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Apologies for the encoding if it's displaying weird for anyone -- if you switch the character set (in FF, View -> Character coding) to "Western" it should work.
Edit: Although for some reason, this post is best viewed in Unicode
There's a lot more to to the doc if anyone is interested. Here's the section on legislation:
Edit: Although for some reason, this post is best viewed in Unicode
There's a lot more to to the doc if anyone is interested. Here's the section on legislation:
The government has played a huge role in setting up, financing and regulating the capital markets. Over the years, critical pieces of legislation have fundamentally changed the way that money moves. In other cases, regulations from the SEC or other groups have had similar effects. This section highlights a few of the major items related to the current crisis.
Community Reinvestment Act
The CRA was passed in 1977 as a way to encourage banks to lend more to inner cities, minorities and other areas that were/are traditionally “underservedâ€. Of course, the areas were underserved primarily because of the high risk of default and low rate of return. Therefore, the CRA had a stick in the form of “regulatory oversightâ€. That is, any bank attempting to merge with or acquire another company had to have a positive CRA rating. The banks looked on the CRA as a “charity tax†and donated money, gave risky loans and performed other non-business savy acts as a way to get approval for big mergers.
Two important things about CRA that have to be included as part of the story:
• Housing prices tracked inflation in a flat line until after CRA, when prices started to decouple from inflation. This effect may not be causal, but it is definitely correlated since the CRA predates the other legislation and many of the “causes†people point to for starting the housing bubble.
• The CRA wasn’t necessarily the direct cause of the problem but it created the opportunity. The CRA didn’t force banks to give bad loans, but it did suggest that they give more to less qualified borrowers if they wanted consideration for mergers and other regulatory acts. So the banks gave a few bad loans… kind of like the first guy who sold a Tulip in Holland. The first price probably wasn’t unreasonable, but it opened the door and created the market. Throw the deregulation efforts of the 80’s on top of it, and you get a massive mess very quickly.
The first MBS (from Bear, consisting of Fannie/Freddie secured Alt-A and subprime loans issued under the CRA) creates a demand. The lack of regulation means Wall Street sees massive dollars in CDO and MBS creation. Banks see massive dollars in originating and selling off loans. Non bank mortgage originators see a “safe target†in poor and vulnerable communities. Borrowers see “Free money†and a chance to get a house they never thought they could afford. So even though it isn’t fair to place all the blame on Jimmy Carter & the Democrats in the 70’s, you can very easily put the CRA in the class of legislation that caused unintended consequences through social engineering.
Yes, CRA only applies to FDIC banks. Yes, most of the sub-prime and alt-a nonsense was created by mortgage companies that weren’t banks, and thus weren’t under CRA anyway. However, most of those mortgage companies only exist because the big banks did the first loans (guaranteed by Freddie/Fannie) under the CRA, and then the investment banks did the first MBS and CDO offerings, creating the demand for crap loans to turn into gold.
So greed was a huge multiplier, but greed only matters if the preconditions exist for greed to have a chance. Some legislation (FHA, CRA) opened the door and other legislation (repeal of Glass-Steagall, etc) encouraged incentives for greed to grow unregulated. I don’t see the story as a simple “this is the thing that caused it all†as much as a “look at all these places where something could have been doneâ€.
Further Reading
• http://bigpicture.typepad.com/commen...erstandin.html
• http://www.ffiec.gov/cra/
• http://en.wikipedia.org/wiki/Community_Reinvestment_Act
Glass Steagall Act
The Glass Steagall Act was passed in 1933 as a response to the great depression. Basically, the US government decided to break up the functions of a bank into different companies. Essentially, investment banks had to be separate from commercial banks. The theory was that this approach would prevent commercial banks from recklessly speculating with depositor money. The separation of “granting credit†from “using credit†was supposed to prevent conflicts of interest that were perceived to have contributed to the market meltdown in 1929. Other parts of the act created the FDIC.
The act was revised in 1956 to further separate insurance underwriting (“protecting creditâ€) from banking practices. An insurance underwriter could neither be a commercial bank nor an investment bank. This act is why a CDS is called a “swap†rather than simply “credit insuranceâ€. If a Swap was considered insurance, it would be illegal for the investment banks to originate the deals.
Many of the classic “big banks†had to break up into multiple companies or reduce their services and focus on one side or the other. Some banks got around the act by creating superficial commercial banks (e.g. Lehman Brothers Bank) which exist solely for compliance reasons.
The law was partially repealed in 1999 with the passage of the Gramm-Leach-Blilely Act. Other portions were repealed or modified under other regulation throughout the 80’s and 90’s.
Further Reading
• http://www.investopedia.com/articles/03/071603.asp
• http://en.wikipedia.org/wiki/Glass-Steagall_Act
Gramm Leach Bliley Act
This act, also called the Financial Services Modernization Act, repealed parts of Glass-Steagall relating to separation of banking activities. Commercial banks, Investment banks and insurance underwriters were allowed to consolidate. One of the first (and the one that prompted the act) was the merger of Citibank and Travellers Group. Note that this merger has recently dissolved, with Citi splitting of parts of Travelers and selling the rest to Metlife.
The primary argument for the act was that people put money into savings when the economy is bad (benefiting commercial banks) but invest when the economy is good (benefiting investment banks). Neither group was well suited to survive the various “lean timesâ€, however a combined company would get the best of both worlds.
The most interesting part of the act was that any merger had to have a “satisfactory CRA ratingâ€. Essentially, this means that the bank has to convince the CRA auditors that the bank supports community reinvestment. Usually, this process worked as a defacto bribe/greenmail system where big banks would dump tons of cash on groups like ACORN just before a CRA audit. From the bank perspective, CRA money was wasted in high risk, low payout loans to unqualified borrowers.
Further Reading
• http://en.wikipedia.org/wiki/Gramm-Leach-Bliley_Act
• http://banking.senate.gov/conf/
• http://banking.senate.gov/conf/grmleach.htm
Securities Acts Amendments (May Day)
In 1975, the government removed the regulation that fixed commission prices for brokerages. In other words, brokerages were free to compete on price of transaction rather than on services. Much as deregulation of airline fares killed some companies and made new ones, the May Day changes killed some investment banks and brokerage houses and allowed new ones to form. Quite simply, the revenue model changed drastically and banks had to rapidly adapt. This act basically forced a lot of the creativity in capital markets that led to the explosion in the 80’s and 90’s.
For example, Salomon Brothers in the early 80’s made more money than almost all of the other brokerages combined. Since they weren’t competing for fixed price commissions, Salomon made money by creating innovative products and services and essentially making new markets all over the place (including… yes… Mortgage Backed Securities!).
Further Reading
• http://curiouscapitalist.blogs.time....all_repeal_it/
• http://www.ft.com/cms/s/0/30031a6c-8...077b07658.html
2004 Leverage Adjustment
In 2004, the SEC changed the leverage limits for a handful of institutions. Rather than the 12 to 1 cap most financial services work with, Lehman, AIG, Bear, Freddie, Fannie and a few others were allowed to leverage up to 30 to 1. Obviously, removing a hard cap on leverage encourages the firms to make larger and riskier bets.
The reason for the change is a little unclear as the actual decision was made by the SEC and very little information is easily available.
Community Reinvestment Act
The CRA was passed in 1977 as a way to encourage banks to lend more to inner cities, minorities and other areas that were/are traditionally “underservedâ€. Of course, the areas were underserved primarily because of the high risk of default and low rate of return. Therefore, the CRA had a stick in the form of “regulatory oversightâ€. That is, any bank attempting to merge with or acquire another company had to have a positive CRA rating. The banks looked on the CRA as a “charity tax†and donated money, gave risky loans and performed other non-business savy acts as a way to get approval for big mergers.
Two important things about CRA that have to be included as part of the story:
• Housing prices tracked inflation in a flat line until after CRA, when prices started to decouple from inflation. This effect may not be causal, but it is definitely correlated since the CRA predates the other legislation and many of the “causes†people point to for starting the housing bubble.
• The CRA wasn’t necessarily the direct cause of the problem but it created the opportunity. The CRA didn’t force banks to give bad loans, but it did suggest that they give more to less qualified borrowers if they wanted consideration for mergers and other regulatory acts. So the banks gave a few bad loans… kind of like the first guy who sold a Tulip in Holland. The first price probably wasn’t unreasonable, but it opened the door and created the market. Throw the deregulation efforts of the 80’s on top of it, and you get a massive mess very quickly.
The first MBS (from Bear, consisting of Fannie/Freddie secured Alt-A and subprime loans issued under the CRA) creates a demand. The lack of regulation means Wall Street sees massive dollars in CDO and MBS creation. Banks see massive dollars in originating and selling off loans. Non bank mortgage originators see a “safe target†in poor and vulnerable communities. Borrowers see “Free money†and a chance to get a house they never thought they could afford. So even though it isn’t fair to place all the blame on Jimmy Carter & the Democrats in the 70’s, you can very easily put the CRA in the class of legislation that caused unintended consequences through social engineering.
Yes, CRA only applies to FDIC banks. Yes, most of the sub-prime and alt-a nonsense was created by mortgage companies that weren’t banks, and thus weren’t under CRA anyway. However, most of those mortgage companies only exist because the big banks did the first loans (guaranteed by Freddie/Fannie) under the CRA, and then the investment banks did the first MBS and CDO offerings, creating the demand for crap loans to turn into gold.
So greed was a huge multiplier, but greed only matters if the preconditions exist for greed to have a chance. Some legislation (FHA, CRA) opened the door and other legislation (repeal of Glass-Steagall, etc) encouraged incentives for greed to grow unregulated. I don’t see the story as a simple “this is the thing that caused it all†as much as a “look at all these places where something could have been doneâ€.
Further Reading
• http://bigpicture.typepad.com/commen...erstandin.html
• http://www.ffiec.gov/cra/
• http://en.wikipedia.org/wiki/Community_Reinvestment_Act
Glass Steagall Act
The Glass Steagall Act was passed in 1933 as a response to the great depression. Basically, the US government decided to break up the functions of a bank into different companies. Essentially, investment banks had to be separate from commercial banks. The theory was that this approach would prevent commercial banks from recklessly speculating with depositor money. The separation of “granting credit†from “using credit†was supposed to prevent conflicts of interest that were perceived to have contributed to the market meltdown in 1929. Other parts of the act created the FDIC.
The act was revised in 1956 to further separate insurance underwriting (“protecting creditâ€) from banking practices. An insurance underwriter could neither be a commercial bank nor an investment bank. This act is why a CDS is called a “swap†rather than simply “credit insuranceâ€. If a Swap was considered insurance, it would be illegal for the investment banks to originate the deals.
Many of the classic “big banks†had to break up into multiple companies or reduce their services and focus on one side or the other. Some banks got around the act by creating superficial commercial banks (e.g. Lehman Brothers Bank) which exist solely for compliance reasons.
The law was partially repealed in 1999 with the passage of the Gramm-Leach-Blilely Act. Other portions were repealed or modified under other regulation throughout the 80’s and 90’s.
Further Reading
• http://www.investopedia.com/articles/03/071603.asp
• http://en.wikipedia.org/wiki/Glass-Steagall_Act
Gramm Leach Bliley Act
This act, also called the Financial Services Modernization Act, repealed parts of Glass-Steagall relating to separation of banking activities. Commercial banks, Investment banks and insurance underwriters were allowed to consolidate. One of the first (and the one that prompted the act) was the merger of Citibank and Travellers Group. Note that this merger has recently dissolved, with Citi splitting of parts of Travelers and selling the rest to Metlife.
The primary argument for the act was that people put money into savings when the economy is bad (benefiting commercial banks) but invest when the economy is good (benefiting investment banks). Neither group was well suited to survive the various “lean timesâ€, however a combined company would get the best of both worlds.
The most interesting part of the act was that any merger had to have a “satisfactory CRA ratingâ€. Essentially, this means that the bank has to convince the CRA auditors that the bank supports community reinvestment. Usually, this process worked as a defacto bribe/greenmail system where big banks would dump tons of cash on groups like ACORN just before a CRA audit. From the bank perspective, CRA money was wasted in high risk, low payout loans to unqualified borrowers.
Further Reading
• http://en.wikipedia.org/wiki/Gramm-Leach-Bliley_Act
• http://banking.senate.gov/conf/
• http://banking.senate.gov/conf/grmleach.htm
Securities Acts Amendments (May Day)
In 1975, the government removed the regulation that fixed commission prices for brokerages. In other words, brokerages were free to compete on price of transaction rather than on services. Much as deregulation of airline fares killed some companies and made new ones, the May Day changes killed some investment banks and brokerage houses and allowed new ones to form. Quite simply, the revenue model changed drastically and banks had to rapidly adapt. This act basically forced a lot of the creativity in capital markets that led to the explosion in the 80’s and 90’s.
For example, Salomon Brothers in the early 80’s made more money than almost all of the other brokerages combined. Since they weren’t competing for fixed price commissions, Salomon made money by creating innovative products and services and essentially making new markets all over the place (including… yes… Mortgage Backed Securities!).
Further Reading
• http://curiouscapitalist.blogs.time....all_repeal_it/
• http://www.ft.com/cms/s/0/30031a6c-8...077b07658.html
2004 Leverage Adjustment
In 2004, the SEC changed the leverage limits for a handful of institutions. Rather than the 12 to 1 cap most financial services work with, Lehman, AIG, Bear, Freddie, Fannie and a few others were allowed to leverage up to 30 to 1. Obviously, removing a hard cap on leverage encourages the firms to make larger and riskier bets.
The reason for the change is a little unclear as the actual decision was made by the SEC and very little information is easily available.
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