Think of it as Obamacare for banks.
Like Obamacare, the massive financial "reform" bill introduced by Sen. Chris Dodd, D-CT, addresses a serious problem…but would, at great expense, make a bad situation much worse.
Most of us are painfully aware the subprime mortgage crisis nearly destroyed our economy.
At the heart of the crisis was fraud. Money was lent to poor credit risks who couldn't pay it back. For instance, a strawberry picker in Bakersfield, California, with an income of $14,000 a year was lent $724,000.
How could firms such as Countrywide Mortgage and Long Beach Savings which were making such loans expect to make money on them?
By selling the loans to the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac), two "Government Sponsored Enterprises" (GSEs) that didn't bother to check whether the mortgages they were buying were any good.
This was partly the result of greed, partly the result of stupidity, and mostly the result of government policy. The Community Reinvestment Act, passed during the Clinton administration, encouraged the GSEs and loan originators to lower lending standards to boost home ownership among the poor and minorities.
Fannie and Freddie combined the mortgages into bonds which they sold to investors with an implicit guarantee the federal government would make them whole if the loans went bad. Many were purchased by Wall Street investment banks, which bundled them into other securities called collateralized debt obligations (CDOs), and sold them to the unsuspecting.
There was fraud here, too, as the Security and Exchange Commission's belated indictment of Goldman Sachs suggests. What sort of sucker would buy a CDO based in substantial part on home loans to people who were likely to default?
The suckers who trusted the bond rating agencies. Whether motivated by gross stupidity or by corruption, or both, Moody's and Standard & Poor's gave AAA ratings to most CDOs, even though few of the securities from which they were comprised were rated that high. In a story with many villains, the rating agencies may be the worst.
The subprime house of cards was built on the ridiculous assumption home prices would go up forever. When prices stopped rising, the house of cards collapsed, nearly taking Wall Street with it.
Part of the problem for firms like Bear Stearns and Lehman Brothers was that they hadn't unloaded all their CDOs at the time they became worthless. But the larger problem was leverage. Some Wall Street firms were gambling with as much as $40 of borrowed money for every dollar of their own capital.
Leverage increases profits when the market is on its way up. But it accelerates losses when the market falls. When the stock market plunged after the housing bubble popped, virtually every major Wall Street firm would have been swept away if it hadn't been for extraordinary intervention by the federal government. As of April 1, five federal agencies chiefly the Federal Reserve and the Treasury Department have provided $4.6 trillion in investments, loans, and guarantees to beleaguered banks, according to the Center for Media and Democracy.
This extraordinary intervention probably prevented the world financial system from seizing up in the fall of 2008. But since then it has served mainly to enrich the very bankers whose recklessness, greed, stupidity and corruption put the system at risk.
"Even if TARP saved our financial system from driving off a cliff back in 2008, absent meaningful reform, we are still driving on the same winding mountain road, but this time in a faster car," said Neil Barofsky, the inspector general for the Troubled Asset Relief Program.
To prevent a repetition of the subprime mortgage crisis, strict standards need to be set for home mortgages; the bond rating agencies must be reformed; limits placed on the amount of leverage banks with federally insured deposits may incur, and "too big to fail" banks should be broken up.
The Dodd bill does none of what's needed. This isn't too surprising, since Sen. Dodd was a "Friend of Angelo" Mozilo, head of Countrywide Mortgage, who received cut rate loans in exchange for political favors.
The Dodd bill does institutionalize bailouts of "too big to fail" firms. This is the opposite of reform.