Wall Street's Greed: How to End Big Banks' Grip on the U.S. Economy

by Shah Gilani

Wall Street's Greed: How to End Big Banks' Grip on the U.S. Economy

Guest Editorial by Shah Gilani, Guest Columnist, Investment U

Wednesday, January 27, 2010: Issue #1184

The Founding Fathers' worst fears have come true.

When they settled in America 234 years ago, they were afraid of any concentration of power in the republic. They were particularly afraid that banking interests could hijack our fledgling democracy.

Today, Wall Street's stranglehold on the economy threatens our very prosperity - and the future of a truly democratic republic.

It's time we address the truth about Wall Street's greed and set a course for a more secure economic future - one anchored by a safe banking system, not a system rigged by banks...

The Unintended Consequences of Wall Street's Greed

The credit crisis and "Great Recession" are the unintended consequences of Wall Street's greed.

I say "unintended consequences" because - let's face it - Wall Street institutions tipped over their money pot and bankrupted the public casino they had created to leverage bets with house money.

  • It all started with the Community Reinvestment Act of 1977 (CRA). This legislation was designed to prohibit discrimination on the basis of race, sex, or other factors in the credit and housing markets. But this eventually led to lax mortgage underwriting standards.
  • In 1999, it wasn't just the Democrats, or President Bill Clinton, who pushed for an expansion of and greater reach for the CRA.
  • In 2002, it wasn't just the Republicans or President George W. Bush who advocated easier documentation terms for homebuyers.
  • And it wasn't just the Democrats and Republicans who pushed for Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) to package and buy trillions of dollars of low-quality, mortgage-backed securities.

However misguided they might have been, these policies were all well intentioned. But each of them had unintended consequences. And Wall Street's absolutism made sure these "consequences" could be shaped into a giant moneymaking scheme.

Consider the truth about the subprime mortgage mess...

The Banking Sector Hits the Real Estate Market

After Wall Street pumped and dumped tech stocks on an unsuspecting American public - resulting in the "tech wreck" of 2000 - and after the terrorist events of 9/11, the Federal Reserve sliced interest rates to record lows. It then kept them there for much too long.

That's when the subprime-mortgage and easy-credit games took off.

Looking at the low default rates on CRA-predicated mortgage loans, bankers figured loan standards were too high. They realized there was room to lower them and still get paid in full.

Standards were lowered across the board, and while bankers were encouraged to make more of these loans than they wanted to, they actually made a good profit on them. As long as housing markets were appreciating, CRA homeowners in distress could actually sell their properties and pay off their loans. Bankers sure weren't complaining then.

Behind the scenes, the public casino was primed for action and the dice were starting to roll. Because Wall Street and its lobbying armies had gutted existing regulations and stifled all efforts to safeguard the public from new exotic derivatives products, there was nothing to stop the juggernaut.

And because banks had no intention of holding on to the garbage they were manufacturing, Wall Street just securitized all the junk that it gathered and sold it off to anyone who would buy it. But not everyone who would buy Wall Street's junk was stupid, so the institutions reformulated new products from that junk...

Wall Street's "Collateralized" Damage

Wall Street's new "collateralized" products were just reconstituted, repackaged loans that redirected cash flows from mortgage payers so that some tranches of these new collateralized pools looked safe and could get top "AAA" ratings from credit rating agencies.

It didn't matter that rating agencies didn't understand the new math. They were in on the game and got rich, too.

To add insult to injury, Wall Street employed another newfangled product: "Credit default swaps." These were insurance-type contracts that anyone could offer on anything. But the real beauty is that these contracts let Wall Street play on every side of every deal.

  • First, Wall Street profited once when it sold the junk.
  • Then it made money when it sold "insurance" on those subprime securities.
  • And it kept profiting as it traded both the junk pools and credit default swaps.

The best part about the whole scheme (which all the institutions were playing) was that the game was self-perpetuating. As long as finance companies, mortgage firms and banks were able to package and sell their pools of mortgages and other "leveraged loans," the money from their sale went back to the folks who originated the individual loans in the first place.

The upshot: those folks could make more loans and start the entire process all over again.

  • The more money that was available, the lower rates went.
  • The lower interest rates went, the cheaper it was to finance and hold a portfolio of assets.
  • But because rates were so low, and the return on quality loans was correspondingly low, bankers needed higher-yielding assets to maximize the spread on their "cost of carrying" pools of assets.

So what happened?

It became necessary to offer mortgages to lower-quality borrowers in order to charge a higher (and more-profitable) interest rate. And that's how the situation snowballed and became a feeding frenzy.

Wall Street's Greed Machine Brings the House Tumbling Down

Wall Street's idea was to "dance until the music stopped." Institutions all knew they'd engineered a housing bubble and that the insane appreciation rates on anything with a roof would eventually fall back to Earth.

But by then, the big players expected they would have found a seat, leaving them to watch the other, less-nimble players stumble and take their lumps.

There was just one problem: Greed.

Wall Street institutions were way too greedy and much too cocky. They thought they'd either be able to unload their junk holdings, or had been clever enough to hedge against risk with their credit-default-swap-insurance schemes.

And because Wall Street believed it was safe, the institutions didn't see what was really happening. They were all in the same boat - and the boat was sinking.

That boat, of course, happened to be the U.S. economy - and other top world economies. Trouble was, in their greed, the banks actually made the boat and forced us into it. But while the boat sunk, they got bailed out while the masses were left to drown.

Financial Darwinism in a Capitalist Democracy Gone Wrong

At this point, you might find yourself asking: So what? Most of the banks have repaid the Troubled Asset Relief Program (TARP) money that they desperately needed. Most are returning to profitability, with some even reporting record profits and paying out record bonuses to executives.

Some banks have become bigger. A lot bigger. And there are more profits available because a couple of the old investment-banking stalwarts - Bear Stearns and Lehman Brothers - crashed and burned.

Is that so wrong? Isn't that part of financial Darwinism in our capitalist democracy?

Well, the truth is not what it appears to be. Bear and Lehman were ruthlessly crushed by their rivals, so that fewer players could gobble up more business.

It wasn't evolution. It was execution.

Here's the trouble, though: The bigger banks get, the more they rely on a de facto government guarantee. And in this case, it's the infamous "Too big to fail" doctrine - one pushed by banks that want to be so big that they can crush (or at least absorb) their smaller rivals.

How to Tackle the Big Banks' "Assault on Our Freedom"

Banks want to be a cartel. They want to be able to raise fees and the cost of money at will for their greater profitability. Big banks are making big money because the government is keeping interest rates low.

Large banks are buying a huge portion of the U.S. Treasuries that the government needs to sell in order to finance the deficit. And that deficit has reached its current size because the money was used to bail out the banks and to mitigate the collateral economic damage that Wall Street caused.

It's a financing game. Another bubble to re-inflate bank balance sheets by allowing them to generate a virtually risk-free, high-net-interest margin.

  • We need to be afraid of what our Founding Fathers were afraid of: Too much power concentrated in too few hands - especially banks.
  • We need to break up the big banks.
  • We then need to spread their pieces around the country, placing credit closer to Main Street.
  • We need to end all proprietary bank trading... eliminate credit default swaps and collateralized debt obligations... and instill transparency in all capital markets products, trading platforms and risk-taking businesses that have any systemic impact.

In short, we need a free market, not a free for all.

Competition and free enterprise are the hallmarks of our economic miracle. I'm for less government, less taxation and more power to the people. But this enormous concentration of power that Wall Street and the U.S. banking system have amassed is tantamount to an assault on our very freedom.

It's time to end Wall Street's absolutism and the tyranny of the banks. And to once again enjoy the financial freedoms that the end of this tyranny will bring.

Best regards,

Shah Gilani

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