Failed and Bailed

In 1999, the provisions of 1933 Glass–Steagall Act that separated banks from trading institutions were repealed through the Gramm-Leach-Bliley Act, signed into law by then-President Bill Clinton. In April 2004, the Securities and Exchange Commission (Bush administration) compounded the error by exempting the five largest “too big to fail” Wall Street financial institutions (Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch, and Morgan Stanley) from the more limiting ceilings on how much they could borrow (as a ratio of their true equity value). The world then witnessed massive mergers of financial players, banking being blended with trading, astronomical bundling of debt – good, bad and indifferent – in a new derivatives market that sucked, vampire-like, on the blood-drain debt that exploded… from stupid sub-prime mortgages to over-leveraged corporations hell-bent on mergers and acquisition regardless of common sense.

And then, in the fall of 2008, utter collapse. Lehman Bros. failed, Bear Stearns vaporized and Merrill Lynch was absorbed by a reluctant Bank of America. The remaining major financial institutions were then accorded rescue lines of credit and investment by American taxpayers, representing some of the biggest welfare payments in U.S. history. Today, as the economy still has a long road to recovery, there are over $700 trillion in global outstanding derivatives and so-called credit default swaps (effectively investment/debt risk insurance). Is this just a ticking time bomb? We have financial institutions accessing near zero Federal Reserve loans through their banking subsidiaries, only to use that money to invest on their own account. Again, these Wall Streeters are enjoying indirect taxpayer subsidies with cheap interest. But what about risk?

Wall Street’s lobbying millions fended off any real regulation, and a very watered down Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) was the only meaningful response. No major traders were charged or held responsible for the irresponsible trading and underlying mendacity necessary to foment such a colossal fraud on the global economy.

To this day, House Republicans continue to block any attempt to provide the kind of funding support necessary to allow the Securities and Exchange Commission to implement the meager regulations needed to make even the insipid Dodd-Frank legislation do the job Congress intended when the bill passed. And so the “too big to fail” mistakes continue to trundle along, as JP Morgan Chase just announced a $2 billion loss due to failed checks and balances in their London office, charged with making investments to hedge economic risk. Oh, and that was right after JPMorgan Chase & Co. gave Chairman and Chief Executive Officer Jamie Dimon $23 million in pay and bonuses for 2011 (and they knew the losses were coming), about the same as the previous year. Ooooops! The Justice Department is investigating, but don’t hold your breath. The regulators come from a long line of Wall Streeters, and campaign contributions from the financial world are in short supply among the Democrats who chair the relevant cabinet posts and major administrative bodies.

So what kind of magic does Wall Street believe it has that can prevent massive economic failures? What was the “magic” they believed post-2000 that would allow them to borrow without limit and still survive? “It was the holy grail of investors. The Black-Scholes equation, brainchild of economists Fischer Black and Myron Scholes [and actually invented in 1973], provided a rational way to price a financial contract when it still had time to run. It was like buying or selling a bet on a horse, halfway through the race. It opened up a new world of ever more complex investments, blossoming into a gigantic global industry. But when the sub-prime mortgage market turned sour, the darling of the financial markets became the Black Hole equation, sucking money out of the universe in an unending stream.

“The equation itself wasn't the real problem. It was useful, it was precise, and its limitations were clearly stated. It provided an industry-standard method to assess the likely value of a financial derivative. So derivatives could be traded before they matured. The formula was fine if you used it sensibly and abandoned it when market conditions weren't appropriate. The trouble was its potential for abuse. It allowed derivatives to become commodities that could be traded in their own right. The financial sector called it the Midas Formula and saw it as a recipe for making everything turn to gold. But the markets forgot how the story of King Midas ended.

“Black-Scholes underpinned massive economic growth. By 2007, the international financial system was trading derivatives valued at one quadrillion dollars per year. This is 10 times the total worth, adjusted for inflation, of all products made by the world's manufacturing industries over the last century. The downside was the invention of ever-more complex financial instruments whose value and risk were increasingly opaque. So companies hired mathematically talented analysts to develop similar formulas, telling them how much those new instruments were worth and how risky they were. Then, disastrously, they forgot to ask how reliable the answers would be if market conditions changed.” The Guardian, February 11^th.

There is nothing wrong with becoming a billionaire. The American Dream is still alive and well. But when getting rich means playing fast and loose with the truth, allowing debt-rating agencies to be hired by the companies they rate, when Federal Reserve near-zero interest rates aimed at creating more credit liquidity are instead swallowed up by greedy traders who would prefer to use that cheap money for their own account, and where high risk investments threaten bank depositors, shareholders, and American taxpayers – if not the global economy – when is enough “enough” already. At what point do we need to reel in the financial community, separate banking from trading once again, eliminate the conflict of interest from debt-rating entities, and reign in the continuing threat of irresponsible greed and its potential impact on each and every one of us? How about NOW?!

I’m Peter Dekom, and how many signs of major financial irresponsibility do we need to see – AGAIN – before we act to prevent such occurrences from dragging us all down – AGAIN?