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During the last major financial crisis of 2008, bad positions on more than $60 trillion worth of over-leveraged credit default swaps were unwound at the same time, creating a chain of events that brought the international banking system to a halt, resulting in a wave of bank bailouts and austerity budgets still with us today. All because banks were betting money they didn’t have at ever larger margins. It seems it’s all systems go again as the U.S. Congress relaxed regulations put in place to prevent a similar crisis as part of its 1.1 trillion-dollar budget bill passed this week.
Back then, banks were allowed to trade over-the-counter sliced-up debt products meant to securitize risk. The so-called “instruments” were known as credit default swaps and collateralized debt obligations a.k.a. CDSs and CDOs. Differently rated investments were packaged together, including the infamous toxic sub-primes that disguised their true value and were exposed as the dogs they were during the meltdown. All because of lax regulation. In fact, regulation was discouraged.
The easy money of the 2000s resulted from the Gramm-Leach-Blily Act and Commodities Futures Modernization Act – both signed into law by Bill Clinton – that overturned the banking regulations of the Depression-era Glass-Steagall Act and the 1956 Bank Holding Company Act, which had effectively separated investment funds and savings accounts, providing a safe investment market for all. Banks could once again invest ordinary people’s savings at ever-greater margins. Greed got greedier and no one was taking away the punch bowl.
This time it was the 2010 Dodd-Frank financial reform law that got chopped up with some last-minute CDS deregulation slipped into this week’s seemingly innocuous budget bill, H. R. Bill 83. It’s a Wall Street love-in all over again. As Paul Krugman noted in The New York Times, the Masters of the Universe have “bought themselves a Congress” (“Wall Street’s revenge,” December 16). He further noted that moral hazard is back in town, where “If banks are free to gamble, they can play a game of heads we win, tails the taxpayers lose.” Indeed, let’s see how long it takes for the greed to get crazy.
In the wake of the passed bill, Massachusetts senator Elizabeth Warren succinctly stated “The American people did not send us here to work for Wall Street banks.” Norman Pollock called it a “Gluttony of American Finance” (December 15), noting that supporting lawmakers received twice as much in donations from Wall Street. Indeed, dollar democracy at its worst.
So, will the coming crisis be different now that we’re back to Free Parking for bankers? Not likely. George Soros, one of the original hedge fund wizards, lays the blame squarely with the former chairman of the Federal Reserve, Alan Greenspan, who started playing fast and loose with low interest rates post-2001 and discouraged the regulation of derivatives in the first place, instead of classifying them as gambling. In this free-for-all period, aggressive banking practices created a market where homes could be bought with no money down and no questions asked, and Americans added more household mortgage debt in 6 years than in the history of mortgages. In everyday terms, that means living beyond one’s means. Call the new deregulation Greenspan 2.0.
Soros also noted that during the Reagan and Thatcher era, a super-bubble was created prior to the housing bubble from the reestablishing of laissez-faire economics. In The Crash of 2008 and What It Means: The new paradigm for financial markets, he noted that “Under its influence the financial authorities lost control of financial markets” where “ever more sophisticated financial instruments were invented, and new ways to keep assets off balance sheets were found. That was when the super-bubble really took off.”
Even the former French finance minister and now IMF chief Christine Lagarde went on record to blame unregulated laissez-faire markets, citing the freewheeling excess and high degree of complexity, leverage, and greed, particularly in the American and British systems. Perhaps then Reagan and Thatcher are to blame? Or did the dominoes of doom start falling prior to the housing bubble, the super-bubble, Reagan, Thatcher?
Do we have to go back before the emergency G20 meetings of 2009-10 in London, Pittsburgh, and Toronto, prior to AIG, Lehman Brothers, and Bear Sterns, prior to the accounting irregularities at Enron, the 2000 dot-com bubble, the ’98 Long-Term Capital Management bailout, the ’97 East Asian emerging market crisis, the ’86 savings and loan crisis, the ’82 international banking crisis, the 1970s real estate investment trusts, the 1960s conglomerate boom, the 1920s Great Depression, the 1907 banker’s panic? How far until we get to the real problem?
In The Ascent of Money: A financial history of the world, Harvard economist Niall Ferguson noted that since 1870 we have had “148 crises in which a country experienced a cumulative decline in GDP of at least 10 per cent” and “87 crises in which consumption suffered a fall of comparable magnitude.” Prior to that, another Harvard economist John Kenneth Galbraith noted that the time between crashes is about 20 years. It seems that crisis is the de facto norm to capitalism, when finance is run as a game and not as real investment to support companies. Perhaps then modern capitalism is the real culprit, where the money men keep adding to their already excessive amounts of wealth, and hang the cost to others.
Some believe that lack of regulation was not what failed to stop big banks from doing what big banks do, but the failure to apply or enforce existing regulations. Alan Beattie noted in False economy: A surprising economic history of the world that “National regulators and national policymakers had lots of tools to stop fantasy financial assets being created, given ludicrously unrealistic prices, and sold on. In a whole string of countries, they chose not to use them.” In other words, the system would have worked if everyone had cared to let it or had not dared to override its supposed self-restraining mechanisms. That’s like asking Winnie the Pooh to share his honey. We’ll see which regulations are upheld and which are ignored this time around.
Of course, we should also examine our own lust for growth, and consider the effects our expanding desires have on social patterns and sustainable living. John Stuart Mill reminded us that the ultimate aim of economics is toward “a stationary state of capital and wealth” and that the ever-increasing demands of an ever-expanding economy are simply incompatible with the ever-dwindling resources of a finite supply.
Dwindling resources and increasing worldwide consumption have put us on a collision course between what we have and what we use, including the increased waste and pollution from fossil fuel emissions and increased contributions to greenhouse gases and global warming. For a society based on a previously abundant supply of oil, new strategies are needed – such as renewable energy and reduced use – imperative if we hope to continue our modern ways.
We seem to grow without concern for sustainability, but a world that cannot reduce its over-consumptive ways may itself be consumed. A world that cannot reduce its waste may itself soon become waste. Growing financial assets for the already excessively wealthy to expand our lust for more is just crazy.
To be sure, the balance is out of whack because government has once more relaxed essential measures put in place to stop what is known to happen whenever the market is run as a free-for-all – whether loosening the amount of money a bank must keep in reserve that frees banks to expand their lending sprees, or nixing the idea of controls on derivatives. Proceed at your own peril.
John K. White, an adjunct lecturer in the School of Physics, University College Dublin, and author of Do The Math!: On Growth, Greed, and Strategic Thinking (Sage, 2013). Do The Math! is also available in a Kindle edition. He can be reached at: email@example.com.