Continued from July 10, 2009
Last post, I left off talking about the fact our current recession is credit driven rather than inventory driven; the “free and easy credit” made available over the past many years was one factor in getting our economy where it stands today.
But, free and easy credit in and of itself wouldn’t have been enough to avoid an impending recession so the government allowed banks to use excess leverage. The building of this credit bubble occurred simultaneously with the consumer credit bubble. It began in 1999 with the repeal of the Glass-Steagall Act.
The Glass-Steagall Act declared certain mandates for investment and commercial banking in order to protect investors from speculative, risky investments. This law seemed to work just fine for over 60 years until the banking industry won its repeal in 1999. Bill Clinton signed the bill calling for its repeal into law in 1999, but there’s plenty of bi-partisan blame to go around. Only one Republican in the Senate voted against its repeal and 38 of 45 Democrats voted for its repeal as well. Ultimately, the repeal of Glass-Steagall passed the House 343-86 and the Senate 90-8. (Source: “Shattering the Glass-Steagall Act” by William Kaufman)
This regarding the repeal of the act from Wikipedia;
Many economists “have criticized the repeal of the Glass-Steagall Act as contributing to the 2007 subprime mortgage financial crisis. The repeal enabled commercial lenders such as Citigroup, the largest U.S. bank by assets, to underwrite and trade instruments such as mortgage-backed securities and collateralized debt obligations and establish so-called structured investment vehicles, or SIVs, that bought those securities. Citigroup played a major part in the repeal. Then called Citicorp, the company merged with Travelers Insurance Company the year before using loopholes in Glass-Steagall that allowed for temporary exemptions. With lobbying led by Roger Levy, the ‘finance, insurance and real estate industries together are regularly the largest campaign contributors and biggest spenders on lobbying of all business sectors [in 1999]. They laid out more than $200 million for lobbying in 1998, according to the Center for Responsive Politics. These industries succeeded in their two decades long effort to repeal the act. ‘ “
But wait there’s more.
In 2000, then Goldman Sachs CEO (and later Bush’s Treasury Secretary) Henry Paulsen petitioned Congress and the SEC to release major brokerage houses including Goldman Sachs from the net capital rule – a rule that limits the amount of leverage a firm can utilize. He failed.
In 2004, Paulson tried again and this time he succeeded. This again, from Wikepedia:
“In 2004, at the request of the major Wall Street investment houses—including Goldman Sachs, then headed by Paulson—the U.S. Securities and Exchange Commission agreed unanimously to release the major investment houses from the net capital rule, the requirement that their brokerages hold reserve capital that limited their leverage and risk exposure. The complaint put forth by the investment banks was of increasingly onerous regulatory requirements—in this case, not U.S. regulator oversight, but European Union regulation of the foreign operations of US investment groups. In the immediate lead-up to the decision, EU regulators also acceded to US pressure, and agreed not to scrutinize foreign firms’ reserve holdings if the SEC agreed to do so instead. The 1999 Gramm-Leach-Bliley Act, however, put the parent holding company of each of the big American brokerages beyond SEC oversight. In order for the agreement to go ahead, the investment banks lobbied for a decision that would allow “voluntary” inspection of their parent and subsidiary holdings by the SEC.
During this repeal of the net capital rule, SEC Chairman William H. Donaldson agreed to the establishment of a risk management office that would monitor signs of future problems. This office was eventually dismantled by Chairman Christopher Cox, after discussions with Paulson. According to the New York Times, “While other financial regulatory agencies criticized a blueprint by Treasury Secretary Mr. Paulson proposing to reduce their stature — and that of the S.E.C. — Mr. Cox did not challenge the plan, leaving it to three former Democratic and Republican commission chairmen to complain that the blueprint would neuter the agency.”[11]
In late September 2008, Chairman Cox and the other Commissioners agreed to end the 2004 program of voluntary regulation.”
Now that big banks could use huge amounts of leverage and could participate in both investment banking and commercial banking, the real ‘fun’ began. Every one of the major banks that failed had leverage of at least twice the prior leverage limit of 14:1 (Source: The Market Ticker, January 2, 2009)
In my view, most of congress was clueless about what these changes (i.e. free and easy credit and the repeal of the Glass-Steagall Act) would do to the economy at some point in the future. The reality is congress was pushing for the banks to loan money for home ownership even if the borrower wasn’t qualified to pay back the loan. Note the following video of a speech Barney Frank made in 2005 denying that there was a housing bubble.
Now, this same rocket scientist wants to relax lending standards again. No, I am not making this up. This from Reuters on June 22, 2009:
Two U.S. Democratic lawmakers want Fannie Mae and Freddie Mac to relax recently tightened standards for mortgages on new condominiums, saying they could threaten the viability of some developments and slow the housing-market recovery, the Wall Street Journal said.
In March, Fannie Mae (FNM.N)(FNM.P) said it would no longer guarantee mortgages on condos in buildings where fewer than 70 percent of the units have been sold, up from 51 percent, the paper said. Freddie Mac (FRE.P)(FRE.N) is due to implement similar policies next month, the paper said.
In a letter to the CEO’s of both companies, Representatives Barney Frank, the chairman of the House Financial Services Committee, and Anthony Weiner warned that a 70 percent sales threshold “may be too onerous” and could lead condo buyers to shun new developments, according to the paper.
The legislators asked the companies to “make appropriate adjustments” to their underwriting standards for condos, the paper added.
In an interview with the paper, Weiner said the rules have “had a real chill on the ability to get these condos sold,” at a time when prices of condos have fallen enough to attract potential buyers.
Can you believe it?
The same bozo who denied there was a bubble in 2005, made the bubble even bigger by pushing for relaxing lending standards then and watched the bubble collapse, is now asking for relaxing lending standards again. Absolutely unbelievable!
To Be Continued…………
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