In the first volume of his memoir A Life in the 20th Century, historian Arthur M. Schlesinger Jr., quoted a little-known letter from President Franklin D. Roosevelt to Colonel Edward M. House, former advisor to President Woodrow Wilson, in November 1933. Wrote Roosevelt: “The real truth of the matter is, as you and I know, that a financial element in the larger centers has owned the Government ever since the days of Andrew Jackson. … The country is going through a repetition of Jackson’s fight with the Bank of the United States — only on a far bigger and broader basis.”
When he penned those words, FDR was about to embark on a series of reforms that saved the banking system during the Great Depression and imposed regulations that kept it in reasonably good working order for two generations. It was left to a fellow Democratic president, one William Jefferson Clinton, to completely undo Roosevelt’s accomplishment 60 years later, paving the way for the financial crisis of 2008 and the Great Recession that followed.
As chief executive, Clinton signed in quick succession the Interstate Banking and Branching Efficiency Act of 1994, which ended restrictions on interstate banking and made possible the creation of nationwide megabanks; the Financial Services Modernization Act of 1999 (Gramm-Leach-Bliley), which repealed the Depression-era Glass-Steagall law and allowed commercial banks, investment banks, and insurance companies to merge; and the Commodity Futures Modernization Act of 2000, which exempted trading in derivatives contracts from government oversight.
With no reluctance, Clinton thereby took on the role of useful neoliberal patsy for the forces that had long campaigned for bank deregulation — Wall Street (in the person of his own Treasury secretary, Robert Rubin, a former Goldman Sachs CEO), the Republican Party (personified by free-market ideologue Sen. Phil Gramm of Texas), and a conservative-dominated Federal Reserve Board (chaired by Reagan appointee and Ayn Rand acolyte Alan Greenspan).
The worst outgrowth of Clinton’s capitulation to the big banks was the opening it created in the 1990s and beyond for the market in derivatives. Derivatives, commonly defined as financial instruments that allow banks and investors to bet on market factors such as interest rates, securities prices, and the creditworthiness of institutions, were a mutant outgrowth of securitization, itself the alchemy of turning cash-based loan assets (home mortgages, credit-card receivables, auto loans) into saleable private bonds or securities.
Derivatives are basically clusters of these asset-backed securities (or certificates of debt), the good and the bad, packaged together in marketable form; they include, in the alphabet jargon of those who speculate in them, CDOs (collateralized debt obligations), CLOs (collateralized loan obligations), and, most toxic of all, CDSs (credit-default swaps), the last-named a form of insurance contract supposedly protecting the holder in case of default.
It was by trading in these unregulated instruments, many of them composed of low-level assets, such as subprime mortgages, that the over-leveraged investment banks and “shadow banks” (hedge funds, insurance companies) got into trouble and ultimately crashed the economy. By 2005, Wall Street banks earned a third of their revenue trading derivatives debt; a year later, they issued $489 billion worth, most of it in risky CDSs. By 2007, CDS contracts reached a pre-crash peak of $62 trillion in circulation. When the end came in 2008, Wall Street banks were carrying derivatives-debt obligations as high as 300 times their cash on hand.
Meantime, in its journey on the road to ruin, the financial-services industry had perversely taken over the American economy, supplanting manufacturing, so that when it went down, it took an estimated 10% of the country’s gross domestic product with it. The sector’s chief nemesis, the toxic CDS, killed the investment banks Bear Stearns and Lehman Brothers outright, and nearly killed the world’s largest insurer, American International Group (AIG), when its financial-products division wrote, according to The Economist, “enough derivatives contracts to destroy the firm” and made it the first candidate for a federal bailout ($182 billion).
Alan Greenspan, like Bill Clinton, who reappointed him Fed chairman twice (1996 and 2000), was initially oblivious to what he had helped to create by easing systemic rules on securities speculation. In 2005, three years before the deluge, he insisted that “increasingly complex financial instruments have contributed to the development of a far more flexible, efficient, and hence resilient financial system.” But by 2008, even Greenspan had disowned CDSs in “shocked disbelief.” Efforts were made to ban them entirely, but when push came to shove, the incoming Obama administration, staffed by pro-bank Citigroup alumni and Clinton retreads, couldn’t bring itself to do so; instead, its endorsed reform (Dodd-Frank) sought to preserve and regulate them.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was the very essence of a Democratic centrist half-measure approach. As Robert Reich points out in Saving Capitalism, Obama opposed capping the size of too-big-to-fail megabanks, rejected a new Glass-Steagall law, never had a single Wall Street executive prosecuted for financial excesses, placed no tough conditions on bank bailouts, and refused to support a modest financial transactions tax. Dodd-Frank’s main legislative provision was requiring banks to successfully pass government “stress tests” by maintaining sufficient funds to withstand potential financial crises.
The law’s only innovations touching on derivatives were (1) the Volcker Rule banning banks from speculative trading using their own (government-insured) deposits, (2) the provision that Elizabeth Warren’s Consumer Financial Protection Bureau (CFPB) mandate the routing of derivative trades through clearing houses and exchanges, and (3) the so-called swaps push-out rule that required investment banks to shift their substandard-derivatives trading into separate subsidiaries ineligible for government deposit-insurance and other support. The push-out rule lasted barely four years, repealed as part of a congressional budget deal in 2014.
The truth is that, except for forcing the 34 largest US banks to raise their overall capital level from $500 billion in the wake of the crash to a safer $1.2 trillion in 2017, along with recovering (through the CFPB) nearly $12 billion in bank overcharges for 27 million American consumers, Dodd-Frank has been only marginally successful. And now, the forces of the political right, having waged guerilla warfare against it on behalf of Wall Street for seven years, are poised to cripple it altogether in one fell legislative swoop.
[Next time: Have we learned nothing from the 2008 debacle?]
Wayne O’Leary is a writer in Orono, Maine, specializing in political economy. He holds a doctorate in American history and is the author of two prizewinning books.
From The Progressive Populist, April 1, 2018
Blog | Current Issue | Back Issues | Essays | Links
About the Progressive Populist | How to Subscribe | How to Contact Us
PO Box 819, Manchaca TX 78652