November, 2009

Partners in Crime - How the Wall Street Bankers and Washington, D.C. Politicians Collaborated to Destroy the American Middle Class.

Opening Comments

In several of my monthly commentaries (reference especially my March, 2009 and June, 2009 commentaries), I addressed the issue of derivatives and how they played a major role in the economic, financial and banking collapse that first became visible in the United States in September, 2008 and continues unabated today.

This commentary will demonstrate that the above-noted economic, financial and banking collapse was no accident but rather resulted from the combined efforts of bankers and politicians.

Specifically, the bankers and politicians did the following:

1. 1994 - 1999 - torpedoed the efforts of a crusading government regulator who wanted to subject over-the-counter derivatives (derivatives that are traded and privately negotiated directly between two parties, without going through an exchange) to rigorous rules and controls;
   
   
2. November 12, 1999 - repealed a long established protective banking law originally enacted during the Great Depression of the 1930's;
   
   
3. December 21, 2000 - passed legislation which specifically protected over-the-counter derivatives from regulation.
   
   

Brooksley Born, Chairman of the Commodity Futures Trading Commission (CFTC)

I suspect that less than 1% of Americans have ever heard of this gutsy, highly intelligent 68 year old retired attorney. From 1996 to 1999, Ms. Born was the Chairman of the Commodity Futures Trading Commission (CFTC), a little known U.S. Government organization whose stated mission is "to protect market users and the public from fraud, manipulation and abusive practices related to the sale of commodity and financial futures and options, and to foster open, competitive and financially sound futures and option markets."

Now, please review the following timeline:

1. derivatives, including over-the-counter derivatives which constitute over 50% of the total derivatives basket, didn't appear on the world financial scene in any meaningful way until about 1990 (reference my March, 2009 Commentary);
   
   
2. two years later, in 1992, the CFTC created a huge money-making opportunity for shrewd, and in many cases, unscrupulous market players by exempting most privately negotiated over-the-counter derivatives from regulation;
   
   
3. two years later, in 1994, Brooksley Born was appointed to the CFTC by President Bill Clinton. Born and her team at the CFTC completed a rigorous financial analysis relating to over-the-counter derivatives. They concluded that the enormous growth of these "weapons of mass destruction," coupled with the U.S. Government's failure to regulate them, would eventually lead to a financial crisis of epic proportions;
   
   
4. two years later, in 1996, Ms. Born was named Chairman of the CFTC and set about to convince the power brokers in the Clinton administration that over-the-counter derivatives had to be regulated by the CFTC. She met enormous opposition from the following Washington, D.C. "insiders:"
   
   
   Alan Greenspan
   
   
   Chairman of the Federal Reserve (the FED) from 1987 to 2006.
   
   Apparently Greenspan had an unusual take on market fraud as he told Ms. Born that "there wasn't a need for a law against fraud because if a floor broker was committing fraud, the customer would figure it out and stop doing business with the broker." Wow! It boggles the mind to think that the Chairman of the FED (the Central Bank of the United States) could make such an outlandish statement;
   
   
   Robert Rubin
   
   
   Secretary of the Treasury (1995 - 1999) in the Clinton administration.
   
   Prior to that, Rubin had spent 26 years at Goldman Sachs, the powerful Wall Street investment bank that has effectively controlled large parts of the United States Government by strategically placing high level executives from its firm in significant government jobs. After leaving his Treasury post in 1999, Rubin joined the Wall Street financial giant, Citigroup, where he was richly compensated. In January, 2009, Rubin was named as "one of the ten most unethical people in business" by Marketwatch, which operates a financial information website;
   
   
   Larry Summers
   
   
   Deputy Secretary of the Treasury (1995 - 1999) in the Clinton administration and Robert Rubin's successor as Treasury Secretary in July, 1999.
   
   Summers, along with Rubin, were also the principal architects of a 1995 plan designed to manipulate the gold market, thereby preventing the American public from realizing that something was very wrong with our financial system (refer to my May, 2009 Commentary);
   
   
   Arthur Levitt
   
   
   The longest serving Chairman of the Securities and Exchange Commission (the SEC) from 1993 to 2001.
   
   Levitt later claimed that Greenspan and Rubin were "joined at the hip in their opposition to Born's attempts to have over-the-counter derivatives regulated and convinced me (Levitt) that such regulation would cause chaos in the financial markets." Prior to his SEC tenure, Levitt had extensive experience in publishing and on Wall Street although his experience paled in comparison to that of Greenspan, Rubin and Summers. I suspect that he deferred to their collective experience in joining the opposition to Ms. Born;
   
   
5. after epic struggles from 1997 to 1999 with Greenspan, Rubin, Summers and to a lesser extent, Levitt, Brooksley Born left the CFTC in April, 1999.
   
   

Banking Act of 1933 (Also Known as the Second Glass-Steagall Act)

The above-noted act was passed on June 16, 1933 in the midst of the Great Depression and in response to a collapse of a large portion of the American commercial banking system in 1933. Its purpose was two-fold:

1. to establish the Federal Deposit Insurance Corporation (FDIC) to insure bank deposits; and
   
   
2. to separate banks according to their type of business - i.e. commercial banking and investment banking - so that each type of bank was restricted to specific activities that didn't infringe on the other's area of expertise.
   
   

Definitions are as follows:

Commercial Bank


"An institution which accepts deposits, makes business loans, and offers related services. Commercial banks also allow for a variety of deposit accounts, such as checking, savings, and time deposit. These institutions are run to make a profit and owned by a group of individuals, yet some may be members of the Federal Reserve System. While commercial banks offer services to individuals, they are primarily concerned with receiving deposits and lending to businesses."


Investment Bank


"An investment bank is a financial institution that raises capital, trades securities and manages corporate mergers and acquisitions. Investment banks profit from companies and governments by raising money through issuing and selling securities in capital markets (both equity, debt) and insuring bonds (e.g. selling credit default swaps), and providing advice on transactions such as mergers and acquisitions. A majority of investment banks offer strategic advisory services for mergers, acquisitions, divestiture or other financial services for clients, such as the trading of derivatives, fixed income, foreign exchange, commodity and equity securities."

The proponents of the Banking Act of 1933 believed that excessive risk taking in the 1920's contributed significantly to the Great Depression of the 1930's. By separating commercial banking activities from investment banking activities, they hoped to accomplish the following:

1. prevent commercial banks from investing their depositor's deposits in risky areas such as securities activities;
   
   
2. prevent investment banks from gaining access to depositor's funds which would then be used in risky areas such as securities activities;
   
   
3. prevent conflicts of interest and fraud related to securities activities.
   
   

Repeal of the Banking Act of 1933 - November 12, 1999

Throughout the 1980's and 1990's, various U. S. commercial and investment banks lobbied and contributed to the D.C. politicians relentlessly in an effort to get these politicians to repeal the Banking Act of 1933. They used the excuse that they simply wanted to have U.S. banking interests in a better position to compete for business throughout the world. Their real reason, of course, was to make as much money as possible, with little or no regard for the risk they took, knowing that they could always dump any bad investments/loans back onto the U.S. Government - i.e. the American tax payer - through bailouts of various sorts.

Finally, on November 5, 1999 (ten years ago), their efforts proved successful as the final bill was passed by the Senate 90 - 8 (1 not voting) and by the House 362 - 57 (15 not voting). The legislation was signed into law by President Bill Clinton on November 12, 1999.

The key players in the repeal of the Banking Act of 1933 were as follows:

Larry Summers


Treasury Secretary (1999 - 2001) under President Clinton and currently President Obama's Director of the National Economic Council. Summers is often rumored to be a potential successor to current Obama Treasury Secretary, Tim Geithner, who is under fire from various quarters because of the on-going economic, financial and banking problems in the U.S.;


Phil Gramm


Former Republican Senator from Texas (1985 -2002) and a senior economic advisor to John McCain's presidential campaign in 2008 before he was forced to step down after making some ill-advised comments;
Jim Leach


Former Republican House of Representatives member from Iowa (1977 - 2007);


Thomas Bliley


Former Republican House of Representatives member from Virginia (1981 - 2001).

The November 12, 1999 repeal of the Banking Act of 1933 enabled commercial banks (JP Morgan Chase, Bank of America, Citigroup, Wells Fargo, etc.) to become involved in activities of investment banks (Goldman Sachs, Merrill Lynch, Bear Stearns, Morgan Stanley, Lehman Brothers).

Commodity Futures Modernization Act (CFMA) of 2000 - December 21, 2000

After Brooksley Born left the CFTC in April, 1999, the bankers and politicians wasted no time in making sure that no future renegade government regulator would ever again attempt to regulate over-the-counter derivatives.

On December 15, 2000, the U. S. Congress passed the Commodity Futures Modernization Act (CFMA) of 2000. Six days later, on December 21, 2000, President Bill Clinton signed the CFMA into law. In simple terms, CFMA clarified that most over-the-counter derivatives would not be subject to regulation by prohibiting the CFTC, the SEC and states from regulating these products.

And who, pray tell, were the cast of characters behind this legislation? As you have probably already guessed, some of the same characters who stifled Brooksley Born's attempts to have the CFTC regulate over-the-counter derivatives and who spearheaded the repeal of the Banking Act of 1933 played prominent roles in the passage of the CFMA of 2000. Specifically, the following individuals were at the forefront of legislation which ultimately led to the economic, financial and banking crises which appeared in September, 2008 and continues to this day:

1. Larry Summers - Deputy Secretary of the Treasury (1995 - 1999) and Treasury Secretary (1999 - 2001) in the Clinton Administration;
   
   
2. Phil Gramm - former Republican Senator from Texas (1985 -2002).
   
   

Impact of the 1999 Repeal of the Banking Act of 1933 and the Passage of the Commodity Futures Modernization Act of 2000

Here is a summary of the results of the above-noted legislation:

1. Enron - bankrupt in 2001 as a result of, among other things, energy derivatives;
   
   
2. JP Morgan Chase - technically insolvent if its extensive derivatives portfolio was valued at realistic values;
   
   
3. Bank of America - same as JP Morgan Chase;
   
   
4. Citigroup - same as JP Morgan Chase;
   
   
5. Wells Fargo - technically insolvent if its real estate loans (especially home equity loans) were valued at realistic values;
   
   
6. Goldman Sachs - same as JP Morgan Chase;
   
   
7. Merrill Lynch - was ready to fail when Bank of America was forced to purchase it in September, 2008. I guess the theory was that the combination of two "sick" companies would make one "healthy" company;
   
   
8. Bear Stearns - was ready to fail when JP Morgan Chase purchased it for very short dollars in March, 2008;
   
   
9. Morgan Stanley - same as JP Morgan Chase;
   
   
10. Lehman Brothers - bankrupt in September, 2008, out of business;
    
    
11. Harvard University in Cambridge, MA lost $1 billion due to derivatives in 2008. Guess who was responsible for that fiasco? None other than Larry Summers, who after leaving the Clinton administration in 2001, became President of Harvard University from 2001 to 2006 and took an active role in Harvard's decision to invest in derivative products;
    
    
12. You will recall that I mentioned that the FDIC came about via the Banking Act of 1933 and was designed to protect those of us who deposited our money in FDIC insured banks. Here is the latest scoop on the FDIC:
    
    
    1. the FDIC's insurance fund dropped to a negative balance of $8.2 billion as of September 30, 2009. This is the first time since 1992 that it has had a negative balance;
       
       
    2. approximately 124 banks have failed in 2009 as of November 20, 2009. The head of the FDIC, Sheila Bair, and others, have estimated that another 500 - 1,000 banks will fail before this debacle is over.
       
       

It should be clear to all Americans that this incestuous relationship between the Wall Street banking fraternity and their political "brothers" in Washington, D.C. has created a poisonous environment in which the bankers and politicians have gotten "filthy rich" while the average American worker has paid, is paying and will continue to pay for years to come, an unconscionable price.

In closing, I'd like to leave you with the words of Andrew Jackson, the 7th President of the United States (1829 - 1837):

"It is to be regretted that the rich and powerful too often bend the acts of government to their selfish purposes….Many of our rich men have not been content with equal protection and equal benefits, but have besought us to make them richer by act of Congress."