3,234 savings and loan associations. The U.S. General Accounting Office estimated cost of the crisis to be around $160.1 billion, about $124.6 billion of which was directly paid for by the U.S. government from 1986 to 1996. The federal government ultimately appropriated 105 billion dollars to resolve the crisis. After banks repaid loans through various procedures, there was a net loss to taxpayers of approximately $124 billion dollars by the end of 1999. This should have been a red flag.
In the late 1990’s there was the Long Term Capital Management failure. LTCM was a speculative hedge fund and again used bad bookkeeping and accounting practices. Seeing no other options the Federal Reserve Bank of New York organized a bailout of $3.625 billion by the major creditors to avoid a wider collapse in the financial markets as they dealt with every major firm on Wall St. This should have been a red flag.
In the early 2000’s Enron collapsed due to “mark to market” bad bookkeeping, which had little basis in reality. Shareholders lost nearly $11 billion when Enron's stock price plummeted to less than $1 by the end of November 2001. The situation was not helped by the disclosure that Enron founder Ken Lay stood to receive a payment of $60 million, while many Enron employees saw their retirement accounts, which were largely based on Enron stock, decimated as the price fell 90% in a year. An official at a company owned by Enron stated "We had some married couples who both worked who lost as much as $800,000 or $900,000. It pretty much wiped out every employee's savings plan as well as their jobs. Of course, executives that understood the real picture sold their shares in advance of the collapse and waltzed away with billions. This should have been a red flag.
We didn’t listen or learn from the above and the greed and risk-taking went on unabated with hedge funds and derivatives, false bookkeeping and bad loans until we ended up with the Great Recession of 2007/2008. This resulted in the loss of millions of jobs, the loss of pension and retirement plans, the loss of homes. It shattered lives and dreams. We still are facing huge unemployment and on-going foreclosures. And nothing has changed. No new regulations have been called for. Glass-Steagall has not been reinstated, derivatives are still exempt from regulation.
In this deregulated world, when markets are up things are great but when the markets go down it is not only those who have gambled or invested that are hurt but the pension funds, the jobs in related fields lost, the prudent, the middle class who have to pay. We have allowed creation of those companies that are too big to fail, who are guaranteed bail-outs by American taxpayer funds and who demand no regulations.
To compound the problem, during this time of corporate greed, of unethical bookkeeping and risk taking, revenues have been lost due to loopholes in the tax code so that the extremely wealthy and large corporations are not paying their fair share of taxes. Jobs and manufacturing have been outsourced, and the middle class is, and has been, in decline for years with stagnant wages and a loss of purchasing power.
The frosting on the cake for me however, was the Supreme Court decision for Citizens United vs the Federal Election Commission where it was ruled that corporations are people and have the same constitutional protections as humans and that money is speech. This has created a hugely unequal playing field in our democracy as there is no limit on the funds large corporations and super PACs can use to buy candidates and campaigns and the record keeping requirements are very non-transparent. This leads to funds being given by possible foreign nationals and multinational corporations who certainly do not have the well being of the American people as their priority. It has led to corporate ownership of government. It has also made the 1 person 1 vote concept irrelevant. Our voices are not heard. We have lost government of the people, by the people and for the people.
Why I support Occupy:
For these reasons, I support the Occupy movement which, although made up of people of all different political persuasions and different priorities, also seeks to overturn the Citizens United decision and to bring transparency and accountability to Wall Street. It has effectively changed the dialog in this country. It is giving us a voice.