[corp-focus] Wall Street's Best Investment II: 12 Deregulatory Steps to Financial Meltdown

[robert weissman]

Wall Street's Best Investment II: 12 Deregulatory Steps to Financial 
Meltdown
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: 
<www.wallstreetwatch.org/soldoutreport.htm>.) 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The Financial Services Modernization Act of 1999 formally repealed the 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Glass-Steagall would be repealed.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:
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