Monday, March 23, 2009

What is Wrong With America Today: Part 1 - Deregulation

This is the beginning of a multi-part series in which I give my take on what is wrong with this country.

The first part is entitled deregulation. Now, this is some what controversial in that it is the single biggest contributor to what has happened in the markets today. But before I get about actually pointing out a couple specific deregulatory measures and why they hurt, I need to address the Community Reinvestment Act. Republicans are big fans of saying that this is what caused the housing crash in 2008. But it is simply ridiculous and its easy to show why.

1. Only 1 in 4 first loans were made through the CRA
2. No where in the CRA does it tell or require or suggest that someone who can't afford to repay a loan, be loaned money.
3. The rate of delinquency for subprime FIXED loans is only 1/3 of those delinquent subprime ADJUSTABLE loans. In other words, fixed loans are more often paid back than adjustable rate loans.
4. The rate of delinquency for loans under CRA is the same or lower than loans NOT under the CRA.

So stop the ridiculous claim that the CRA is responsible for this mess. A little investigation proves every point in that argument wrong.

Now, on to deregulation.

Deregulation isn't always bad. The problem is not that deregulation happened, but rather WHAT was deregulated that matters. So I will start with the Gramm-Leach-Bliley Act of 1999.

What did the GLBA of 1999 do? It repealed the wall of separation created during the Great Depression that kept regular banks, investment banks, and insurance groups separate. This particular act of deregulation allowed the likes of AIG and Citigroup to exist in their current hybrid forms. Before this bill, AIG would not have been allowed to be both an insurer of investment banks while itself making risky investment. Before this bill, Citi would not have been able to be both an investment bank, depositors banks, and buy up travellers insurance group. This alone would have allowed both of them to be able to be nationalized and parcelled with out having to be kept afloat. In other words, they wouldn't have been "to big to fail". For that matter, AIG would NOT have failed as its biggest problem is not what it originally did, provide insurance to investment banks, but rather the fact that it ALSO participated in the same risky investments that it insured! Citi can be counted in the same boat. Had the GLBA never been passed, this country would not have had to bail out AIG or CITI. They are THE direct result of this law deregulating them.

The second and possibly most dangerous of these deregulatory measures was the Commodity Futures Modernization act of 2000.
This repealed the ban on single-stock futures and worse still, insured that banking institutions would not be regulated as futures contracts. In other words, futures traders were regulated, unless they became a bank as well, which was now allowed as of 1999 after passage of the GLBA. Futures have always been a risky business that needed to be regulated to prevent your money from being spent horribly on, essentially, bets. But that was now completely possible. Unregulated gambling with your investment money by super banks who now invested your money, took your deposits, and insured the investments. One stop shopping, with a single point of failure. This one thing alone made Enron's disaster possible and should have been shut down after Enron. But it wasn't. And now here we are in 2008 still dealing with the same problem.

You may be wondering about Credit Default swaps and how they play into all this. Well, credit default swaps were a creation of JPMorgan Chase. Or at least they were one of the earliest adopters. They bundled 9 billion in loans, sliced them up, and sold them. Problem was, this was never a regulated industry. There was no way to properly track the value of the loans in the bundles. The JPMorgan Chase credit default swap used this to get bad loans and bad debt off their books and pawned off on someone else without them knowing. The JPMC credit default swap desk became known as the Morgan Mafia. But despite the knowledge that these practices were likely dangerous, other companies, like AIG and CITI began adopting this completely unregulated market.

The lack of regulation mixed with deregulation, allowed for everyone of the nasty situations we see developing in front of us today. Had credit swaps been illegal or regulated properly, this wouldn't have happened. Had the GLBA of 1999 not been passed, CITI and AIG would not exist in their current form and not be a huge problem. Had the CFMA of 2000 not been signed, these new super banks would not be able to make these massively risky futures bets with your money with out regulation.

This idea that smaller government is better has proven a failure. In an unregulated market, short term greed wins out over common sense. And in the end, the CEO's still made millions, while the rest of us foot the bill for their mistakes. Deregulation has become a fundamental flaw in America today. Its time we stop believing in the invisible hand of the markets ability to keep its investors in line. It is a false belief that has proven catastrophic. Its time to start fixing America again!

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