It all began with a little tweak in the system, with a little deregulation.

After the Great Depression, two new laws were enacted in the United States – the Glass-Steagall Act and the Securities and Exchanges Act- aimed at curbing the financial mismanagement that led to it. They restricted irresponsible dealings and required regular and extensive disclosure of financial information. The banking sector was tightly regulated.

All was going good and no one suspected the financial sector for a long time; until the Oil Shock struck the world. The Arabs were making money rapidly-faster than they could consume it. Their reserves of petro-dollars was doubling by the day and quadrupling overnight. They invested all this in western banks. The banks now had more deposits than investments. Ideally, this is a good place to be in. But greed crept in through the backdoor. The banks did not want to sit on all the green that they had going on for them. They wanted to ‘invest’ it and ‘diversify’ their funds. They argued that they could allocate all the resources (money) they had more effectively. Of course there would be the occasional profits, they said, but that is all a by-product of a much greater enterprise. In effect their arguments veiled selfishness as altruism.

Regan, it seems, was won over by this argument or probably his funders were. There were substantial deregulations during his administration. Of particular relevance is the Garn-St.Germain Act which deregulated the Savings and Loans (S&L) companies. This led to a slew of irregularities in this sector. What came into play was a principle that has run amuck whenever a financial crisis has struck – the principle of Moral Hazard, which means that someone else must pay for your sins. It was and still is a very attractive principle for the capitalists. It means that they can take unlimited risks without any liability. When the S&L companies were deregulated they were allowed to play with the life savings of thousands of people. They could throw it anywhere they liked and all they lost was nothing. It was the taxpayers who lost money. There was a $124 billion bailout, courtesy of the honest taxpayer. They were scammed by the Regan Administration, hands-in –glove with the S&L companies.

This, though, did not mean that there was no accountability. There was the conviction of Charles Keating followed by Michael Milken, Ivan Boesky et al for fraud and insider trading. But neither did it make up for the lax enforcement of law and the deregulations nor did the people get their hard-earned money back. Overall, it was a post-dated cheque.
With Bill Clinton in office, Wall Street and Washington got cosier. Under his administration, the Gramm-Leach-Bliley Act was passed. It repealed the Glass-Steagall Act and paved the way for the formation of Citigroup, hence its nickname – The Citigroup Relief Act. As a matter of fact, when the Fed was given powers to regulate the financial industry, Alan Greenspan refused to do so, saying that it was unnecessary. After that, the Clinton Administration, especially Larry Summers, Alan Greenspan and Phil Gramm, helped enact the Commodity Futures Modernization Act which banned all regulation of derivate trading and exempted them from anti-gambling laws.

A word about the derivate is in order here. In general, they are agreements between two parties that is dependent upon a future outcome. What it is dependent upon and how exactly the future outcome determined is is every mathematician’s nightmare. These financial instruments do not have a value of their own accord. They derive them from various other factors, which, again, are incredibly complex. Along with CDS and CDO’s they form the bedrock of the 2008 crisis. Hardly anybody could understand what it was, using them was a different matter altogether. It was and still is a cruel joke.

When Gorge Bush reigned over the United States, the warning signs were all over. The sickening economy was starting to reveal its ugly symptoms. Fannie Mae Freddie Mac ‘s massive accounting fraud was followed by Worldcom inflating its assets by $11 billion. Arthur Andersen was convicted for shredding Enron documents, which may have concealed another scam. Amidst all this, a new variety of extremely complex financial instruments arose – securitization of mortgages in the form of credit default swaps (CDS) and co-lateral debt obligations (CDO). I reiterate what I said earlier – no one , except the statisticians who designed them, knew what they were. That group of ignoramuses included traders and economists. Instead of checking this alarming development, the SEC lifted the leverage limits on the investment banks.
Leverage is the ratio of a company’s debt to its total finance. After the SEC lifted the limits, this ratio ran as high as 33 to 1. It meant that a one percent decrease in their asset value could virtually wipe out the entire capital. This was indeed a very dangerous situation. In real terms, it meant exploitation of the taxpayers’ money on unimaginable scales.

Gradually, a massive housing and credit mortgage bubble grew, fed by the investment banking industry. It was threatening to overwhelm the US economy. Raghuram Rajan, the former chief economist at the IMF, warned of this danger and Larry Summers promptly dismissed him as a Luddite. After the warning and dismissal, Goldman Sachs, Morgan Stanley, Deutsche Bank et al, used CDS to bet against their own securities. What this meant was that they were selling ‘stuff’ to their investors saying that their investment was safe, while at the same time betting that it would fail. They were betting against themselves. It was a crazy system (I do not know if I can use the word system).

In 2007, house ownerships were at an all time high while savings at an all time low. The housing bubble burst. The sub-prime mortgage crisis hit the world.

March 2008, Bear Stearns collapsed followed by the Lehman Brothers in September. AIG was circling the drain. The US economy was on the verge of a virtual meltdown. A fluttered Bush administration, immediately injected money into the economy, the banks, I mean. A $700 billion emergency bailout was approved for the financial industry. Housing prices dropped by over 30% over the next three years, unemployment rose from 5% to 10% in a year; billions of dollars were lost to the people of the United States. The crisis had hit home.
Washington and Wall Street remain unrepentant. Obama, the ‘change man’, appointed many Wall Street executives to senior regulatory and economic policy positions. The two have never been snugger. Democrats or Republicans, it does not matter, it never has. It looks like Greed has won in the long run.