Many warned deregulation would cause financial crisis & taxpayer bailouts

Many smart people warned against financial industry de-regulation and predicted the consequences in starkly accurate terms.

A decade ago, many warned against the 1999 Financial Services Modernization Act, which allowed financial institutions to grow too-big-to-fail, unregulatable, and inscrutible. And 15 years ago, the General Accounting Office (GAO) warned that failure to regulate the derivatives market could force “a financial bailout paid for by taxpayers.”

In 2000, Ralph Nader predicted this crisis.

Two years earlier, in 1998, the late, brilliant Molly Ivins warned against passage of the Financial Services Modernization Act, predicting that massive financial institutions (like AIG) might take on excessive risk and require taxpayer bailouts:

Watch the House pass a bad bill. Watch the Senate make it worse. Watch the banking industry dig its own grave. Watch supposedly smart people set up a financial disaster. Can we see President Clinton veto this mess? Veto, Clinton, veto.

Not since Congress passed the Garn-St. Germain bill in 1981 – the one that deregulated the S&Ls and unleashed a half-a-trillion-dollar disaster, which the taxpayers of this country wound up paying for – has there been a move to match this for pure folly.

In May, the House passed (by one vote) a bill to eliminate barriers between banks, brokerage firms and insurance companies. This sets up financial holding companies that can offer all three types of services simultaneously. The most obvious risk is that a blunder in the insurance or brokerage end of the business could bring down a bank, putting insured deposits at risk. The taxpayers, of course, then wind up with the tab, as we did with the savings-and-loan mess.

In 1999, Senator Byron Dorgan predicted that passage of the Financial Services Modernization Act could lead to “massive taxpayer bailouts”:

This bill will also, in my judgment, raise the likelihood of future massive taxpayer bailouts. It will fuel the consolidation and mergers in the banking and financial services industry at the expense of customers, farm businesses, family farmers, and others, and in some instances I think it inappropriately limits the ability of the banking and thrift institution regulators from monitoring activities between such institutions and their insurance or securities affiliates and subsidiaries raising significant safety and soundness consumer protection concerns.

Sen. Dorgan and the late, great Sen. Paul Wellstone expressed grave concern about dismantling financial regulations put in place to prevent another Great Depression. Sen. Dorgan even predicted the time frame to within a year:

“I think we will look back in 10 years' time and say we should not have done this but we did because we forgot the lessons of the past, and that that which is true in the 1930’s is true in 2010,” said Senator Byron L. Dorgan, Democrat of North Dakota. “I wasn’t around during the 1930’s or the debate over Glass-Steagall. But I was here in the early 1980’s when it was decided to allow the expansion of savings and loans. We have now decided in the name of modernization to forget the lessons of the past, of safety and of soundness.”

You can watch Sen. Dorgan speaking on this issue in 1999 or watch him speaking about it on a recent episode of The Rachel Maddow Show.

Fifteen years ago — in 1994 — a 200-page General Accounting Office (GAO) report called for regulation of the exploding derivatives market, warning that it could result in “a financial bailout paid for by taxpayers”:

This combination of global involvement, concentration, and linkages means that the sudden failure or abrupt withdrawal from trading of any of these large dealers could cause liquidity problems in the markets and could also pose risks to the others, including federally insured banks and the financial system as a whole…

Although the federal government would not necessarily intervene just to keep a major OTC derivatives dealer from failing, the federal government would be likely to intervene to keep the financial system functioning in cases of severe financial stress. While federal regulators have often been able to keep financial disruptions from becoming crises, in some cases intervention has and could result in industry loans or a financial bailout paid for by taxpayers…

The immediate need is for Congress to bring currently unregulated OTC derivatives activities of securities firm and insurance company affiliates under the purview of one or more of the existing federal financial regulators and to ensure that derivatives regulation is consistent and comprehensive across regulatory agencies…

GAO also recommends that Congress systematically address the need to revamp and modernize the entire U.S. financial regulatory system. Gaps and weaknesses in OTC derivatives regulation clearly demonstrate that the existing regulatory structure has not kept pace with the dramatic and rapid changes in the domestic and global financial markets that have occurred over the past several years.

The Columbia Journalism Review provides an analysis of this document and the media and financial industry’s reaction to it.

Posted by James on Thursday, March 26, 2009