So says Peter Wallison in today's WSJ:
The GLBA's [Gramm-Leach-Bliley] "repeal" of a portion of the Glass-Steagall Act of 1933 is said to have somehow contributed to the current financial meltdown. Nonsense.
Adopted early in the New Deal, the Glass-Steagall Act separated investment and commercial banking. It prohibited commercial banks from underwriting or dealing in securities, and from affiliating with firms that engaged principally in that business. The GLBA repealed only the second of these provisions, allowing banks and securities firms to be affiliated under the same holding company. Thus J.P. Morgan Chase was able to acquire Bear Stearns, and Bank of America could acquire Merrill Lynch. Nevertheless, banks themselves were and still are prohibited from underwriting or dealing in securities.
Allowing banks and securities firms to affiliate under the same holding company has had no effect on the current financial crisis. None of the investment banks that have gotten into trouble -- Bear, Lehman, Merrill, Goldman or Morgan Stanley -- were affiliated with commercial banks. And none of the banks that have major securities affiliates -- Citibank, Bank of America, and J.P. Morgan Chase, to name a few -- are among the banks that have thus far encountered serious financial problems. Indeed, the ability of these banks to diversify into nonbanking activities has been a source of their strength.
Most important, the banks that have succumbed to financial problems -- Wachovia, Washington Mutual and IndyMac, among others -- got into trouble by investing in bad mortgages or mortgage-backed securities, not because of the securities activities of an affiliated securities firm. Federal Reserve regulations significantly restrict transactions between banks and their affiliates.
Like a lot of things, the CDS market contributed to the current crisis. But the Commodities Trading Modernization Act as the root cause? Don't make me laugh.
Absent the act, the entire market would have just wound up London, beyond reach of US regulation, and other points offshore. And it is precisely in the London market where the most serious CDS problems first emerged.
The root cause of the crisis is that complex mathematical models (which had never experienced a stress test in a down market) predicted that it was safe for financial companies to leverage themselves at 30-1 on securities backed by $500,000 125% LTV-mortgage loans to immigrant house painters who could not document their income, but could demonstrate that they had paid all their bills on time and responsibly used their $500 credit line from the local equivalent of JC Penny. Many financial company executives worldwide, ranging from frontline mortgage brokers, to high-flying executives of Wall Street investment houses, to the risk managers of conservative state-owned German Landesbank , allowed the computer software incorporating these models to make their buying, purchasing and lending decisions for them.
The resulting relaxation of lending standards for home mortgages resulted in a rush of speculative investment in residential real estate. A bubble. When prices were finally pushed so high by speculation that nobody was left who wished to buy a home as shelter instead of as a get-rich-quick scheme, the bubble popped and prices began to crash. This triggered a wave of mortgage defaults unprecedented since the Great Depression. More important than the number of defaults, though, is the losses taken with each default. These exceeded the most wildly pessimistic estimates contained within the mathematical models described above, triggering an even BIGGER collapse in the value of the mortgage-backed securities, as the holders realized they were actually at substantial risk of losing some of the underlying principal, not just an occasional coupon payment as the models claimed.
Where are your online predictive analytics now, Ditech?
But some of his other votes may have:
The fact that people represented the risky mortgages as happy good fun debt in many different levels is what created the mess.
I don't think it's accurate to say FM/FM created the market for subprime mortgages, though they certainly participated. They could have been more prudent - much more prudent - but the market for the stuff was there anyway.
We just had the largest bankruptcy in history - Lehman Brothers. There over $400 billion (notional amount) of credit default swaps outstanding on Lehman securities. ISDA just had an auction to help settle the liabilities resulting from the Lehman CDSs. The net exposure - industry-wide - on Lehman CDSs was about $6 billion. That's for all participants in CDSs with respect to the largest bankruptcy in history. In other words, not even a drop in the bucket.
It doesn't surprise me that know-nothings will try to affix the blame, especially in an election season. But to blame CTMA is almost as moronic as blaming GLB - these acts had virtually nothing to do with the crisis (indeed GLB *helped mitigate* the crisis by allowing large solvent banks like Chase and BofA to buy up investment banks like Bear and Merrill).
FM/FM may not have created the market but they were the the accelerent. Their unslakable thirst for subprimes coupled with the ability to borrow ridiculous amounts of cash (because of implicit US backing) seems to be what turned a small-mediumish problem into an utter debacle. Hooray for moral hazard -- if I bet long and win, profit for me. But if I lose, well, the House (i.e. the US taxpayer) picks up the loss. Why not bet long?
As I said above, it is moronic to argue that CTMA caused the crisis. And, look, it's uber-moron Matt Taibbi making that very argument. Sweet, sweet vindication of my position.
I have no problem with fixing things that need to be fixed, including any of our regulatory structures. (By the way, I should add that even if Gramm-Leach-Bliley didn't cause this, nobody has ever convinced me that Glass-Steagell was such a terrible idea-- what, exactly, is the extra value gained in merging commercial and investment banks?) The problem I have is the blame game. If someone wants to say "here's what's wrong with subprime lending and how to fix it", that's fine. If someone instead is saying "here's what's wrong with subprime lending and it's all the Democrats' (or Republicans') fault", that's not helpful at all.
Maybe the truth is that there really aren't any economic problems today -- since no one and nothing is responsible, ipxi dixit, there can be no problem. Maybe we should all just go to Katie's restaurant in Wilmington, Del. -- the place that hasn't been there for over 20 years -- and talk to the people who aren't there, just like Sen. Biden does. That's where he gets his information on how working folks are doing these days. That's likely as good a source as either the NYT or WSJ are using.
This.
FM/FM had a nice little
racketbusiness going up until 2004, when certain accounting irregularities were exposed and plunging headfirst into the subprime/alt-a mess, in the name of increasing homeownership, became the price imposed by Barney Frank &Co for letting them off the hook.It's as though after being caught with your hand in the cookie jar, they were ordered to go to the party at 4 am with an 8-ball of coke as part of their community service.
This is the main reason I'm skeptical that government regulation can solve this sort of problem in the future. It asks me to believe that guys like Barney Frank, in the USA and overseas, will encourage future lenders to make credit terms on home buyers _tougher_ instead of easier.
Good luck with that. It'd be the accomplishment of the ages.
I don't know whether that repeal was beneficial or damaging in the end, but I believe it did influence the decision making process of the financial companies quite a bit.
The GREs didn't enter this market until 2005....which was actually close to the end of the RE bubble. That's one of the reasons they crashed and burned so spectacularly. They bought the garbage at the tail when it was the most overpriced.
And the GREs didn't buy up _any_ of the idiotic mortgages &loans being issued overseas by banks and brokerages in the UK, Iceland, Belgium, Spain and Germany. The kool-aid was swallowed world wide, not just in the USA. In fact, it's increasingly looking like things may be even worse in Euroland than in this country.
Bad ideas can spread worldwide especially fast nowadays. Cheap airfare + internet, I suppose.
I propose that banks (which are federally insured) not be allowed to underwrite mortgages where the buyer can't come up with a 5% down payment. I know that this will keep some people from qualifying to buy a home, but those people should rent until they figure out how to save money.
Term limits for congressmen and senators also wouldn't be a bad idea. I can't think of a workable way to keep those who are on the government dole from contributing to those who steer the pork to them, so I say periodically kick all the bums out.
To Connecticut Lawyer, though: I'm house-hunting in Marin County, CA at the moment, &I see a lot of foreclosed-on stuff floating around that I guarantee you wasn't being sold to "poor people with bad credit" at any time. Everyone, it seems, was buying stuff they couldn't actually afford, with the (allegedly) sure prospect of selling it two years down the line at a handsome profit, before the rates reset and things got messy. Was this maybe a device designed to help "poor people with bad credit" that got taken up by everyone and anyone? Because that's what it looks like from here.
The real cause is unsupervised financial markets, and the sponsor of that very bad idea was Reaganomics.
Repealing Glass-Steagall was important in a symbolic way, in that it indicated to the money managers that they could operate like bucket shops and nobody would object -- until the crash, anyway.
By the time G-S was repealed, the institutions it covered had been eclipsed by newer, more dangerous organizations that had not been thought of in the New Deal. It should have been extended and expanded.
All unsupervised financial markets crash, every 6 to 20 years. During the period of adult supervision, which lasted six decades, there were no crashes.
Free markets in abstract financial instruments are suicidal.
I don't see a lot of VC posts linking the the Chicago Boyz lately, compared with times past. Why is that?
Gramm/Leach/Bliley--it hasn't been the companies that combined commercial and investment banking that failed.
CTMA--credit default swaps are a very minor part of the problem.
accounting irregularities at Fannie and Freddie during the Clinton administration
lavish parties for AIG salesmen--though that sure is Congress's focus
high salaries for Wall Street execs--though that sure is Zywicki's and Bernstein's focus
the Community Reinvestment Act--it isn't inner city loans that are the source of the problem
excessively easy money--the Fed isn't responsible for credit spreads which shrunk steadily from 2002 to 2007. Also, the European Central Bank hasn't been so easy, but problems in Europe are just as bad.
In my view, imprudent mortgage lending and rating agency mistakes are the major culprits. I would suggest (i) that no GSE be permitted to buy a mortgage that didn't have a 20% downpayment and that no federally insured institution be permitted to originate or hold such a mortgage, or any securities backed by such mortgages. If private mortgage brokers want to set up a business selling such mortgages to hedge funds, that's fine.
President's Remarks at the 2004 Republican National Convention
Thanks to our policies, homeownership in America is at an all-time high. (Applause.) Tonight we set a new goal: seven million more affordable homes in the next 10 years so more American families will be able to open the door and say: Welcome to my home. (Applause.)
REPUBLICAN PLATFORM 2000
Renewing America's Purpose. Together.
"Homeownership is central to the American dream, and Republicans want to make it more accessible for everyone. That starts with access to capital for entrepreneurs and access to credit for consumers. Our proposals for helping millions of low-income families move from renting to owning are detailed elsewhere in this platform as major elements in Governor Bush’s program for a New Prosperity."
Zywicki is right. There's plenty of blame to go around here. No simple explanation is correct.
5%? That's crazy. Banks should not be permitted to give out mortgages unless the buyer can pony up the customary 20% down payment. And not where that 20% comes from a HELOC or some other debt - I mean 20% real money.
Also, we ought to be banning ARMs and other crzy mortgages. Buyers can choose from 15-year fixed rate and 30-year fixed rate. That's it.
Because more are doing it.
"Elliot123 - the banks are deadbeats that are not able to meet their obligations either, Lehman is already in bankruptcy and the other banks are only going to meet their obligations and avoid bankruptcy thanks to government intervention... do you think they get a pass?"
Of course not. Why should they? But I note we hear all kinds of analysis about credit default swaps, tranches, leverage, Glass Seagal, mark-to-market, Fannie Mae, Freddie Mac, Sarbanes-Oxley, and MBS, but very little about the good old American deadbeat sitting in his Lazy Boy watching his 42 inch plasma. What little we do hear trumpets his unbelievable stupidity: "The poor deadbeat was just doing what he was told to do."
This is what Right-Wing talking point repeaters claim about the CRA when confronted with...umm...actual facts: That the CRA created a certain climate.
Bovine fecal material.
Before Gramm-Leach, operators that wanted to avoid Glass-Steagall just opened up a subsidiary offshore, in a shady, ungoverned location like London or Brussels. Anyone actually interested in getting out from under Glass-Steagall
had already done so years earlier.
The primary motivation of Gramm-Leach was not to make life easier for multinational finance corporations. Life was already easy...elsewhere. It was to encourage operators to employ people in NYC as well as London.
There were undoubtedly many loans that should not have been made. But reasonable loans default sometimes also. Not all the defaults by any means were idiotic transactions to begin with.
Once you have defaults, and securitization, and companies using leverage to buy the MBS, the stability of the system is highly dependent on accurately valuing the mortgages and securities. That is, if you're going to borrow a ton of money to buy mortgages, or MBS, and you get the default rates wrong, for example, it's not going to matter much if the underlying mortgages are sound. Push to the edge, and misjudge, and you're off the cliff.
You could buy a portfolio of 30-year, fixed-rate, 20% down payment mortgages, and if you overleverage because your model mispriced the mortgages, you're done.
But those three banks are each getting $25B in taxpayer money.
See
What am I missing? They're getting federal money because they're not having serious problems?
Countrywide, one of the worst sub-prime lenders, was not a bank, and was not pressured (not by the government anyway) to lend money to people with bad credit.
This thing has many causes. I've never heard or read a smart person blame it on the CRA or the GLBA.
When I got a loan for 5% down (1996) I had to pay insurance on the loan until it was up to 20%. That seemed reasonable to me - has this gone out the window?
Yeah, I remember Gramm saying that.
Come on, some us weren't found yesterday under a cabbage leaf. Since 1980 and before, it's all been about 'maximizing profit potential,' 'unlocking shareholder value,' 'getting inhibiting regulations off the statute books' and 'unleashing the power of the market.'
Well, it's been unleashed. How do you like them apples?
How should we deal with profit potential, shareholder value, inhibiting regualtion, and the power of the market?
When you can't argue the law or the facts, you pound the table. But it's still in support of a fairy tale.
If you want me to believe regulation could have avoided this mess, you have to convince me regulatory agencies and their elected overseers will act to make it harder for people to obtain home financing, instead of easier. And that they will then maintain this stance over the long haul.
They won't. Whether the politicians involved are Democrats or Republicans. Labour or Tories. Social Democrat or Christian Democrat. Evidence to that effect is currently pouring in from all over Europe as well as the good ole USA.
Politicians _like_ cheap home financing.
Here's a follow-up question: Could this legislation pass Congress today? Why not? (Hint: Their last names are Frank and Dodd.)
'How should we deal with profit potential, shareholder value, inhibiting regualtion, and the power of the market?'
I liked the New Deal ideas: modest restrictions on the inherent tendency of unsupervised markets to act like a turbocharger (the faster it goes, the faster it goes, up to when it disintegrates).
Both Republicans and Democrats are now blaming 'greed, just plain greed' (quoting the Republican governor of my state, for example). But how does greed differ from maximizing profit potential?
The problem with maximizing profit potential and with free markets in general is that you get what the market gives, whether, after you've got it, you wanted it or not.
As people like c.gray so eloquently demonstrate, it wasn't American regulations that caused offshore markets to behave like . . . well, like markets.
The Glass-Steagall restrictions certainly allowed US banks and investment banks to make lots and lots of money. They may perhaps have dampened the annual profit in some years. As the market heads down and down (to, I suspect, a crash), it becomes less and less obvious that the anti-GS approach really does maximize profits over any span longer than a decade or so.
How did allowing both commercial and investment banks to be owned by the same holding company cause a problem?
More generally, people put money into commercial banks because they want it to be safe, and into investment banks because they want it to be at-risk.
When one bank includes both types of customers, all the deposits become at-risk deposits. The customers who thought they were buying safety with their fees panic when they find out they weren't.
And your posts, while giving us excellent insight into your opinions on the virtues of the New Deal regulations, and an excellent repetition of "progressive" talking points, are devoid of any facts, any theory, or even a single wild-ass guess, purporting to explain how Glass-Steagall would have saved us from the current crisis, or even how the repeal of some its provisions contributed to the crisis.
That's because you can't. There are no facts to back it up. In actual fact, permitting commercial banks to buy out the troubled investment banks is helping to mitigate the current crisis. While this may well be saving up trouble for a future day, it has nothing to do with the problem the financial industry currently faces.
You, and others like you, are the mirror-image of the "conservatives" nattering on about the CRA. Neither group has an argument that can withstand even minimal exposure to an actual examination of the facts. That's a sign neither really cares about the truth. Each group just wants the emotional satisfaction of blaming their favorite bugaboo for everything, truth be damned.
Well, good luck with that. When confronted with a serious crisis, it might be cathartic to select a jet-black goat and sacrifice it to one's gods, but doing so is not likely to provide a constructive set of solutions.
As I noted above, I think there is way too much emphasis being placed on the quality of the mortgages. Investors make money - boxcars of it - investing in risky securities all the time. Think of successful VC firms, for example. The trick is to get the financing and the pricing right.
Getting the pricing right is very difficult, though more transparency in the market would help. That's one advantage of bringing things into exchanges, though I don't know if that can be done. It seems clear that the model approach introduces new elements of risk. Getting the financing right requires, maybe, a much more conservative approach, in terms of leverage, capital requirements, etc.
The idea that paying commercial banks (or anybody else) trillions of dollars to take over sour paper is 'helping' is another c.gray smile a day.
Thanks, c.gray.
G-S as written 60 years ago obviously wouldn't have done anything. Even extending it to US non-bank banks would not certainly have helped, given the fact that hot money does not readily recognize international borders.
It would, however, have firewalled commercial banks from the wilder ranges of free-market finance capitalism, so that the crash of, say, Bear Stearns would have had no more effect than the crash of, say, WorldCom.
There's a reason we had finance panics every 6 to 20 years through '29, then a drought for six decades, and now a return of panics.
I think it was New Deal-style adult supervision. If you have a different explanation, I'd like to hear it.