Wall Street reforms

Great Debates
61

Let me give an example of the problems of deregulation, which might make things clearer. Consider the regulation called speed limits. In most roads I drive on they get violated when conditions permit, though usually by a relatively small margin. Let’s consider deregulating speed limits.

Many, if not most, of the driving population would not change their speed significantly. However some set would consider the decrease in travel time they get from speeding (and maybe a thrill factor) worth the risk of doing so. How fast is too fast? It is impossible to tell until an unexpected event causes a high speed crash. If we can guarantee that only the speeder gets injured, it might be considered ok, (but see motorcycle helmet controversy) but in reality the speeder might hurt others in the crash, either in his car or outside of it, and the crash cleanup might slow up traffic.
Are these negatives directly due to deregulation? Of course not, the proximate cause was the wet spot or sun in the eyes or texting or whatever. But given that it should be known that eliminating the speed limit would allow this behavior, it has to be called the actual cause, since the hazards I mentioned are always with us. Of course setting a speed limit at any speed will not prevent crashes, but it does limit them.
So, I don’t think it is unreasonable to call deregulation the actual cause of many of the problems we saw.

62

Correct me if I’m wrong but isn’t the primary deregulatory move that you are blaming the '80s banking crises on the ability for thrifts to make more commercial loans? What if the problem was a residential rather than commercial real estate bubble? Wouldn’t the crises have been even worse? Perhaps the regulatory framework that created thrifts in the first place is the real problem. I mean it seems like they are pretty overrepresented in the current banking crises as well.

Sorry, but I also blame the borrowers. They should have known they couldn’t afford the houses. I blame them just as I would blame someone who goes bankrupt because they spend all of their money gambling (not too uncommon to see someone cash a paycheck at a casino).

63

I don’t have any problem against regulation that makes sense. I do have a problem with people blaming deregulation for anything and everything. For example, with the current crises, I certainly believe that a lack of proper regulation was one of the problems. I don’t see deregulation as a very big problem though; I don’t think the regulations were ever there in the first place. I also think there were several other problems many years in the making that helped cause the crises including certain improper regulations. Deregulating certain things and regulating others could have significantly lessoned the crises.

64

I think the thread speaks for itself.

65

He was the driving force behind it. He wanted to let the market dig the S and Ls out of their hole. That was back in the day when congress worked fairly bipartisanly and Reagan had just won a landslide for his conservative agenda, so he got what he wanted.

66

The regulations were all there in the first place. There were regulations that controlled mortgage lending that were literally chansawed at a press conference. There were regulations that controlled bond ratings agencies until they were allowed to self-regulate, and that’s how garbage securities made up of deregulated million dollar mortgages to unemployed drug dealers were given AAA ratings. There was legislation that prevented predatory lending until the Bush administration actually blocked the Attorney Generals of all 50 states from enforcing them. There was regulation on bank capital requirements and debt:asset ratios till 2005 when the biggest banks and investment houses got the SEC to no longer enforce them. Almost all of this happened from 2003 onwards, and caused a huge boom in bad lending which then fed into securities markets and the wider financial system. The canary in the coalmine, although a relatively small part of the overall dollar number of bad loans, was subprime debt. The poorest people, people who were previously known as “renters” and who’d only taken the mortgages because deregulated mortgage lenders were giving them two or three year teaser rates that were cheaper than lending and were told “you can just refinance in two/three years when the real rate kicks in”, defaulted first on their mortgages. You can see how the financial crisis started as there was a surge in subprime mortgage interest rate resets :


67

What specifically was deregulated regarding the rating agencies? What is the specific act that deregulated these agencies?

68

There wasn’t any specific act, like there wasn’t any specific legislation that allowed banks to lever up their debt:assets ratio from 10:1 to 30 and 40:1. It’s just regulatory arbitrage, firms moiving from regulator to regulator depending on which one offers to regulate least. In the case of the ratings agencies it all started to go wrong when the people paying for the ratings changed from potential investors to the security originators, but the situation only really disintegrated over the past few years. It got to the point that ratings agencies actually shared their ratings models with the securities firms so that they could put together securities that would get the right ratings. Credit derivatives only really took off a decade ago so there was no real data to accurately base risk on, so they just made it up, rated everything AAA and saw their profits go through the roof :

How did they justify that AAA rating? By looking at the historic cost of rolling credit derivatives on indices of investment-grade corporate issuers, which generally have a high-BBB rating. These had been around for about three years when the first CPDOs were rated, and the roll had never cost more than 3 basis points. Factoring in that cost, at a leverage of 15-to-1, and using historic 6-month default rates for the portfolio (since the index would be rolled every six months), the proposed trading strategy would never lose money. Hence a AAA rating.
Let me reiterate that, just to drive the point home. The ratings agencies said: you can take a BBB-rated index, leverage it 15-to-1, and follow an entirely automatic trading strategy (no trader discretion, no forecasting of defaults or anything, just a formula-driven adjustment to the leverage ratio and an automatic roll of the index), and the result is rated AAA.
Needless to say, this worked out really well for all concerned. But that’s not really the point. The point is: the notion that you could grant a AAA based on a trading strategy for which there was at best three-years of data (three years that encompassed not a single recession, I’ll note) is mind-boggling. And, worse than that, nobody at the agencies apparently stood up and said, “wait a second: how can you turn a BBB into a AAA by leveraging it 15-to-1? That’s impossible!” Which, of course, it is.
I want to be very clear about something: we’re not talking about a CDO where the AAA investor is providing leverage, and there are subordinate investors below who bear the first risks of loss. This was a trading strategy; the investor in the AAA CPDO had first-loss risk with respect to a BBB portfolio. The trading strategy was just supposed to generate enough returns to create “virtual” subordination to justify the AAA.
When I first heard about this product, I thought: whichever agencies rated this thing have lost their minds. When people asked me whether it made sense as an investment, I said: it’s an outright fraud. You’re practically guaranteed to lose money. I never bought or sold one of these things myself, and neither did anyone else in our group. But the existence of such a ridiculous product should have been a wake-up call about just how divorced from reality the agencies were. And if they were out to lunch on something as straightforwardly absurd as the CPDO, how out to lunch were they on other products, ones that were far more significant to the markets and the economy, where the absurdity of their assumptions was less-obvious?
How did a market that, I thought, had really helped capitalism work in 2002 become the great destroyer of capitalism of the last two years? There were a lot of contributors to the catastrophe, but one indispensable one is that the ratings agencies monetized their sterling reputations in an extraordinary fashion, and nobody in regulatory apparatus of government saw that this was happening, and what it might portend. The success of 2002 depended on market confidence in the ratings agency process: that’s what made investors willing to buy the notes issued by structured finance vehicles that issued the credit protection that made it possible for banks to hedge. Without that confidence, the market would never have developed. And by 2006, the agencies understood just how much that confidence was worth.
http://theamericanscene.com/2008/12/23/ahi-quanto-a-dir-qual-era-e-cosa-dura-esta-selva-selvaggia-e-aspra-e-forte-che-nel-pensier-rinova-la-paura

Here’s how it looked inside the firms :
this instant message exchange between two unidentified Standard & Poor’s officials about a mortgage-backed security deal on 4/5/2007:
Official #1: Btw (by the way) that deal is ridiculous.
Official #2: I know right…model def (definitely) does not capture half the risk.
Official #1: We should not be rating it.
Official #2: We rate every deal. It could be structured by cows and we would rate it.
A former executive of Moody’s says conflicts of interest got in the way of rating agencies properly valuing mortgage backed securities.
Former Managing Director Jerome Fons, who worked at Moody’s until August of 2007, says Moody’s was focused on “maxmizing revenues,” leading it to make the firm more “issuer friendly.”

I don’t know what americanscene.com is like politically or factually in general ,it just happened to come up when I was googling for CDPOs.

69

In other words, the rating agencies weren’t deregulated, you just think they should have been regulated differently.

The word, deregulate, is defined as “to remove government regulatory controls from”. In other words, if the government regulations existed and they were either removed or eased, you can use the word deregulate. If the government regulations weren’t ever there, you have to use a different word that actually fits with the context.

70

And you’re back to nitpicking again. I guess that you could say that technically the regulations that existed relating to bond ratings agencies werem removed due to a combination of congressional indifference, regulatory arbitrage and regulators like the Fed not wanting to get involved. But the fact remains that this, shall we say, loosening of any kind of standards accelerated to the point where it became dangerous in the 2002-onwards period. I know for instance congess jumped all over the Fed to sort the ratings agencies out after Enron blew up but the Fed declined and ignored the issue. But however you look at it a handy shorthand way of describing it is that they were deregulated.

Is this the only quibble you have with my original post? You’re acceptinng the rest of it is correct?

71

The rating agencies were bought off. They knew that had to give great ratings to whatever piece of crap the financial companies gave them. They were paid very well to do what they were told. If they didn’t give the rating they wanted, they would go to a different agency that would. They were knee deep and guilty of betraying the public trust. They were pathetic.

72

I think it is a little more nuanced than that, but I essentially agree. Most of the major rating agencies are paid by the company that is being rated. This would be the big names that you hear of like Moody’s and S&P. There are a few that are paid by customers that want the ratings such as Lace. Naturally, a rating agency paid in the Moody’s fashion would seem to have a conflict of interest whereas those paid like Lace would not.

The conflict of interest is a big problem as well as the fact that companies can go shop for the best rating. That is less of an issue as most major institutions or instruments that needed a rating were required to get both a Moody’s and S&P rating.

73

I have other problems with your post, but this is a major sticking point for me. The regulations were not there in the first place. It’s not a nitpick; it’s a fundamental piece of the issue. If the regulations were never there in the first place then the problem is not deregulation, it is lack of regulation. Unless you can point to a specific regulation that was in place that is no longer in place or was weakened, then the problem was not deregulation. You can still say it is a regulatory problem though.

Since you still seem to keep using the language of either deregulation, or weakened regulations, or non-enforcement of regulations, I will ask you again a specific and simple question. What specific regulation was in place before and what specific act or action either removed or weakened that regulation?

74

http://www.bloomberg.com/apps/news?pid=email_en&sid=aJ8HPmNUfchg
Even Greenspan who helped cause this mess ,sees he did the wrong thing. Now he wants the huge banks broken up because they control the market and stifle fair competition. Can you image that. He sees ever greater sized companies inhibit capitalism. Remember that lesson. Bigger and bigger companies are anti-capitalistic and are bad for the consumer . There is no value in allowing endless acquisitions.

75

And I keep telling you that the record shows that regulations were variously prevented by the Bush administration from being enforced, relaxed, not enforced by regulators and drastically altered to allow banks to take on exponentially more risk without any specific legislation being passed to authorise the changes.

76

You don’t have to change regulations, just defund the regulators or put in those who will not regulate. They did that for 8 years. Put an industrial exec in charge of regulating his own industry and watch what happens. Everything the companies do will be fine.

77

Did George Bush sign an Executive Order ordering banks to take on more risk?

78

Here in lies the problem, you don’t need competition you need ACTUAL competition.

There is a thing called an effective monopoly, this is something that on paper is fine, but in the real world controls the market. For instance eBay is an effective monopoly. Sure anyone can start an online auction site, but eBay is so far ahead, it’s unlikely anyone would catch. Could it be done? Of course, but it isn’t going to happen soon.

Banks are forbidden to collude in their business practices, for that is akin to price fixing which is illegal. But the fewer the number of business the easier it is to figure out what there doing with no collusion.

For instance, BoA can’t call Citibank and ask them about their rates, but they can watch and see what happens. If BoA has to watch three or four other banks, than it’s a simple matter of having “effective collusion.”

It doesn’t matter if there are 10,000 smaller banks, because the smaller banks can’t do anything on their own. So BoA doesn’t have to watch them only the few “superbanks” that are on their own level.

Regulation is needed when there are so few comanies that can participate. For example if you have a project that is 100 billion dollars, only a few banks world wide can afford to go in on a piece of that.

But this fact gets lost when people say “Yes, but there are thousands of banks.” But none of those are big enough to participate, so the field of competition is really a lot less than it seems.

79

No, but the guy he appointed to run the SEC changed the rules so that they could. So he didn’t order them to do it, he just allowed them to do it. He also did everything he could to prevent law enforcement officials from enforcing laws relating to predatory mortgage lending right when all the bad mortgages started being written. The guys he appointed to run other regulators like the OTS all played their part in stripping awat various regulation too.

80

Ken Lay's Alive! - Greg Palast This is how it is done. You strip as much regulation as you can ,then put an industry insider in charge of regulating his own industry. He gives them everything he can, like Pauson and Geithner did for Goldman. It is not illegal, just immoral and unethical.