Once upon a time, not so very long ago ...
What Was The Glass-Steagall Act?
The Glass-Steagall Act
In 1933, in the wake of the 1929 stock market crash and during a nationwide commercial bank failure and the Great Depression, two members of Congress put their names on what is known today as the Glass-Steagall Act (GSA). This act separated investment and commercial banking activities. At the time, "improper banking activity", or what was considered overzealous commercial bank involvement in stock market investment, was deemed the main culprit of the financial crash. According to that reasoning, commercial banks took on too much risk with depositors' money. [...]
Reasons for the Act - Commercial Speculation
Commercial banks were accused of being too speculative in the pre-Depression era, not only because they were investing their assets but also because they were buying new issues for resale to the public. Thus, banks became greedy, taking on huge risks in the hope of even bigger rewards. Banking itself became sloppy and objectives became blurred. Unsound loans were issued to companies in which the bank had invested, and clients would be encouraged to invest in those same stocks.
by Reem Heakal, investopedia.com -- Jul 16, 2003
'The more things change ...' eh?
The regulations of Glass-Steagall were designed to reel in real abuses; designed to prevent Banks from turning their customers into so much chattel:
Understanding How Glass-Steagall Act Impacts Investment Banking and the Role of Commercial Banks
cftech.com -- Apr 12, 1998
The Generally Accepted Rationale for the Separation of Commercial and Investment Banking
The generally accepted rationale for the Glass-Steagall Act is well expressed in the brief filed by the First National City Bank (1970) in support of the Comptroller of the Currency (William Camp), who had given the bank permission to offer commingled investment accounts. For this case (Investment Company Institute v. Camp, 401 US 617, 1971), which the Supreme Court decided in favor of the Investment Company Institute, FNCB's attorneys described the rationale for the Act thus: (First National City Bank, 1970, pp. 40-2):
The Glass-Steagall Act was enacted to remedy the speculative abuses that infected commercial banking prior to the collapse of the stock market and the financial panic of 1929-1933. Many banks, especially national banks, not only invested heavily in speculative securities but entered the business of investment banking in the traditional sense of the term by buying original issues for public resale. Apart from the special problems confined to affiliation three well-defined evils were found to flow from the combination of investment and commercial banking.
Provisions of the Glass-Steagall Act
were directed at these abuses:
(1) Banks were investing their own assets in securities with consequent risk to commercial and savings deposits. The concern of Congress to block this evil is clearly stated in the report of the Senate Banking and Currency Committee on an immediate forerunner of the Glass-Steagall Act.
(2) Unsound loans were made in order to shore up the price of securities or the financial position of companies in which a bank had invested its own assets.
(3) A commercial bank's financial interest in the ownership, price, or distribution of securities inevitably tempted bank officials to press their banking customers into investing in securities which the bank itself was under pressure to sell because of its own pecuniary stake in the transaction.
Then fast-forward to the economic boom times of the nineties. We find neo-fiscal advocates who want to unleash the Banks from the shackles of Glass-Steagall Act, that had bound them for generations. That was ancient history, this was the new age of internet investing.
That was then, this is now ... Just think of the deregulated possibilities ...
U.S. Senate Committee on Banking, Housing, and Urban Affairs
Information Regarding the Gramm-Leach-Bliley Act of 1999
November 1, 1999
Summary of Provisions
-- Repeals the restrictions on banks affiliating with securities firms contained in sections 20 and 32 of the Glass-Steagall Act.
-- Creates a new "financial holding company" under section 4 of the Bank Holding Company Act. Such holding company can engage in a statutorily provided list of financial activities, including insurance and securities underwriting and agency activities, merchant banking and insurance company portfolio investment activities. Activities that are "complementary" to financial activities also are authorized. [...]
-- Lifts some restrictions governing nonbank banks.
-- Provides for a study of the use of subordinated debt to protect the financial system and deposit funds from "too big to fail" institutions and a study on the effect of financial modernization on the accessibility of small business and farm loans.
-- Provides for Federal bank regulators to prescribe prudential safeguards for bank organizations engaging in new financial activities.
-- Provides for national treatment for foreign banks wanting to engage in the new financial activities authorized under the Act.
-- Allows banks to continue to be active participants in the derivatives business for all credit and equity swaps (other than equity swaps to retail customers).
-- Provides for a "jump ball" rulemaking and resolution process between the SEC and the Federal Reserve regarding new hybrid products.
The rationalizations were many back in the late 90's ... the retrospective "proof of concept" follow-up investigations, are still nowhere to be found.
It's easy to promise the Moon, when 10 years later, no one bothers asking "Hey -- Where's the green Cheese?"
October 22, 1999
Sen. Phil Gramm, chairman of the Senate Committee on Banking, Housing and Urban Affairs, was among the Senate and House conferees who reached a compromise early Friday morning on details of financial services modernization, including the Community Reinvestment Act.
Gramm made the following statement after the compromise was reached:"The financial services modernization legislation is the most important banking legislation in 60 years. The people it will benefit most are working families. It is legislation that we can be proud of, and it will become law because it will pass both houses of Congress by large margins and will be signed by the President.
"The hallmark of the bill is that it will make an array of financial services available to every American consumer that will provide lower prices and one-stop shopping at financial supermarkets in every city and town in the country.
And the Banks went forth to "create wealth and opportunity" in new and exotic ways. Instead of just making Loans to Small Businesses and Home-owners -- Banks were now free from that 'overwhelming burden of regulation' (as Maddow put it) ...
-- they were free to offer new sub-prime loans, and free to bundle up those sub-primes, and re-sell them as AAA Mortgage-backed gold, to unsuspecting institutional investors, like your neighborhood Pension fund;
-- they were free to over-leverage their growing wealth, into ever greater piles of "Virtual, Derived-Wealth" ... Oh the power of an above average ROI ... and magic of the securitization of unwanted risk ...
Credit Default Swaps: The Next Crisis?
by Janet Morrissey, Time-Business -- Mar 17, 2008 [a pre-bust date]
Indeed, commercial banks are among the most active in this [credit default swaps] market, with the top 25 banks holding more than $13 trillion in credit default swaps --where they acted as either the insured or insurer -- at the end of the third quarter of 2007, according to the Comptroller of the Currency, a federal banking regulator. JP Morgan Chase, Citibank, Bank of America and Wachovia were ranked among the top four most active, it said.
Credit default swaps were seen as easy money for banks when they were first launched more than a decade ago. Reason? The economy was booming and corporate defaults were few back then, making the swaps a low-risk way to collect premiums and earn extra cash. The swaps focused primarily on municipal bonds and corporate debt in the 1990s, not on structured finance securities. Investors flocked to the swaps in the belief that big corporations would seldom go bust in such flourishing economic times.
The CDS market then expanded into structured finance, such as CDOs, that contained pools of mortgages. It also exploded into the secondary market, where speculative investors, hedge funds and others would buy and sell CDS instruments from the sidelines without having any direct relationship with the underlying investment. "They're betting on whether the investments will succeed or fail," said Pincus. "It's like betting on a sports event. The game is being played and you're not playing in the game, but people all over the country are betting on the outcome."
Funny how the Fed ended up issuing $16 Trillion in TARP-type Bailout Funds, to deal with the creative "investing" Banks had so cleverly cross-wired away, to the tune of 13T in CDS alone ...
Kind of sounds like the Securities and Exchange Commission (SEC) really wasn't following that 'over-leverage derivative betting-action' all that closely, now were they? Not when the "final-answer payout", can cascade like dominoes, only to fall upon that last player standing. No one wants to get stuck with that "hot potato".
Why Did the Fed Bailout AIG and Not Lehman Brothers?
by Ron Fields, newsflavor.com -- Sept 17, 2008
Today, September 16, 2008, the Federal Reserve Bank “loaned” American International Group approximately $85 billion dollars and giving the government a 79.9% stake in the company. However, earlier in the day, Lehman Brothers filed for Chapter 11 bankruptcy protection after reportedly asking if the Fed would loan to Lehman. What was it about American International Group that inclined the Fed to make such an unprecedented loan to a private company?Nice, imagine you have home-owner insurance and a Tornado wipes out "entire neighborhoods" in your city. But all the local insurers, don't have enough "capital reserves on hand" to rebuild "entire neighborhoods" -- so No One gets rebuilt, and the local insurers, all go Chapter 11. That was the double-barrel AIG threat the Fed was staring down in Fall of 2008.
American International Group is one of the world’s largest insurance companies, insuring risks across a wide spectrum of activities, from property and casualty, to director and officer insurance, to one of the most arcane areas of insurance -- credit default swaps. Although “credit default swaps” does not sound like insurance, it is a type of insurance in which AIG played a large role. A credit default swap is a contract by which one party agrees for a certain payment to accept the risk that another party’s bonds will not default.
That is all a long-winded explanation of a type of insurance, but that does not explain why the Fed opted to bailout AIG and not Lehman Brothers. The reason for the bailout is that the entire credit default system is a large unknown to the Fed, and the Fed fears that if a large credit default player like AIG cannot make good on its swaps, then a lot of bonds will not in reality be insured, and the balance sheets of many large banks holding low-rated bonds will be severely impaired causing any number of large institutions (banks and otherwise) to suddenly become insolvent. The Fed feared that a credit default meltdown could meltdown the entire financial system and cost the Fed many multiples of $85 billion.
The credit default market is not organized on any exchange. Each arrangement is unique and structured privately. Often the counterparty risk assumed in a credit default swap is swapped again to another party or broken up and swapped out to multiple players, kind of like reinsurance. The only problem is that no one has a handle on exactly how much exposure exists in the credit default market. The risk is that as one follows the trail of swaps, the last man standing will not have the capital to honor the swap agreement, and that will put the swap holder and the swap maker both into default
Read what this SEC Chairman said about these flaky CDS insurance policies, not too long after that; he kind of spills the beans, about these 'poison pills' that were/still are contaminating the entire financial system. Ooops ...
Everything You Wanted to Know about Credit Default Swaps--but Were Never Told
by Peter J. Wallison -- AEI Online (December 2008)
Nevertheless, Securities and Exchange Commission (SEC) chairman Christopher Cox was quoted in a recent Washington Post series as telling an SEC roundtable: "The regulatory black hole for credit-default swaps is one of the most significant issues we are confronting in the current credit crisis . . . and requires immediate legislative action. . . . The over-the-counter credit-default swaps market has drawn the world's major financial institutions and others into a tangled web of interconnections where the failure of any one institution might jeopardize the entire financial system." [...]"inaccurate credit models" ... "faulty credit evaluation" ... Well, isn't that special?
The fact that AIG was rescued almost immediately after Lehman's failure led once again to speculation that AIG had written a lot of CDS protection on Lehman and had to be bailed out for that reason. [...] As outlined in a recent Washington Post series on credit risk and discussed below, AIG's exposure was not due to Lehman's failure but rather the result of the use (or misuse) of a credit model that failed to take account of all the risks the firm was taking. It is worth mentioning here that faulty credit evaluation on mortgage-backed securities (MBS) and collateralized debt obligations (CDOs) have also been the cause of huge losses to commercial and investment banks.
The failure of one CDS Bank could cause a chain reaction, that brings them all down!?
What are they "backing their Bonds with" anyway, besides their Corporate logos? ... and their AIG Insurance?
Well, some post-mortgage-meltdown Laws were passed; exceptions and exemptions were granted, of course. Such is the currency of a Senator.
No Way were the multi-armed
Bandits Banks going back to that dingy Glass-Steagall cage. Not when there were still kingdoms and villages, for them to conquer ... to capitalize ... to commoditize.
The Dodd-Frank Wall Street Reform and Consumer Protection Act:
Issues and Summary
by Baird Webel, Coordinator Specialist in Financial Economics
July 29, 2010 -- Congressional Research Service
Policy Issues 
The Commodity Futures Modernization Act of 2000 (CFMA) largely exempted swaps and other derivatives in the OTC market from regulation. The collapse of AIG in 2008 illustrated the risks of large OTC derivatives positions that are not backed by collateral or margin (as a central clearing house would require). If AIG had been required to post margin on its credit default swap contracts, it would not have been able to build such a large position, which may have reduced the threat to systemic stability and resulting a costly taxpayer bailout. Such disruptions in markets for financial derivatives during the recent crisis led to calls for changes in derivatives regulation, particularly in the OTC market.
Derivatives reform focused on requiring the OTC markets to adopt features of the regulated markets, including mandatory clearing through derivatives clearing organizations, trading on exchanges or exchange-like facilities, registration of certain market participants, and the like.
Provisions in the Dodd-Frank Act (Titles VII and XVI)
The Dodd-Frank Act mandates centralized clearing and exchange-trading of many OTC derivatives, but provides exemptions for certain market participants. The act creates a process by which federal regulators (either the [Commodity Futures Trading Commission] CFTC or the SEC) will determine which types of swaps and security-based swaps will be subject to the clearing requirement. It also requires reporting of all swaps and security-based swaps, including those that are not subject to or are exempt from the clearing requirement, to regulated entities or to regulators themselves. The act requires regulators to impose capital requirements on swap dealers, security-based swap dealers, major swap participants, and major security-based swaps participants. The CFTC is to regulate “swaps,” which include contracts based on interest rates, currencies, physical commodities, some credit default swaps, whereas the SEC will have authority over “security-based swaps,” including other credit default swaps and equity swaps. Both agencies will be given the power to promulgate rules to prevent the evasion of the clearing requirements created by the act.
30) For more information, see CRS Report R40965, Key Issues in Derivatives Reform, by Rena S. Miller.
31) P.L. 106-554, 114 Stat. 2763.
32) Dodd-Frank Act § 723 (swaps) and § 763 (security-based swaps (SBS)).
33) Contracts with a large number of underlying securities will be swaps; contracts based on single securities or narrowbased security indexes will be security-based swaps.
SOoooo, the Commodity Futures Trading Commission (CFTC) was granted the Exception-fulfillment-authority to put
Here's what they finally DID ... a rather mild, paper-tiger attempt, to re-cage the commercial banking investment fervor, that the Phil Gramm coalition unleashed upon the masses:
CFTC unveils new oversight regime for swap trading platforms
US regulators unveiled a proposed new oversight regime for the trading of swaps yesterday that aims to shed light on how those financial instruments are priced and could lead to major changes in the industry.
by Sarah N Lynch, Dow Jones Newswires -- Dec 10, 2010
[...]Hey CFTC, Where are the "essential" CDS capitalization-backed "margin requirements" that will prevent another CDS meltdown-avalanche from reaching such threatening levels, like they did throughout the entire last decade? This plan, kind of sounds like Deja-Vu all over again.
The law requires that standard swap contracts traded between major players such as banks are executed on trading platforms. The swaps can be traded on a traditional futures exchange like those run by CME Group. But the law also provides for an alternative kind of platform known as a swap execution facility, or SEF. These platforms are meant to be used by institutional investors to help match buyers and sellers.
To address these concerns, the CFTC yesterday proposed allowing SEFs to offer three different kinds of trading models that can only be used in certain cases. But it's possible the industry may see the CFTC's proposal as too strict -- especially because it would force at least some companies to change how they do business.
If a swap is traded 10 times a day or more, it would need to be traded on a SEF model that most closely resembles an exchange and has a central order book open to all market players.
If a swap doesn't have sufficient trading volume and isn't an overly large trade, then it could be executed on a second kind of SEF model that offers a so-called "transparent request for quote system." This system would be different from what some companies have in place today, a CFTC staffer told reporters late Wednesday. While some firms now only allow customers to submit quote requests to a handful of dealers, this new model of trading wouldn't let them limit how many companies can see the quote.
The CFTC's proposed rules also create a third kind of SEF category that can be used to execute illiquid swaps, swaps not covered by the CFTC's clearing and trading rules, or block trades -- large trades executed away from the public marketplace. This kind of SEF would allow for voice brokering or for the use of a limited request for quote model in which only a small group of market participants see the quote.
The rules also lay out various other requirements for an SEF to operate, including registration rules and 15 core principles they must follow.
Sounds like, Virtual Risk is still being virtually traded -- just with a little more visibility this time around. But for visibility to work, watchmen still need to be watching. Over leveraging the Swap Insurer's meager capital, must still be avoided. Tornadoes, like credit-defaults, are bound to happen ... That's why someone bothered to invent Insurance, in the first place!
Where is the Threshold that says: "THIS MUCH of offloading of this Virtual Risk" -- is really TOO much?
FLASH-trade-forward to the near-collapse of the Euro-Markets, that we saw the 1% Lemmings all fleeing, as recently as last week ...
17 Countries, but Even More Unknowns
by Gretchen Morgenson, NYTimes -- October 8, 2011
As the situation in Europe deteriorates, our own financial institutions are coming under growing scrutiny from investors. American banks have made loans to European ones. Some have also written credit insurance on the debt of European institutions and troubled nations like Greece. So if a default were to occur, some banks here would be on the hook.
Whatever the case, American banks have been writing more credit insurance lately. As of the end of June, some 34 federally insured commercial banks had sold a total of $7.5 trillion of credit protection, on a notional basis, according to the Comptroller of the Currency. That was up 2.3 percent from the end of March.
For investors, the challenges in trying to assess the true exposures are real. Many of the risks in these institutions are maddeningly hard to plumb, and open to a range of interpretations. The fact is, investors must deal with significant gaps in the data when trying to analyze a bank’s exposure to credit default swaps. Even the people who set accounting rules disagree on how these risks should be documented in company financial statements.
A recent report by the Bank for International Settlements noted: “Valuations for many products will differ across institutions, especially for complex derivatives which may not trade on a regular basis. In such cases, two counterparties may submit differing valuations for valid reasons.”
Investors, therefore, have to trust that the institutions are being appropriately rigorous.
Just trust them -- yeah right! Just trust the 7.5T credit-swaps they have racked up again.
What were reasons we needed the Glass-Steagall Act in first place, again?
Haven't we EVEN MORE reasons, now -- given the Systemic near-collapse of our Economy, that the Gramm-Leach-Bliley experiment, has just put us through?
It seems Our Trust has become just another "tradable commodity" just like so much else, in today's modern world; thanks to those "unplumbable valuations" that our Deregulatory visionaries have bestowed us ...
For those not lucky enough to be born into the 1% (or not heartless enough, to have clawed your way into to it) -- inherit the whirlwind my friends; inherit that invisible "free market" wind ... the risk is exhilarating, if it doesn't wipe out your neighborhood first ...