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Fifteen years ago Charles Bowsher warned us about unregulated OTC derivatives. Now he’s warning us about mark-to-myth accounting rule changes.

We now know just how dangerous unregulated OTC derivatives like credit default swaps are to the global financial system. But 15 years ago – 4 years before Brooksley Born’s warning and more than 6 years before the CFMA 2000 was passed in a bipartisan rejection of regulation, Charles Bowsher, as Comptroller General of the United States, sounded the warning in the GAO report, FINANCIAL DERIVATIVES Actions Needed to protect the Financial System and in testimony before Congress.

From his 1994 GAO report:

Much OTC derivatives activity in the United States is concentrated among 15 major U.S. dealers that are extensively linked to one another, end-users, and the exchange-traded markets. This combination of global involvement, concentration, and linkages means that the sudden failure or abrupt withdrawal from trading of any of these large dealers could cause liquidity problems in the markets and could also pose risks to the others, including federally insured banks and the financial system as a whole.

From his 1994 testimony before Congress:

Given the gaps and weaknesses that impede regulatory preparedness for dealing with a financial crisis associated with derivatives, we recommend that Congress require federal regulation of the safety and soundness of all major U.S. OTC derivatives dealers. The immediate need is for Congress to bring the currently unregulated OTC derivatives activities of securities and insurance firm affiliates under the purview of one or more of the existing federal financial regulators and to ensure that derivatives regulation is consistent and comprehensive across regulatory agencies. We also recommend that the financial regulators take specific actions to improve their capabilities to oversee OTC activities and to anticipate or respond to any financial crisis involving derivatives.

Now Charles Bowsher is sounding another warning, this time about accounting rule changes that have replaced mark-to-market with mark-to-myth.

FHLB Executive Who Left Cites Securities Valuations

Charles Bowsher said he resigned last month as chairman of the Federal Home Loan Bank system’s Office of Finance because he wasn’t comfortable with the way the banks value their mortgage securities.

"I decided I didn’t have confidence in the financial statements," Mr. Bowsher said in an interview, confirming remarks that previously appeared in a Bloomberg News article. Mr. Bowsher, a former partner at the accounting firm Arthur Andersen, said he believes financial companies generally, not just the home-loan banks, have too much discretion in valuing assets such as mortgage securities. "They put a lot of assumptions in there," he said.

The Office of Finance coordinates debt sales by the 12 regional home-loan banks and compiles combined financial results for them. But the individual banks and their auditors are responsible for accounting policies.

Tyler Durden, guest posting at naked capitalism, explains what this means in a must read post, FHLB Chairman Disgusted With FASB Accounting Alchemy, Quits

When the man in charge of the second largest borrower in the U.S. is willing to lose his job due to his discomfort with the FASB’s shift in accounting rules, you can bet that the tragic fallout of all the "market buoying" recent events is only a matter of time.

…one of the men who knows the ins and outs of the financials of banks involved in the mortgage crisis more intimately than even Bernanke and Geithner, let alone Obama, is saying that the newly implemented changes by the FASB will throw the whole system into tailspin and he want none of it.

If this isn’t the most damning condemnation of the Kool Aid the administration, the Treasury, the Fed, the FASB, the FDIC, and all the other alphabet soups are trying to make the common U.S. citizen drink and have seconds, then nothing else possibly could be…. of course until Bowsher is proven right and everything collapses into the smoldering heap of defaulted MBS still marked at par on various liquidating banks’ balance sheets…

Oh and yes, let’s hold a moment of silence for Lehman which held billions of mortgage backed securities that it too was "holding until maturity." Well, Lehman is no more, and all these securities now trade, in the form of the company’s general unsecured claims, at the generous price of 12 cents on the dollar… Furthermore, one can’t say the market is illiquid – the bid-ask spread is only 1 cent. And as there are over $150 billion of these claims floating around, one can’t say the market is in any way limited from a price discovery standpoint.

Maybe if more honest leaders follow in Bowsher’s unique example, the general population will finally start seeing though the everyday lies and misinformation coming out of D.C.

One last note on where the pressure came for FASB to change it’s rules – that would be our Democratic majority Congress, led by Barney Frank (for background see ubetchaiam’s diary, Mark to Whatever You Think is Right)

x-posted at oxdown

From naked capitalism: Wiliam Black Savages Treasury’s Conduct on AIG

And to Black’s point, the real issue is fraud. Why is no one at Treasury willing to use the F word? Who would it embarrass? There is not reason for NOT pursuing that angle, save that AIG must have the 5×7 glossies on some pretty influential people, or that pursuing fraud at AIG would, via a daisy chain of connections, reveal that fraud was pervasive, and the Treasury is desperate to preserve the false image that the system has integrity.

From bernhard at MoA, A New ‘Paulson Plan’:

Luckily for the administration the public, while watching the AIG show, misses the real robbery.

Most of the money used for the general bailout is coming from the Federal Reserve and is not under control of Congress. The new version of the Term Asset-Backed Securities Loan Facility (TALF) will put another trillion Fed/taxpayer money at risk. The program will lend to banks and hedgefunds to buy up ‘asset’ backed papers (bundled consumer and loans, commercial real estate loans etc.). It allows for great profits for those bank entities with the Fed taking 90% of the risk (also here):

Through the program, an investment fund can put down $5 to $14 for every $100 it plans to spend, borrowing the remaining $95 to $86 cheaply from the Fed. It agrees to buy highly rated securities issued by lenders that the Fed deems eligible collateral for the loans.

The aim is said to be to create more consumer lending, but I see no signs that consumers are willing to borrow more. Saving rates are going up as people become more frugal.

I suspect the more likely but unspoken real aim of the program seems to move ‘toxic’ assets from the banks balance sheets by subsidizing the buyers of these assets with the default risk transfered to the Fed.

Our own government, now controlled by the Democrats, continues with the giant rip off. Why?

Maybe it has something to do with those two numbers at the top of the post: $114 million and $5.1 billion.

$114 Million

From opensecrets.org: TARP Recipients Paid Out $114 Million for Politicking Last Year:

The struggling companies whose freewheeling business practices have contributed to the country’s economic woes are getting a lucrative return on at least one of their investments. Beneficiaries of the $700 billion bailout package in the finance and automotive industries have spent a total of $114.2 million on lobbying in the past year and contributions toward the 2008 election, the nonpartisan Center for Responsive Politics has found. The companies’ political activities have, in part, yielded them $295.2 billion from the federal government’s Troubled Asset Relief Program (TARP), an extraordinary return of 258,449 percent.

“Even in the best economic times, you won’t find an investment with a greater payoff than what these companies have been getting,” said Sheila Krumholz, the Center’s executive director. “Some of the companies and industries that have received payments may now consider their contributions and lobbying to be the smartest investments they’ve made in years.”

Grand totals from the excel file available for download:

“Campaign Contributions, 07-08 Cycle” = $37,477,300
“Campaign Contribs to Democrats” = $21,423,761
“Campaign Contribs to Republicans” = $15,991,543

That’s right, last year the Democrats raked in $5+ million more than the Republicans from TARP recipients.

$5.1 Billion

From the Democracy Now! transcript: “Sold Out”: New Report Follows Lobbying Money Trail Behind Deregulation that Helped Cause Financial Crisis

ROBERT WEISSMAN: Well, we saw over the last decade and really the last three decades, with both parties in power in Congress and the executive branch, this long series of deregulatory moves. And as you go step-by-step through them, you see that those are the things that really paved the way for the current financial collapse.

Perhaps the signature move was the 1999 repeal of the Glass-Steagall Act, which had prevented co-ownership of commercial banks and securities firms, investment banks. That was precipitated by and directly authorized the creation of Citigroup, which is now sucking so much public taxpayer money and has really been at the cutting edge of driving the financial crisis we’re now in.

You can go forward another year and see that Congress, with the Clinton administration authorization, prohibited the executive branch agencies from regulating financial derivatives, the instruments that no one can really understand or get a handle on but which have multiplied the problem from the housing crash many-fold over. So we now have $600 trillion in financial derivatives being traded around the world, with no one having a handle on what they are, who owes whom, and all of this requiring us to pour tens of billions of more dollars more every day, it seems, into AIG.

You can step forward and look at the failure to enforce rules against predatory lending, beginning with the Clinton administration, but really accelerating in a really terrifying way with the Bush administration, so that there were about three actions taken by federal regulators in the peak period of predatory lending—three—against some of the commercial lenders and mortgage brokers who were undertaking some of the most abusive predatory lending activities. And on and on it goes.

And there was, of course, over the last three decades a real surge in deregulatory ideology. And perhaps the people who were putting this stuff forward believed in it. But it also makes sense to think that, maybe a little bit, they were influenced by the staggering amounts of money that the financial sector was pouring into Washington, as you said, more than $5 billion in campaign contributions and lobbying money. And, you know, they got a good return on investment, and it was good for them while it lasted. It’s turned out to be quite a disaster for them but, more importantly, for the rest of the country and the world.

For more on the history of the repeal of Glass-Steagall and the prohibition of financial derivative regulation, see my previous diaries (here, here and here).

The amount of money at stake is mindblowing. That, in addition to ideology, is what we’re fighting against.

I’ll just end by quoting phred:

This is not a D v. R problem, this is absolutely an elite v. the rest of us problem and it is global. Obama picked his side, now we have to see whether he is willing to reconsider the team he picked and join us instead.

x-posted at oxdown

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Note: This is part 4 of a series on the (mostly) legislative history of financial deregulation that has contributed to our current financial and economic crisis. For the entire series, including the timeline (where most of the reference links are), see the Financial Regulation Timeline page. Please use the comments to contribute links and other information. Thanks, selise.

Behind the debates over future policy is a debate over history—a debate over the causes of our current situation. The battle for the past will determine the battle for the present. So it’s crucial to get the history straight.

— Joseph Stiglitz, 2009 in Vanity Fair

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In a previous post on OTC Derivatives (Which Idiot Decided Not to Regulate Credit Default Swaps?) we looked at the legislative history of the Commodity Futures Modernization Act of 2000. Today the topic is the Gramm-Leach-Bliley Act and the repeal of Glass-Steagall—a part of the deregulation story of how our banks got "too big to fail." For additional details and reference links see my Financial Regulation Timeline webpage.

From Stiglitz’s 2003 book, The Roaring Nineties (typos are mine):

For more than half a century, commercial banking, which takes deposits from households and firm and makes conventional loans, had been separated from investment banking, which helps firms issue new bonds and shares. The same company could not lend money and also sell securities, in other words. The Glass-Steagall Act, which barred this, was one of the reforms put in place by the administration of Franklin Roosevelt, in response to the wave of bank failures that had followed the Great Crash of 1929. But the ideas behind Glass-Steagall went back even further, to Teddy Roosevelt and his efforts to break up the big trusts, the large firms that wielded such economic power. TR and the Progressives of the early twentieth century were alarmed not only about the concentration of economic power but about its impact on the political process. When enterprises become too big, and interconnections too tight, there is a risk that the quality of economic decisions deteriorates, and the "too big to fail" problem rears its ugly head. Expecting to be bailed out of trouble, managers become emboldened to take risks that they might otherwise shun. In the Great Depression, when many banks were on the ropes, it was, in effect, the public that bore the risk, while the bank got the reward. Wen banks failed, the taxpayers paid the price through publicly funded bailouts.

The Glass-Steagall Act of 1933 addressed a very real problem. Investment banks push stocks, and if a company whose stock they have pushed needs cash, it becomes very tempting to make the loan. The U.S. system worked in part because under Glass-Steagall the banks provided a source of independent judgments on the creditworthiness of businesses. When a "full-service" bank makes most of its money by selling equities and bonds or arranging "deals," issuing loans becomes almost ancillary—a sideline.

With Glass-Steagall, the United States rejected the course followed by other nations, such as Japan and Germany, that did not separate commercial and investment banking—I believe to our evident benefit. But American banks themselves saw Glass-Steagall as reducing their opportunities for making profits and not surprisingly began to insist that the rules separating commercial and investment banking had become passé. In an age of free-floating capital and giant multi-national companies, they argued, banks had to be integrated, to make advantage of what are called "economies of scope"—the benefits that businesses can reap by working in many different areas at once. Global competition was too intense for bank concentration to be a serious worry (though in fact, many borrowers, especially small and medium-siaze firms, have access only to a few potential lenders), and Glass-Steagall supposedly put American banks at a disadvantage.

In the mid-nineties, the banks mounted a concerted campaign to have Glass-Steagall repealed. The conditions were favorable. Prosperity made the notion of bank failure seem very remote (though the S&L crisis of the eighties ought to have been a caution).

In late 1986 and early 1987 Glass-Steagall restrictions on commercial banks were beginning to be successfully challenged in the courts, with the New York State Banking Department and with the Federal Reserve. At the end of April and again in May 1987 the Federal Reserve Board voted 3-2 to permit commercial banks to engage in some limited securities underwriting over the objections of Fed Chairman Paul Volcker who opposed the change. In June, soon after Alan Greenspan publicly backed the Treasury Department’s new position on the creation of a few very large banks, the Reagan administration announced its choice of Greenspan to replace the retiring Volcker.

Top officials at the Treasury Department have concluded that the Government should encourage creation of very large banks that could better compete with financial institutions in Japan and Europe.

The Treasury plan, which would permit the acquisition of banks by large industrial companies, was also endorsed by Alan Greenspan, in an interview before President Reagan nominated him this week to be chairman of the Federal Reserve Board.

Formation of such large banks has been hampered by two of the nation’s principal banking laws: the Glass-Steagall Act of 1934, which separates underwriting and commercial banking, and the Bank Holding Company Act of 1956, which prohibits nonbanking companies from owning banks.

In the Administration, the hope is that Congress can be persuaded to loosen the regulations. The banking industry, which has considerable political influence, is divided: The largest banks strongly support the changes while smaller banks fear they would be put out of business.

The Reagan Administration has met frustration in its efforts to lessen regulation of banking, largely because Paul A. Volcker, the current Federal Reserve chairman, has firmly opposed any move that would begin to break down the barriers that prohibit large nonbanking companies from owning banks.

But after Mr. Volcker departs in August, the Federal Government’s major regulators will be speaking with a nearly unified voice. Both Robert L. Clarke, Comptroller of the Currency, and L. William Seidman, chairman of the Federal Deposit Insurance Corporation, support in principle the Gould approach, as do several Fed governors.

In the interview, Mr. Greenspan said ”the separation of commerce and banking at this stage is simply not helpful” because it cuts off one important source of new capital. He added that the declining profits of the leading American banks had hampered their ability to raise capital in stock offerings. That leaves them only one practical source for large injections of funds: the industrial sector of the economy.

Given the current banking environment, Mr. Greenspan said, ”I do not have a fear of undue concentration of banking powers.”

Volcker continued to oppose the expansion of banks into the securities underwriting business until his retirement in August 1987 when Alan Greenspan was sworn in as Chairman of the Federal Reserve. But at this time there was still support for Glass-Steagall in Congress (even from Schumer who wrote an oped for the NYT, Don’t Let Banks Become Casinos) and so, even with Greenspan at the Fed continuing to advocate for repeal, the most Citicorp and others could do was to chip away at regulations. Over the years several attempts were made to change the law but failed to win passage in Congress. It would take a Republican Congress and the Clinton administration’s Robert Rubin and Larry Summers at Treasury to finally repeal Glass-Steagall.

In January of 1995, Robert Rubin became Treasury Secretary. Before joining the Clinton administration, Rubin had worked for 26 years at Goldman Sachs. In March, Rubin asked Congress to repeal the Glass-Steagall Act and to change the Bank Holding Company Act of 1956. Several hearings were held on Representative James A. Leach’s H.R.1062 ("Financial Services Competitiveness Act of 1995" to modernize Glass-Steagall) but the bill died in committee.

In April of 1998, Citicorp (banking) and Travelers Group (insurance) announced their supermerger. Although in violation of Glass-Steagall Act and the Bank Holding Company Act, a temporary waiver delayed required divestitures for two years and chairmen Sandy Weill and John Reed indicated that they intended to pursue changing the law rather than divestiture. Citibank spent "$100 million on lobbying and public relations" in the year prior to repeal.

On January 6, 1999, Leach introduced H.R.10, the Financial Services Act of 1999, and the push for repeal was on for the 106th Congress. That spring, the House Banking and Financial Services committee, chaired by Leach, the Senate Banking committee, chaired by Senator Phil Gramm, and the House Commerce committee, chaired by Representative Tom Bliley, held a total of 8 days of hearings. On April 28, 1999, Gramm introduced S.900, the Senate’s version of H.R.10 and it passed 54-44 on May 6. H.R.10 was passed in the House by 343-86 on July 1. Although there was general agreement on the main points, significant controversy remained regarding whether the Fed or Treasury should have the primary regulatory role and on proposed exemptions to the Community Reinvestment Act.

On July 2, 1999, Rubin retired and Larry Summers became Treasury Secretary. In October Rubin joined Citigroup where he would eventually be paid over a $115 million.

On July 20, 1999 the House amended S.900 with the contents of their own bill and then the House and Senate sent it conference committee on the 30th where it remained for almost 2 months with no action taken. Reporting on the conference negotiations in the LA Times on November 2, 1999, Robert Scheer wrote:

Only last week, as the bill was being pushed through a congressional conference committee, Treasury Secretary Lawrence H. Summers rushed back from a trip to China to huddle with lobbyists representing Citigroup, Goldman Sachs, Merrill Lynch and other financial giants. The meeting was closed to the media and public, but one participant told the New York Times that Summers lectured the lobbyists on how to spin this bill so it appears to be in the public interest. "He said it would be very unfortunate if any financial institution were to suggest that they do not see the broad public purpose of this legislation," the lobbyist reported.

Finally, during the first week of November, S.900, the Gramm-Leach-Bliley Act, was reporting out of committee and passed in the Senate 90-8 and in the House 362 – 57. Glass-Steagall was finally repealed and Democrats as well as Republicans celebrated.

And now, more than 20 years after the Volcker lost his battle to protect Glass-Steagall, where are we? Here’s a clue from Yves Smith at naked capitalism: Another Sign That Volcker is Marginalized (And a Preview of His Program)

Last week. Bloomberg reported that Volcker, who many regard as the best asset on Obama’s economics team, is sorely underutilized:

Paul Volcker has grown increasingly frustrated over delays in setting up the economic advisory group President Barack Obama picked the former Federal Reserve chairman to lead…

Volcker, 81, blames Obama’s National Economic Council Director Lawrence Summers for slowing down the effort to organize the panel of outside advisers….Summers isn’t regularly inviting Volcker to White House meetings and hasn’t shown interest in collaborating on policy or sharing potential solutions to the economic crisis,

The usual denials ensued. But a story that corroborates this picture comes from the Globe and Mail, courtesy reader Marshall. Volcker is very much in favor where bank do the bulk of credit intermediation and focus on traditional lending. Effectively, he is calling for the re-imposition of Glass Steagall, the Depression-era legislation that separated commercial banking from investment banking. As we discuss below, this is a radical idea and is at odds with the program Geithner announced earlier this week…

x-posted at oxdown

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Note: This is part 3 of a series on the (mostly) legislative history of financial deregulation that has contributed to our current financial and economic crisis. For the entire series, including the timeline (where most of the reference links are), see the Financial Regulation Timeline page. Please use the comments to contribute links and other information. Thanks, selise.

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In 1992, H.R.707, the Futures Trading Practices Act of 1992 was signed into law. This bill "granted the Commission the authority to exempt over-the-counter (OTC) derivative and other transactions for CFTC regulation." Also in 1992, Congressmember Ed Markey, as chair of the House Subcommittee on Telecommunications and Finance, asked the General Accounting Office (GAO) to report on the potential risk due to the growing use of derivatives. The report was released 2 years later in May of 1994 and warned that the "the sudden failure or abrupt withdrawal from trading of any of these large dealers could cause liquidity problems in the markets and could also pose risks to the others, including federally insured banks and the financial system as a whole." This set off a flurry of hearings and in July Markey introduced H.R.4745, the "Derivatives Dealers Act of 1994," to legislate some regulation for OTC derivatives (under the jurisdiction of the SEC). However the bill only had one co-sponsor (Mike Synar) and never made it out of committee.

In January of 1993, just 2 days after Bill Clinton’s inauguration and on Wendy Gramm’s last day as chair, the Commodity Futures Trading Commission (CFTC) exempted "certain swap agreements and hybrid instruments from regulation under the Commodity Exchange Act."

In May of 1998, the CFTC proposed "reexamining its approach to the over-the-counter (OTC) derivatives market" and sought public comment. In particular, Brooksley Born, chair of the CFTC, "was concerned that unfettered, opaque trading could “threaten our regulated markets or, indeed, our economy without any federal agency knowing about it,”… She called for greater disclosure of trades and reserves to cushion against losses." However, senior members of the Clinton administration pressured her to back off and when she did not, Greenspan, Rubin and Levitt asked Congress to act to prevent the CFTC from regulating OTC derivatives. Congress responded with a 6 month restraint period, during which the CFTC "may not propose or issue any rule or regulation, or issue any interpretation or policy statement, that restricts or regulates activity in a qualifying hybrid instrument or swap agreement" (language from H.R.4328). After a year of conflict, including a number of contentious Congressional hearings, in January of 1999, Brooksley Born announced she would not be seeking a second term as CFTC chair.

In November 1999, Clinton’s Treasury, Fed, SEC and new chair of the CFTC recommended to Congress in their joint OTC Derivatives Report to Congress that the CFTC be permanently barred from regulating most swaps. Congress eventually did so in the Commodity Futures Modernization Act of 2000:

The act has been cited as a public-policy decision significantly contributing to Enron’s bankruptcy in 2001 and the much broader liquidity crisis of September 2008 that led to the bankruptcy filing of Lehman Brothers and emergency Federal Reserve Bank loans to American International Group[1] and to the creation of the U.S. Emergency Economic Stabilization fund.

Throughout 2000 hearings were held on how to modify the Commodity Exchange Act and several bills were proposed but not passed. Finally, the Commodity Futures Modernization Act was introduced as H.R.5660 in the House on December 14, 2000 and as S.3283 in the Senate on December 15, 2000. Also on December 15, the House version of The Commodity Futures Modernization Act, over 100 pages long and, according to Michael Greenberger, written by investment bank lawyers was attached as a rider the Omnibus appropriations bill (H.R. 4577) while in conference. Later that day, just before adjourning for Christmas and less than 2 hours after it was reported out of committee, the conference report was passed by the House 292 – 60 and by unanimous consent by the Senate before the bill had even been reported to the Senate floor.

Michael Greenberger, who was at the time the director of the CFTC’s division of Trading and Markets has said, "Quite frankly I think at the time anybody who opposed it was deemed to be a little bit crazy." Greenberger and his boss Brooksley Born at the CFTC were two within the Clinton administration who did oppose it.

x-posted at oxdown

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Appendix – BACKGROUND on OTC Derivatives:

notes (1994 GAO report is helpful):

1. exchange vs otc (privately negotiated bilateral contracts)
2. derivative types: equity, credit risk, foreign currency exchange rates, interest rates,…
3. contract types: futures (std contract, on an exchange), forwards (custom contract, otc), options (exchange or otc), swaps (otc)
4. use: hedge or bet

one type is CDSs – but only one – that is why this is not the perfect storm, it could be worse. !? wonder what the size and risk of other unregulated financial instruments?

credit default swaps (CDS) from wikipedia:

…credit default swaps are commonly used contracts to insure against the default of financial instruments such as bonds and corporate debt. But they also are bought and sold as bets against bond defaults — a buyer doesn’t necessarily have to own a bond to buy the credit default swap that insures it. When traders buy swap protection, they’re speculating a loan or bond will fail; when they sell swaps, they’re betting that a borrower’s ability to pay will improve.

Banks and other institutions have used credit default swaps to cover the risk of default in mortgage and other debt securities they hold.

It acts like ‘insurance’ but isn’t. "It is an insurance contract, but they’ve been very careful not to call it that because if it were insurance, it would be regulated. So they use a magic substitute word called a ’swap,’ which by virtue of federal law is deregulated," according to Michael Greenberger, a law professor at the University of Maryland and a former director of trading and markets for the Commodity Futures Trading Commission. [22] The deregulation of the swaps market is thanks to provisions in The Commodity Futures Modernization Act of 2000.

Credit default swaps are the most widely traded credit derivative product.[3] The Bank for International Settlements reported the notional amount on outstanding OTC credit default swaps to be $42.6 trillion[4] in June 2007, up from $28.9 trillion in December 2006 ($13.9 trillion in December 2005). By the end of 2007 there were an estimated $45 trillion [5] to $62.2 trillion [6] worth of credit default swap contracts outstanding worldwide. On September 23, 2008, Christopher Cox, Chairman of the U.S. Securities and Exchange Commission, placed the worldwide CDS market at $58 trillion, and stated it was "completely lacking in transparency and completely unregulated."[7] The U.S. Office of the Comptroller of the Currency reported the notional amount on outstanding credit derivatives from reporting banks to be $16.4 trillion at the end of March 2008. (For reference and perspective, the U.S. GDP for 2007 was $13.8 trillion[8], while the world’s GDP for 2007 was estimated at $54.3 trillion [9])

In 2007 the Chicago Mercantile Exchange set up a federally regulated, exchange-based market to trade CDSs. So far, it hasn’t worked because It’s been boycotted by banks, which prefer to continue their trading privately.

It appears that large, but more manageable, losses in the housing market, as the speculative bubble burst, have been amplified by an unregulated market of financial instruments, which appears to be something on the order of the world’s annual GDP. In other words, there is just not enough money in the world to cover the bets that have been made.

Warren Buffett has called called them "financial weapons of mass destruction." Any attempt to seriously address our current financial crisis must take CDSs into account. Hugh in the comments at FDL and bernhard at Moon of Alabama have advocated nullifying them (see also the warning against). From bernhard:

…Declare All Credit Default Swaps Null And Void. That would solve 80% of the problems the banks have right now. Some would still fail, but with the big issue removed, interbank lending and commercial lending would carry less risk and revive.

x-posted at oxdown

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It has become conventional wisdom among Democrats that Republicans (epitomized by Phil Gramm, past chair of the Senate Banking committee) were responsible for pushing deregulation that "set the stage for the financial meltdown." But what about the Democrats? Have their policies been supportive of the regulation that would have prevented what has been called the greatest financial crisis since the Great Depression? Answering this question has become more important as Obama puts together an economic team that includes names from the era of deregulation.

Looking back through the legislative and administration record since the early ’90s, what emerges is not primarily a partisan battle of Democrats vs Republicans, although that was part of it. The battle was one of the majority of Congress (usually under Republican control) allied during the Clinton administration with Treasury (Rubin and then Summers), the Fed (Greenspan) and the SEC (Levitt, who now says he regrets his role) against a few people in Congress (Markey) and the CFTC (Born and Greenberger) who thought that over-the-counter (OTC) derivatives should not be left entirely unregulated.

Other regulatory issues, for example, the repeal of Glass-Steagall, exceptions from the Investment Company Act of 1940, exclusion from the Commodity Exchange Act (CEA) for some electronic trading systems for financial products contracts (aka, "the Enron loophole"), the use of Structured investment vehicles (SIVs) by mortgage lenders for off-balance-sheet accounting, changes by the SEC to release investment banks from the "net capital rule," credit rating agencies that are paid by the companies they rate instead of investors and the practice of using marking to model as a means of "marking to myth") when no liquid market exists for accurate marking to market have also been reported as contributing factors, but the complete lack of regulation for OTC derivatives such as credit default swaps (CDSs) is one of the most important and at this time, probably the most dangerous. So, the series will begin with OTC derivatives, to be followed by other issues as time and interest permit.

x-posted at oxdown