A Perfect Storm

Being motivated by the discussion on this thread, as well as some recent radio commentary I've heard, I decided to talk about something I'm not really qualified to talk about, that being the recent collapse of our economy thanks to the financial industry and its Congressional collaborators. I understand that health care reform is on the minds of many, but there are some equally important issues our government has chose to shelve until some later date, which I believe is placing our economic recovery at great risk, and could undermine the success of whatever other reforms our government attempts.

Some of the subjects I'm going to cover are well-worn, especially for those who have tried to figure out just what the hell happened to us. As many of you already know, the Gramm-Leach-Bliley Act of 1999 repealed many of the provisions of Glass-Steagall, opening the doors for banks and security firms to copulate and produce risky babies. Here's a helpful little brochure the Fed sent out to bankers to help them with their courtship:

This brochure highlights the major provisions of the Gramm-Leach-Bliley Act (the “Act”), which was signed into law in November 1999. As I am sure you are aware, the law updated U.S. financial services laws and removed the remaining walls that fragmented the financial marketplace. This legislation, which represents the most significant change in the U.S. financial services industry in 66 years, repealed the core provisions of the Glass-Steagall Act and the Bank Holding Company Act that restricted bank holding companies from affiliating with securities firms and insurance companies.

The Act now permits banks, insurance companies, securities firms, and other financial institutions to affiliate under common ownership and offer their customers a complete range of financial services. As you know, the Act established two new corporate vehicles for the conduct of financial service activities -- the financial holding company and the financial subsidiary. The Act also established the concept of functional regulation of subsidiaries of financial holding companies, and established the Federal Reserve as the umbrella supervisor.

An incredibly poor supervisor, as it turns out. That sentence was catnip for the Libertarians, who will hopefully run off into the corner and enjoy it without posting Tomes of information about the need to abolish said Fed.

Not satisfied with this incredibly reckless deregulation of the financial industry, Phil Gramm proceeded to pound a few more nails into our coffin with the Commodity Futures Modernization Act of 2000, which not only created the "Enron Loophole" that eventually had us paying $4.00 per gallon of hotly-traded gasoline, it also facilitated credit default swaps, which eventually knocked us and the rest of the world to its knees:

The market for the credit default swaps has been enormous. Since 2000, it has ballooned from $900 billion to more than $45.5 trillion — roughly twice the size of the entire United States stock market. Also in sharp contrast to traditional insurance, the swaps are totally unregulated.

When the mortgage-backed securities that many swaps were supporting began to lose value in 2007, investors began to fear that the swaps, originally meant as a hedge against risk, could suddenly become huge liabilities.

The swaps' complexity and the lack of information in an unregulated market added to the market's anxiety. Bond insurers like MBNA and Ambac that had written large amounts of the swaps saw their shares plunge in late 2007.

Gramm was rewarded for these "accomplishments" by UBS Warburg in 2002 with a vice-chairmanship, which was without a doubt the worst of many bad decisions they made. UBS got deep into mortgage-backed securities and lost some 70% of its worth because of it.

Now I want to talk about something that's been seriously under-reported by most of the media, and I've touched on this a few times when we discussed bad mortgage loans. From the transcript of an award-winning NPR "This American Life" segment:

It is a lot of money. And that money comes with an army of very
nervous men and women watching over the pool of money: investment managers.
This army is nervous because they don't want to lose any of that money and they
also want to make it grow bigger. But to make it grow, they have to find something
to invest in. So, for most of modern history, they bought really, really safe, really
boring investments: things called treasuries and municipal bonds. Boring things. But
then, right before our story starts, something changed, something happened to that
global pool of money.
Ceyla Pazarbasioglu: This number doubled since 2000. In 2000 this was
about 36 trillion dollars.
Adam Davidson: So, it took several hundred years for the world to get to 36
trillion. Then, in six years, to get another 36 trillion.

Adam Davidson: How's the world get twice as much money to invest? Lots of
things happened, but the main headline is all sorts of poor countries became kind of
rich making TVs and selling us oil: China, India, Abu Dhabi, Saudi Arabia. Made a lot
of money and banked it. China, for example, has over a trillion dollars in its central
bank, and there are office buildings in Beijing filled with math geniuses-real math
geniuses-looking for a place to invest it. And the world was not ready for all this
money. There's twice as much money looking for investments, but there are not
twice as many good investments. So, that global army of investment managers was
hungrier and twitchier than ever before.

That's right, the global pool of (investment) money doubled during this decade, and that money needed a place to go. And the newly created mortgage-backed securities fit the bill nicely. In many ways these were easy to sell, even thought they were risky, because everybody wanted a piece of the American pie. Global investors could actually consider themselves absentee landlords of American neighborhoods.

But guess what? There weren't enough home loans being written to service this new financial sector, so the top-down pressure commenced. Things like due diligence and risk assessment on individual home loans became a serious impediment to the river of money that needed to flow, so pretty soon that river eroded those obstacles, and the global pool of money flowed.

But it wasn't just foreign investors or even U.S. banks who were impacted; U.S. manufacturing and service corporations liquidated assets and steered pension funds towards making these products an integral part of their portfolios, and the exposure widened. When the house of cards finally fell, we realized too late that the disease had spread everywhere. Caught in the perfect storm, all we could do is cower and thumb our worry beads.

Why do I bring this up now? Because we have yet to replace those regulatory walls that we need so badly. The lions got into the village and ravaged us, and we haven't lifted a finger to reconstruct the Boma to keep them away.