The Gramm-Leach-Bliley Act of 1999, a road to economic disaster?

[frickaline]

Before I begin, let me just say that I'm far from an expert in the area of economics. It is because of this that I began doing research into some of the causes of this economic crisis in an effort to educate myself and better understand what is going on. I wanted to pass on my findings for consumption, education, and also correction in the case that my analysis is somehow flawed.

From what I understand, one of the root causes of the current crisis stems from banks selling off loan risk to other banks in the form of credit derivatives and credit default swaps. The problem is, the risk associated with the original loan is not well communicated or tracked as the derivative is sold and resold from bank to bank. Also, there is currently no regulation of this market.

So where did these types of investments come from? According to what I have been reading, there is no clear/exact date of inception but it is around 1997 when they first seem to show up.(1) There seems to be no direct legislation that explicitly created this form of trade, but the The Gramm-Leach-Bliley Act of 1999 (aka GLB Act) was the legislation that allows for mergers between banks and other types of financial institutions such as investment institutions.(2) It was through these mergers that the credit derivatives market would balloon.



The above picture comes from a Feb. 2008 article from the NYT.

No one knows how troubled the credit swaps market is, because, like the now-distressed market for subprime mortgage securities, it is unregulated. But because swaps have proliferated so rapidly, experts say that a hiccup in this market could set off a chain reaction of losses at financial institutions, making it even harder for borrowers to get loans that grease economic activity.

http://www.nytimes.com/2008/02/17/business/17swap.html?_r=1&oref=slogin

A similar assessment came from Time back in March 2008.

Credit default swaps are insurance-like contracts that promise to cover losses on certain securities in the event of a default. They typically apply to municipal bonds, corporate debt and mortgage securities and are sold by banks, hedge funds and others. The buyer of the credit default insurance pays premiums over a period of time in return for peace of mind, knowing that losses will be covered if a default happens. It's supposed to work similarly to someone taking out home insurance to protect against losses from fire and theft.

Except that it doesn't. Banks and insurance companies are regulated; the credit swaps market is not. As a result, contracts can be traded — or swapped — from investor to investor without anyone overseeing the trades to ensure the buyer has the resources to cover the losses if the security defaults. The instruments can be bought and sold from both ends — the insured and the insurer.

http://www.time.com/time/business/article/0,8599,1723152,00.html

So who is responsible for this mess? Lets take a look at this legislation.

The bills were introduced in the Senate by Phil Gramm (R-TX) and in the House of Representatives by James Leach (R-IA). The bills were passed by a 54-44 vote along party lines with Republican support in the Senate and by a 343-86 vote in the House of Representatives. Nov 4, 1999: After passing both the Senate and House the bill was moved to a conference committee to work out the differences between the Senate and House versions. The final bill resolving the differences was passed in the Senate 90-8-1 and in the House: 362-57-15. This 'veto proof legislation' was signed into law by President Bill Clinton on November 12, 1999

http://en.wikipedia.org/wiki/Gramm-Leach-Bliley_Act

Well, for one thing:

Senate Vote On Passage: S. 900 <106th>: Gramm-Leach-Bliley Act
Ayes:
1 D, 44 R, 1 I

Nays:
39 D, 0 R, 1 I

http://www.govtrack.us/congress/vote.xpd?vote=s1999-105

...and for another:

Arizona
Aye AZ McCain, John

http://www.govtrack.us/congress/vote.xpd?vote=s1999-105

Hopefully this is a good starting point. Please feel free to add/comment as always, thanks!


Sources
(1) http://db.riskwaters.com/public/showPage.html?page=11368
"From an uncertain inception date, the credit default swap market has blossomed to become a major asset class in the capital markets"
http://www.nytimes.com/2008/02/17/business/17swap.html?_r=1&oref=slogin
"...credit default swaps, arcane financial instruments invented by Wall Street about a decade ago."

(2) http://en.wikipedia.org/wiki/Gramm-Leach-Bliley_Act
" repealed part of the Glass-Steagall Act, opening up competition among banks, securities companies and insurance companies. The Glass-Steagall Act prohibited a bank from offering investment, commercial banking, and insurance services."
http://www.securitization.net/pdf/GLBreview.PDF
'Securities and insurance firms will now have wide latitude to enter the banking business by acquiring or establishing insured depository institutions, or by combining with banking "organizations" '

edit: fixed a footnoting error.

[frickaline]

1. so what are people's thoughts on this?

[blue neen]

2. I think the public needs to be reminded of McCain's vote on this bill.

Now he wants to act like he's riding up on a white horse to rescue us all. He freaking helped start this disaster in the first place.

A maverick, my foot.

[frickaline]

4. Indeed, John and the WSJ are working hard to cover this up

The WSJ Gets McCain's Gramm-Leach-Bliley vote wrong:

http://www.dailykos.com/storyonly/2008/9/16/203823/008/1013/601053

[roseBudd]

15. A dittohead got pwned by me big time because of WSJ misinfo!

[woolldog]

3. Good work.

But I guess I don't see the connection between GLB and credit default swaps? It's not clear to me that GLB is responsible for the booming credit swap market. If it is, can you explain exactly how so?

[frickaline]

5. This was a point I struggled with also

As I see it, there isn't a direct correlation however, the tools of trading these derivatives in large, daily quantities would not be available to a bank by itself. By merging with a trading/investment company they gain access to these tools.

Also, note that the act did have prohibitions in it stipulating what could not be traded by banks post merger. Once such stipulation applied to the insurance market prohibiting underwriting there. Why was this not applied to the mortgage sector as well?


"The Act will enable securities firms and insurance companies to establish or acquire banking companies, both large and small; and banking companies to acquire insurance companies"

"Banks are precluded from engaging in an insurance underwriting, real estate development and merchant banking activities with certain limited exceptions"

"...the Act is likely to constrain in a material fashion any effort by the OCC to authorize the underwriting of insurance-like products as part of
the business of banking"
http://www.securitization.net/pdf/GLBreview.PDF

[frickaline]

6. Actually this guy says it better than I can:

Gramm-Leach-Bliley effectively repealed the second Glass-Steagall Act which, among other things, barred investment banks and retail banks from merging. Gramm-Leach-Bliley effectively removed this restriction, allowing a single institution to both create a debt-based investment, and then facilitate its sale. Previously, with two institutions involved in that process (Three if you count the investment rating company - Moody's for example), there would have to be a high degree of clarity involved. One institution (Investment bank) wouldn't just buy, repackage, and re-sell another institution's (Retail bank) products without first understanding exactly what it was. It would also be far less likely to hold those assets and count them as capital.

http://www.dailykos.com/storyonly/2008/9/16/203823/008/1013/601053

[TxBlue]

7. This bill repealed Glass-Steagall and totally opened door to this present mess

Blame goes to Gramm - McCain's chief economic advisor.

[Supersedeas]

8. when Sen Hagel introduced the bill to regulate, Fannie and Freddie (McCain jumped on board)

At the same time Senator Hagel (an Obama Supporter) was introducing the Federal Housing Enterprises Regulatory Reform Act of 2005 (a bill which never made it out of the Republican controlled Banking, Housing and Urban Affairs Committee), another ALTERNATIVE proposal was also being considered.

The objection give to Senator Hagel's proposal was that it added another layer of government bureaucracy.

Senator Mike Crapo of Indiana made an alternative proposal to the Banking, Housing, and Urban Affairs Committee. Thus, the Banking Committee had two proposals to consider. See:

http://thomas.loc.gov/cgi-bin/bdquery/D?d109:7:./temp/~bd8Tkv:@@@L&summ2=m& |/bss/d109query.html|#major%20actions

Further deregulating the Banking and Financial System, the Financial Services Regulatory Relief Act tweaked the reforms previously conceived by Senator Gramm (McCain's Economic Advisor). Majority Leader Bill Frist pushed the legislation through the Senate getting the law passed by the Senate and the House and signed by President Bush just before the November elections of 2006.

Barely a peep of opposition was made to the alternative bill. Certainly, no opposition to the Financial Services Regulatory Relief Act was voiced by Senator McCain who is all about deregulation on some days and restricting the excesses of capitalism with regulation and bureaucracy on others--depending on the audience and which way the wind blows, I suppose.

And nadda peep about this from the Free Ride Media

[frickaline]

9. wow, I can't believe this isn't getting any press

I'd love to see that link but it seems broken. If you get a chance, could you fix that one? (This tool might help: http://tinyurl.com)

thanks for the insight.

[Supersedeas]

10. Have a look at PL 109 - 351; HR 3505; SR 109-256 Hagel's bill was killed, yet Crapo's flew threw

Here's a link:

http://tinyurl.com/4ajhx7

Also see S.2856

Also note the Jeb Hensarling - R - Texas (House sponsor of the above deregulation) was one of the cry babies, hiding behing Nancy's skirt, and blaming the failure of the bailout on his feeling being hurt by Speaker Pelosi harsh words -- because he didn't have the courage to take a principled stand. Another RW Coward from Texas.

Jasmine Jeb Hensarling and Eric Pretty-boy Cantor are two sorry sacks of shit.

[frickaline]

11. Thanks

God what a mess! I wish the press would do their job and cover this. If we're going to make sure this cannot happen again, we have to understand the initial problem. The American public need education on these issues and we aren't getting it.

[Supersedeas]

12. Why would the Media do real homework when off-the-cuff opinions from a chattering cocktail reporter

Homework, like, requires real substance and real....i dunno...work. More substance than a media anchorcreep can handle -- color them bored and all with actual votes and meaningful stances.

As long as McCain and Palin keep repeating unchallenged McCain's support for a bill to regulate Fannie and Freddie -- a bill than never made it OUT OF COMMITTEE -- when the bill that DID make it out of committee and DID BECOME LAW that FURTHER DEREGULATED financial institutions without one blink of opposition from McCain, the Media Free Ride for McCain continues.

[Better Believe It]

13. More On Repeal Of Glass-Steagall

http://www.democraticunderground.com/discuss/duboard.php?az=show_mesg&forum=389&topic_id=4136666&mesg_id=4136666

[Supersedeas]

19. thanks for the link

[roseBudd]

14. Thanks for writing this for DUers! I have been using Garmm-Leach-Bliley for 2 weeks on MSM site

[Waiting For Everyman]

16. The Commodities Futures Modernization Act (also by Gramm) is part 2.

And his wife Wendy prototyped it as the Chairman of the CFTC. Google her, she's a peach. And then see this one...

http://archive.salon.com/tech/feature/2004/01/28/wendy_gramm/index.html

Here's who tried to stop the train for several years, and finally got something passed this past May...

http://levin.senate.gov/newsroom/release.cfm?id=299103

The Enron Loophole in the Commodity Futures Modernization Act enabled energy market manipulation AND completely hid the trading of swaps and derivatives. A nice two-fer, huh? This summer, we had both atrocities working on us at once - in the foreclosure crisis and the gas crisis.

[frickaline]

17. Thanks for the links, I'll definitely check those out

[Overseas]

18. Short answer= yes. That and Glass Steagall repeal. //nt