Where this economic crisis came from
Lax regulation of a "shadow banking industry" is cited

Highlights and [bracketed comments] added

Over the past three decades, there has been a sea change in the way that credit is extended in America, creating the problems -- and the need for reforms -- that we face today.

At the heart of the financial crisis lie the complex, opaque derivative securities created not by traditional Main Street banks but by Wall Street, and with the passive complicity of regulators. 

Wall Street created, originated and sold an alphabet soup of derivative securities, and it was such synthetic instruments -- not traditional mortgage loans, small-business loans or other standard lending originated by banks -- that unleashed a flood of credit, created a vast excess of housing, weakened the capital structure of the banking industry and undermined popular confidence in banks. 

In previous generations, home buyers obtained mortgages and other loans from local, or Main Street, banks, which typically held those loans until they were fully repaid -- and therefore had an interest in making loans that borrowers could afford. 

But then Wall Street started slicing, dicing and packaging mortgages into bundles that served as the basis for bonds sold in the securities markets. Traditional bank deposits were no longer the primary funding source for credit. Instead, loans were being financed by the capital markets and packaged and sold by Wall Street. Mortgages were originated by one firm, packaged by another, sold by a third and serviced by yet another -- but none of them worried about whether the mortgages would be repaid, because they didn't hold the loans on their books.

[HOT: The blaming of Wall Street overshadowed a major contributor to the collapse - vertically integrated volume homebuilders that offered mortgage, title and insurance services. Their financial services competed with banks, but they weren’t held to the same standards as banks, and they weren’t regulated. With a profit motive and the sale of homes on the line, many of them relaxed lending standards, artificially inflated appraisals, used substandard construction materials and labor, and concealed defects and building code violations through sweetheart deals with favored inspectors.] 

Securitized debt grew nearly 50-fold from 1980 to 2000 -- compared with a mere 3.7-fold increase for bank loans. In 1998, traditional bank lending was surpassed by securitized debt for the first time. By the end of 2007, Wall Street accounted for two-thirds of all private U.S. debt. This growing market for synthetic mortgage-backed securities inundated the country with credit that, combined with historically low interest rates and exotic new mortgage products, fueled the housing bubble and turned our financial markets into a virtual casino. In the collapse that followed, billions of dollars' worth of mortgage-backed securities were written off.

But the public continues to think of banks as the primary source of credit -- and to blame banks for the credit crunch. Public officials contribute to the confusion by criticizing banks -- while allowing Wall Street to operate this "shadow banking industry," which exists outside the standards for safety and soundness that apply to banks and without obligation to make clear the extent of such firms' debt, leverage, capital or reserves.  

[HOT: Lewis Spellman, a University of Texas professor and economist who once worked for the Federal Reserve, spoke to a group of futurists about why economists missed the financial collapse, giving us a new perspective. He developed the tool that the Feds used for decades to control inflation and guard against a runaway economy by managing the availability and cost of capital. He told us that the collapse was bound to happen because of outsourcing to the Asia and the huge amount of money being poured back into the U.S. So much money was invested here by China that it dwarfed what the Federal Reserve had available, and the Fed lost its ability to control the runaway economy. Housing seemed like a better investment than stocks, and China bought up many of those mortgage-backed securities. Although housing may not have caused the global collapse, it was the spark. Spellman said any of several other bubbles could have triggered it too, but as it turned out it was housing. We describe this in our white paper, “Texas Homebuilding and the Global Financial Collapse.”] 

Many Wall Street firms played significant and contributory roles in the evolution of this crisis. Wall Street's most prominent investment bank, Goldman Sachs, historically the industry leader, was at the forefront of the creation, origination and sales of derivative securities -- and also spent $40.6 million on lobbying and campaign contributions from 1998 to 2008. In 2008 alone, Goldman spent $8.97 million in this way -- almost 11 percent more than the Financial Services Roundtable, a trade organization that represents 150 top financial institutions.

[HOT: The $40 million spent by Goldman Sachs over 10 years nationally is not that impressive compared to what homebuilder Bob Perry spent in Texas. According to Andrew Wheat of Texans for Public Justice, since 2006 Perry spent “more than $21 million to political candidates and judges - including the nine Republican justices who make up the Texas Supreme Court.” He funded tort reform and even bought his own state agency, the Texas Residential Construction Commission. His political contributions, influence of the Texas legislature, and control of the TRCC successfully protected builders from homeowner lawsuits.] 

The conversion of this investment bank into a giant hedge fund went unchecked by legislators and regulators, despite constituting a radical change to our financial system. And it has received billions upon billions in taxpayer bailout funding to keep it alive.

By contrast, consider how regulators treat Main Street banks compared with the way they deal with this highly connected investment bank: When M&T Bank applied for regulatory approval to acquire a modest-size bank in Utica, N.Y., it took 10 weeks and a promise to divest three branches before permission was granted. When this Wall Street investment house decided to seek a commercial bank charter in the midst of the financial storm, permission was granted in less than a week. 

By obtaining this charter, Goldman Sachs received access to the Federal Reserve Discount Window and the Federal Deposit Insurance Corp., which has long been funded by dues from thousands of community-based banks across the United States -- and which has since guaranteed $28 billion of the investment bank's debt securities. That's equal to 10 percent of all funds guaranteed under the government's Temporary Liquidity Guarantee Program. 

The same could be said of many other large financial firms that are also big spenders in Washington. The 10 largest recipients of federal Troubled Assets Relief Program funds -- including two Wall Street investment banks and three other, non-bank institutions that participated -- spent $82.4 million on lobbying and campaign contributions in 2008 and $523.6 million over the past 10 years. 

This sort of behavior is simply wrong. Corporate leaders have an obligation to set the right tone -- a moral tone -- lest public confidence in our private enterprise system erode. 

Also, we must restore the balance of regulatory oversight between commercial banks and other parts of the financial services industry. We should do so not only to be fair to banks but because the nation's ailments won't be cured unless solutions are directed at the entire financial system, not just one-third of it.

[HOT: We say “Fix Housing First," NOT by artificially stimulating the sale of homes to people who can't afford and shouldn't be allowed to buy them, but by regulating the unregulated and restoring fairness for homeowners.] 

The writer is chairman and chief executive of M&T Bank, one of the 20 largest U.S. bank holding companies.

 Robert G. Wilmers (Chairman & CEO, M&T Bank), Washington Post op-ed column, 07/28/2009
Source: http://www.washingtonpost.com/wp-dyn/content/article/2009/07/26/AR2009072602190.html

SAMPLING OF READER COMMENTS: (most recent first)

anne3 wrote: 

If the best that the "best and brightest" can come up with is to turn mortgages into securitized debt, floating on the giddy hope that housing prices would continue their steep ascent, holding no one accountable for actually having the income to support the loans - then it is no wonder we're spending time in the toilet of a terrible recession, dealing with pipes clogged with toxic assets. 

What Wall Street has handed us is a gigantic fraud, packaged as "capitalism" and that profits only Wall Street. 

Thanks to Wilmers for being open about the issues. So many in Washington and on Wall Street seem uncomfortable with this truth. 

datdamwuf2 wrote: 

One good thing came of the new SEC chairman, their investigations are up 300% and the cases they are bringing far outstrip those brought during the Bush years. Even while the economy was on meltdown, the Bush SEC chairman did nothing to step up enforcement, glad we have some people that care in there now. 

7/28/2009 5:03:04 PM 

Recommend (1) Report Abuse Discussion Policy 

JLaP wrote: 

Quality analysis of how we got to where we are. I'd like to see the author write, from his unique perspective, two companion pieces. The first would give his perspective on the incentive structure that led/allowed and fostered the creation of toxic financial products. The second would lay out the reforms he would propose. 

TheDemocrat wrote: 

The Republicans were in control of The United Sates House of Representatives for 28 years. The current crisis is the direct result of 28 years of rightwing Republican deregulation, corruption and greed which became fatally toxic under Bush/Cheney and the republican congress. 

dbmjd wrote: 

First thought: Thirty years ago a local bank would make a loan, say for a house, at a set rate for a set number of years (say 30 years). That did not work for the reason that there was no long term deposit base to keep a constant profit nor a way to hedge in the event of skyrocketing rates. (like the 80's) A way to hedge the banks risk needed to be invented. Securitization was a reasonable method. The way it was executed by the industry was unregulated and failure resulted. There is still a need to have a regulated method to originate the loan and hedge the interest rate risk. 

Second thought: I applied for a job at a firm that originated mortgages. During my interview I had it explained how the business worked. My question was. Isn’t that illegal? The prospective employer answered "that's the way it’s done." The whole industry, from originator, to bank or savings & loan to the firms that sold the security were all crooks.

We need to regulate financial institutions so that they behave in the manner that gives value to the nation and to the customer. The institutions will always be able to profit from the spread and should be allowed to. They should not be allowed to rip off the citizenry with impunity. 

grembacki wrote: 

Gosh, no one still knows how this all happened...try the clowns in Congress and Wall Street who fed them toxic peanuts to see nothing, hear nothing, and do nothing. You got to love Barney and Dodds and Geitner and Summers along with the fright master Paulsen. 

digby2 wrote: 

I'd like to see Goldman's risk profile and mathematics for when they started packaging up sub-primes (most likely more and more towards the end) and selling them as high grade securities. How could they have had a model for those since it was a new product and most of those people never qualified for a loan before. I don't think they cared. 

miriamac2001 wrote: 

Where's my pitchfork? 

BruceM1 wrote: 

"At the heart of the financial crisis lie the complex, opaque derivative securities created not by traditional Main Street banks but by Wall Street, and with the passive complicity of regulators" 

--- 

Thank you for hitting it on the head; "with the passive complicity of regulators". Regulators, if they had been doing their job, could have stopped derivatives in their tracks. They didn't. Wall Street got a tool that was too difficult to handle and they eventually broke it. Of course the regulators, i.e. the government, guaranteed (at least partially) some of obscure derivatives, and that means we pay for it. 

But what is governments answer? Capitalism is BAD, it doesn't work; we need more regulation. If this wasn't so tragic, I'd be laughing. For every greedy Wall Street broker put in prison over this, there should be an incompetent regulator there also. 

ripvanwinkleincollege wrote: 

There is not an excess of housing. There is an excess of overpriced housing. Many people still lack affordable housing, and are paying more than 50% of their income in rent or mortgages. In the DC area, this includes unrelated people doubling or tripling up to share apartments, townhouses and detached homes which are affordable to singles or young couples in other regions of the country without such sharing. The government could help by buying raw land or semi-developed land, and then zone it exclusively for apartments and/or low-income townhomes which the private market will not otherwise build. 

paulrcooley wrote: 

"Corporate Leaders", of Wall Street, seem in this case simply to have been pirates. It begins to seem that the entire Federal regulatory enterprise is in over its collective head - in what, I'd rather not say in a public forum. 

digby2 wrote: 

Don't expect the people on Wall Street to do any self-examination of their responsibility for the financial crisis. They don't have a conscience. 

MHughes976 wrote: 

The British Government has, rather cravenly in my view, given up on any idea of breaking up the big banking corporations - though part of the reason is that the cooperation of the US government could not be expected. 

Once gamblers know, even at the backs of their minds, that they will be bailed out they gamble more recklessly. They may not want to have this knowledge but they do have it and it has to influence them. Behind all the talk of financial arrangements so complex that no one could understand their risks lies the fact that the main players did not really need to understand the specific risks of this or that option. All they needed to understand was that they had a ticket which would pay off whichever horse came in first or last. The payers would be the mass of people. 

They'll do it again and next time it will be worse. 

digby2 wrote: 

Didn't the banks design a lot of the mortgage products like teaser rates and other exotic mortgage products? And the banks are all like a bunch of lemmings. But I heard lemmings weren't that stupid. And they knew they had a ready place to sell them on Wall Street or maybe to Fannie and Freddie first. Wall Street thought they could package them up and call them AAA. Freddie and Fannie had very little capital so you know who was going to end up holding the bag- the taxpayers. The quants or whoever on Wall Street who designed all these hybrid products said they couldn't fail. And I am pretty sure that these people never made a mortgage loan in their lives. I guess they just relied on a few assumptions all based on statistics and past history. They probably say now that they didn't know the economy, the housing or mortgage market and unemployment could get so bad. Well you helped to make it that bad. 

[HOT: Speaking of lemmings… When the mortgage arm of vertically integrated volume builders made risky loans and were allowed to resell them as securities, other banks and mortgage companies felt compelled to follow.]

digby2 wrote: 

How much in dues to the FDIC did Goldman pay to get their guarantee of $28 billion? I would be upset if my bank had been paying dues for years and Goldman just steps in and gets $28 billion. And personally I do not expect Goldman to act like a retail or commercial bank in any way as far as safety and soundness. That’s just not what they do or how they operate. And I don't think they care if they help retail customers or care if they help actual communities by making either retail or commercial loans. It’s just another scam. 

RedRat wrote: 

Wall Street has learned the lesson of Las Vegas Casinos. There is an enormous cash flow both coming in an going out, but to get rich all you have to do is skim off a few percentage points from that flow. Both winners and losers pay to play. What a deal. 

jusolart wrote: 

Most thinking citizens have long known that a majority of federal office holders are on the take, and have been for decades. The devil is how to let these folks know that we don't want and won't long endure that kid of misrepresentation. Sigh... 

leedolce wrote: 

Derivative securities, created by Wall Street, with the passive complicity of Government Regulators and the active blessing and support of ALAN GREENSPAN. Let's be sure to mention the FED's role in our recent crisis... and now, their complicity in the doling out of tax payer bailout dollars to the same Wall Street firms that caused the credit crisis in the first place. Ben Bernanke, the New Greenspan... another case of serving Wall Street first, at the risk of taxpayer funds. 

dick-x wrote: 

An additional point: After the financial debacle of the S&Ls in the 1980s, the secondary mortgage market was created in an effort to maintain bank liquidity. It didn't take the banks long to realize they could get rid of the risk implied with any loan by selling ALL mortgage loans to the 2nd mortgage market and make their money with fees. The concept spread. 

Any negative comment in an appraisal was reason to reject that loan from purchase by the 2nd mortgage market. Therefore, only "cooperative" appraisers were used, spreading the fraud further by inclusion. Included in a list of banks personally known to me were Citibank and Marine Midland. So the banks WERE at fault for creating the bad mortgage loans before they went to the secondary market and then on to Wall Street. A pox on the regulators or auditors again. And, I understand, they are still doing it! 

Overdenkotten wrote: 

Boy I really trust a bank CEO telling me about the evils of banking in America. "Don't let Goldman Sachs rip off America guys, let me do it!" 

Wellspring wrote: 

What a disgraceful attempt to revise history. Wall Street and the GSEs did play roles in the mortgage debacle. However their roles were limited to finding ways for banks to offload millions of loans made under the most questionable of circumstances ("liar's Loans") to people who could not afford to repay the loans after artificially low-payment periods expired. The ill-conceived "originate-to-sell" model allowed banks to escape responsibility for loans they knew would not perform satisfactorily to term. With no skin in the game, traditional underwriting gave way to making loans to anyone who could "fog a mirror." For the CEO of a major bank to say otherwise demonstrates that banks have learned nothing from the mortgage crisis and subsequent government bailout. It also puts the nation on notice that this will not be the last bank-caused crisis. 

2009frank wrote: 

Why are American taxpayers concerned, confused and upset? Wilmers blames Wall Street, Banks and credit. Then there are the gazillions of folks who don't make their house payments. So who does the government bail out? Right! Wall Street, banks and the folks who are so irresponsible (or brilliant) that didn't pay their bills. Now you and I are paying the taxes for government to provide the stimulus; and you and I are paying our bills - because we believe that not to do so will result in trouble. All I know is that I have half what I did before Obama/Pelosi/Reid and it appears I will be paying a lot more in taxes for the rest of my life while they enjoy spending other people’s money and getting zero for it. While it is an overused word recently, the response to the financial crisis appears to be very stupid. 

mupright_2000 wrote: 

The whole banking industry needs to new regulations, from the Wall Street banks to the mortgage lenders, to credit card operators, to main street banks. On top of that, they should not be allowed to develop new "financial instruments" until approved for use by the government regulators. 

sasha2008 wrote: 

96,000 JOBS lost at CITI-jobs created by those BUSH TAX CUTS! JOBS JOBS JOBS? BUSH TAX CUTS STILL VALID! 

WHERE ARE THE JOBS? 

Daytona1 wrote: 

Mmmm. Let’s see what has really happened over the last 8 months or so to improve our plight! Nothing! Spin that creates a false picture of unemployment! Spin that creates hope for the future! Tighten your belts America and don't worry that garbage your picking through for the next meal is an illusion! Your friendly banker is trying to get it right again! Right? 

I have consulted for 35+ years in business organization and ethics. I have found that small town banks are the threat to the "to big to fail" which really are "too big to succeed" institutions. All the checks and balances you put into place are mere dreams of illusion. Ethical standards be damned and share holder equity be the guiding moral of the day. Until the "too big to fail" are broken into manageable smaller institutions and become transparent in their operations nothing will change and America will become a third world county quicker than you can say Larry Summers. 

jack_of_hearts wrote: 

This hold up in broad daylight of the American people isn’t over yet. To date Geithner and Bernanke have given the crooks cash equal to over a 100 thousand dollars per taxpayer. The largest transfer of wealth in the history of mankind. 

gitarre wrote: 

It's a bit simplistic to blame Goldman and Wall Street. Remember the S&L crisis? That was a gigantic real estate bubble that burst, along with a massive banking meltdown that included thousands of SMALL banks and savings-and-loans. And all of this BEFORE hedge funds, the new derivatives, and "exotic" mortgages. New regulations? Sure. But how about getting to fundamentals (like excessive leverage) instead of always fighting the last war? 

zcezcest1 wrote: 

One of the biggest problems behind the financial meltdown was the concentration of financial power in too few hands -- too far removed from the communities they serve. The government should have done lots to help the regional banks and local credit unions. The assistance to Wall St may have been necessary. But it’s inexcusable that the large banks are given competitive advantages over the neighborhood banks. This MUST change. 

7/27/2009 1:08:08 AM 

Recommend (3) Report Abuse Discussion Policy 

kylake62 wrote: 

I would say that close regulation must be the order of the day. People who run the financial industry, know how to make things work, to their own well being. Regulators need stay on top of things and stop the Crap. We need people who will also keep tabs on the regulators. As long as there are Bankers and Greed, the people will fall victim to those who are smart and crafty. We need to install a gallows in the main street of every town. We need to use the gallows several times a day. The super intelligent and crafty ones would soon get it right. The average ol' boy does not know on a day to day basis what the hell is going on. The average ol'b oy works, raises a family and flops exhausted at the end of the day, all so a fine tuned thief can take advantage of his labor and his leisure. The smart and informed deceitful one will come to an end, if we the less informed, will demand, justice and truth. The average ol' boy does not understand the ins and outs of the financial market. We only know that they steel from us routinely.