Deregulation

Much of our regulation of banking was created during FDR's terms as President, during the Great Depression. A leading figure in that Administration was Marriner Eccles, who instituted much of the banking regulation and became Chairman of the Federal Reserve. Eccles was the founder of First Security Bank of Utah and a descendant of Mormon Pioneers.

Among one of the major accomplishments of the regulation was dividing commercial banking from investment banking. Broadly, commercial banking was limited to taking deposits and providing a certain rate of return, in turn lending that money out locally, usually to its same customers, at a slightly higher rate of return, thus turning a profit. It was relatively risk-free. Stocks, bonds and other securities, which carried greater risks, but also greater returns on investment was the purview of investment banking. The investment banks finaced larger capital projects, dealt with larger nation-wide corporations and not only bought and sold securities, but provided financial advice on topics such as mergers and acquisitions.

The creation of the Federal Depositor Insurance Corporation, although largely financed by the banks themselves, guaranteed deposits in the advent of a bank failure, thus providing "moral hazard" in that the U.S. government stood behind the deposits...if self-funding was exceeded, the full faith and credit of the United States stood behind the deposits (up to a certain limit on each account).

In general, the Federal Reserve regulated commercial banking, and the subsequent Securities and Exchange Commission (SEC) was created to regulated the investment banks (Wall Street).

Other financial instituions (such as Savings and Loans, Credit Unions, etc.) sprang up over time and were intially regulated through state law. Following the Savings and Loan crash in the eighties and nineties, which occured largely by deregulating them and allowing them larger markets (such as real estate and development lending, the Office of Thift Supervision was created at the federal level to oversee the Savings and Loans sector - or what was left of it.

Beyond banking and financial institutions, local, state and federal government regulation followed the expansion and increasing complexity of the broader society. Indeed, the rise in government regulatory and oversight functions became known as the "Progressive Era," running from the late eighteen hundreds to the nineteen twenties, particularly the Administrations of Theodore Roosevelt (the "Trust Buster") and Woodrow Wilson. During this era, the country experienced hugeindustrial and population growth and became a world power. Perhaps, government desired a sense of sharing that power, as critics of the era today profess, but much of this was due simply to the normal constraint of democracy upon the economic system of capitalism.

Waves of immigrants arrived to staff the country's growing industrial power. Citizenship conveyed voting power and voting power brought about the concept of "social justice" wherein government intervened to prevent the worst forms of exploitation. In some respects, the "worker" of the new largely industrial North was little better off than the pre-Civil War slave of the agrarian South...and as government stepped in to bring an end to slavery, it subsequently stepped in to regulate the use of labor in the North. It is difficult to defend Child Labor laws as "socialism," although the immigrants of industrialization brought many of those ideas as well.

I would suggest that the "Progressive Era" did have a profound change on American society in a sense similar to the expansion of Rome or any historical Empire. As the population grew in both numbers and diversity of ethnic cultures, the need for greater administrative control and "law" grew with it.

There is a second important factor in this growth of government power, democracy. Throughout human history, the wealthy and powerful have seldom had a problem accessing government...whether a monarch or a president; a Roman senator or a U.S Congressman. Democracy didn't overturn this, but it did shift the emphasis from the rule of a minority to the rule of the majority, consequently giving a "voice" to all within the society via their "vote."

Time is up for today...will continue for another post or two on this topic.

The Community Reinvestment Act (CRA)

The first CRA bill was passed in 1977, under the Carter Aministration, and was pretty much an outgrowth of the earlier Great Society of LBJ and Civil Rights. IT's immediate justification was anti-discrimination regarding bank lending in low income, minority neighborhoods and intended to eliminate a common banking practice of "redlining." Redlining consisted of avoiding lending in these neighborhoods, according to the banks, because of poor credit performance, high rates of crime and the general higher risk found there.

The "counter-argument" was not to deny the statistical evidence regarding these factors, but to insist that "credit worthiness" needed to be based on individual performance, rather than neighborhood performance and to do otherwise was to continue a system of segregation that perpetuated the very factors the banks pointed to as reasons for non-lending.

Over the years, particularly as African Americans gained seniority in Congress, as a result of re-election, and rose in the Congressional leadership (particularly in the House of Representatives and the Democratic Party), the original CRA legislation was from time to time stregthened. Pressure was bought to bear on the Federal Reserve to, in turn, pressure the banks under their jurisdiction into paying greater attention and they responded by establishing offices in the various Federal Reserve regional banks to perform studies, coordinate banks and civic groups (such as ACORN)to encourage more communication, and to publish guidelines for the banks to use, which used "alternative measures of creditworthiness" for low-income, minority loan applications (e.g. combining household income although everyone in the household might not be part of a "traditional family," etc.).

As I understand it, it was not however, until the Clinton Administration and the growing merger mania and push for deregulation and expansion of national banks, that CRA compliance went from something approaching "voluntary," to meaningful penalities for non-compliance. Much of what had heretofore been informal became formal. Reports were required to measure compliance via 12 "assessment critieria," and banks were "scored" on the degree of compliance. At least one major bank expansion (The Continental Bank of Illinois request to purchase a smaller Arizona bank) by a Federal Reserve ruling that held Continental Bank to be CRA non-compliant.

This simultaneous expansion, but consolidation through mergers and acquisitions, in the wake of the failure of numerous Savings and Loan banks earlier created new opportunities for financial services. The intense competition created through the expansion and consolidation was a factor in the drive for increasingly "innovative products" (perhaps an equal contribution in this drive was the advancement of information technology which allowed the real-time sharing of information, the gathering of large data bases, etc.).

Personally, I would contend that much of this was also driven by the now middle-class hunger for credit and a growing awareness within the financial services industry that a great deal more money could be made by pressuring the more numermous "customers" living on the margins, than the "fat cat on the hill" who had the resources and education to avoid what become essentially a variation of "pay-day lending."

In a 1990's Michael Moore documentary, Moore interviews economist and real estate Professor Elizabeth Warren (now Chairwoman of the Financial Crisis Inquiry Commission). Warren relates the story of her conducting a seminar for banking executives at Citigroup on how they may avoid consumer risk through a more careful screening of credit applicants. As she wound up the several hour presentation, the senior executive in the room spoke up, telling her: "That's very interesting Professor Warren, but it is from those people living on the edge of bankruptcy that we make most of our money."

Thus, far more than the CRA Program and "banks being forced to lend to low-income minorities who were poor risks," I'd suggest that banks found they could not lend fast enough.

Studies since the economic crisis in the Fall of 2008 conducted by the Federal Reserve, the FDIC, several Universities and numerous other independent sources tend to uphold this conclusion.

In a December 4, 2008 speech to the Consumer Federation of America, Shelia Bair, Chairwoman of the FDIC (and a Bush appointee), stated: "I think we can agree that a complex interplay of risky behaviors by lenders, borrowers, and investors led to the current financial storm. To be sure, there's plenty of blame to go around. However, I want to give you my verdict on CRA: Not Guilty."

Bair points out that during the "bubble" of subprime mortgages from 2004-2006 (I'd suggest 2003-2006), only about 25% of the subprime loans (termed "higher-priced loans," since increased risk increased the loan fees and interest rates) were made by CRA-covered banks. Three-fourths of the subprime loans made during this period were made by private independent mortgage companies and large-bank affliates not covered by CRA rules.

The other studies back up Bair's conclusion. A Fed study showed that there was no significant difference in the foreclosure rate in low-income, minority neighborhoods, covered by the CRA, than in low-income, NON-minority neighborhoods.

Another study showed that mortgages made last...just before the crash...failed first, as lending standards decreaded, decreases unrelated to the CRA. And, as Bair concluded in her speech: "And the fact is, the lending practices that are causing problems today were driven by a desire for market share and revenue growth...pure and simple.

In the next post...we'll explore banking deregulation.

The Economic Crisis

For the past few months, I've been engaged in internet discussion and research concerning the economic crisis, the bailout of American banks and its origins.

What motivated this interest was a question in my mind regarding right wing, conservative claims, primarily on public internet forums, that the origin of the crisis could be traced to the Carter Administration's sponsered legislation termed the Community Reinvestment Act (CRA). The "theory" put forward is that, through this legislation, and subsequent amending legislation during the Clinton Administration, U.S. banks were "forced" by the Federal Government into making bad loans to low-income, minority neighborhoods and that this federal government intervention led directly to the collapse of the subprime mortgage market.

Additionally, the more recent Democratic guilty parties are Christopher Dodd, currently head of the Senate Banking Committee and Barney Frank, Chairman of the House Financial Services Committee (the House of Representatives equivalent of the Senate Banking Committee).

Supposed "proof" of these charges are that Dodd received special treatment regarding his own home loan from a Countrywide mortgage program called "Friends of Angelo," Angelo being the founder and CEO of Countrywide. The "proof" regarding Frank is that Frank (with an openly gay sexual orientation) had a boy friend at one of the Government Sponsered Enterprises (Freedie Mac or Fannie Mae) and repeatedly defended the GSEs, referring to them as "financial sound," when in fact they were on the brink of bankruptcy due to their portfolio of bad mortgages. Associated with these charges are the repeated attempts by the Bush Administration and the Republican Congress to "reign in" the GSE's and prevent undue risk.

In sum, the conclusions arrived at from this interpretation of the cause of the economic crisis are: 1) government intervention into the banking system - via the CRA - orginated the bad mortgage problem leading to excessive forecluses leading, in turn, to the economic crisis. 2) Democrats were basically behind the CRA and the subsequent protection of the GSEs, which led to the crisis, since the GSEs are the single largest underwriters in the U.S. mortgage industry.

There are a few "side-lights" to this general theory. One is that ACORN, supported by Democrats, particularly Barack Obama (during his work as a Chicago Community Organizer)was a major, basically African-American, organization that pressured Democratic politicians into support for the CRA and banks (through the organization of demonstrations, disruption of banking business and discrimination law suits), and thus played a major role in causing the economic breakdown.

After checking into the above, I found that there was indeed "some truth" in the facts, but that the facts in themselves did not lead to a cause and effect conclusion regarding the charges and the economic meltdown. Further, I had two doubts regarding that cause and effect: 1) if the CRA "caused" the meltdown, why didn't it occur earlier, at a time closer to the inception of the CRA? 2) if Democrats were primarily to blame for subprime loans, why did the growth in the number and value of subprime loans virtually double under a Republican President, George Bush, and a Republican Congress?

Thus, I began my own research into the economic crisis of 2008-2009.

What follows in a series of posts are my own conclusions...beginning in the next post with a debunking of the above theory and then exploring what I now consider to be largely an accidential convergence of errors into the "Perfect Storm."

Those "errors" consist broadly of four events: 1) massive deregulation of the financial services industry; 2) The events of 9/11/2001 and its impact on national economic policy; 3) the failure of risk management models; and 4) global competition in a global economy, wherein the United States, ridden with debt, and guided by obsolete economic policy, has tried to maintain its post WW II status as the "model" for that global economy.

More in the next Post.