CQR Financial Industry Overhaul · 30/07/2010 · — the Troubled Asset Relief Program (TARP) — to wprevent some of the biggest financial firms from collapsing. Policymakers figured

Financial IndustryOverhaulWill the new law avert another crisis?

On July 15, three Republican senators crossed the

aisle to help pass the most sweeping financial-

regulation overhaul since the Great Depression.

Supporters of the 2,300-page legislation say the

new rules will rein in investment risk-taking by big financial firms

that otherwise might endanger the economic system again. Trading

in complex investments known as derivatives will also get closer

scrutiny. But some critics say that the law’s effectiveness depends

on the same federal regulators who missed the signs of the last

impending crisis. Other critics say the new law is nowhere nearly

as tough as it needed to be. They point out, for example, that the

law doesn’t prevent banks from growing to enormous size, which

many analysts say makes financial institutions unmanageable and

leads to conflicts of interest.

I

N

S

I

D

E

THE ISSUES ....................631

BACKGROUND ................638

CHRONOLOGY ................639

CURRENT SITUATION ........644

AT ISSUE........................645

OUTLOOK ......................647

BIBLIOGRAPHY ................650

THE NEXT STEP ..............651

THISREPORT

The financial system overhaul passed by Congress onJuly 15 is designed to prevent the kinds of risky housing loans that led to millions of foreclosures and global economic chaos.

CQResearcherPublished by CQ Press, a Division of SAGE

www.cqresearcher.com

CQ Researcher • July 30, 2010 • www.cqresearcher.comVolume 20, Number 27 • Pages 629-652

RECIPIENT OF SOCIETY OF PROFESSIONAL JOURNALISTS AWARD FOR

EXCELLENCE � AMERICAN BAR ASSOCIATION SILVER GAVEL AWARD

630 CQ Researcher

THE ISSUES

631 • Are tougher rules for fi-nancial firms needed?• Was unethical behaviorby bankers a major factorin the economic crash?• Should big banks bebroken up?

BACKGROUND

638 Early Bank BattlesThe nation’s founders debated the dangers of alarge central bank.

638 The Federal ReserveThe system set up in 1913remains largely the sametoday.

641 Regulation, DeregulationBanking regulations wererelaxed in the early 1980s.

644 Crash of 2008Risky securities led to aglobal economic crisis.

CURRENT SITUATION

644 Reform LegislationThree Republicans madepassage of the sweepinglaw possible.

646 Fraud EnforcementGoldman Sachs wascharged with selling secu-rities intended to fail.

OUTLOOK

647 New Crash Ahead?Boom-and-bust cycles arelikely to continue.

SIDEBARS AND GRAPHICS

632 Three-Quarters of BankingSector ‘Too Big to Fail’Biggest banks are worth over$10 trillion.

634 Lawmakers Reject ‘RainyDay’ Fund for BanksGlobal finance ministers rejecta similar fund.

636 What’s in the New FinancialRegulation LawKey provisions of the 2,300-page law.

639 ChronologyKey events since 1929.

640 Did Weakened RegulationsFuel the Economic Crisis?Critics of regulation say “constant vigilance” is theonly answer.

642 Mystery of the May Mini-crashDid big banks use high-speedtrading to spook Congress?

645 At IssueDo Fannie Mae and FreddieMac bear primary responsi-bility for the financial crisis?

FOR FURTHER RESEARCH

649 For More InformationOrganizations to contact.

650 BibliographySelected sources used.

651 The Next StepAdditional articles.

651 Citing CQ ResearcherSample bibliography formats.

FINANCIAL INDUSTRY OVERHAUL

Cover: AFP/Getty Images/Paul J. Richards

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Financial Industry Overhaul

THE ISSUESWhen 30-year-old

Chris Fargis appliedfor a job on Wall

Street a couple of years ago,he didn’t have a business de-gree or experience in finance.His ace in the hole was poker.Fargis had played onlinesince about 2001 — playingup to eight hands at a time— and Toro Trading soughthis gambling skills when ithired him as a trader.“If someone’s been suc-

cessful at poker, then there’sa good chance they couldbe successful in this busi-ness,” said company founderDanon Robinson.Robinson isn’t the only fi-

nancial executive who thinksso. “There’s a certain maturityand ability to deal with risk thatis hard to get any other way— unless you put the moneyon the table at some point inyour life,” said hedge fund ex-ecutive Aaron Brown. 1

Nevertheless, ever sinceseveral big Wall Street firmstumbled to the verge of col-lapse in 2008, helping pre-cipitate a worldwide reces-sion, economists, lawmakers and thepublic have grown skeptical of WallStreet’s “casino culture” and obsessionwith risky bets. 2

Huge “financial supermarkets” likeCitigroup and JP Morgan Chase engagein investing that resembles “gamblingmore closely than banking,” even asthey ask depositors to trust them withtheir personal savings, complainedNouriel Roubini, a professor of eco-nomics at New York University’s SternSchool of Business, and StephenMihm, a professor of history at theUniversity of Georgia. 3

Banks’ increasingly single-mindedpursuit of fast profits rather than longer-term value investments — and the grow-ing use of large amounts of “leverage,”or debt, to make trades — has harmedthe whole economy, says Dean Baker,chief economist at the Center for Eco-nomic and Policy Research, a liberalWashington think tank.“The reason why we’re sitting here

with 10 percent unemployment is thatwe had a housing bubble that was dri-ving the economy down the wrongpath,” focusing homeowners on the il-lusory “housing wealth” they believed

they were gaining as houseprices rose and encouraginginvestors to buy packages ofmortgage loans rather thanstock in companies that couldhave been long-term job cre-ators, he says.Based on such concerns,

when Democrats took con-trol of the White House andboth houses of Congress in2009, debate began on leg-islation to tighten bankingrules to limit the possibilitythat risky investing with bor-rowed funds would again sinkthe financial system. The year-and-a-half struggle to enactthe legislation is a testamentto both the issue’s complex-ity and banks’ political powerand intense struggle to fightoff new rules. Three Repub-lican senators, Scott Brownof Massachusetts and Maine’sSusan Collins and OlympiaSnowe finally crossed the aisleto give supporters of the over-haul the 60 Senate votes theyneeded to overcome a finalRepublican filibuster of theplan on July 15, and PresidentObama signed the measure intolaw on July 21.In the wake of the debate,

questions persist about whetherincreased bank regulation is a good ideaand whether current proposals wouldbe effective.Most conservative analysts assert a

strong “No” to both.Government regulation actually en-

courages carelessness, said Peter J. Wal-lison, a fellow at the free-market thinktank American Enterprise Institute. “Mar-ket participants believe that if the gov-ernment is looking over the shoulder ofthe regulated industry, it is able to con-trol risk-taking,” so customers stop try-ing to determine for themselves whethera financial firm is behaving responsibly.

BY MARCIA CLEMMITT

Getty Images/Scott Olson

An independent consumer protection bureau created bythe financial system overhaul has the power to regulateconsumer loans, credit cards and mortgage-lendingpractices. However, lawmakers bowed to pressure fromthe auto industry and exempted automobile dealers

from oversight by the agency.

632 CQ Researcher

Regulation also “impairs innovation” andraises prices, Wallison said. 4

But while the new legislation won’tforestall the next economic crash, rulesare valuable, and current proposalsare a “definite improvement” over thestatus quo, says Baker.For example, there will be closer

scrutiny of complex investments knownas derivatives, whose value is derivedby a formula based on the shiftingvalues of some asset or assets, suchas the value of the Japanese yen com-pared to the U.S. dollar. Under thelegislation, most derivatives now will“be traded in some regulated way”rather than in unsupervised trader-to-trader deals, says Baker. Supervisedtrading will pose fewer risks to in-vestors, Baker says.“Also a clear plus is the Consumer

Products Financial Services Agency,” saysBaker. “People get burned on financial

products all the time” so having a gov-ernment office to look out for con-sumers’ interests will be a help, he says.In the 2008 crash, the federal gov-

ernment stepped in with taxpayer funds— the Troubled Asset Relief Program(TARP) — to prevent some of thebiggest financial firms from collapsing.Policymakers figured the biggest firmswere so deeply entwined with the restof the economy that their demise wouldtake other firms down with them. Inshort, the mega-firms were “too big tofail,” or TBTF.As a result, many expected legisla-

tive efforts to limit banks’ size or thescope of activities a single firm couldpursue. The Obama administrationand many in Congress steadfastly op-posed this approach, however.“The trickiest banks” — the ones

good at figuring out ways to circum-vent rules to maximize profits —“tend

to be large,” said Richard W. Fisher,president of the Federal Reserve Bankof Dallas. That being the case, thereis “only one way to get serious about[TBTF] — . . . ‘shrink ‘em,’ ” he said.“Banks that are TBTF are simply TB— ‘too big.’ We must cap their sizeor break them up.” 5

Today’s biggest banks have attaineda scale “that’s impossible to run pru-dently,” says James K. Galbraith, a pro-fessor of economics at the Lyndon B.Johnson School of Public Affairs at theUniversity of Texas, Austin.But while the desire to break up

super-big institutions is “understand-able,” it’s “ultimately futile,” said MarkZandi, chief economist for Moody’sEconomy.com, a West Chester, Pa.-based financial research company.Breaking up banks “would be toowrenching and would put U.S. insti-tutions at a distinct competitive dis-advantage vis-à-vis their large globalcompetitors,” he said. 6

Also hotly debated is how big arole unethical conduct played in thecrisis. In April, the Securities and Ex-change Commission (SEC) filed a civillawsuit charging the big New York in-vestment bank Goldman Sachs withfraud for selling investors mortgage-backed securities the bank knew wereintended to fail. Some analysts say thesystem’s future soundness depends onwhether the government will contin-ue to crack down.Many of today’s financial-industry

practices amount to “fraud” or “out-right criminal negligence,” chargesGalbraith. When it comes to sellinginvestments made up of packaged mort-gage loans — so-called mortgage-backed securities — for example, fraud-ulent behavior was evident throughoutthe system, he says.First, “you had a massive issuance of

mortgages to people who couldn’t paythem. The guy who made those loans”committed fraud “because he knewthey couldn’t pay” but made the loansanyway “to generate a fee” for himself,



Galbraith says. Then the ratings agencies— companies such as Fitch, Moody’sand Standard & Poor’s that assess in-vestments according to relative risk —extended the fraud by “labeling thesethings triple A,” or very low-risk securi-ties. “That’s the same thing as moneylaundering. It takes something dirty andmakes it clean,” Galbraith argues.Finally, investment firms that market-

ed mortgage-backed securities to pen-sion funds and other traditionally low-risk investors misled buyers — by passingoff bad goods to suckers, he says. Charg-ing companies who commit such frauds“is the only hope we have” of cleaningup the industry, he says.But most bankers deny unethical

conduct.“I am saddened and hurt by what

happened in the market,” said FabriceTourre, the 31-year-old Goldman Sachsvice president whom the SEC hascharged with helping the bank engineera fraudulent deal in which two Euro-pean banks lost $1 billion. “I believe myactions were proper.” 7

As lawmakers, economists and thepublic wonder whether financial re-forms will prevent the next financial-market meltdown, here are some ofthe questions that are being asked:

Are tougher rules for financialfirms needed?Over the past three decades, many

rules governing financial firms have beenrescinded as policymakers embraced thephilosophy that markets function bestwhen left alone. Following the 2008 crash,however, some economists have calledfor reinstating stricter curbs on banking.“I hope it’s no longer controversial”

to say that a hard-line free-market phi-losophy has been “thoroughly dis-credited,” says Texas’ Galbraith. “Whenpeople say this today, they’re just cov-ering for the fact that they’re backingwhat special interests want.”“Taxpayers are providing a sub-

stantial benefit to the shareholders andcreditors of institutions considered too

big to fail” by putting up bailout funds,said Zandi of Moody’s Economy.com.In return, big financial firms should “besubject to greater disclosure require-ments, required to hold more capital,satisfy stiffer liquidity requirements, andpay deposit and other insurance pre-miums commensurate with . . . therisks they pose to the system.” 8

“The financial reform bill goes in theright direction . . . but it doesn’t go farenough,” however, said New York Uni-versity’s Roubini. An effective lawwould have to restructure the industryby limiting bank size and the numberof different financial businesses one in-stitution could pursue, he said. 9

Baker of the Center for Economic andPolicy Research would like to see a pro-

vision “with teeth” requiring commercialbanks, which take deposits and lend toindividuals and businesses, to be sepa-rate entities from investment banks, whichissue, price and trade stocks and bonds.The legislation is “probably better

than nothing,” says Galbraith. Never-theless, “I’m disappointed in it, and ifI were a member of Congress, I’m notsure whether I’d vote yes or no.”Behind-the-scenes deals between law-

makers and financial firms turned thelegislative process “into a victory lapfor Wall Street,” charged Simon John-son, a professor of entrepreneurship atthe Massachusetts Institute of Technol-ogy’s Sloan School of Management. Afterthe 2008 bailout, “administration offi-cials promised they would be back laterto fix the underlying problems. Thisthey — and Congress — manifestlyhave failed to do. Our banking struc-ture remains unchanged . . . and theincentives and belief system that liebehind reckless risk-taking has onlybecome more dangerous.” 10

“Regulatory changes in most casesrepresent a too-late attempt to catch upwith the tricks of the regulated,” whowill quickly find ways to circumvent newrules, said Dallas Fed chief Fisher. 11

In addition, many financial regula-tors come from the banking industry,and that fact will always compromiseenforcement, says Baker. “Imagine ifwe had a Labor Department wheremost people were from the UnitedAuto Workers. It would be very hardfor them to take an independent view”of labor issues and crack down onformer colleagues, he says.But many conservative commentators

challenge the notion that the financialindustry needs more rules.As it stands, the legislation is “worse

than nothing,” says Mark A. Calabria,director of financial regulation studiesat the libertarian Cato Institute. There’sno need to re-regulate banks becausethey were never actually deregulated,and any claim that deregulation

Derivatives Market Dwarfs Global GDPThe value of the worldwide trade in derivatives — financial instruments that represent bets on shifting prices, not real assets — exceeds $1 quadrillion, or more than 20 times the value of the world’s gross domestic product.

Source: Peter Cohan, “Big Risk: $1.2 Quadrillion Derivatives Market Dwarfs World GDP,” Daily Finance, June 2010

Value of WorldwideDerivatives Market and GDP

Gross domesticproduct

Derivatives

$1.2 quadrillion

$50 trillion

Continued on p. 635

634 CQ Researcher


While deliberating new banking rules that might mitigatefuture financial crises, U.S. lawmakers and banking of-ficials considered and rejected a plan to have banks put

funds upfront into a fund that would pay creditors and depositorsshould a large bank fail. Some financial-industry analysts say thatsuch advance preparation for the likely inevitable failure of morebig financial firms down the line is a plan well worth pursuing.“An advance-payment bailout fund was a House proposal

that didn’t get nearly enough attention,” says Dean Baker, chiefeconomist at the Center for Economic and Policy Research, aliberal think tank. The final congressional bill instead includedwhat Baker calls a misguided proposal to have banks ante upsuch funding only after financial firms actually crash.Having such a fund available before a crisis “would allow the

regulators to shut down” ailing institutions in a quick, orderlyfashion before problems worsened and spread, Baker says, With-out it, “regulators won’t have the tools to shut down” ailing bigbanks. Furthermore, the plan is a proven idea “that we alreadyhave in place” in the Federal Deposit Insurance Corporation(FDIC) and use routinely for smaller banks, Baker says.Without an advance fund, if a big bank fails, “government

regulators can go to Congress and ask for money” to addressthat specific emergency, “but Congress might say they don’twant to provide the money” or ask the financial industry forit, or the request might get tangled up in a legislative logjamof some kind, he says.The provision might not be needed if the only problems in

the system came from a handful of “rogue institutions,” says Baker.“But what we got in 2008 was not rogue. You didn’t so muchhave rogue players as a system that was totally out of whack,”he says. “A fund that’s ready and waiting would be a backstop”for the day when a large firm was “suddenly insolvent.”When failing banks are closed, the money to pay creditors

“shouldn’t take the form of a post-crisis tax,” says Amy Sepin-wall, an assistant professor of legal studies and business ethicsat the University of Pennsylvania’s Wharton School. “I thinkthere should be a perpetual tax on the players” in recognitionof the fact that, no matter what laws and regulations are inplace, there will always be the possibility of some financial in-stitution taking too many risks and failing.“People on Wall Street are incredibly intelligent” and may

“develop strategies to circumvent whatever rules Congress” putsin place to rein them in, says Sepinwall. “Maybe that’s the wayit’s supposed to be,” since the circumvention often leads to in-novation, some of which is very valuable. At the same time,however, it’s obvious that some financial-market innovationswill be extremely risky, she says.For that reason, requiring regular payments from the whole

industry into a fund that could serve as a backstop for firms

whose innovative financing arrangements go south is probablya good idea, she says. “One could key the tax to the size ofthe bank,” she says. Such an upfront fund would constitute a“recognition of the principle of ‘moral luck’ ” — the idea that,while many people may drink and drive, for example, onlysome will have an accident, but that everyone who engagesin the risky behavior, not just those who crash, actually bearssome degree of responsibility, Sepinwall explains.Like Congress, finance ministers and central-bank chiefs of

the G20 — 19 nations and the European Union — consideredbut rejected an international version of the bank shutdown fundin deliberations this summer. Given the increasingly interna-tional nature of the financial system, the European Union andsome others want each country to tax its banks to create apool to be used to resolve failed banks, to avoid delaying theprocess or sticking taxpayers with the bill.Some countries that impose limits on how much risk bank-

ing institutions may take on, such as Canada, object to theidea. 1 They argue that “since their regulatory systems are strong,”their local institutions “shouldn’t have to pay for what happensin riskier countries” without the foresight to ban risky practicesup front, says Sepinwall.In the U.S. debate over financial reform, key congressional

Republicans persistently demanded that the fund be removed fromthe bill on the grounds that it might actually be used to keep fal-tering institutions alive. “The bill reported out of committee sets upa $50 billion fund that, while intended for resolving failing firms,is available for virtually any purpose that the Treasury secretarysees fit,” wrote Alabama’s Sen. Richard Shelby, the top-rankingRepublican member of the Senate Banking Committee. “The mereexistence of this fund will make it all too easy to choose bailoutover bankruptcy. This can only reinforce the expectation that thegovernment stands ready to intervene on behalf of large and po-litically connected financial institutions.” 2

The fact-checking website PolitiFact notes, however, that Shel-by’s statement — which was widely echoed by other Republicanand conservative commentators — ignores specific bill languagethat bans use of the funds for any purpose except those con-nected with closing large firms that falter. “The legislative languageis pretty clear that the money must be used to dissolve — mean-ing completely shut down — failing firms,” said PolitiFact. “Thefund cannot be used to keep faltering institutions alive.” 3

— Marcia Clemmitt

1 For background, see “Canada Urges G20 to Stop Bank Tax Talk,” CTVtelevision online, June 1, 2010, www.ctv.ca.2 Quoted in “Sen. Richard Shelby Overlooks Safeguards in Financial Regu-lation Bill,” PolitiFact.com, http://politifact.com/truth-o-meter/statements/2010/apr/16/richard-shelby/sen-richard-shelby-overlooks-safeguards-financial-/.3 Ibid.

Lawmakers Reject ‘Rainy Day’ Fund for BanksGlobal finance ministers rejected creation of a similar fund.


helped trigger the 2008 crisis ignoreshistory, he says.As evidence, Calabria points to

studies showing that government “out-lays for banking and financial regula-tion increased from only $190 millionin 1960 to $1.9 billion in 2000 and tomore than $2.3 billion in 2008 (in con-stant 2000 dollars.)” The annual aver-age of new financial-industry rulesproposed by the Treasury Departmentgrew “from around 400 in the 1990sto more than 500 in the 2000s.” 12

Misguided regulation has actuallybeen the key driver of the financialmeltdown, not actions financial firmstook on their own, Calabria argues.For example, federal rules “micro-

manage the relationship between capi-tal and assets,” specifying, for example,that banks must hold more capital inreserve to back their lending to corpo-rations than for their lending to nationalgovernments, he says. But the recent fi-nancial meltdown of Greece demon-strates that government’s so-called “sov-ereign” debt can be far riskier thancorporate debt, Calabria argues.Furthermore, when the Federal Re-

serve lowered interest rates after theSept. 11, 2001, terrorist attacks, to jump-start business expansion and consumerspending, Fed Chair Alan Greenspan leftthe low rates in place too long, fuelingthe over-borrowing spree that led to thecurrent troubles, Calabria says. The low-ered rate “was needed for six months,not three years,” he says. “Did the Fedjust not get that they were setting upbad incentives” that encouraged too manypeople to take out mortgages?The call for more regulation is a

“new culture war” launched by pro-government liberals, said American En-terprise Institute president Arthur C.Brooks. The panic the economic down-turn engendered among Americans isallowing liberals to “attack free enterpriseopenly and remake America in [their]own image” by “expand[ing] the powersof government” to rigorously control an

industry that was not at fault, Brookssaid. “In truth . . . government housingpolicy,” which encouraged too manyAmericans to take out mortgages to buyhomes, “was at the root of the crisis.” 13

Was unethical behavior bybankers a major factor in theeconomic crash?Some observers are convinced that

financial markets are hotbeds of un-ethical conduct, but others point outthat seeking profit is not only legalbut is what the public demands thatfinancial firms do.Goldman Sachs is “a great vampire

squid wrapped around the face of hu-manity . . . little better than a criminalenterprise that earns its billions by bilk-ing the market, the government, andeven its own clients in a bewilderingvariety of complex financial scams,”fumed financial reporter Matt Taibbi. 14

In 2006, Goldman sold $76.5 billionin mortgage-backed investments, ofwhich about $59.1 billion — more thanthree-quarters — consisted of hundredsof home loans that either were madeto people with very bad credit or hadother serious problems, such as riskyterms like a no down-payment re-quirement, Taibbi said. Then, “someDutch teachers’ union that a year be-fore was buying ultra-safe U.S. Treasurybonds . . . runs into a Goldman sales-man who offers them a different, ‘justas safe’ AAA-rated investment that, atthe moment anyway, just happens tobe earning a much higher return thanTreasuries. Next thing you know, a bunchof teachers in Holland are betting theirretirement nest eggs on a bunch ofmeth-addicted ‘homeowners’ in Texasand Arizona. . . . This isn’t really com-merce, but much more like organizedcrime . . . a gigantic fraud perpetratedon the economy that wouldn’t havebeen possible without accomplices inthe ratings agencies and regulators will-ing to turn a blind eye,” said Taibbi. 15

“It is unacceptable to continue al-lowing Wall Street to put their short-

term gambles ahead of the long-termprosperity of Main Street America,”said Sen. Jeff Merkley, D-Ore., whosought to ban so-called “proprietarytrading” — banks trading securities fortheir own profits rather than on be-half of customers — but secured onlyminor limitations on such trades. “We’veseen how proprietary trading can causeconflicts of interest when firms betagainst securities they help put togetherfor their clients,” Merkeley said. 16

Sen. Carl Levin, D-Mich., whocosponsored Merkeley’s proposal, la-beled many bankers’ primary motiva-tion “extreme greed.” 17

In many cases, both sellers and buy-ers of the complex investments called“derivatives” are “cheaters,” charged FrankPartnoy, a professor of law and financeat the University of California, San Diego,and a former associate at the New YorkCity-based financial services firm Mor-gan Stanley. Some derivatives allow peo-ple to avoid taxes by making their in-vestment portfolios appear to have adifferent mix of risks and assets thanthey actually do, he said. In a so-called“equity swap,” a “bank that sells the swapmakes money, and the purchaser . . .makes money because they effectivelyget to liquidate a portion of their stockposition without paying tax. They bothwin,” but the public loses a legitimatepart of the tax base, Partnoy said. 18

“Ethical rot” and “perverse incentives. . . caused the ongoing financial cri-sis,” said William K. Black, an associ-ate professor of economics and law atthe University of Missouri who was afederal bank regulator during the sav-ings and loan meltdown of the late1980s. For example, “executive com-pensation and the compensation sys-tems used for appraisers, accountantsand rating agencies were designed” tocreate a business climate in which “fraud-ulent and abusive lending and ac-counting practices drove good prac-tices out of the marketplace.” 19

“I don’t think those who went intofinance are greedier or more deficient

Continued from p. 633

636 CQ Researcher

in moral scruples than others,” but theincentives in the way financial mar-kets currently operate “led them to be-have” as if they were, said Joseph E.Stiglitz, co-winner of the 2001 NobelPrize for economics and a professor ofeconomics at Columbia University. Theidea that “you have to pay me more ifI succeed in increasing profits” became“conventional wisdom,” leading bankersto neglect the fact that banks “are ameans to an end” in the economy, “notan end in themselves.” 20

“A good financial system” managesrisk, allocates capital and runs the econ-omy’s payment system “at low transac-tion costs,” said Stiglitz. “Our financialsystem created risk and mismanagedcapital, all the while generating hugetransaction costs” — financial firms’ out-

sized profits compared to other indus-tries. While bankers claim that productslike derivatives created real value in theeconomy, “it is hard to find evidenceof any real growth associated” with these“so-called innovations,” Stiglitz said. 21

“So deceptive were the systems ofcreative accounting” employed in pur-suit of large returns that bankers “didn’teven know their own balance sheets,and so they knew that they couldn’tknow that of any other bank,” Stiglitzsaid. No wonder then that lending be-tween banks — which allows bankersquick access to cash they can then loanto businesses — froze up in a crisis oftrust that helped topple the world’seconomy, he said. 22

Financial-industry executives mostlyreject such charges.

Far from ignoring obligations to so-ciety, most bankers embrace their so-cial purpose, said Goldman Sachs Chair-man Lloyd Blankfein. “I know I couldslit my wrists and people wouldcheer,” but accusers don’t realize thatthe bank does “God’s work,” Blank-fein said. “We help companies to growby helping them to raise capital. . . .This, in turn, allows people to havejobs that create more growth and morewealth. It’s a virtuous cycle.” 23

Some bankers have exhibited a “failedmoral compass” by “hiring people andpromoting people based simply . . . oncommercial productivity” rather than the“many other criteria that could be used,”acknowledged Brian Griffiths, vice chair-man of Goldman Sachs International.Nevertheless, “my reading of [Scottish


H ere are key provisions of the sweeping 2,300-page finan-cial reform law signed by President Obama on July 21,2010:

Overseeing the system’s financial health: A new 10-member council of financial regulators, drawn from several dif-ferent agencies, will monitor not just individual financial firmsbut their interactions, to help head off emerging risks for aneconomic crash. 1

Breaking up big banks: Regulators get new authority toseize and break up troubled financial firms whose large sizemeans their troubles could damage the economy. The Treasurywould fund the initial costs of winding down the bank, butregulators could recoup those funds from the failed bank andfrom special fees imposed on all big financial firms.

Curbing financial-market speculation: A watered-downversion of part of the so-called Volcker Rule limiting but notentirely banning banks from using depositors’ money to spec-ulate in financial markets.

Limiting banks’ derivative trading: Phased in over sev-eral years, banks are required to spin off some derivatives trad-ing into separate, affiliated companies. For the first time, manyderivatives must be traded through clearinghouses or publicexchanges, rather than over the counter.

Overseeing insurers, hedge funds, and private equityfunds: A new Federal Insurance Office in the Treasury De-partment will monitor, but not regulate, the insurance indus-try, which previously has been overseen only by states. Hedgefunds and private equity funds must register with the SEC asinvestment advisers and provide information on trades to help

regulators monitor financial-system risk.Improving how securities are rated: The SEC will conduct

a two-year study on whether to create a federal board to assignratings agencies to each security deal. Some lawmakers had pushedfor immediate random assignment of rating agencies as a way toend banks “shopping” for securities they trade.

Overseeing the Federal Reserve: The Fed faces a one-time audit of the emergency loans and other actions it took tohelp financial firms weather the 2008 crisis, but the centralbank’s decision-making about monetary policy — how it setsinterest rates — will not be audited.

Protecting consumers: An independent consumer finan-cial protection bureau will regulate and police consumer-loan,credit-card and mortgage-lending practices. This provision wasenacted despite strong objections from the financial industryand from congressional Republicans. Automobile dealers wonan exemption from oversight by the agency.

Cleaning up mortgage lending: Lenders must verifyborrowers’ income and determine in advance whether theycan meet the loan payments before originating a mortgage,thus ending the risky “liar loans” implicated in some homeforeclosures.

Curbing executive pay: Shareholders of all publicly tradedcompanies, not just financial firms, get a nonbinding advisoryvote on how executives are compensated.

1 See Open Congress website, www.opencongress.org/bill/111-h4173/text;Alison Vekshin and Phil Mattingly, “Overhaul of Financial Regulation on Pathto Obama’s Desk,” Bloomberg/Business Week, June 26, 2010, www.businessweek.com.

What’s in the New Financial Regulation Law


philosopher and economist] Adam Smithis that self-interested actions,” though“they may sometimes be selfish,” pro-duce social good, he said. (Smith’s 1776treatise An Inquiry into the Nature andCauses of the Wealth of Nations theorizesthat an “invisible hand” guides the freemarket to produce and price things cor-rectly, despite seeming chaos.) “I thinkthat the injunction of Jesus to love ourneighbors as ourselves is a recognitionof self-interest” as a positive social force,said Griffiths. 24

Banks do only what society asks ofthem, says Amy Sepinwall, an assistantprofessor of legal studies and businessethics at the University of Pennsylva-nia’s Wharton School. “We live in a get-rich-quick culture, and we ask people[in the financial industry] on our be-half to make as much money as pos-sible in as little time as possible, so ina way we’re sort of licensing this.”“Individuals prefer to spend rather

than save, and, as a result, demand thekind of financial alchemy that cantransform one’s house into a virtualATM or one’s exceedingly modest sav-ings into a fiscal cushion that can sus-tain a long, comfortable retirement,”Sepinwall said. Thus, the risk thatcrashed the system “is the inevitableprice of our preferences for leisure overtoil and consumption over savings.” 25

Should big banks be broken up?Proponents of limiting the size and

scope of each individual bank arguethat today’s biggest firms are too largeto be effectively managed. But otheranalysts say that the real problem isnot overlarge banks but misguided gov-ernment policies, such as bailing outinstitutions the government deems“too big to fail.” No matter how largethe company, if it fails financially, itshould go bankrupt, rather than beingrescued, these commentators say.“The best way to prevent a bank

from becoming too big to fail is pre-venting it from becoming too big inthe first place,” said Robert Reich, sec-

retary of Labor in the Clinton admin-istration and a professor of public pol-icy at the University of California,Berkeley. Lawmakers should cap thedeposits any one bank can hold, re-instate the so-called Glass-Steagall banon combining an investment bank anda commercial deposit-holding bank inone company and force banks to spinoff their derivatives-trading operationsinto separate companies, Reich said.(Only a limited form of the last ofthese provisions survives in the cur-rent legislation.) 26

“If they’re too big to fail, they’realso becoming too big to be saved,too big to be bailed out and too bigto be managed,” said New York Uni-versity’s Roubini. “No CEO can mon-itor the activities of thousands of sep-arate profit and loss statements” 27

“Where within one institution you havecommercial banking, investment bank-ing, underwriting of securities, market-making and dealing, proprietary trading,hedge fund activity, private equity activ-ity, asset management, insurance,” it “cre-ates massive conflicts of interest,” saidRoubini. “These institutions are alwayson every side of every deal. That’s aninherent conflict of interest that cannotbe addressed” by simply setting up in-ternal barriers within the company. 28

Bank “swaps desks” that trade incertain risky derivatives should be spunoff into separate enterprises that donot have “access to government back-stops,” said Dallas Fed chief Fisher andFederal Reserve Bank of Kansas CityPresident Thomas M. Hoenig. 29

Some commentators argue that thebiggest banks generally became bigthrough sweetheart deals with the gov-ernment, and since that makes themboth tools and symbols of dangerouslyconsolidated government power, theyshould be broken up.“Big banks are bad for free mar-

kets” because “they are conducive towhat might be called ‘crony capital-ism,” said Arnold Kling, an adjunctscholar at the Cato Institute. Thus, “there

is a free-market case for breaking uplarge financial institutions: that our bigbanks are the product, not of eco-nomics, but of politics.”The key example cited by Kling and

many other conservative and libertari-an commentators is Fannie Mae andFreddie Mac — two huge stockholder-owned but government-sponsored in-stitutions that buy and securitize mort-gages. “Created by the government,”these two institutions “always benefit-ed from the perception that Washing-ton would not permit them to fail,” afact that “gave them important advan-tages in credit markets and allowedthem to grow bigger than they other-wise would have,” he said. 30

Some of the biggest private banksalso have pursued “public purposes im-posed on them by Congress” — suchas increasing mortgage lending to ex-pand home ownership — in an at-tempt to woo lawmakers into regulat-ing them more lightly over the years,said Kling. At the government’s insti-gation, big banks, along with FannieMae and Freddie Mac, created a mar-ket in which high-risk mortgages were“securitized” — packaged to be soldas investments — driving house pricessky high, and the bursting of this pricebubble caused the financial crash, hesaid. The root cause, however, was “banks’being big enough to achieve real po-litical power. To expand free enterprise,shrink the banks.” 31

But shrinking banks “wouldn’t reallysolve our problems, because it’s perfectlypossible to have a financial crisis thatmainly takes the form of a run on small-er institutions,” said Paul Krugman, a pro-fessor of economics and international af-fairs at Princeton University and winnerof the 2008 Nobel Prize for economics.In the Great Depression of the 1930s,the “Federal Reserve believed that it wasOK to let [the small banks] fail,” but “asit turned out, the Fed was dead wrong:the wave of small-bank failures was acatastrophe for the wider economy,” hesaid. Regulators should limit risky lending

638 CQ Researcher


and the use of borrowed funds to buyinvestments, rather than trying to capbanks’size, Krugman said. 32

Unilaterally limiting the size of U.S.-based banks would put the countryat a competitive disadvantage becausebig U.S. companies with internationaloperations would end up using thebigger banks that were based else-where, said Rob Nichols, president ofthe Financial Services Forum, a bank-ing industry trade group. 33

Rebuilding the Glass-Steagall wallbetween depository banks and in-vestment banks is completely besidethe point because, in fact, “very fewfinancial holding companies decidedto combine investment and commer-cial banking activities,” even after Con-gress allowed them to do so in 1999,says Cato’s Calabria. Bear Stearns andLehman Brothers, “the two investmentbanks whose failures have come tosymbolize the financial crisis, . . . werenot affiliated with any depository in-stitutions,” and, in fact, if they had had“a large source of insured deposits,they would likely have survived theirshort-term liquidity problems” ratherthan going under and precipitating awider crisis, he said. 34

BACKGROUNDEarly Bank Battles

M oney is power, and even in theearliest days of the republic,

lawmakers debated the benefits anddangers of having a large central bank.They worried that big financiers mightjoin with politicians or the wealthy toturn the democratic republic into anoligarchy — a state run for the benefitof a powerful few. 35

The first such debate centered onwhether to establish a single bank withclose ties to the federal government.

Backers of the idea, like TreasurySecretary Alexander Hamilton, point-ed out the value of having a banklarge enough to offer credit to gov-ernment, issue paper money — cur-rency — that could be used nation-wide, and facilitate payments amongbusinesses in multiple states. 36

Skeptics, like Thomas Jefferson, wor-ried about centralizing economic power.A large bank might easily become a king-maker and make unilateral decisions abouthow much currency to issue, for exam-ple, Jefferson and others said. “I sincerelybelieve . . . that banking establishmentsare more dangerous than standing armies,”the future third president wrote. 37

Hamilton won the day, and in 1791President George Washington signed alaw chartering the First Bank of theUnited States, with 80 percent privateand 20 percent government ownership.During its 20-year charter as the sole

federally affiliated bank, the firm col-lected tax revenues on behalf of the gov-ernment and issued the only currencyaccepted as payment of federal tax bills.State-chartered banks issued the lion’s

share of paper money in circulation. Butthe First Bank’s role in clearing state-to-state payments meant that it held largeamounts of state currency and could de-mand that states fork over gold or sil-ver reserves to redeem those notes. Thisgave the bank enormous power to de-termine the country’s money and cred-it supplies — decisions that affect pricesand whether businesses can get loans.By and large, the bank was a boon

rather than a bane to the young re-public, helping businesses to thrive. By1825, when the young United Statesand the old United Kingdom “had rough-ly the same population . . . the Unit-ed States had nearly 2.5 times the amountof bank capital as the UK,” as well asa stock market “able to attract capitalfrom around the world,” wrote MIT’sJohnson and business consultant JamesKwak in their 2010 book 13 Bankers:The Wall Street Takeover and the NextFinancial Meltdown. 38

The Federal Reserve

I n the 1830s, President Andrew Jack-son — who believed that only goldand silver rather than paper currencyshould be used as money — railedagainst what he called a dangerous mo-nopoly held by the Second Bank, char-tered in 1816. The battle marked theseventh president as somewhat old-fashioned in an age when industrial-ization and urbanization created a needfor centralized banking, but the behav-ior of Second Bank president NicholasBiddle also provided evidence that therewas reason to fear big banks’ power.An ally of Jackson rival Kentucky

Sen. Henry Clay, Biddle expanded thebank’s lending to win support for Clayand the bank. Jackson nevertheless de-feated Clay in the 1832 presidentialelection, but afterwards Biddle drasti-cally cut lending and demanded thatstates pay gold and silver to redeemtheir currencies, contracting the moneysupply and causing loan interest ratesto double. “The bank is trying to killme,” Jackson fumed. 39

Jackson vetoed renewal of the Sec-ond Bank’s charter. But, at least partlyas a result of having no big bank tomanage the money and credit supply,“the U.S. economy . . . suffered throughsevere business cycles” — booms anddepression-level busts —“through therest of the 19th century,” Johnson andKwak write. 40

Nevertheless, American industrythrived, as railroad, oil and chemicalcompanies launched new products. Then,near the end of the 19th century, manycompanies in industries like steel mergedinto huge corporate entities, dubbed“trusts” — monopoly or near-monopolyenterprises that executives argued cutcosts. But Presidents William McKinley,Theodore Roosevelt and William HowardTaft tried to break up the trusts, sayingthey had power to raise prices andlower wages without restraint.

Continued on p. 640


Chronology1900s-1920sFederal Reserve system islaunched to curb the cycle ofsteep economic booms andbusts, but stock market crashes,triggering economic collapse.

•

1930s-1970sBanking rules are tightened.Following the Great Depression,the economic boom-and-bustcycle stabilizes.

1933Glass-Steagall Banking Act sepa-rates investment banks from com-mercial — deposit-holding —banks and establishes federal de-posit insurance.

1934Securities and Exchange Commissionestablished to regulate stock trading.

1935Fed’s regulatory powers expanded.

1936Commodity Exchange Act requirescommodity futures to be tradedon public exchanges.

1938Federal National Mortgage Association(Fannie Mae) established.

1974Congress creates Commodity FuturesTrading Commission (CFTC).

•

1980s-1990sBanking regulations ease, andnew products like adjustable-ratemortgages and mortgage-backedsecurities are introduced.

1980Congress allows banks to competefor deposits by offering higher inter-est, expands loans savings & loans(S&Ls) may make, and bans statecaps on first-mortgage interest rates.

1984Congress eases rules to allow in-vestment banks to package andsell mortgages as securities withvarying risk levels.

1989Resolution Trust Corp. created totake over insolvent S&Ls.

1994Congress lifts restrictions on inter-state banking.

1995Nearly a third of S&Ls have failedand been shut down.

1998Losses on derivatives bought withborrowed funds sink big hedge fundLong-Term Capital Management.

1999Gramm-Leach-Bliley Act repeals 1933ban on combining investment andcommercial banking in one company.

•

2000s-2010sHousing price bubble swellsthen pops, triggering worldwiderecession.

2000Commodity Futures ModernizationAct deregulates derivatives trading.

2006High-risk loans, such as interest-onlyand no-documentation loans, ac-count for 13 percent of new mort-gages, up from 2 percent in 2003.

2007Two hedge funds run by invest-ment firm Bear Stearns go bank-rupt. . . . German bank IDK suffersheavy losses on subprime invest-ments. . . . May foreclosure filingsup 90 percent from May 2006. . . .Government takes over Fannie Maeand Freddie Mac, the two big government-sponsored institutionsthat buy and securitize mortgages.

2008Federal Reserve lends JP MorganChase $29 billion to buy BearStearns. . . . Lehman Brothers in-vestment firm goes bankrupt. . . .Fed creates $85 billion loan fundto rescue insurer AIG. . . . Con-gress passes $700 billion bailoutplan — the Troubled Asset ReliefProgram (TARP) — devised byBush Treasury Secretary HenryPaulson to buy up risky invest-ments held by “too big to fail” financial firms.

2009Congress restricts compensationfor highly paid workers at firmsbailed out with TARP funds. . . .Congressional Oversight Panel forTARP says the Treasury paid morethan market value for bank assets.. . . Bank of America and Citi-group return their TARP funds tothe government.

2010SEC charges Goldman Sachs bankwith fraud in derivative-trading case;in July Goldman settles the casefor $550 million. . . . On July 15,Congress passes sweeping legisla-tion tightening rules for the finan-cial industry. . . . A White Housereport says that many banks over-paid their executives during the fi-nancial crisis. . . . Federal FinancialCrisis Inquiry Commission threatensto audit Goldman’s derivatives-trading business.

640 CQ Researcher

The rise of the trusts ushered in anew era of big banking, this timeallied with big industry, rather thangovernment. The banking empire ofConnecticut-born J.P. Morgan hadbecome financier of choice for fast-consolidating industries, lending moneyto buy stock and helping arrange merg-ers. By 1900, Morgan’s banks wereraising 40 percent of all industrial cap-ital in the United States.In 1907, however, a failed scheme by

some investors to manipulate the priceof copper stocks panicked Wall Street,

triggering a run on New York banks anda market crash that saw stocks lose near-ly 50 percent of their value. The so-called Banker’s Panic demonstrated thatwhile a large corporation-allied bank likeJ.P. Morgan’s may help industries grow,it does not promote economic stabilitythe way a federal bank could, by man-aging money and credit supplies. Al-though Morgan used his own cash tohelp keep the banks afloat, the federalgovernment ultimately had to deposit$25 million into banks in New York tobail out the banks and prevent economicmeltdown.

After the panic, bankers pushedfor a government-affiliated bank toact as lender of last resort to headoff crashes. Rep. Charles A. Lind-bergh, Sr., R-Minn., father of famedaviator Charles A. Lindbergh, Jr., grum-bled that it was “a wonderfully de-vised plan specifically fitted for WallStreet securing control of the world,”using taxpayer cash. 41

Democratic President Woodrow Wil-son engineered a compromise pro-posal to create a central banking sys-tem that would be privately ownedbut receive some government input.



The weakening or elimination of many banking and in-vesting regulations over the past three decades contributedto the financial crisis, many analysts say. Conservative com-

mentators, on the other hand, argue that most regulation fails toaddress the real problems behind troubled financial markets andonly hinders financial firms in finding creative solutions.Even small rules can make a big difference, some analysts say.In June 2007, for example, the Securities and Exchange Com-

mission eliminated a Depression-era rule intended to keep tradersfrom driving down a company’s stock to the point of ruin whenmarket prices were falling. The so-called “uptick rule” imposedlimits on “short selling” — borrowing, rather than buying, stockswhose price was dropping; selling them; and then buying themback at a lower price and pocketing the difference between thetwo prices before giving the stocks back to their real owner.The uptick rule had banned short selling unless a stock’s

price had recently “ticked up,” thus eliminating some of theprofit motive in quick sales rather than longer-term investments.In the 1930s, the SEC determined that short selling by peoplewho were not really investing in a company but merely trad-ing borrowed stock in search of quick profits had worsenedthe stock-market crash and ruined some companies. 1

The rule’s repeal is partly responsible for recent financial-market plunges, said Muriel Siebert, former state banking super-intendent of New York state and the first woman member ofthe New York Stock Exchange. 2 “The SEC took away the short-sale rule and when the markets were falling . . . investors justpounded” some companies’ stocks.Reinstating the rule “might have had some benefit” in mitigating

the 2008 crash, said Federal Reserve Chairman Ben S. Bernanke. 3

To have their full effect, the new rules Congress createdshould cover all kinds of financial traders, but mostly won’t,many industry critics say.

“Current reforms won’t deter the reckless financial engi-neering, investing, and inflation of values” that create specula-tive financial “bubbles” whose collapse can bring down the sys-tem, said Nomi Prins, a senior fellow at Demos, a New YorkCity-based liberal research and advocacy group. 4

For example, drafters of current legislation largely have ig-nored the “shadow-banking system,” a group of financial play-ers who take big risks but because most regulation doesn’t applyto them never will have to pay for problems they exacerbate,said Prins. Investment groups called “private-equity funds,” forexample, “are financial-pyramid bottom-feeders. . . . They buydistressed companies or assets, load them up with debt, extractnear-term profit, and are gone before any collapse occurs,” shesaid. Such actions increase the risk of a system collapse becausethey usually buy complex, poorly understood assets that maybe very risky and use borrowed money to do so, just as hap-pened in the mortgage meltdown, said Prins.Instead of ignoring some financial enterprises, lawmak-

ers should require “leveraged funds” of all kinds — that is,any organizations that borrow money to invest — to regis-ter with the SEC, report their borrowing and trading activ-ities to regulators in detail, and have limits on how muchthey can borrow, she said. 5

The Federal Reserve system — the public-private bankingnetwork that not only regulates banks but also makes key de-cisions about the country’s credit and money supply — alsogot too little attention from lawmakers this year, some analystssay. Although Congress approved some additional auditing forthe Fed, lawmakers left too many of its activities in darkness,says Robert D. Auerbach, a professor of public affairs at theUniversity of Texas, Austin.The Fed has “done a lot of devilish things” over many decades,

such as secretly lending money to foreign governments at the

Did Weakened Regulations Fuel the Economic Crisis?Critics of regulation say “constant vigilance” by bank customers is the only answer.


The Federal Reserve Act of 1913 es-tablished a network of private re-gional banks empowered to use pub-lic funds to shore up troubled banks,loosely overseen by the presiden-tially appointed Federal ReserveBoard.The system exists today in much

the same form in which it was creat-ed. To get some idea of its power,one need only observe that “every dol-lar bill in the country says ‘Federal Re-serve Note’ on it,” says Robert D. Auer-bach, a professor of public affairs atthe University of Texas, Austin.

Regulation, Deregulation

I t soon became clear, however, thatthe system was no panacea for fi-nancial busts.In the 1920s, good times rolled, in-

dustry grew and stock prices soared,tempting more stock investors into thegame, with a growing number buyingsecurities with “leverage,” or using bor-rowed cash.The young Federal Reserve had con-

siderable power to affect the money andcredit supply and thus slow an econo-

my where debt was growing excessive.But slowing a boom is “never popularwith politicians concerned about the nextelection, banks making large profits . . .or ordinary people benefiting from a bur-geoning economy,” so the Fed kept in-terest rates low, said Johnson and Kwak.In October 1929, an increasingly

unstable stock market began experi-encing unnerving one-day price drops.At the same time, housing prices weredropping around the country. Panicabout financial firms’ stability led tobank runs that helped trigger the GreatDepression of the 1930s.

behest of the White House, and “thereshould be checks and balances. Theyshould tell Congress” of their activi-ties because in many ways, “they runthe country, as unelected officialswith no accountability,” Auerbach says.What’s required is not full public dis-closure but merely disclosure to themembers of Congress with oversightauthority. “If the CIA can make dis-closures” to congressional oversightpanels, then the Fed can do so with-out damage also, he says.But many conservative commenta-

tors argue that regulation simply can’tbe the answer to creating a sounderbanking system.“Regulation as protection is a false

promise, and to the extent that anynew regulation is presented to thepublic as a protection” against future harms, “people are beingmisled,” says Marvin Goodfriend, a professor of economics atthe Carnegie-Mellon Tepper School of Business in Pittsburgh.History has plenty of examples showing that financial regulation

often does not work, Goodfriend says. “There were plenty of reg-ulations in the mortgage markets, for example, but they didn’t pro-tect people. There is a role for regulation, but it should not be over-sold.” For example, “a too big to fail” rule — should one be enacted— “could be gotten around by the industry, and they would getaround it,” he says.Instead, to create a well-functioning market in which frauds

and risk are at a minimum, “there is no solution except con-stant vigilance” by “informed customers,” — borrowers, de-

positors, stockholders, and investors,among others — who “discipline firms”by their vigilant search for value, Good-friend says.On that basis, rather than rules per

se, he would like to see more stan-dardization of financial products. “Stan-dardization is a public good” because itleads to more informed customers whocan keep banks honest. “I want to beable to compare” investments.Goodfriend says that he’d start an ef-

fort to standardize financial-product de-scriptions by examining how more trans-parent labeling was achieved for otherproducts, such as nutritional labeling onfood. Because of that history, “we’re notflying blind” in trying to accomplish stan-dardized labeling for investments, he says.Transparency might extend to all types

of investments, including initial public offerings — IPOs — ofcompany stock, he says.

— Marcia Clemmitt

1 For background, see Robert Holmes, “Uptick Rule: Meaningful or Mean-ingless,” The Street.com, Feb. 27, 2009, www.thestreet.com.2 Quoted in Gretchen Morgenson, “Why the Roller Coaster Seems Wilder,”The New York Times, Aug. 26, 2007.3 Quoted in Jesse Westbrook, “Bernanke Says There May Be Benefit toUptick Rule,” Bloomberg.com, Feb. 25, 2009, www.bloomberg.com.4 Nomi Prins, “Shadow Banking,” The American Prospect, May 4, 2010,www.prospect.org5 Ibid.

Federal Reserve Chairman Ben S.Bernanke said a rule regulating

“short selling” might have softened the2008 economic crash.

Getty Images/Win McNamee

642 CQ Researcher

President Franklin D. Roosevelt, in-augurated in March 1933, sought a lawto stop banks from making risky WallStreet investment bets with Main Streetdepositors’ money. The Banking Actof 1933 — dubbed the Glass-SteagallAct after cosponsors Sen. Carter Glass,D-Va., and Rep. Henry B. Steagall, D-Ala.— required traditional “commercial”banks — which take deposits and makeloans — to be separate entities from“investment” banks, which help raisecorporate capital and issue and tradesecurities. It also created the FederalDeposit Insurance Corporation to in-sure bank deposits and facilitate anorderly shutdown of commercial banksthat got into trouble.Decades of moderate business cycles,

without steep booms and busts, fol-lowed, although historians disagree

about whether stricter banking lawswere largely responsible. By the late1970s, however, a new school of free-market economists joined with banksto press for loosening the restraints.Beginning with the Reagan adminis-

tration, in 1981, banking rules were re-laxed, and financial firms got larger andtook on a more varied and riskier mixof investments, loans and deposits.At the same time, Americans became

more comfortable with borrowing; andworkers whose companies once offeredpensions now had to invest retirementmoney in stocks and bonds. Wages stag-nated, leading to increased borrowingas Americans sought the higher stan-dard of living that by now was con-sidered an American birthright.A new era of steeper booms and

busts was about to begin.

In the 1980s, savings and loan asso-ciations (S&Ls) — local institutions thattook deposits and made mortgage loans— were among the first financial firmsto be deregulated. Initially, profitssoared. Between 1986 and 1995, how-ever, regulators closed 1,043 failing S&Ls— about a third of the total — main-ly because they’d lent to risky borrow-ers who defaulted. By 1999, around$124 billion in taxpayer money hadshielded S&L depositors from losingtheir savings. 42

The advent of fast computers al-lowed financiers to design new invest-ment instruments — “derivatives” —whose values, often based on complexformulas, could make them effective“hedges” against failing bets on tradi-tional investments, like a company stock.Mostly traded over-the-counter rather


B y April 2010, the Dow Jones Industrial Average hadclimbed to 11,205 — nearly 70 percent over its March2009 level — and Wall Street seemed to have put the

2008 financial-market crash behind it. Then, on May 6, a so-called “flash crash” sent the Dow plummeting 998 points —nearly a tenth of its value — in just a few minutes, before re-gaining about 600 of those points by day’s end. 1

High-frequency trades (HFT) — instantaneous stock trades gen-erated by computers — were widely blamed for the dizzying drop.Only a handful of big firms, such as the investment bank

Goldman Sachs, use HFTs, but the trades represent about 75 per-cent of overall trading volume and have enormous power topush the market sharply up or down, “usually without funda-mental or technical reason,” charged financial blogger TylerDurden. High-frequency traders can make lightning-quick tradesand thus turn a profit based on market shifts that are actuallycreated by HFT itself, he said. 2

As a result, “based on a few lines of code” in a big bank’sHFT computers, “retail investors,” who don’t understand thatthe market is being driven by computerized buying rather thanreal-world events, “get suckered into a rising market that hasnothing to do with” factors that might legitimately raise stockprices, such as “some Chinese firms buying a few hundredextra Intel servers,” Durden said. 3

Some in Washington are sounding alarms. “I’m afraid that

we’re sowing the seeds of the next financial crash,” said Sen.Ted Kaufman, D-Del., who holds an MBA from the Universityof Pennsylvania’s Wharton School and was a longtime aide toVice President Joseph Biden. “We’re dealing with something high-ly complex and completely unregulated. The last time we hadthat mix, with the practitioners telling us, ‘Don’t worry about it,’things didn’t end well.” 4

Moreover, some high-frequency traders use their speedadvantage to profit in ways that are, if not illegal, at leasthighly unfair, said David Weild, a former vice chairman ofthe NASDAQ stock exchange. Some HFT firms use theirhigh speed and the slower trading algorithms used by in-vestors like pension funds to buy the next stock those in-vestors will want, and then sell it back at a higher price.“It is increasingly clear that there are quite a number of[such] high-frequency bandits in the high-frequency-tradingcommunity,” said Weild. 5

Some commentators even suspect that big-bank, high-frequency traders deliberately created the May 6 markettumble to warn Congress of what havoc bankers could causeif lawmakers passed a tough banking law. On the day ofthe 998-point drop, Congress was deliberating two provi-sions that were anathema to the financial industry — aforced breakup of the nation’s six largest banks and a re-quirement for an independent audit of the Federal Reserve’s

Mystery of the May Mini-crashDid big banks use ultra-high-speed trading to spook Congress?


than in managed exchanges as stocksare, derivatives are essentially bets onhow some shifting quantity or quanti-ties will change. A derivative’s value canderive from literally any changing quan-tity, such as stock prices, the value ofone nation’s currency in terms of an-other, or even how many sunny daysa region will experience. Derivativescan theoretically be designed to hedgeagainst any risk.Derivatives markets boomed in the

1990s, with many individual and in-stitutional investors borrowing millionsor even billions of dollars to buy them.Nevertheless, as the investments grewmore complex, their risks became hard-er to discern, triggering huge lossesfor some.In the late 1990s, Brooksley Born —

then chair of the Commodities Futures

Trading Commission (CFTC), which over-sees the “futures contracts” that help farm-ers lock in favorable prices for wheatand other crops — sought to have heragency designated to oversee derivativestrading. Born made her pitch after thespectacular demise of Long-Term Capi-tal Management (LTCM), a huge “hedge”investment fund that collapsed “becauseit had $1.25 trillion worth of derivativecontracts at the same time as it had lessthan $4 billion in capital to supportthem” and thus was utterly unable tomake good on its losing bets. 43

But financial firms and policymak-ers, including Federal Reserve Boardchairman Alan Greenspan, shot downBorn’s proposal, arguing that the LTCMcrash was an aberration.In 2000, President Bill Clinton signed

the Commodity Futures Modernization

Act, eliminating a longstanding legal rulethat over-the-counter derivatives “con-tracts” were valid only if one of thetrading parties actually owned the se-curity that they were betting against, ex-plained Lynn A. Stout, a professor ofcorporate and securities law at the Uni-versity of California, Los Angeles. 44

Under the new law, even a personwho does not own a particular securitymay invest in an over-the-counter de-rivative that will pay off if that securityfails. Supporters argued the changewould keep American investment firmscompetitive with those in countries thatdo not restrict derivatives trades. ButStout compares it to permitting “the un-scrupulous to buy fire insurance onother people’s houses.” In that case, “theincidence of arson would rise dramati-cally,” she notes dryly. Similarly, under

2008 bailout of the banks. That the “flash crash” occurredduring discussion of these proposals suggests it “could havebeen an act of financial terrorism,” wrote liberal bloggerDavid DeGraw. 6

“The amalgamation of events is eerily similar to what tookplace on Sept. 29, 2008,” when the House of Representativesvoted to reject the federal bailout plan for banks, the TroubledAsset Relief Program (TARP), said DeGraw. “Immediately afterthe vote, big banks made the market plunge a record 778 points,sparking widespread . . . panic that helped convince Congressto eventually pass” the measure. 7

Many in the HFT community dismiss such claims as non-sense, however, and argue that HFT did not cause the May 6crash. “This crisis was precipitated by panic selling by humans,”not HFT, because “we just had had a huge run-up in the equitiesmarkets, we were in the midst of a 10 percent correction be-fore the mayhem unfolded, and on top of that you had veryvexing news” about the financial collapse of the Greek gov-ernment, said Manoj Narang, founder of the New York City-based HFT information firm Tradeworx. 8

Meanwhile, the Securities and Exchange Commission isproposing additional “circuit-breaker” mechanisms that wouldhalt securities trading briefly if any stock price declined by alarge amount within a five-minute period, to forestall panic sell-offs that turn into market crashes. 9

But some analysts say that ever-rising trading speeds sim-ply make the market too difficult to control by such mecha-nisms. “There’s a speed that’s too fast, and right now we’re atit,” said Michael Goldstein, a professor of finance at BabsonCollege, a business school in Wellesley, Mass. “Like our high-ways have a minimum speed and a maximum speed, maybeit’s time for our highways in trading to have a minimum speedand a maximum speed as well.” 10

— Marcia Clemmitt

1 For background, see Matthew Philips, “Fast, Loose, and Out of Control,”Newsweek, June 1, 2010, p. 42.2 Tyler Durden, “Goldman’s $4 Billion High Frequency Trading Wildcard,”Zero Hedge blog, July 2009, http://zerohedge.blogspot.com.3 Ibid.4 Quoted in Philips, op. cit.5 Quoted in Timothy Lavin, “Monsters in the Market,” The Atlantic, July/August2010.6 David DeGraw, “Was Last Week’s Market Crash a Direct Attack by FinancialTerrorists?” AlterNet web site, May 10, 2010, www.alternet.org.7 Ibid.8 Quoted in “‘Flash Crash,’ the Untold Story by Tradeworx’s Manoj Narang,at High-Frequency Trading Leaders Forum,” press release, Golden Networkingweb site, June 2, 2010, www.prlog.org.9 Jim Puzzanghera, “New Circuit Breakers Will Likely Prevent ‘Flash Crash,’Experts Say,” Los Angeles Times, June 3, 2010, p. B3.10 Quoted in ibid.

644 CQ Researcher


the 2000 law, some derivatives dealerscertainly design some securities to fail,just so they can make surefire betsagainst those failures, she said. 45

Nevertheless, as regulations loosened,the financial industry increased its prof-itability and thus its importance to thecountry’s overall financial picture. Be-tween 1980 and 2005, financial-sectorprofits grew by 800 percent, comparedto 250 percent in other industries. 46

Crash of 2008

T he economy enjoyed a wealth boomas the 21st century began. Home

ownership soared as borrowers took ad-vantage of low interest rates set by theFederal Reserve to keep the economymoving after the 9/11 terrorist attacks.New kinds of mortgages — with ultra-

low introductory interest or requiring nodownpayment — enticed many to takeout second mortgages to get cash tospend. Speculators buying houses todayso they could “flip” them at higher pricesto other buyers tomorrow helped drivereal-estate prices skyward and, alongwith them, Americans’ perception thattheir personal wealth was soaring. An-other computer-based banking innova-tion, “securitization,” increased mortgageavailability by allowing banks to pack-age hundreds of mortgages and sell themto investors, thus getting the loans offbanks’ own books and freeing them tomake new loans. 47

In 2007 the wheels came off thewealth machine.Some of the riskiest mortgage hold-

ers were defaulting. And since notlocal banks but investors owned the“securitized” debt — as well as deriv-atives based on the mortgage-backedsecurities, which many had taken onlarge amounts of additional debt tobuy — financial losses from the un-paid mortgages quickly spread aroundthe globe.The amount of apparent wealth that

a highly leveraged system with multi-

ple complex paper assets can produceis enormous. Currently, the worldwidederivatives market alone is said to havea value of about $1.2 quadrillion, orabout 24 times the value of the en-tire world’s annual gross domestic prod-uct (GDP). Such a wealth bubble mayquickly deflate, however, if the valueof underlying assets wanes or growssuspect, as happened with high-riskmortgage loans in the 2000s and withsketchy start-up companies in the 1990s’Internet stock bubble. 48

Most banks knew they had risky se-curities on their books and, suspectingthat other banks did too, refused to offerthem the short-term credit they neededto make business loans. The supply ofhome buyers dried up, and house pricesdropped, wiping out the paper wealthagainst which many consumers had bor-rowed their spending money. The econ-omy ground to a halt, and some fi-nancial institutions that were believed— rightly or wrongly — to have theriskiest investment portfolios stumbled.Beginning in 2008, the Treasury De-

partment and the Federal Reserve workedtogether to save some “too big to fail”financial institutions, — while allowingothers, like the financial-services firmLehman Brothers, to go under.In March, the Federal Reserve lent

$29 billion to help the JP Morgan Chasebank acquire the failing investment firmBear Stearns. In September, the Feder-al Reserve put up $85 billion — laterincreased to over $180 billion — to saveAIG, Inc., an insurance firm that hadhelped investors “hedge” bets with arisky derivative called a “credit defaultswap.” When investments tumbled invalue in the general slump, AIG wasunable to pay off its many CDS oblig-ations. Also in September, the govern-ment seized the government-sponsoredmortgage giants Fannie Mae and FreddieMac, as mortgage defaults swelled.Despite the taxpayer-funded “bailout”

of big financial companies, however, adeep economic recession spread world-wide and persists.

CURRENTSITUATIONReform Legislation

A fter a long and intense battle onCapitol Hill, financial reform legis-

lation is now in place.The fierce 2010 congressional bat-

tle to enact the legislation was Wash-ington’s response to widespread angerover the Wall Street bailout and pub-lic distaste for companies many be-lieve handed out huge bonuses to thevery executives who put profits aheadof customers’ interest and helped pre-cipitate the economic crash.Passing the legislation has not been

easy, however. The year-and-a-halfstruggle to get a majority of Housemembers, 60 senators and the WhiteHouse to agree on just what new rulesare needed reveals both the issue’scomplexity and banks’ enormous po-litical clout. In the early morning hoursof Friday, June 25, a House-Senateconference committee agreed on finaldetails to merge separate versions offinancial-reform legislation passed ear-lier this year by the two chambers.No conference-committee Republicanvoted to approve the bill, arguing thatit would cripple the financial industryand the economy, although it containsfar less stringent curbs on banks thanmany economists, and even somebankers, recommend.In the full Senate, however, three

Republicans, Scott Brown, (Mass.) andMaine’s Susan Collins and OlympiaSnowe, crossed the aisle on July 15to give supporters the 60 votes theyneeded to overcome a final Republi-can filibuster of the plan, and Presi-dent Obama signed the measure intolaw on July 21.

Continued on p. 646

no


At Issue:Do Fannie Mae and Freddie Mac bear primary responsibilityfor the financial crisis?yes

yesMARK A. CALABRIADIRECTOR OF FINANCIAL-REGULATIONSTUDIES, CATO INSTITUTE

FROM CATO INSTITUTE WEBSITE, JUNE 25, 2010,WWW.CATO.ORG.

p erhaps it should come as no surprise that Sen. Christo-pher Dodd, D-Conn., and Rep. Barney Frank, D-Mass,the 2010 financial-reform bill’s primary authors, would fail to end the numerous government distortions of

our financial and mortgage markets that led to the crisis. Bothhave been either architects or supporters of those distortions.Nowhere in the bill will you see even a pretense of rolling

back the endless federal incentives and mandates to extendcredit, particularly mortgages, to those who cannot afford topay their loans back. After all, the popular narrative insiststhat Wall Street fat cats must be to blame for the credit crisis.Despite the recognition that mortgages were offered to un-qualified individuals and families, banks will still be requiredunder the Dodd-Frank bill to meet government-imposed lend-ing quotas.Apologists for government-mandated lending are correct in

pointing out that much of the worst lending was originated bystate-chartered lenders, such as Countrywide, and not federallychartered banks. However, they either miss or purposely ignorethe truth that these non-bank lenders were selling the bulk oftheir loans to Fannie Mae, Freddie Mac or the government cor-poration Ginnie Mae. About 90 percent of loans originated byCountrywide, the largest subprime lender, were either sold toFannie Mae or backed by Ginnie Mae. Subprime lenders wereso intertwined with Fannie and Freddie that Countrywide aloneconstituted over 25 percent of Fannie’s purchases.While one can debate the motivations behind Fannie and

Freddie’s support for the subprime market, one thing shouldbe clear: Had Fannie and Freddie not been there to buy theseloans, most of them would never have been made.And had the taxpayer not been standing behind Fannie

and Freddie, they would have been unable to fund such largepurchases of subprime mortgages. Yet Congress believes it ismore important to expand federal regulation and litigation tolenders that had nothing to do with the crisis rather than fixthe endless bailout that Fannie and Freddie have become.Nor has there been any discussion in Congress about re-

moving the tax preferences for debt. Washington subsidizesdebt, taxes equity and then acts surprised when everyonebecomes extremely leveraged.Until Washington takes a long, deep look at its own role

in causing the financial crisis, we will have little hope foravoiding another one.no

JULIA GORDONSENIOR POLICY COUNSEL, CENTER FORRESPONSIBLE LENDING

FROM TESTIMONY BEFORE FINANCIAL CRISIS INQUIRY COMMISSION, JAN. 13, 2010

s ince the problems in the subprime market became evi-dent in early 2007, many in the mortgage industry evad-ed responsibility by blaming the borrowers.

However, the stereotypes of the risky borrower or the bor-rower overreaching to purchase a McMansion turn out to befalse. Research shows that an elevated risk of foreclosure wasan inherent feature of the defective, exotic loan products thatproduced this crisis. Loan originators frequently specialized insteering customers to higher-rate loans than those for whichthey qualified, which are loaded with risky features.In addition, given the long-standing political dispute over the

very existence of the Federal National Mortgage Association(Fannie Mae) and the Federal Home Loan Mortgage Corpora-tion (Freddie Mac), it is not surprising that these government-sponsored enterprises (GSEs) are often blamed for the crisis.Those blaming the GSEs point to their decision to purchasesubprime securities from Wall Street.The fact is, while we agree that Fannie Mae and Freddie

Mac should not have purchased subprime mortgage-backedsecurities (MBS), their role in purchasing and securitizingproblem loans was small in comparison with that of privateindustry. All subprime mortgage-backed securities were createdby Wall Street. Fannie Mae and Freddie Mac did not securitizeany of these loans because the loans did not meet their stan-dards. When they finally began to purchase the MBS, theywere relative late-comers to a market that had been createdby private-sector firms and they purchased the least risky andmost easily sellable of the securities.In fact, the GSEs’ role in the overall mortgage market di-

minished substantially as subprime lending rose. As of 2001,Fannie Mae and Freddie Mac funded almost two-thirds ofhome mortgage loans across the United States. These wereloans that Fannie Mae and Freddie Mac purchased directlyfrom originators who met the GSE guidelines and either heldon their balance sheets or securitized and sold to investors.Subprime loans accounted for just 7 percent of the market.Around 2003, private issuers began to introduce new, riskier

loan products into the market and began to displace the GSEs.In early 2004, private-issue MBS surpassed the GSE issuancesof all loans and by early 2006, Fannie and Freddie’s marketshare of new issuances had dropped to one-third of the total.As the role of the GSEs was declining, the percentage of sub-prime loans in the mortgage market almost tripled.

646 CQ Researcher

Republican opposition to the mea-sure remains strong, however. “I thinkit ought to be repealed,” said HouseMinority Leader John Boehner, R-Ohio.“I think it is going to make credit hard-er for the American people to get.” 49

The new law:• Gives regulators authority to as-

sess whether a bank poses a risk tothe economy and to break apart orclose such banks;• Limits some derivatives trading;• Tightens capital standards;• Sets up a consumer-credit watch-

dog agency in the Federal Reserve; and• Allows Congress to seek audits

of the Federal Reserve. (See sidebar,p. 634.)“We shouldn’t put in place a regu-

latory regime that overly reacts and, asa result, significantly dampens our ca-pacity to have the most vibrant capitaland credit markets in the world,” saidSen. Judd Gregg, R-N.H. 50

Some Republicans did seek toughrules, however. In May, for example, theSenate approved an amendment fromCollins requiring banks with more than$250 billion in assets to meet slightlystricter capital requirements than in thepast, and the plan made it into the finalpackage. Collins’ amendment would pre-vent the biggest banks, which makemany high-risk trades, from trading withtoo much borrowed money. 51

Democrats including the Obamaadministration are all over the map intheir views, hotly debating nearlyevery proposed provision. The Obamaadministration actually opposed Collins’amendment, for example. 52

In both the current and recent ad-ministrations, Treasury Department lead-ers mainly come from the financial in-dustry and the Federal Reserve, a factthat likely drives White House warinessof some rule tightening, many observerssay. “Isn’t it interesting that the WhiteHouse is opposing” an amendment torequire the Federal Reserve to undergostringent independent auditing, given that

Treasury Secretary Timothy Geithner “isa former head of the New York Fed,”says Texas’ Auerbach.Some Democrats have fought for very

strict regulation. Sens. Sherrod Brown(Ohio) and Ted Kaufman (Delaware)proposed forbidding any single bankfrom holding more than 10 percent ofthe country’s deposits, and Sen. AlFranken (Minnesota) wanted an inde-pendent board to assign financial firmsa credit ratings agency for each pro-ject, rather than letting banks “shop” foragencies as they do now. Neither mea-sure made it into the law. 53

But many Democrats also havefought to soften bill provisions. Forexample, Sen. Tom Harkin (Iowa) andRep. Greg Meeks (New York) suc-cessfully pushed to keep the SEC fromregulating so-called equity-indexed an-nuities — products often fraudulentlysold to seniors as ultra-safe, fixed-in-come investments, even though theirvalue depends on stock prices, andboth the SEC and the courts have ruledthat the SEC should regulate them. 54

Its architects praise the law. “Thisis going to be a very strong bill, andstronger than almost everybody pre-dicted it could be,” said House Fi-nancial Services Committee ChairmanBarney Frank, D-Mass. 55

But many analysts say the legislationwill do little to limit banking risk.“Lobbying in the gazillions pre-

dictably stopped the needed major struc-tural reforms . . . revealed by the scopeand scale of the financial crisis,” saidRobert Johnson, director for global fi-nance at the Roosevelt Institute, a liber-al think tank in New York City. “We stillhave many practices that are not trans-parent and many off-balance-sheet prob-lems that disguise the conditions of ourfinancial firms.” 56

Fraud Enforcement

I n the end, laws make no differ-ence unless they’re enforced, and

financial-sector enforcement has beenchancy at best over the years, partlybecause of the industry’s vast influ-ence, many observers say.Nevertheless, no matter how lightly

an industry is regulated, the ability tocrack down on at least the most abu-sive behavior always exists, says Texas’Galbraith. “You can’t decriminalize fraud.Good accounting, good auditing and ap-propriate criminal referrals are what weneed” from regulators, he says. “Mysense is that once the wheels [of civiland criminal investigations] start turning,the effects are pretty powerful,” includ-ing making other industry players “thinktwice” about their behavior. At present“it’s hard to judge” how much enforce-ment activity is bubbling, but there areencouraging signs, Galbraith says.On April 16, for example, the SEC

filed a civil lawsuit charging GoldmanSachs with fraud for selling mortgage-backed securities the bank knew wereintended to fail. The so-called Abacus se-curities were designed by a hedge-fundmanager, John Paulson, who did not buyany of the securities but designed themto fail so that he could profit by bettingagainst them using derivatives, underthe legal permission granted by the 2000Commodity Futures Exchange Act. 57

In mid-July, Goldman agreed to pay$550 million to settle the case, an amountthe SEC notes is “the largest-ever penal-ty paid by a Wall Street firm.” In the set-tlement, the bank neither admitted nordenied the SEC’s allegation that it hadcommitted fraud, however. 58

Some analysts say that the fine isfar too small to deter bad behavior bythe high-rolling financial industry.For one thing, the fine amounts to only

about two weeks’ worth of profits forGoldman Sachs, according to the inde-pendent, foundation-funded investigativejournalism organization ProPublica. 59

“It’s the largest fine in SEC history,and that’s the bad news . . . because itshows how ineffective the SEC has beenfor decades now,” said the University ofMissouri’s Black. While “losses caused




by securities fraud have grown into themultibillion dollars” over the past fewdecades, “the SEC not only didn’t bite,but it forgot that it had teeth.” The Gold-man Sachs fine “is very, very weak; it’snot going to have any significant deter-rent effect,” said Black. Furthermore, civillawsuits against the bank will be ex-tremely difficult to pursue, since the SECdid not exact an admission of intentionaldeception from the bank, he said. 60

Goldman, in fact, reportedly expectedto have to pay a $1 billion fine. 61

Meanwhile, states, especially in theWest, are said to be pursuing numer-ous fraud cases involving the mortgageindustry, and some in Congress alsohave shown interest, Galbraith notes.Last November, for example, Rep. MarcyKaptur, D-Ohio, introduced legislationto hire up to 1,000 new FBI agents topursue cases of suspected corporate,securities, and mortgage fraud. 62

White-collar enforcement, especiallyin finance, has always faced severe chal-lenges, at least partly because regula-tors mostly come from the regulatedindustries, says Baker of the Center forEconomic and Policy Research. “It’s asif [big pharmaceutical manufacturers]Pfizer and Merck appointed membersto the Food and Drug Administration,”Baker says. “This remains an enormousproblem not addressed by” legislation.In the Federal Reserve system, for

example, which is charged with over-seeing banks, “you’ve got the New Yorkbanks electing” the very officials whowill oversee them, says Texas’ Auer-bach, author of the 2008 book Decep-tion and Abuse at the Fed: Henry B.Gonzalez Battles Alan Greenspan’s Bank.“There was massively too much lever-

age” — the use of large amounts of debt,rather than actual assets or capital, topurchase investments —“in the financialsystem” before the last crash, noted RichardBreeden, who chaired the Securities andExchange Commission from 1989 to1993. “Regulators had the authority tocontrol that and eliminate it” but didn’t.“We can keep passing laws, but if the

regulators don’t have the backbone toenforce the rules and to be realistic, thenthat’s a different problem.” 63

Currently, for example, pro-regulation,liberal advocates are pressing the ad-ministration to appoint Elizabeth War-ren, a Harvard Law professor and headof Congress’ oversight committee for thefinancial-industry bailout, as chief of thenew consumer-protection agency creat-ed by the reform law. “Professor War-ren has a proven track record as a smartand tough consumer advocate” and infact was the first person to propose thatthere be such an office, said Sen. BernieSanders, I-Vt., in a letter to PresidentObama urging Warren’s appointment. 64

However, with the banking indus-try believed to strongly oppose War-ren’s nomination, Senate Republicanswould likely filibuster it, and even withall Democrats and Independents vot-ing “yes,” Senate Democratic leaderswould still have to win over at leastone Republican vote to get the 60 votesneeded to end a filibuster and approveher nomination. 65 If Obama “nomi-nates a zealot or an activist, I think itwill bring to life our greatest fears aboutthis consumer protection agency,” saidSen. Bob Corker, R-Tenn. 66 Meanwhile,Wall Street activities continue much asthey did pre-crash, observers say.For example, “many big banks have

not modified their [employee com-pensation] practices from what theywere before the crisis,” paying execu-tives in ways that incentivize “exces-sive risk-taking,” said Federal ReserveChairman Ben S. Bernanke in June. 67

“Despite all those dramatic con-gressional hearings, average compen-sation of Wall Street bankers rose by27 percent in 2009,” said Nomi Prins,a senior fellow at the liberal New YorkCity-based think tank Demos. Mean-while, “banks posted their lowest lend-ing rates since 1942, despite all thesubsidies and cheap money they re-ceived from, well, us” as a supposedincentive to help the economy by mak-ing business loans, she said. 68

OUTLOOKNew Crash Ahead?

M ost analysts don’t see an end toextreme boom-and-bust cycles in

financial markets.The new financial industry overhaul

legislation “will have relatively little im-pact” on slowing growth of specula-tive “bubbles,” like the vastly inflatedstock prices for fledgling Internet com-panies in the so-called dot.com bub-ble of the 1990s and the soaring houseprices of the early 2000s, says Bakerof the Center for Economic and Poli-cy Research.“I believe that nothing in the [new

legislation] will prevent another crisis,”said Richard Marston, a professor of fi-nance at the University of Pennsylva-nia’s Wharton School. The basic prob-lem is that “securitization” — conversionof pools of loans, like mortgages andcredit-card debt, into packages to besold as investments — “has changedbanking in a fundamental way,” he says.“It ties all financial institutions and in-vestors together,” so that risky investmentactivities can’t easily be walled off fromthe rest of the system, and risk spreadseasily throughout the economy. 69

Congress didn’t even pretend to ad-dress the real causes of the crash,some analysts say.No legislation to reform the finan-

cial industry could “address the under-lying problems” that really triggered theeconomic meltdown, said Wharton fi-nance professor Franklin Allen. Low in-terest rates and “global imbalances” ofwealth, such as large reserves of cur-rency in Asia, led to over-borrowing,visible in the proliferation of high-riskmortgages, and the law’s provisions “donothing” to address these. 70

“A number of . . . provisions in thebill . . . run far afield from Wall Streetreform and will ultimately harm Main

648 CQ Researcher


Street,” said American Bankers Associa-tion President Edward L. Yingling. “Thisbill will, in the end, add well over a thou-sand pages of new regulations for eventhe smallest bank,” with the result that“the capability of traditional banks to pro-vide the credit needed to move the econ-omy forward has been undermined.” 71

Some analysts say it’s unlikely law-makers can ever effectively address theproblem of “wealth bubbles,” whoserapid deflation triggers financial andeconomic meltdowns.“I don’t think the problem of bubbles

is an economic problem. It’s a politicalproblem,” says Cato’s Calabria. “Thepublic loves a bubble” because peoplerejoice when their house values or stockportfolios make them feel wealthy, hesays. That being the case, neither law-makers nor regulators nor banks willever get much support for deliberatelytrying to pop wealth bubbles or slowtheir development, he suggests.“Based on what’s in the bills, in 10

to 15 years there will be another crash,”Calabria predicts.

Notes1 For background, see Nathaniel Popper, “Trad-ing Firms Put Their Money on Poker Experts,”Los Angeles Times, May 1, 2010.2 For background, see Kenneth Jost, “FinancialCrisis,” CQ Researcher, May 9, 2008, pp. 409-432, and Thomas J. Billitteri, “Financial Bailout,”CQ Researcher, Oct. 24, 2008, pp. 865-888.3 Nouriel Roubini and Stephen Mihm, “Bust Upthe Banks,” Newsweek, May 17, 2010, p. 42.4 Ibid.

5 Remarks at the SW Graduate School of Bank-ing 53rd Annual Keynote Banquet, FederalReserve Bank of Texas website, June 3, 2010,http://dallasfed.org.6 Testimony before House Financial ServicesCommittee, Sept. 24, 2009, www.house.gov/apps/list/hearing/financialsvcs_dem/zandi_testimony.pdf.7 Quoted in Chris Adams and Greg Gordon,“Goldman Executives: ‘No Regrets’ for Dealsthat Accelerated Crisis,” McClatchy Newspapers,April 27, 2010, www.mcclatchydc.com.8 Testimony before House Financial ServicesCommittee, Sept. 24, 2009, www.house.gov/apps/list/hearing/financialsvcs_dem/zandi_testimony.pdf.9 Zach Carter and Nouriel Roubini, “How toBreak Up the Banks, Stop Massive Bonuses,and Rein in Wall Street Greed,” Alternet blog,May 18, 2010, www.alternet.org.10 Simon Johnson, “Wall Street’s Victory Lap,”Huffington Post blog, May 26, 2010, www.huffingtonpost.com.11 Remarks at the SW Graduate School ofBanking, op. cit.12 Mark A. Calabria, “Did Deregulation Causethe Financial Crisis,” Cato Policy Report, July/August 2009, www.cato.org.13 Arthur C. Brooks, “The New Culture War,”The Washington Post, May 23, 2010, p. B1.14 Matt Taibbi, “Will Goldman Sachs ProveGreed is God?” The Guardian [UK], April 24,2010, www.guardian.co.uk/business/2010/apr/24/will-goldman-prove-greed-is-god.15 Matt Taibbi, “The Greatest Non-Apology ofAll Time,” The Smirking Chimp blog, June 19,2009, www.smirkingchimp.com.16 “Merkley-Levin Amendment to CrackDown on High-Risk Proprietary Trading,” pressrelease, Office of Sen. Jeff Merkley, May 10, 2010,http://merkley.senate.gov.17 Ibid.18 Joe Kolman, “The World According to Frank

Partnoy,” DerivativesStrategy.com, October 1997,www.derivativesstrategy.com.19 William K. Black, “The Audacity of Dopes,”Huffington Post blog, May 28, 2010, www.huffingtonpost.com.20 Testimony before House Committee on Fi-nancial Services, Jan. 22, 2010.21 Ibid.22 Ibid.23 Quoted in John Arlidge, “I’m Doing ‘God’sWork.’ Meet Mr. Goldman Sachs,” LondonTimes online, Nov. 8, 2009, www.timesonline.co.uk.24 Regulation, Freedom and Human Welfare,St. Paul’s Institute panel discussion, transcript,Oct. 20, 2009, www.stpauls.co.uk/documents/st%20paul%27s%20institute/regulation%20freedom%20and%20human%20welfare%20transcript.pdf.25 Quoted in “ ‘A Race to the Bottom’: As-signing Responsibility for the Financial Crisis,”Knowledge at Wharton newsletter, Dec. 9, 2009,http://knowledge.wharton.upenn.edu.26 Robert Reich, “Why the Finance Bill Won’tSave Us,” Huffington Post blog, May 24, 2010,www.huffingtonpost.com.27 Carter and Roubini, op. cit.28 Ibid.29 Shahien Nasiripour, “Regional Fed ChiefsLining Up to Support Tough Derivatives Pro-vision, Obama Administration Still Opposed,”Huffington Post blog, June 11, 2010, www.huffingtonpost.com.30 Arnold Kling, “Break Up the Banks,” CatoInstitute, March 26, 2010, www.cato.org.31 Ibid.32 Paul Krugman, “Financial Reform 101,” TheNew York Times, April 2, 2010, p. A23.33 Quoted in Martha C. White, “Should WeBreak Up Big Banks?” Walletpop.com, Dec. 5,2009, www.walletpop.com.34 Calabria, op. cit.35 For background, see Simon Johnson andJames Kwak, 13 Bankers: The Wall Street Takeoverand the Next Financial Meltdown (2010).36 For background, see “The First Bank of theUnited States: A Chapter in the History ofCentral Banking,” Philadelphia Federal Reserve,www.philadelphiafed.org/publications/economic-education/first-bank.pdf.37 “Private Banks,” Thomas Jefferson Encyclo-pedia online, wiki.monticello.org/mediawiki/index.php/Private_Banks_%28Quotation%29.38 Johnson and Kwak, op. cit., p. 17.39 Quoted in ibid., p. 20.40 Ibid.41 Quoted in ibid., p. 28.

About the AuthorStaff writer Marcia Clemmitt is a veteran social-policy re-porter who previously served as editor in chief of Medi-cine & Health and staff writer for The Scientist. She hasalso been a high school math and physics teacher. Sheholds a liberal arts and sciences degree from St. John’sCollege, Annapolis, and a master’s degree in English fromGeorgetown University. Her recent reports include “Gridlockin Washington” and “Health-Care Reform.”


42 Timothy Curry and Lynn Shibut, “The Costof the Savings and Loan Crisis: Truth andConsequences,” FDIC Banking Review, De-cember 2000, p. 26, www.fdic.gov/bank/analytical/banking/2000dec/brv13n2_2.pdf.43 Quoted in Les Leopold, The Looting ofAmerica: How Wall Street’s Game of FantasyFinance Destroyed Our Jobs, Pensions, andProsperity (2009), p. 68.44 Lynn A. Stout, “The Natural Result of Dereg-ulation,” The New York Times online blogs,April 16, 2010.45 Ibid.46 Johnson and Kwak, op. cit., p. 60.47 For background, see Marcia Clemmitt,“Mortgage Crisis,” CQ Researcher, Nov. 2, 2007,pp. 913-936.48 Peter Cohan, “Big Risk: $1.2 Quadrillion De-rivatives Market Dwarfs World GDP,” Daily Fi-nance, AOL, June 9, 2010, www.dailyfinance.com.49 “Boehner Wants Reg Reform Repealed,”Politico, July 15, 2010, www.politico.com/blogs/glennthrush/0710/Boehner_sees_Democratic_civil_war.html?showall.50 Quoted in Herszenhorn and Wyatt, op. cit.51 Pat Garofalo, “Fed and Treasury Work to NixCollins’ Amendment Mandating More Capitalfor Risky Banks,” Think Progress blog, May 20,2010, http://wonkroom.thinkprogress.org.52 Ibid.53 Ryan Grim, “Wall Street Reform: Progres-sive Dems Glimpse Victory,” Huffington Post,May 6, 2010, www.huffingtonpost.com.54 Shahien Nasiripour, “Dem-sponsored Loop-hole in Financial Reform Bill Could Hurt Se-niors,” Huffington Post, June 24, 2010, www.huffingtonpost.com.55 Quoted in “Lawmakers Agree on WallStreet’s Biggest Overhaul Since 1930s,”Bloomberg/Business Week, June 25, 2010, www.businessweek.com.56 Quoted in Lynn Parramore, “ ‘Disappoint-ing and Inspiring’: Roosevelt Fellows and Col-leagues React to FinReg,” Huffington Post,June 25, 2010, www.huffingtonpost.com.57 For background, see “What Goldman’sConduct Reveals,” The New York Times onlineblogs, April 16, 2010, http://roomfordebate.blogs.nytimes.com.58 Marian Wang, “Goldman’s SEC Settlement bythe Numbers: We Do the Math,” ProPublicablog, July 15, 2010, www.propublica.org.59 Ibid.60 Quoted in “Goldman ‘Too Big to Prose-cute,’ ” The Real News website, July 17, 2010,http://therealnews.com.61 Susan Pulliam and Susanne Craig, “Goldman

Talks Settlement with SEC,” The Wall Street Jour-nal, May 7, 2010, http://online.wsj.com/article/SB10001424052748704370704575228232487804548.html?mod=WSJ_business_LeadStoryRotator.62 For background, see “Kaptur IntroducesLegislation to Beef Up FBI Anti-fraud Efforts,”press release, office of Rep. Marcy Kaptur,Nov. 3, 2009, www.kaptur.house.gov/index.php?option=com_content&task=view&id=502&Itemid=86.63 Jesse Westbrook and Otis Bilodeau, “Regu-latory Overhaul Won’t Stop Next Crisis, SayLevitt, Breeden,” Bloomberg, June 16, 2010,www.bloomberg.com.64 Quoted in “Will President Obama AppointElizabeth Warren to Head the Consumer Finan-cial Protection Bureau,” ABC News Political Punchblog, July 20, 2010, http://blogs.abcnews.com.65 For background, see Marcia Clemmitt, “Grid-lock in Washington,” CQ Researcher, April 30,2010, pp. 385-408.

66 Quoted in Brian Beutler, “Signs Point toTough Haul for a Potential Elizabeth WarrenNomination,” Talking Points Memo blog, July 21,2010, http://tpmdc.talkingpointsmemo.com.67 Quoted in Eric Dash, “Fed Finding StatusQuo in Bank Pay,” The New York Times, June 8,2010, p. B1.68 Nomi Prins, “Speculating Banks Still Rule —Ten Ways Dems and Dodd Are Failing on Fi-nancial Reform,” AlterNet website, April 14, 2010,www.alternet.org.69 Quoted in “Regulating the Unknown: CanFinancial Reform Prevent Another Crisis,” Knowl-edge at Wharton newsletter, June 9, 2010,http://knowledge.wharton.upenn.edu.70 Quoted in “Banking Reform Proposals:Why They Miss the Mark,” Knowledge atWharton newsletter, Feb. 17, 2010, http://knowledge.wharton.upenn.edu.71 Edward L. Yingling, press statement, AmericanBankers Association, June 25, 2010, www.aba.com.

FOR MORE INFORMATIONCato Institute, 1000 Massachusetts Ave., N.W., Washington DC 20001-5403; (202)842-0200; www.cato.org. Libertarian think tank analyzes financial-reform and otherpublic policies.

Center for American Progress, 1333 H St., N.W., 10th Floor, Washington DC 20005;(202) 682-1611; www.americanprogress.org. Progressive policy analysis and advocacygroup on issues including banking reform and the economy.

Center for Capital Markets Competitiveness, U.S. Chamber of Commerce,1615 H St., N.W., Washington, DC 20062; (202) 463-3162; www.uschamber.com.Business group opposed to tightening regulation of financial industry offers infor-mation and commentary.

Congressional Oversight Panel, 732 North Capitol St., N.W., Rooms C-320 andC-617, Washington, DC 20401; (202) 224-9925; http://cop.senate.gov/index.cfm.Web site of the congressionally appointed panel overseeing the TARP bailout pro-gram includes testimony and reports on how the TARP bailout of firms like insurerAIG is affecting financial markets and the economy.

Financial Crisis Inquiry Commission, 1717 Pennsylvania Ave., N.W., Suite 800,Washington, DC 20006-4614; (202) 292-2799; www.fcic.gov. Web site of the government-appointed panel researching causes of the 2008 financial-market crash includes reportson how financial markets operate.

Pew Financial Reform Project, 901 E St., N.W., Washington, DC 20004-2008;(202) 552-2000; www.pewfr.org. Foundation-funded group provides nonpartisananalysis of financial reform and the 2008 financial crisis.

Roosevelt Institute, 570 Lexington Ave., 18th Floor, New York, NY 10022; (212)444-9130; www.rooseveltinstitute.org. Nonprofit group studies and promotes policiesrelated to the progressive legacy of President Franklin D. Roosevelt and first ladyEleanor Roosevelt.

Zero Hedge blog, www.zerohedge.com. Financial analysts blog on market andeconomic news.

FOR MORE INFORMATION

650 CQ Researcher

Selected Sources

Bibliography

Books

Black, William K., The Best Way to Rob a Bank Is to OwnOne: How Corporate Executives and Politicians Lootedthe S&L Industry, University of Texas Press, 2005.An associate professor of economics and law at the Uni-versity of Missouri-Kansas City and former bank regulatordescribes how savings and loan executives, abetted by manygovernment regulators and lawmakers, committed account-ing fraud and looted their banks.

Johnson, Simon, and James Kwak, 13 Bankers: The WallStreet Takeover and the Next Financial Meltdown, RandomHouse, 2010.Johnson, a professor of entrepreneurship at the MassachusettsInstitute of Technology and former International Monetary Fundchief economist, and business journalist Kwak argue that bankshave repeatedly fought the U.S. government for political powerand generally won the battle.

Ritholtz, Barry, Bill Fleckenstein and Aaron Task, BailoutNation: How Greed and Easy Money Corrupted WallStreet and Shook the World Economy, Wiley, 2009.Money manager Ritholtz, hedge fund manager Fleckenstein andbusiness reporter Task trace the history of U.S. business bailouts,arguing that financial firms’ political power has gradually allowedcorporations to police themselves in economic booms and relyon docile government bailouts when times are bad.

Woods, Thomas E., Jr., Meltdown: A Free-Market Look atWhy the Stock Market Collapsed, the Economy Tanked, andGovernment Bailouts Will Make Things Worse, RegneryPress, 2009.A senior fellow at the libertarian Mises Institute argues thatFederal Reserve attempts to manage the money supply are aroot cause of financial collapses.

Articles

Dorgan, Byron L., “Very Risky Business: Derivatives,”Washington Monthly, October 1994, http://findarticles.com/p/articles/mi_m1316/is_n10_v26/ai_15818783/?tag=content;col1, p. 7.In the early years of the now gigantic derivatives-tradingmarket, a U.S. senator discusses his qualms about the complexinvestments in light of the recent S&L collapse.

Lavin, Timothy, “Monsters in the Market,” The Atlantic,July/August 2010, www.theatlantic.com/magazine/archive/2010/07/monsters-in-the-market/8122.The Securities and Exchange Commission is trying to mon-itor how computer-driven high-frequency trading at everfaster speeds affects financial markets.

Ornstein, Charles, and Tracy Weber, “Texas MortgageFirm Survives and Thrives Despite Repeat Sanctions,”Pro Publica web site, July 2, 2010, www.propublica.org.Despite piles of customer complaints, a mortgage companyescapes regulatory consequences.

Philips, Matthew, “Fast, Loose, and Out of Control,”Newsweek, June 1, 2010, www.newsweek.com/2010/06/01/fast-loose-and-out-of-control.html, p. 42.Is new ultra-fast stock-trading technology a boon or a baneto financial markets?

Roubini, Nouriel, and Stephen Mihm, “Bust Up theBanks,” Newsweek, May 17, 2010, p. 42.Roubini, a New York University professor of business, andMihm, a University of Georgia history professor, argue thatthe biggest banks are too big to be properly managed andshould be broken up.

Taibbi, Matt, “The Great American Bubble Machine,”Rolling Stone online, April 5, 2010, www.rollingstone.com/politics/news/12697/64796.A business reporter argues that the growing number ofGoldman Sachs’ veterans serving as government officials in bothparties has given the bank unfair opportunities to manipulatefinancial markets and public policy.

“What Goldman’s Conduct Reveals,” The New York Timesblogs, April 16, 2010, http://roomfordebate.blogs.nytimes.com/2010/04/16/what-goldmans-conduct-reveals.Experts representing numerous points of view on financial-industry practices comment on the meaning and probableoutcome of the Securities and Exchange Commission’s Aprilcivil lawsuit filed against investment bank Goldman Sachs.

Reports and Studies

Gokhale, Jagadeesh, “Financial Crisis and Public Policy,”Cato Institute, March 23, 2009, www.cato.org/pubs/pas/pa634.pdf.A senior fellow at a libertarian think tank argues that gov-ernment policies encouraging home ownership — includingloose regulation of risky mortgage lending — were the realroot of the financial crash.

Miller, Rena S., “Key Issues in Derivatives Reform,” Con-gressional Research Service, Dec. 1, 2009, www.fas.org/sgp/crs/misc/R40965.pdf.An analyst at Congress’ nonpartisan research office describeshow derivatives work and what regulatory safeguards havebeen proposed to guard against their risks.


Enforcement and Crime

Di Luca, Leo, “Fed Gets More Power, Responsibility,”The Wall Street Journal, July 16, 2010.The Wall Street reform bill gives the central bank more re-sponsibility and tools to avert another financial crisis.

Goldfarb, A. Zachary, “Bear Stearns Blames ‘Self-FulfillingProphecy,’ ” The Washington Post, May 6, 2010, p. A15.Former Bear Stearns executives told a panel investigatingthe origins of the financial crisis that their firm’s 2008 near-collapse was caused by the market’s loss of confidence.

Gordon, Greg, “Securities Probe of Wall St. Banks Widens,”Seattle Times, May 14, 2010, p. A9.Banks are facing increasing scrutiny from the Justice De-partment and the Securities and Exchange Commission afterpreliminary criminal inquiries into the behavior of GoldmanSachs and Morgan Stanley expanded to four other banks.

Scherer, Michael, “The New Sheriffs of Wall Street,” Time,May 13, 2010.In a male-dominated financial industry, three prominentwomen are spearheading the effort to clean up Wall Street.

Ethics

Caruso, B. David and Michael Gormley, “Bonuses Ascend to$20.3 Billion in 2009,”The Associated Press, Feb. 24, 2010.Wall Street bonuses climbed 17 percent to $20.3 billion in2009, even after investment banks were bailed out in 2008.

Donmoyer, Ryan, and Laura Litvan, “Ethics Office ProbesWall Street Giving Before Vote,” The San FranciscoChronicle, July 15, 2010.A congressional ethics office is investigating campaign do-nations given to eight lawmakers by the financial industrylast December as the House was preparing to vote on aWall Street reform bill.

Legislation

Baker, Peter, “Obama Issues Sharp Call for Reforms onWall Street,” The New York Times, April 23, 2010.President Obama is confronting intense lobbying effortsseeking to undermine new financial regulations that he saysare necessary to prevent a second Great Depression.

Hirsh, Michael, “Financial Reform Makes Biggest BanksStronger,” Newsweek, June 25, 2010.The Dodd-Frank bill that President Obama calls “the tough-est financial reform since the one we created in the after-math of the Great Depression” actually strengthens the po-sition of the biggest banks.

Kuhnhenn, Jim, “Wall Street Crackdown, Consumer Guards,on the Way,” The Associated Press, July 15, 2010.The Wall Street reform bill passed by Congress on July 15imposes strict restrictions on banks and expands consumerprotections two years after the mortgage crisis plunged theU.S. into a recession.

Recovery

Hill, Patrice, “Recovery Slows Down as Stimulus FundingExpires,” The Washington Times, July 4, 2010.With many stimulus measures ending this spring, someeconomists are calling for more federal cash to maintain theeconomy’s slow recovery.

Lee, Don, “Recession May Not Be Over, Panel Says,” LosAngeles Times, April 13, 2010, p. 2.Setting an end date to the recession “would be premature,”according to the National Bureau of Economic Research.

Shell, Adam, “Investors Anticipate Jobs Recovery,” USAToday, March 9, 2010, p. 1B.Investors are optimistic that the market will soon create newjobs for unemployed Americans, despite the government’sannouncement that 36,000 jobs were lost in February.

Trumbull, Mark, “Troubling Reason for Drop in Unem-ployment Rate: People Exiting Work Force,” The ChristianScience Monitor, July 2, 2010.Although America’s unemployment rate dropped to 9.5 per-cent in June, the decline was instigated by people leavingthe labor force as opposed to an addition of new jobs byemployers.

The Next Step:Additional Articles from Current Periodicals

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MLA STYLEJost, Kenneth. “Rethinking the Death Penalty.” CQ Researcher

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APA STYLEJost, K. (2001, November 16). Rethinking the death penalty.

CQ Researcher, 11, 945-968.

CHICAGO STYLEJost, Kenneth. “Rethinking the Death Penalty.” CQ Researcher,

November 16, 2001, 945-968.

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Documents

CQR Financial Industry Overhaul · 30/07/2010 · — the Troubled Asset Relief Program (TARP) — to wprevent some of the biggest financial firms from collapsing. Policymakers figured