1. The failure of the Federal Reserve Board, the FDIC, the OTS and the DOJ to regulate the subprime mortgage originators and to impose more detailed and informative disclosure statements on the ARMS and Option ARMS. If many of these exotic loans had been classified as consumer products, they would have been banned by the Consumer Products Safety Commission. The failure of the SEC to adequately investigate any of the regulated enterprises under its jurisdiction was also a substantial factor with the Bernard Madoff case being Exhibit Number One.
2. The failure to increase and enhance financial market regulations after LTCM. Long-Term Capital Management was a hedge fund that blew up in 1998 after losing $4 billion investing in complex derivatives, necessitating a federal bailout. A movement quickly began to regulate derivatives like mortgage-backed securities through the Commodity Futures Trading Commission, but then-Fed Chairman Alan Greenspan, then-Treasury Secretary Robert Rubin and others blocked those efforts, which helped set the stage for the 2008 meltdown. And, Greenspan was also a strong advocate for the ARMS and Option ARMS mortgage products.
3. The repeal of the Glass-Steagall Act. In 1999, Congress repealed the Glass-Steagall Act of 1933 after the financial services industry gave more than $80 million in campaign contributions to members of Congress on both sides of the aisle. Former Senator Phil Gramm of Texas led the supporters of the repeal efforts. The repeal eliminated the separation of commercial and investment banking mandated after the Great Depression. This allowed big banks to get even bigger and subjected depositors to the risk of a whole new array of speculative investments, such as MBS and other derivatives.
4. The failure to create any type of regulatory structure to deal with the credit-default swaps and other forms of derivates that created trillions of dollars of contingent liabilities.
5. The failure to rein in Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac were private companies backed (and now owned) by the federal government that buy and then securitize home mortgages from lenders who originate them, thus providing liquidity to the U.S. mortgage market. These companies also created, sold and invested in billions of dollars of MBS and, more than any other player, fueled the MBS market. In 2005, after an accounting scandal at the companies, Congress sought to more closely regulate Fannie Mae and Freddie Mac and prohibit them from owning MBS. The bill failed to pass. Fannie Mae and Freddie Mac then increased their costly participation in the MBS market, which eventually led to their takeover by the federal government.
6. The SEC let banks pile up new debt. In 2004, the five largest Wall Street investment banks convinced the SEC to exempt their brokerage units from an old regulation (the "net capital rule") that limited the amount of debt they could take on. This unleashed the Wall Street firms to borrow billions of dollars to invest in MBS, credit default swaps and other risky, exotic securities. Bear Stearns, for example, was leveraged 33 to 1 when it melted down — for every $1 in capital it had $33 in debt. Lehman Brothers' $613 billion in debt made its bankruptcy the largest in U.S. history —10 times larger than Enron.
7. The abuses of the Community Reinvestment Act. Congress passed the Community Reinvestment Act in 1977, and revised it in 1995, to encourage banks to make home loans to lower-income customers, in part to expand home ownership. The intentions were good, but abuses led to unsafe lending practices, which led to many defaults and contributed to the 2008 credit market meltdown. Many of the subprime originators used the Act as cover to make hundreds of thousands of loans that they knew the consumers could not pay once the first reset date occurred.
About the Author: O. Max Gardner III has been a licensed attorney in North Carolina 1974 and is a member of of the National Association of Consumer Bankruptcy Attorneys. Mr. Gardner is AV Rated with Martindale Hubbell and is frequently a featured speaker on Consumer Bankruptcy Law at numerous National and Local Bankruptcy Seminars and Conferences.
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