Why Wall Street Is Burning

What do you get for $700 billion? Especially since this could be the biggest pig in the history of pokes. Well, for starters, one hopes we at least get back the fundamental New Deal marketplace protections that served us well since the Great depression – before they were systematically undermined by the deregulation wrecking crew.

This deregulation assault started with the Republican “Contract with America in 1994. Over a presidential veto, Congress passed the Private Securities Law Reform Act rolling back landmark 1933 and 1934 national securities laws. The PSLRA made it harder for shareholders to recover from fraud, opening the door to Enron and its ilk. They walked right through. Also during the 1990’s, Clinton Administration Treasury Secretary and “wunderkind” Robert Rubin (eventually Chairman of now troubled Citibank) led a bipartisan effort to repeal another Depression Era law, Glass–Steagall, prohibiting the same firms from being both a commercial and investment bank. The Act initially was passed to prevent a repeat of 1920’s scams where banks created speculative instruments that allowed mortgage debts to be turned into securities then sold to unsuspecting investors with little scrutiny of the actual loan. Sound familiar?

For a while, banks then minted money, including by doling out the some $1 trillion in mortgages still outstanding. Some are now on the verge of default. How many? How much? No one knows. But of three million sub prime and adjustable loans, roughly 18% are past due. Rubin opined recently that such “excesses leading to disruptions are just how our markets work.” His excesses, our disruptions.

Last year, the Supreme Court got into this deregulation game. In a case called Stoneridge, a five justice majority narrowly re-interpreted those same New Deal securities laws, concluding that “third parties” (think investment banks) that developed illegal schemes allowing others (think Enron) to lie may not be liable to victimized shareholders. Otherwise, said the Court, “overseas firms . . .could be deterred from doing business here.” Like they are lining up now. Stoneridge was heavily politicized, with Treasury Secretary Paulson personally lobbying President Bush to support Wall Street – and to prohibit the filing of SEC an amicus brief on behalf of shareholders. Through a series of Stoneridge-like decisions, the High court has invited this atmosphere of the robber barrons and excess during our very own gilded age.

Sounding more like Herbert Hoover every day, President Bush’s answer to all of this is to plead for calm. Former Fed Chairman Alan Greenspan is less sanguine: “this is a once in half a lifetime – probably once in a lifetime type of event; it outstrips anything I’ve seen and it is still not resolved. Indeed it will continue to be a corrosive force until the price of homes stabilizes.” Former AIG head Hank Greenberg suggested this week that we have gone from “greed to fear.” One invites the other.

What say our presidential hopefuls?

Initially, John McCain was most concerned that “taxpayers are not involved,” perhaps forgetting taxpayers are also the homeowners, retirees, insurance holders – and voters. Saying that the economy is “fundamentally strong” but then “in crisis,” McCain declared the “regulatory system is broken,” blaming those very same poor Depression Era statutes. “They were designed for the days when in the stock market they used to hold up cards and yell. Now the global economy is instantaneous, around the globe; we need to catch up the regulatory bodies”. Actually, he has it backwards. The real problem is how safeguards contained in those statutes have been repeatedly undermined. McCain then called for a Commission – and for firing SEC Chief Chris Cox who actually supported investors in Stoneridge. McCain also opposes the Mortgage Reform and Anti-Predatory Lending Act now stalled in the Senate creating a federal duty of care, ability to repay and a registry of mortgages and their issuers.

The recent and startling collapse of Wall Street institutions like Bear Sterns(bailout), Lehman Brother’s(bankrupt) and AIG(bailout) are actually not the first deregulation dominos to fall. Others were – Enron, World Com, Health South, Tyco and the rest – all also from putting profits first and truth second. Then, as now, politicians postured; there were congressional hearings and calls for reform. A few laws were strengthened; some crooks went to jail – but mostly business on the Street continued as usual. They simple blew some new bubbles.

Playing with other people’s money, these high fliers created new financial instruments, then chopped them into countless pieces nearly impossible to value. They made billions when the pieces were swapped and loans were made (and sold) - unconcerned whether they actually were repaid. Now the day of reckoning has come for these robber bankers. Those that played the fastest and the loosest (which ones? how many?) are at the abyss. So are we.

To some ancient history, the last financial crisis of this magnitude was also due to runaway deregulation – the savings and loan meltdown in the 1980’s. (Back then, “reformer” McCain was one of the “Keating Five,” reprimanded by the Senate Ethics Committee for showing “poor judgment” after intervening with regulators on behalf of campaign contributor Lincoln Savings). Taxpayers ended up bailing out banks to the tune of $160 billion. That may soon look like chump change. Creation of a federal entity to “absorb” the present debt as now proposed could result in a bailout topping $1 trillion.

And what about Democratic presidential candidate Barack Obama? At least he has been closer to the mark. “Too many people in Washington and on Wall Street were not minding the store” he urged. “For eight years, we’ve had policies that shredded consumer protection by loosening oversight and regulation. The result is the most serious financial crisis since the Great Depression”. But it’s not just eight years; it’s closer to twenty. While as yet uncommitted on the trillion dollar bailout, Obama has proposed a specific regulation package to address some but not all that ails our markets, such as stronger capital requirements for those exotic mortgage securities and more power for the Federal Reserve. But the system itself is in need of a major overhaul.

During his acceptance speech in Denver, Barack Obama promised the American people he would do his best to prevent this election from being about just “small things”. So far, perhaps because his opponents desperately want the opposite (“give them bread, give them circuses”), that hasn’t happened. It had better soon – because we have some very big things to worry about. Gordon Gekko notwithstanding, unchecked greed is not good. Adam Smith’s invisible hand needs highly visible oversight. So together with Bailout Central, here are some specific reforms for both candidates – and the voters – to consider:

• Enact the anti-predatory lending legislation.
• Reenact Glass Steagall
• Increase shareholder power to hold corporations accountable, including to recover losses against third parties’ fraudsters.\
• Impose strict transparency requirements on the $50 trillion in corporate derivatives and other instruments now used to slice us up debts like sushi.
  
• Make the SEC a real watchdog again.

Then we can at least begin the road back to a time when U.S. markets were the envy of the world.

 Al Meyerhoff is a class action attorney in Los Angeles [alm@csgrr.com].