Current Financial Crisis – Anatomy, Timeline and Solution
Just read an interesting article by Bruce Wiseman on the anatomy/timeline of the current financial crisis and a solution:
I’m not a financial expert, but the article is rather long (about 5,000 words, rich in detail and a good read) so I’ll try to summarize:
1. Community Reinvestment Act (CRA) is rewritten by Congress and opens the door to loans that set aside basic sound lending criteria.
2. The repeal of the Glass Stegall Act in 1999 opened the door to the merger of commercial and investment banks. There was now nothing to prevent the combined institutions from packaging up sub-prime CRA mortgages with normal prime loans and selling them off as Mortgage-Backed Securities through a different arm of the same financial institution.
3. In 2004, Henry Paulson (then Chairman of Goldman Sachs) takes the lead with other investment banks to convince SEC regulators to waive a rule that required the banks to maintain a certain level of reserves. The enormous capital thus freed up was used to purchase vast quantities of Mortgage- Backed Securities (spiked with the sub-prime CRA loans) which were sold around the globe. Goldman made billions.
4. Basel II. The Bank of International Settlements (BIS – meeting in 2004) required banks to adjust the value of their marketable securities (such as mortgaged backed securities) to the “market price” of the security – known as Mark to the Market.
When news spread of the sub-prime CRA loans in the packages of mortgage-backed securities, the value of these securities fell and when one bank sold these securities they got LOW LOW prices. Instantly, per Basel II, hundreds of billions of dollars of these securities being held by banks around the world had to be marked down. It didn’t matter that the vast majority of the loans in these portfolios were paying on time – other banks now had to “mark to the market”, driving their financial statements into the toilet. Banks couldn’t lend – credit markets froze.
5. Paulson’s $700 billion bailout carried a provision for the Federal Reserve to start paying interest on the money banks deposited with it. Hmmm – banks can’t lend because of Basel II and Paulson arranges for the Fed to start paying interest. Wiseman comments:
“So, given, the provisions of Basel II and the refusal of the BIS to lift or suspend the regulations when they are clearly the driving force behind the planet wide credit crisis, and considering the lack of provisions in Paulson’s bailout bill to mandate that taxpayer funds given to banks must actually be lent, and given the added incentive in the bill for banks to deposit their bread with the Fed, one gets the idea that maybe, just maybe, these programs weren’t designed to cure this crisis; maybe they were designed to create it.”
Wiseman further speculates that the purpose of the financial crises is to take down “the U.S dollar as the stable datum of planetary finance and in the midst of the resulting confusion, put in its place a Global Monetary Authority”, such as was recommended last year (and is now widely being promoted) by the President of the New York Federal Reserve bank, a fellow by the name of Timothy Geithner, our new Secretary of the Treasury. Among Wiseman’s recommendations:
1- Cancel any aspects of Basel II that are causing banks to mis-evaluate their assets.
2- Remove the provision of TARP that permits the Fed to pay interest on deposits.
3-Mandate that any funds given under the TARP bailout or that are to be given to banks in the future must be used to lend to deserving borrowers.
4- Repeal The Community Reinvestment Act.
5- Reinstate Glass Stegall.
6- Restore mandated capital requirements to investment banks.
What say all of you?
I think his basic assumption has problems: that the economy is basically sound, only needing a bit of tweaking here and there to return to the robust, healthy dynamic system that it has been. If you go through Chris’ crash course, it seems obvious the problems are more profound than that, and that a fundamental shift is required, one that includes environmental concerns and population growth, addresses the things that weren’t working even in the "good times," etc. He seems short-sighted, looking only at the more obvious causes of the immediate downturn, and not considering the larger, chronic issues.
1- Cancel any aspects of Basel II that are causing banks to mis-evaluate their assets.[/quote] You mean mark to market? I think that would make the books look better. But I don’t think it provides a necessarily more realistic valuation of those assets.
[quote=ltlredwagon] 2- Remove the provision of TARP that permits the Fed to pay interest on deposits. [/quote] Good idea; seems like a drop in the bucket in the long term, really. Kind of like focusing on the AIG bonuses… small stuff; definitely unfair, but how important when we’re talking about trillions.
[quote=ltlredwagon] 3-Mandate that any funds given under the TARP bailout or that are to be given to banks in the future must be used to lend to deserving borrowers. [/quote] I don’t even think that needs to be mandated. If there were any deserving borrowers out there, they’d be lent to. The problem is everyone is overleveraged.
[quote=ltlredwagon] 4- Repeal The Community Reinvestment Act. [/quote] Don’t really know much about this.
[quote=ltlredwagon] 5- Reinstate Glass Stegall. [/quote] Probably a good idea.
[quote=ltlredwagon] 6- Restore mandated capital requirements to investment banks. [/quote] Or at least increase the amount of mandated capital. I can see how being able to lend more in a growing economy could stimulate progress, employment, education, research, and quality of living and this could occur more rapidly than if lending was severely limited to capital only. There must be a better balance between how much fractional lending is okay, and where we are now – but I still think the issue has more to do with making bad loans and very risky, stupid loans, than with the amount of capital itself. If the banks had the capital to cover, we wouldn’t be in the mess we’re in right now, or at least, not as much, but if the banks hadn’t made so many bad loans, we wouldn’t be in this mess either. I think its more a result of risky lending rather than fractional reserve banking, but maybe the capital required should be increased a bit.
Would repealing the community reinvestment act do any good at this point?
It’s basically done it’s damage… That said, it probably should be repealed anyway, to prevent future abuse.
Sadly, I think most of these efforts would ultimately be in vain, as the coup de grace has been delivered…
Well, more of a death of a thousand cuts, but the point remains.
I’m interested to read other peoples thoughts on the matter.