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How We Got In This Basket II

October 5, 2008

Part II – The Deregulation Of The 90s

A lot of us missed the next one. While the Congress of the 90’s was deregulating energy, telcom, and other markets, there were two other deregulations that got pushed through in 1999 and 2000. One was the Gramm-Leach-Bliley Act (GLBA). The other was the Commodity Futures Modernization Act. Both were passed to fix what were argued to be over-regulated markets.

There are two sides to the GLBA argument. One is that the passage of the GLBA has actually been a bit of a Godsend in our current crisis. Without it, the private buyout of banks that some argue have kept things afloat thus far could never have happened. Investment banks would not have been allowed to purchase commercial banks, and many of the private bailouts we’ve seen would not have been possible. However, there is an argument to this. Private buyouts such as these had already been allowed before GLBA, but upon special authorization only. One example was the 1998 creation of Citigroup from a merger of Citibank and Travelers Insurance by special waiver. In times of crisis, these waivers could have been granted.

The other side says the GLBA is a problem because it has the potential to increase conflicts of interest between banking entities, and allows the creation of financial entities that are so large, their failure has the potential to destroy the entire market. However, the argument against this states that to not allow deposit holding commercial banks to enter other markets and provide investment services stifles competition, and in the end hurts both the market and the consumer.

To understand either side, we need to look back to 1933. In 1933, with the public angered by the actions of an unregulated market with little to no transparency or oversight and overwhelming conflicts of interests in the financial sector, the Glass-Steagall Act was passed. Along with creating the FDIC, which has been updated many times over the years, it required the separation of deposit taking and investment banks. It also required the separation of any banking and commercial interests. The separation of banking and commercial interests was not repealed by the GLBA, and still stands.

By the late 1990s,  these far reaching regulations, which had not been updated, were argued to be losing relevancy to our changed times and markets. But instead of updating them, Congress decided, as part of the GLBA, to do away with Glass-Steagall’s regulation of banking interests. From what I have seen, this deregulation may have also allowed deposit holding banks to enter the securities market.

The second deregulation most of us missed is a little thing called the Commodity Futures Modernization Act (CFMA).  This one’s a little more sneaky. The 262 page bill was passed with no debate on the floor of the house or senate and signed into law on Dec. 14, 2000. It is identical to a bill that was considered dead. As such, it was tacked onto a funding bill for the Depts. of Labor, Health and Human Services, and Education (known as an “omnibus spending bill”) just as Congress was about to break for the winter holiday. Omnibus spending bills are a common haven for earmarks, both in the form of governmental spending and legislation.

The problem with this one is that it specifically banned regulation of “credit swaps”. Credit swaps are a strange, intangible, paper driven market that I have not really begun to grasp. As such, I’m not even going to try and explain it. How bad are these things? 5 years ago, Warren Buffet called them “financial weapons of mass destruction“, fearing the crisis we have now.

As of yet, I have not been able to find any argument to show that an unregulated credit swap market was a good idea. If anyone reading this can, please post it here and I will update this entry. I have, however, found a great explanation of why it was a bad idea in a 40 minute interview with Michael Greenberger. He was the head of the commission that regulated these markets until 1999, and lobbied to increase regulations because our current situation could arise. He does a much better job of explaining how the CFMA and credit swaps helped bring us to this point than I could. But now, I wondered, how does all this relate to the current crisis?

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