Phil Gramm, the Glass-Steagall Act and the Commodity Futures Modernization Act

The Big Takeover (Excerpt)

The global economic crisis isn't about money - it's about power. How Wall Street insiders are using the bailout to stage a revolution

March 19, 2009

Matt Taibbi, Rolling Stone - In 1999, Gramm co-sponsored a bill that repealed key aspects of the Glass-Steagall Act, smoothing the way for the creation of financial megafirms like Citigroup. The move did away with the built-in protections afforded by smaller banks. In the old days, a local banker knew the people whose loans were on his balance sheet: He wasn't going to give a million-dollar mortgage to a homeless meth addict, since he would have to keep that loan on his books. But a giant merged bank might write that loan and then sell it off to some fool in China, and who cared?

The very next year, Gramm compounded the problem by writing a sweeping new law called the Commodity Futures Modernization Act that made it impossible to regulate credit swaps as either gambling or securities. Commercial banks — which, thanks to Gramm, were now competing directly with investment banks for customers — were driven to buy credit swaps to loosen capital in search of higher yields.

"By ruling that credit-default swaps were not gaming and not a security, the way was cleared for the growth of the market," said Eric Dinallo, head of the New York State Insurance Department.

The blanket exemption meant that Joe Cassano could now sell as many CDS contracts as he wanted, building up as huge a position as he wanted, without anyone in government saying a word.

"You have to remember, investment banks aren't in the business of making huge directional bets," says the government source involved in the AIG bailout. When investment banks write CDS deals, they hedge them. But insurance companies don't have to hedge. And that's what AIG did. "

They just bet massively long on the housing market," says the source. "Billions and billions."

Thanks to Geithner, AIG Was Forced to Pay 100% to Creditors - With OUR Money

Credit default swaps are often so complicated and difficult to understand that these can be presented as a safe and viable investment to even sophisticated institutional investors including pension funds, credit unions mid-sized and smaller financial institutions, as well as school districts and other governmental subdivisions. CDS were often marketed to such investors under the claim that these could provide a higher return than "comparable" investments. However, the risk of the CDO's was often far greater than those investments to which these were being compared. - Credit Default Swaps (CDS) Sold as Safe are Potentially Toxic Waste, Shepherd Smith Edwards & Kantas

October 28, 2009

Crooks & Liars - Matt Taibbi says we should run Elizabeth Warren for president in 2012, and the more I read about how the since-appointed members of the Obama administration handled the financial crisis, the more I like the idea:

Oct. 27 (Bloomberg) -- In the months leading up to the September 2008 collapse of giant insurer American International Group Inc., Elias Habayeb and his colleagues worked nights and weekends negotiating with banks that had bought $62 billion of credit-default swaps from AIG, according to a person who has worked with Habayeb.

Habayeb, 37, was chief financial officer for the AIG division that oversaw AIG Financial Products, the unit that had sold the swaps to the banks. One of his goals was to persuade the banks to accept discounts of as much as 40 cents on the dollar, according to people familiar with the matter.

[...] Beginning late in the week of Nov. 3, the New York Fed, led by President Timothy Geithner, took over negotiations with the banks from AIG, together with the Treasury Department and Chairman Ben S. Bernanke’s Federal Reserve. Geithner’s team circulated a draft term sheet outlining how the New York Fed wanted to deal with the swaps -- insurance-like contracts that backed soured collateralized-debt obligations.

CDOs are bundles of debt including subprime mortgages and corporate loans sold to investors by banks.

Part of a sentence in the document was crossed out. It contained a blank space that was intended to show the amount of the haircut the banks would take, according to people who saw the term sheet. After less than a week of private negotiations with the banks, the New York Fed instructed AIG to pay them par, or 100 cents on the dollar. The content of its deliberations has never been made public.

The New York Fed’s decision to pay the banks in full cost AIG -- and thus American taxpayers -- at least $13 billion. That’s 40 percent of the $32.5 billion AIG paid to retire the swaps. Under the agreement, the government and its taxpayers became owners of the dubious CDOs, whose face value was $62 billion and for which AIG paid the market price of $29.6 billion. The CDOs were shunted into a Fed-run entity called Maiden Lane III.

[...] A spokeswoman for Geithner, now secretary of the Treasury Department, declined to comment. Jack Gutt, a spokesman for the New York Fed, also had no comment.

One reason par was paid was because some counterparties insisted on being paid in full and the New York Fed did not want to negotiate separate deals, says a person close to the transaction. “Some of those banks needed 100 cents on the dollar or they risked failure,” Vickrey says.

In other words, Geithner used taxpayer money from one big disaster to paper over the fact that all the other parties were bankrupt, too - and probably still are, no matter what you read in the papers. Wait until the commercial market crashes. Wheee!

Too Big to Fail Means Too Big to Exist

May 24, 2010

USAWatchdog.com - Both the House of Representatives and the Senate have passed their versions of financial reform legislation. Now, the process of reconciliation takes place between both bodies of Congress to iron out a final bill the President can sign into law. There is plenty in the bill such as new consumer protection, increased power given to regulators to prevent systemic risk, and new powers to oversee the $600 trillion derivatives market. These are just a few of the highlights, and there is no telling what will actually end up in the final bill. (The derivatives problem alone can kill the U.S. economy. I wrote about this in a post called “Can The Financial System Really Be Fixed? Some Say No.”)

“Too big to fail”

The most important issues that could cause another financial crisis are not covered in the pending legislation. The biggest problem is the enormous size of the institutions being regulated. “Too big to fail” means they are simply too big, and shrinking them is not on the table. Last month, Senator Sherrod Brown (D-Ohio) explained the size problem this way:

“Fifteen years ago, the assets of the six largest banks in this country totaled 17 percent of GDP. The assets of the six largest banks in the United States today total 63 percent of GDP, and that’s too (big)–we’ve got to deal with risk to be sure, but we’ve got to deal with the size of these banks, because if one of these banks is in serious trouble, it will have such a ripple effect on the whole economy.”

After the Senate passed its version of financial reform, Representative Alan Grayson said,

“Too big to fail means too big to exist. We have to systematically dismantle the institution that caused the systemic risk to the economy and that, for sure, the Senate bill does not do.”

I don’t see any way we are going to see a breakup of the banks. There are some amendments that will force banks to spin off risky trading operations. The banks are against any trading restrictions or spin-offs. So, getting that into a final bill is going to be tough. I don’t think the big banks will get appreciably smaller until after the next meltdown, and one is coming sooner than later.

Big institutions take big risks.

There was a time when banks were not allowed to take on too much leverage. The max was about 10 or 12 times capital. During the Bush Administration, the caps on leverage were unlocked and banks took on insane amounts of risk. During the last financial crisis, it was not uncommon for banks to be leveraged 40 times capital (sometimes even higher!)

The pending financial reform legislation doesn’t really address limits on leverage. To be fair, President Bill Clinton signed into law the Gramm-Leach-Bliley Act (GLBA) in 1999. That legislation repealed the Depression era laws of the Glass-Steagall Act and allowed banks to have unlimited growth and take on much more risk. Without GLBA, also know as the Financial Services Modernization Act, the banks would have never grown “too big to fail.”

Fannie and Freddie

Neither the House nor Senate bills address failed mortgage giants Fannie Mae or Freddie Mac. The government took over these two institutions in 2008. They have a combined taxpayer liability of more than $6 trillion! There is not a mention of reform or how we are going to budget for this slow motion train wreck. I guess if Congress just ignores a problem, it doesn’t exist or it will vanish all on its own. Omitting this from financial reform legislation is too stupid to be stupid.

The Fed gets more power!

Finally, the big winner in all of this is the Federal Reserve. The regulator who stood by and watched as the financial system spun out of control is going to be rewarded by getting more power! These are the same people who fought regulation of the derivatives market and pushed for repeal of the Glass-Steagall Act. The Fed will likely get authority to oversee a new consumer protection division for businesses such as mortgages and credit cards. Also, the Fed will supervise the biggest and most complex financial companies. This is like the proverbial fox guarding the hen house. The pending legislation may force an audit of the central bank, but I wouldn’t count on any meaningful look at the secret deals of the Federal Reserve. I hope I am wrong.

Congressman Grayson recently summed up the importance of financial reform by saying,

“We have a basic choice we have to make. Do we want a government of the people, by the people and for the people, or of Wall Street, by Wall Street and for Wall Street? It is disturbing how much this government is by Wall Street and, therefore, you end up with bills that are for Wall Street.”

Failure Is the Only Reform We Need
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Fannie, Freddie and Gold
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Fraud, It’s Much Bigger Than Goldman Sachs