How Deregulation Gave Way to a Global Financial Collapse
Written By: Cal Burgess, Retirement Servicing Group PLLC
Prior to 1980, there had not been a major financial collapse in the market since the Great Depression. Protective measures had been put in place to help shield investors from heightened periods of volatility.
For example, commercial banks who received deposits for basic checking or savings accounts were prohibited from offering risky investments such as mutual funds. These were the days prior to adjustable rate mortgages and predatory lending. All of these measures were put into place by the Glass Steagall Act of 1933, after our country survived the Great Depression. At least that’s the way it was until 1980.
In 1980, President Jimmy Carter signed into law the Depository Institutions Deregulation and Monetary Control Act of 1980, the first of two measures put into place that would eventually set the stage for the world’s first global recession. This new act gave unprecedented opportunities to the banking world. The act allowed banks to merge together and took away the restrictions on what a financial institution was allowed to charge as an interest rate.
The act also gave birth to the second mortgage, eliminating the first lien restrictions on mortgages. Furthermore, banks were allowed to pay whatever rate was deemed appropriate by the bank. CD rates offered in the 1980s were exceeding 15 percent, the highest CD rates ever charged in U.S. history.
Additionally, prime rates for mortgages in the 1980s exceeded 20 percent. Many financial professionals today still blame the Monetary Control act of 1980 as a contributing factor for the recession of the 1980s.
Just 19 years later, in 1999, the Graham-Leach-Bliley Act opened the doors to our financial collapse. This act would bring to life total deregulation of the banking industry, the start of the subprime industry, the financial collapse of Wall Street in 2008, and over $3.5 trillion of emergency government intervention.
This was the first step towards the financial implosion of the Euro and the inevitable collapse of Greece. The Graham-Leach-Bliley Act of 1999 changed our financial world forever. Sens. Phil Gramm, Jim Leach and Thomas Bliley passed a law in 1999 that allowed securities firms, investment banks, commercial banks and insurance companies to consolidate. This law allowed four powerhouses to form (Citigroup, Travelers, Primerica and Smith Barney); which was previously prohibited by the Glass Steagall Act of 1933.
Additionally, officers were allowed to serve on multiple boards simultaneously. The general consensus before this change was to separate banking services, insurance services and securities services, as it was deemed a conflict of interest to combine these services.
With the federal deregulation brought by the Monetary Control Act of 1980 and the Graham-Leach-Bliley Act of 1999, all financial services could be offered simultaneously without any restrictions on what interest rates could be charged or how the mortgage loans were underwritten. Basically, any U.S. citizen or U.S. resident over the age of 18 could qualify for a mortgage loan with no money down, regardless of whether or not they were able to repay the loan.
Banks were able to offer these products by consolidating subprime mortgage loans, credit card debt and other debt obligations into collateralized debt obligations. By using this approach, banks could rid themselves of any liability or chance of default simply by not servicing the loan.
They would instead sell it to Wall Street as a CDO. When the subprime loans started to default, the investor bore all the risk, not the bank that issued the mortgage loan. Investment banks were able to do this by paying rating agencies such as Standard and Poor’s and Moody’s in return for favorable investment ratings of these CDOs.
The high ratings of the CDOs spurred a rally in the market and ultimately led to hyper-inflated home values. Because the CDOs were highly rated, demand for these products skyrocketed. Since higher demand ultimately lead to higher pricing, loans became easier to approve and resulted in stretched home values; otherwise known as “loose-value appraisals.”
The thought process was: The higher the home value, the more interest earned, thus higher profits stemming from these CDOs. This practice caused home values to increase on a national level, otherwise known as “artificial inflation.” Furthermore, over 90 percent of these mortgage loans, due to the deregulation of the banking industry, were adjustable rate mortgages. These types of mortgages would cause the interest rate to jump significantly, typically between the second and 10th year of the 30-year loan, and essentially made the payments impossible to repay for many borrowers.
The inevitable default of these CDOs caused a complete collapse of the banking industry in 2008, spurring an emergency bailout of more than $800 billion from the federal government. Because these investment banks were able to leverage their assets by over a 30:1 ratio, the government had to bail out many investment banks and Lehman Brothers was forced to claim bankruptcy due to an inability to pay.
These CDOs fell from the highest ratings to some of the lowest ratings within a span of a couple of weeks, causing the integrity of our top rating agencies to be questioned. Year to date, over $3.5 trillion has been pumped into our free market thanks to the financial collapse of the banking industry. And we can’t forget about the millions of homes that were foreclosed on and the implosion of Fannie Mae and Freddie Mac.
Today, Wall Street still adamantly opposes regulation; and many of the same people who helped contribute to our financial collapse on a global level are still in power. In fact, many of these individuals were able to walk away from their bankrupted companies with up to hundreds of millions of dollars, all while many portfolios and retirement plans were completely destroyed.
For these reasons alone, many investors are looking into safe money solutions such as fixed indexed annuities and indexed universal life, in order to rid themselves from heightened periods of volatility. Investor fears are on the rise and many financial advisors are struggling to provide adequate recommendations simply because of the federal bailout, which is causing dynamic shifts in the market place, thus changing all the rules. Added to which, many top Wall Street firms have announced layoffs up to and over 10 percent in order to prepare for extended periods of volatility in anticipation of decreased revenue.
In today’s financial arena, the threat of quantitative easement three and the inability of our country’s leaders to resolve our mounting debt (not to mention the crisis in Europe) is disconcerting to many investors and/or retirees, fueling the need for safe money havens.
These safe money solutions are now being integrated by several Wall Street firms; and yes, the same firms that adamantly opposed these products in the past. In the finance world, adaptation to differentiated products can be a major key to survival. Millions of investors today are welcoming these safe money solutions with open arms, either for lifetime guarantees or a temporary alternative to a volatile market.
Through financial guarantees such as lifetime income and eliminating all market exposure, these products will continue to thrive for generations to come. Although these products are not for everybody, they provide guarantees absent in many portfolios today providing sleep insurance, a cure for investor insomnia.