Beginning of the End? 1998 Citicorp and Travelers agree to combine two companies. Financial times labeled “a merger that redefines world finance Merger required repeal of Glass-Steagall Act Citi spent millions in lobbying for change Growing support in Academia and most importantly with Fed chief Alan Greenspan 1999 Congress passed the Gramm-Leach-Bliley Which repealed the Glass-Steagall Act of 1933
More of the Beginning of the End ? Bear Stearns, Merrill Lynch, Lehman Brothers, Morgan Stanley and Goldman Sach ask and receive increase in leverage above 12x capital Decision not made in a vacuum Granted US international banks right to leverage up to compete with dominating European international banks Hedge funds add to problem
Mortgage Loan and S&L History ***Savings & Loans Banks (S&L) “infected” by financing long term mortgages with short term deposits*** 1960’s Regulation Q Govt. set Savings and Certificate of Deposit rates 1970 Rule change - S&L’s to become Real Estate Developers 1980 S & L s went broke – took 20 years
Freddie Mac & Fannie Mae systems are the answer to the S&L interest mismatch problem
Good idea –
Relief of interest rate mismatch in S&L industry (buying and selling of MBS in the open market) Should be government regulated not government operated!
Freddie Mac and Fannie Mae unforeseen consequences Effect of Common and Preferred Stock Purchase by Federal Savings Banks Allowed to purchase w/o limitations Political (govt.) agenda – homes for everyone!
Market Engineering the real collapse Credit Default Swaps Bucket shops/gambling on the stock market Subprime Loans to individuals that couldn’t afford them MSB (mortgage back securities) Pooled security – secured by individual mortgages CMOS (Collateralized Mortgage obligation) Pooled security – secured by commercial mortgages ARS (Auction Rate Securities) debt instrument (corporate/municipal bonds) with a long-term nominal maturity – interest rate regularly reset via a Dutch auction
The contributing Factors Excessive Leverage Leveraged investors can not survive a sharp drop in asset prices Volatility Widespread Product confusion ARS (Auction Rate Securities) MSB/CMOS (Mortgage Backed Securities) Subprime (loans/mortgages) No regulator controls CDS (Credit Default Swaps)
Accounting Fair Value Accounting – allows banks to manipulate balance sheet through continued acquisitions – not holistic growth.
Wachovia 50% + of equity attributed to good will
Regions Bank 59% of equity attributed to goodwill
Accounting should be reality (cost and cash flow) not theory
From inflation to deflation Deleveraging means less credit available Deflation seed sowed when external credit markets dried up Inflation comes from to much credit available Inflation caused by excessive credit creation outside commercial banking Fed gave up control of the banking system No opposition to repeal of 1907 and 1933 acts Explosive growth in non-banking lending UPS (united Parcel Service) making SBA loans