“Our soundness standards should be no more or no less stringent than those the market place would impose. If banks were unregulated, they would take on any amount of risk they wished, and the market would price their capital and debt accordingly. Ideally, banks should also face regulatory responses to their portfolio risks that simulate market signals. And these signals should be just as tough, but no tougher than market signals in an unregulated world. Perfection would occur if bankers had a genuinely difficult choice deciding if they really wanted their institutions to remain insured or become unregulated.”
— Alan Greenspan Banking in the Global Marketplace
“The Class [A] through Class [C] Notes will be governed by, and construed in accordance with, the law of the State of New York. The Class [D] Notes will be governed by, and construed in accordance with, the laws of the Cayman Islands.”
— Goldman Sachs, ABACUS 2007 AC1, Indicative Terms, Page 20.
@papicek you say borrowed, I say stole… The govt is way too big. It’s a beast that we should starve. Riddled with cancer.”
Speaking For Myself . . .
Frankly, I’m having a hard time finding a sane critic of Occupy Wall Street or any of the branch affiliates, such as my own beloved Occupy Boston. Some critics I’ve spoken with have sounded intelligent and curious, but upon closer examination, many share the obsession that Occupy (and Obama, democrats in general and even America) are commies and Marxists. I mention it because this keeps cropping up, though I don’t know why. Faux News? Perhaps. Probably. I couldn’t care less. If people are stupid enough to believe this claptrap, there’s no hope for them. My belief is that these people are driven exclusively by an overwhelming hatred of the left and nothing else, and that in policy matters, if all they have to bring to the table is name calling and lies, they have absolutely nothing to offer.
One of the claims I’ve often heard are variants of “government is the problem,” “government is no solution to the problem,” etc. Seemingly, these people are content to see government whither away to practically nothing except a kick-ass military. Obviously, they haven’t thought that one through yet. Well, in one respect the #Occupy movement would agree: campaign finance reform and rolling back the Fourteenth Amendment rights granted non-citizen entities like corporations is central to the #Occupy movement. We may not agree how to accomplish this, but in the main, removing the amplifying effects money brings to our national debate is central and one of the very first aims that the #Occupy movement addressed. In one other respect both the supporters of the #Occupy movement and it’s critics agree: we do not particularly like being made to feel as though we’ve become serfs (in the sense Hayek means). The critics see government as the enslaving entity while #Occupy sees corporate hegemony in the same light.
Empirical evidence can be found on both sides of this argument, but it is a moot question because the two institutions use one another to further their aims—profits for corporations with the attendant astronomical levels of looting on the corporate hand and party unity with good prospects for re-election (along with the opportunity to do some looting for purely personal gain on the other). Hand in glove: those of us who look see the glove (our elected officials) for the most part, and not the corporate hand within animating it.
Both unite to make one fist though.
What this post is about is the recent history of government regulation of banking. Strange that it begins in the same year (1978) when the first of an unending tale of union concessions began, but I suggest no link, other than the fact that equity in American society came under attack on both fronts. I draw on a very handy timeline of banking deregulation (pdf), written by Matthew Sherman and published by the Center for Economic Policy Research. Through my own research, I knew the pieces of legislation, but Sherman includes the important changes in regulatory policy as well as an important Supreme Court decision which I hadn’t known about. Kudos and thanks to Mister Sherman for his work here and to the CEPR for making it available.
From 1978 to 2000, Sherman lists six major pieces of deregulation which came out of Congress, but his history begins with Marquette vs. First of Omaha. This case overturned state usury laws, and a bank chartered in Minnesota was allowed to impose an interest rate in Nebraska which had been prohibited by Nebraskan law as usurious. What followed was “a competitive wave of deregulation”1 as states began dropping their usury laws to allow banks to charge whatever interest rates on loans the market would bear. By 1981, Jeff Gerth was reporting about Maryland Governor Pierre S. du Pont’s efforts to entice banks to his state by virtually eliminating taxes on them and offering them a safe regulatory haven. What follows used to be news. Not any longer. Nowadays, it is recognized that the real decisions are made in secret, packaged in secret and rushed through Congress or State legislatures:
“An examination of the Delaware legislation and the process by which it was enacted, including interviews with dozens of bank officials, state officials, legislators and consumer advocates, disclosed the following:
– The legislation was drafted in private over a period of six months by lawyers for two large New York banks, the Chase Manhattan Bank and J.P. Morgan & Company, without any written analysis by any Delaware official involved.
– Other parties who might have raised questions about the bill, including other state officials, the press and the public, were intentionally kept in the dark, according to bankers and state officials.
– Many legislators say they did not read the 61-page bill before agreeing to sponsor it and did not understand the complicated measure before voting on it.
– Some legislators and consumer attorneys say the handling and timing of the only hearing for the bill – it lasted three hours – was unfair, preventing many legislators from attending and inhibiting rebuttal from the bill’s opponents. The bill’s supporters say the deliberations were the most extensive they had seen in Delaware in the last four years.”2
The benefits of increased competition did not come to pass, however. What did happen was that very shortly after, credit card interest rates soared as high as 18% as banks cashed in on their new-found freedom to charge whatever they wanted (partly driven by Alan Greenspan as he raised the prime rate as high as 20% in order to curb the “stagflation” resulting from the Arab oil boycott) and as interest rates trended upward, so did consumers filing for bankruptcy:
Source: FDIC, The Effect of Consumer Interest Rate Deregulation on Credit Card Volumes, Charge-Offs, and the Personal Bankruptcy Rate, March 1998.
The “free market” was coming to a theater near you, and far from being beneficial, it was beginning to look like a disaster. Two years later, the Depository Institutions Deregulation and Monetary Control Act, an initiative of the Carter administration, was passed, which allowed banks to merge. It also removed the interest rate ceiling on deposit accounts, theoretically offering consumers greater flexibility in choosing the bank offering the highest rate of return on savings. Sadly, only the interest rates on highly restrictive accounts like 6-month and 1-year certificates of deposit went upward. Briefly. If you needed a working account where you could get at your money, your return began dropping from about 5% on a passbook savings account to near zero, where it is today.
Two years after the Depository Institutions Deregulation and Monetary Control Act Congress was at it again, and the Garn-St. Germain Depository Institutions Act was passed, which effectively removed all restrictions on Savings and Loans, who could now lend to commercial borrowers (less security on more risk than home loans), and allowed money market accounts to compete across state lines and deliberately undercut existing state regulatory powers.
Yes, undercutting states’ rights here was a Reagan initiative. On signing the bill, Reagan proclaimed, “All in all, I think we hit the jackpot.”3 Not quite. What resulted from the influx of new profitability was the upsurge in sweetheart loans, speculative lending and leveraging which lead to the S&L Crisis. Of course, while S&L’s doubled and in some cases tripled in size, banking regulators we cut, underpaid, and inexperienced, and the results were inevitable. Millions of insured depositors were placed at greater risk of being wiped out entirely and eventually Washington had to fund failing S&L’s and step in to save ordinary American’s deposits. If Reagan’s goal was to shrink the size of government, he almost succeeded. The Federal Savings and Loan Insurance Corporation, for whom Congress appropriated first $15 Billion in 1986, then $10.75 Billion in 1987, was insolvent by 1989 and dissolved. All in all, the cost to taxpayers (by the 1990’s) of deregulation topped $100 Billion.4 Poor Ronald. One regulatory agency was replaced by another, the newly created Office of Thrift Supervision (under the Treasury Department), brought into being by George H. W. Bush and the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, which, predictably, removed the regulations restricting bank holding companies from acquiring Savings and Loan institutions,and the big boys of Wall Street were on the verge of sweeping up all the chips. Which they have not been slow to take advantage of: in the years 1994 to 2003, 3,517 banks have merged or been swallowed up in the US.5
The trends here are several: on the banking side, there was greater freedom to expand into new markets and let the market determine costs and prices. On the borrowers’ and depositors’ side, costs went up, returns plummeted, and any business caught with loan obligations at a higher interest rate through an accident of the market was caught at a competitive disadvantage unless it could refinance (not always the case), and small businessmen had something new to worry about. The second trend was in bank consolidation. Part the reason that bank holding companies were allowed to buy up S&L’s was because it had become clear by the time the FSLIC was about to go belly up that the problem was bigger than even Washington could handle. It needed private bankers to step in and help resolve S&L insolvencies. The trend here is in concentrating the risk into fewer and fewer banks, and in a fairly short period, the banking landscape in America had changed enough that “systemic risk” became the Sword of Damocles we all dine under today.
No part of deregulation had yet to perform as promised, yet the neoliberals weren’t done yet. After a brief hiatus post-S&L Crisis, the Riegle-Neal Interstate Banking and Branching Efficiency Act was passed with broad bipartisan support. Suddenly, major regional banks such as Washington Mutual and even the colossus that is Bank of America became possible. Riegle-Neal had repealed the remaining restrictions on interstate banking, and states had become powerless to regulate within their borders. What began as regulatory competition among states eventually took state legislatures completely out of the picture. At the state level, free market deregulators had won convincingly. Risk was spread out, but it was also amplified, and the total lack of prudent lending rampant in California, Texas and Florida later came back to bite Massachusetts, Ohio and Michigan.
As I said, the neoliberals weren’t finished. This time, it wasn’t Congress who dropped the ball, but the free market fanatic, Alan Greenspan, who, in 1996 reinterpreted the Glass-Steagall Act to allow commercial banks, those holding insured (by the taxpayer) deposits, to earn up to 25% of their revenues through the far riskier practice of investment banking. This was an irresponsible exposure of both depositors and taxpayers to elevated levels of risk. Greenspan’s gesture was completed in 1999, when Congress passed the Financial Services Modernization Act, otherwise known as Gramm-Leach-Bliley. This repealed the remaining safeguards in Glass-Steagall and allowed banks to become “Financial Services” companies, offering (taxpayer insured) commercial banking services, investment banking services, and even insurance. Congress thus ratified the 1998 Citigroup merger with Travelers (insurance and investment banking) which had taken place the year before. At no time since the Great Depression had the US allowed risk to permeate every sector of the economy until Graham-Leach, and if nobody saw what was coming, it was simply because they didn’t bother to look.
It was only a matter of time.
Meanwhile, bank innovation began to take off. Interest rate swaps, credit default swaps, securitization of debt instruments and the CDO market was taking off, and at the behest of Alan Greenspan and Lawrence Summers, Congress passed the Commodity Futures Modernization Act of 1994, solely to prevent the Commodity Futures Trading Commission from regulating the fast growing market of credit derivatives trading. The banks’ freedom to dump risk made credit easy. Borrowing skyrocketed. Housing (and other asset prices) prices went through the roof. It was all a vicious circle of inflation: too much credit (what came to be called “Greenspan dollars”) chasing too small a market.
Still, in spite of the fact that we were edging closer to the abyss, Washington freed things up just a little more. This time, it was the SEC, who in 2004 allowed investment banks to voluntarily regulate themselves under the Consolidated Entities Program. which allowed “global investment bank conglomerates that lack a supervisor under law to voluntarily submit to regulation.” The result that a risky world became even riskier as investment banks were allowed to gamble on smaller reserves and increase their leverage. The very next year, the housing market peaked and investment banks like Goldman Sachs began to think of ways of getting out—while making a killing.
Bear Stearns and Lehman Brothers. Washington Mutual and Merrill Lynch. In the years 2000 to 2004, 25 bank failures are recorded by the FDIC. In the period from 2005 to the present, that number rises to 409. The cost to the taxpayer to safeguard depositors and resolve outstanding issues is unknown. Some lending facilities, like the Primary Dealer Facilities remain secret.
Secrecy is, of course, at the root of the problem. Banks, no more than other companies, maintain proprietary accounting information—crucial details only insiders know about. By 2002, accounting scandals had become so commonplace that Forbes Magazine published a list of the biggest offenders: Enron, Adelphia, Merck, Qwest, Tyco, etc. Energy sector companies based in Texas are well represented here: CMS Energy, Duke Energy, Dynergy, El Paso, Halliburton and Reliant Energy. Some of the big names in Telcoms as well: Adelphia, AOL/Time Warner, Qwest, WorldCom and Global Crossing. The telcoms in particular were some of the darlings of Wall Street, which, for all the disclosures mandated by law and regulation, is indicative of the disconnect between securities “experts” on Wall Street and reality, due to the secrecy of boardrooms, accounting departments and those auditors tasked with reporting to the SEC, and more importantly, shareholders and the markets.
Of course, I’m not suggesting we can legislate integrity. May as well try and hold back the tide.
By the time the housing market in the US reached the stratosphere, a new class of lender had sprung up, small mortgage loan companies which did not take deposits, were not banks at all, and were therefore completely unregulated. The most notorious of which was a wannabe filmmaker, Daniel Sadek of Quick Loan Funding:
“Quick Loan Funding was financing two hundred million dollars a month in mortgages. This guy Daniel Sadek had a third grade education; he’d never gotten an MBA. He was running a company that at its peak had 700 employees and was getting financing through Bear Stearns, through Citigroup, through Wells Fargo, who all gave him lines of credit and securitized his loans so he could lend. You. Money.”6
“If we had a prime borrower on the line, we hung up on them,”‘ Buksoontorn says. “We were geared toward subprime because they were easier to close. We were giving them money no other bank would dare to give them.”7
Cowboy capitalism. The excesses of the free market we’ve all witnessed are known, and it is way past time that the lunatic right, fueled by sensationalist reporting from FoxNews was ignored. A sound banking system has been central to any economy since the Renaissance and the invention of double-entry accounting in the thirteenth century. Letting the market sort it all out has not made matters any better, but on the contrary, has a history of hidden costs (ie: market inefficiencies) which others not involved in these abusive practices must shoulder, or go under themselves. This is not a matter of Marxist ideology, as my twitter foes contend, but of social equity. The banking landscape created by Washington, at the behest of bankers, still exists today. Systemic risk is no less now, for all the provisions of Dodd-Frank, than it was in 2007.
What, one wonders, are the goings-on in Washington these days as the regulatory provisions mandated by Dodd-Frank are being written right now, with Wall Street lobbyists right in the thick of things. Who, one wonders, will do the regulating? An ex-Wall Street banker? What are the odds?
1Sherman, Matthew; A Short History of Financial Deregulation in the United States, CEPR, 2009. (pdf)
2Gerth, Jeff; New York Banks Urged Delaware To Lure Bankers, New York Times, 17 March 1981.
3Reagan, Ronald; Remarks on Signing the Garn-St Germain Depository Institutions Act of 1982, 15 October 1982.
4CHRONOLOGY-S&L crisis of the 1980s.
5Pilloff, Steven J.; Bank Merger Activity in the United States, 1994–2003, Staff Study of the Federal Reserve Board of Governors, May 2004. (pdf)
6Faber, David; House of Cards, CNBC Original Documentary, 2009. I must take a moment here to praise David Faber and the team who put this story together. They succeeded brilliantly in telling a very complex story with balance and humanity, and it is well worth the time.
7Ivry, Bob; `Deal With Devil’ Funded Carrera Crash Before Bust (Update3), Bloomberg, 18 December 2007.