I have recently been on a kick of looking at the mortgage foreclosure crisis that started the whole recession going. Part 1, Part 2, and Part 3, looked at securitization, and Part 4 looked at the strategic default. I also wrote a post here about the greed of originators who loaned money to people that they knew couldn't pay, knowing that the loan would be sold off to investors long before the first payment was due, thus removing all incentive for originators to make sure people could actually pay the loans back.
This post will look at why the process was so profitable, or to be more accurate, why did this happen so recently, and what changed that made it happen. The Republicans would have you believe that the Democrats are to blame, claiming that banks were required by the Clinton administration to loan to minorities. The truth is far more sinister.
The blame has its roots in the Great Depression, and the banking act of 1933, most commonly called the Glass-Steagall Act. The act separated the Commercial Banking and Investment worlds. At the time, "improper banking activity", or what was considered overzealous commercial bank involvement in stock market investment, was deemed the main culprit of the financial crash. According to that reasoning, commercial banks took on too much risk with depositors' money.
Commercial banks were accused of being too speculative in the pre-Depression era, not only because they were investing their assets, but also because they were buying new issues for resale to the public. Thus, banks became greedy, taking on huge risks in the hope of even bigger rewards. Banking itself became sloppy and objectives became blurred. Unsound loans were issued to companies in which the bank had invested, and clients would be encouraged to invest in those same stocks.
The Glass-Steagall Act prevented the banks from making these risky investments, and prevented another crash caused by greed and sloppy lending practices. At least until the Gramm Leach Bliley Act came along in 1999. This law relaxed the regulation and interinvestment restrictions between the Banking, Insurance, and Securities Companies, allowing loans to be converted into securities and sold to investors.
The bill was introduced by Phil Gram (R-Texas), Jim Leach (R-Iowa), and Thomas Bliley (R-Virginia). The bill passed with Yea votes coming from both parties- 90 to 7 with 2 abstentions in the Senate, and 362 to 57 with 15 abstentions in the House. This was a true bipartisan effort. It was signed into law by President Clinton in November of 1999.
This law allowed mergers of companies like Citi Bank (Banking) and Travellers Group (Insurance) to form Citi Group ( a failed company that needed bailout), with brands like Smith Barney, Travelers, Citibank, and Primerica.
The year before (1998) sub-prime loans were just 5% of all mortgage lending, but by the time of the mortgage crisis in 2008, the number of sub prime mortgages was near 30%.
According to the Congressional record, top Citigroup officials were allowed to review and approve drafts of the legislation before it was formally introduced. After resigning as Clinton's Treasury Secretary and while secretly in negotiations to head Citigroup, Robert Rubin helped broker the final deal to pass the bill, and he later became one of three CEOs that headed up CitiCorp, and also served as Citigroup's chairman until 2007. Robert Rubin received over $17,000,000 in compensation from Citigroup and a further $33,000,000 in stock options as of 2008. Rupin also was a part of the Enron scandal, but wascleared of all charges that he used influence with the Treasury to keep Enron's status from being downgraded so Citi would not lose money.
So there you have it- both parties sold us down the river.
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