The Perfect Storm
Let us retrace the steps that led to the meltdown that occurred in 2008. This will make an interesting case study. After this meltdown in 2008, everything changed. Everything has really been a series of dominos. When one domino falls, it hits another tipping it over as well. Let us go back to the beginning.
In the 1980s investment banks went public. This brought major money to the markets for investing. Deregulation of the savings and loan institutions in 1982 led to bad investments. The Depository Institutions Deregulation and Monetary Control Act of 1980 and the Garn-St. Germain Depository Institutions Act of 1982 was the path to deregulation. The deregulation not only allowed thrifts to offer a wider array of savings products but also significantly expanded their lending authority. They began to invest in real estate ventures. Most of these investments were designed to be tax write-offs. This led to a real estate boom in the early part of the 1980s.
The Tax Reform Act of 1986 significantly decreased the value of many such investments, which were held more for their tax-advantaged status than for their inherent profitability. This contributed to the end of the real estate boom of the early to mid-1980s and facilitated the Savings and Loan crisis.
Prior to 1986, passive investors did much of the real estate investments. It was common for syndicates of investors to pool their resources in order to invest in property. This applied to commercial or residential properties. They would then hire management companies to run the operation.
TRA 86 reduced the value of these investments by limiting the extent to which losses associated with them could be deducted from the investor’s gross income. This, in turn, encouraged the holders of loss-generating properties to try to unload them, which contributed further to the problem of sinking real estate values.
In the 1980s, Keating ran American Continental Corporation and the Lincoln Savings and Loan Association. He took advantage of loosened restrictions on banking investments. His enterprises began to suffer financial problems and federal regulators investigated Keating.
His association with five U.S. senators due to financial contributions brought help from these senators. These Senators argued for preferential treatment from the regulators, which led to them being dubbed the Keating Five. When Lincoln failed in 1989, it cost the federal government over $3 billion dollars and about 23,000 customers were left with worthless bonds.
Deregulation continued during the Clinton administration too. Larry Summers served as the US Secretary of the treasury between 1999 and 2001 under Clinton. During this time, he was most noted for his support in getting the Gramm-Leach-Bliley act through congress. This repealed the Glass-Steagall Act that passed in 1933 after the great depression started. This was the final capstone in removing all regulations from the bankers.
This helped pave the way for the market manipulation to come as big banks pulled the strings. By the late 1990s, Big Banks began to merge. In 1998, City Group merged with Travelers to form Citicorp. This was illegal under the Glass-Steagall Act, but they were given a year pass until the Gram-Leach Bliley bill could be passed. This act is also known as the Financial Services Modernization act. By the end of the Clinton administration, there were major players and monopolies.
Once total deregulation was accomplished, Investment banks came up with a new group of products known as derivatives.
Larry Summers and Alan Greenspan (chairmen of the Federal Reserve) fought the regulation of derivatives. Brooksley Born tried to regulate the market. Larry Summers and Alan Greenspan shut her down with the aid of congress. The Commodity Futures Modernization Act shut down any regulation. By 2003 derivatives in the US were a 56 trillion-dollar market!
By the time George W Bush took office, there was a major financial powerhouse in play. There were two financial conglomerates. (Citicorp, J.P. Morgan) There were three Insurance Securities companies. (AIG, MBIA, and AMBAC) There were five major investment banks. (Goldman Sachs, Morgan Stanley, Lehman Brothers, Bear Stearns, and Merrill Lynch) There were three Rating agencies. (Moody’s, Fitch, and Standard and Poor’s)
A Securitization food chain linked everything together
HOME BUYERS–MORTGAGE LENDERS–INVESTMENT BANKS–INVESTORS.
Before deregulation, mortgage banks made loans for housing. People paid the lender back. Because the bank would be on the hook for the loan, they were very careful about who was receiving the loan. They were very cautious about making loans.
After deregulation and under the new system mortgages were sold to investment banks. Commercial mortgages, corporate buyout debt, home mortgages, car loans, student loans, and credit card debt all combined to create something called Collateralized Debt Obligations or CDOs. Investment banks sold these CDOs to investors all over the world. The investment banks paid the rating agencies to rate these loans. CDO’s were given a triple-A rating, (AAA) the highest rating available. They got these ratings because security insurance companies like AIG insured all CDO’s.
Because investment banks sold these CDOs to investors, now when you paid your mortgage it bypassed the lender and the investment bank and went straight to the investor. Since mortgage companies were no longer on the hook for the loans it granted to consumers, anyone could get a loan. Since investment banks needed CDOs to sell to make profits, it did not care who received these loans.
The rating companies received money to rate these CDO’s. They were paid by the investment banks. The rating companies gave the CDO’s the highest rating. Since retirement accounts like 401k, 401b, and pension funds could only hold securities with the highest rating, a lot of CDOs made their way into these retirement funds. Predatory lending became a common practice to produce even more CDOs for an ever-growing market demand.
Even though these CDO’s were insured, they were very risky. The problem was anyone could take a policy out for any CDO they wished. That meant that companies like AIG would make higher profits from premiums made on the same CDO. You could not have 20 people insure the same house, but you could have 20 people insure the same CDO. This created a market manipulation that valued some CDOs higher than others.
On October 14, 2004, the New York State Office of Attorney General Eliot Spitzer announced that it had commenced a civil action against Marsh & McLennan Companies for steering clients to preferred insurers with whom the company maintained lucrative payoff agreements, and for soliciting rigged bids for insurance contracts from the insurers. The Attorney General announced in a release that two AIG executives pleaded guilty to criminal charges in connection with this illegal course of conduct. In early May 2005, AIG restated its financial position and issued a reduction in book value of USD $2.7 billion, a 3.3 percent reduction in net worth.
On February 9, 2006, AIG and the New York State Attorney General’s office agreed to a settlement in which AIG would pay a fine of $1.6 billion.
In 2007, the housing market began to show signs of cracks. Predatory lending was beginning to come back and haunt the industry. In 2008, everything began to collapse. The whole economy began to meltdown. Higher gas prices fueled the fire creating a domino effect almost as if someone was orchestrating this from behind the scenes.
Then in September of 2008 the major investment bank, Lehman Brothers filed bankruptcy. Bankruptcy laws are different around the world. The global corporations that failed had different impacts around the world. In London Lehman had to completely close its doors the very day it filed bankruptcy. Jobs in England immediately vanished.
By the time the dust cleared 50 million people fell below the poverty line. 30 million people were unemployed. Lehman Brothers was gone, Bank of America purchased Merrill Lynch, and J.P. Morgan-Chase purchased Bear Stearns. Bankruptcies in 2008 shot up 32 percent from the previous year. The greatest recession to ever hit America was now in full swing.
A lot of money vanished because of this crash. As debts were canceled through bankruptcies and housing markets readjusted their perceived values, the money supply drastically fell. CDO’s were nothing but debt and most of these so-called assets were junk. This is what happens when monetized debt and perceived wealth is readjusted and packaged as investments. Adding insult to injury credit was severely tightened creating an even harder environment for recovery.
For those who don’t know, a reserve currency is a currency that other nations keep in their central bank as a means to back and give value to the currency they distribute. Right now the dollar is king. There is some speculation that all the currencies will reset in one global currency reset event. While there are changes coming to the international community, I view this as highly unlikely. There are a lot of reasons for this.
Most people have no idea how bad things are. The financial crisis of 2008 brought about a forced awareness about global debt and how debt is used to enslave people. Before this most people could not grasp what a trillion dollars even looks like let alone how big the nation’s debt is.
A bigger problem than this is world debt. Costs for international conflicts and world debt is causing even bigger problems for our currency. As the US dollar is used to finance global obligations world debt rises. This will keep going until we see a crash of a system that is no longer sustainable by any means. Ultimately this may mean the end for the US dollar as the main world reserve currency. Great debate has surfaced as to what will replace it. The next series of links provide some great observations.
When debt is monetized and the currency supply grows, inflation absorbs the currency’s value. Whenever currencies are inflated through an ever-growing money supply it is always hardest on the poor. The 2008 meltdown robbed the middle class and the poor of wealth. The debts that were canceled also represents money that was removed from circulation.
As a result of the canceled money supply, the Federal Reserve started their Quantitative Easing program. The idea was to make up the portion of the expanded money supply that was lost due to canceled debt by expanding the base currency supply. Unfortunately, this is not without consequence.
Since the majority of our currency is overseas and since the demand for currency remains strong, we have not felt the drastic effect of inflation yet. Many other nations were affected by this meltdown. It was a global meltdown but in the end, it was the deregulation policies put into effect by the United States that did the damage world-wide.