[Vision2020] Financial Crisis: The Legacy of the Clinton Bubble

[Ted Moffett]

>From the Institute for Public Accuracy:

http://www.accuracy.org
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TIMOTHY CANOVA, canova at chapman.edu,
http://www.chapman.edu/law/faculty/canova.asp, http://ssrn.com/author=405808

Canova is professor of international economic law at the Chapman
University School of Law in Orange, California. His articles related to
the current crisis include the piece "The Legacy of the Clinton Bubble."

"I am unconvinced that this $700 billion bailout for
Wall Street will have any lasting positive effect. If the goal is to
help the credit markets, the Federal Reserve already has the authority
to purchase commercial paper and support the money markets. The Bush
administration is once again using fear to scare people into supporting
a dangerous course. There are almost 10,000 foreclosures a day now, and
between one and two million adjustable rate mortgages are due to adjust
upward in the next year. Without help for the bottom of the pyramid,
Wall Street will be back next year asking for another trillion dollars.
This was Japan's quagmire in the 1990s. The decline in housing prices
must be stopped in its tracks and the sooner the better.

"Obama is saying many of the right things -- that we should be
helping Main Street as well as Wall Street, and that we need to
re-regulate Wall Street. But like many in Congress, he's also saying
that these things can wait until next year, that such measures should
not be in the bailout package. However, now is the time when Wall Street
is desperate for taxpayer help for Congress to demand real help for Main
Street."

Canova addressed what's missing from this rescue package: "First,
there should be a moratorium on foreclosures and the Bankruptcy Code
should be amended to allow people to modify their mortgage loans and
stay in their homes. Congress should also extend the ban on
short-selling in financial stocks. This could all be accomplished
immediately. Any exceptions to a moratorium on foreclosures or to a ban
on short-selling can wait some weeks or even months. Likewise, Congress
should pass at least $50 billion in revenue sharing for state and local
governments which have been hit hard by the decline in tax revenues
stemming from falling property values."

Canova highlights the need to scrutinize the Federal Reserve: "It
was the Fed that helped gut the Glass-Steagall Act that had kept banks
separate from securities speculation, and it was the Fed that lobbied
against margin requirements and reserve requirements, and against the
regulation of derivatives and hedge funds. All of this was the
inevitable result of making the Federal Reserve 'autonomous,' a
euphemism for the capture of the Fed by the same financial interests it
should have been regulating. It's like the fox running the henhouse.

"The Fed clearly violates both the Constitution's Appointments
Clause and its private non-delegation doctrine. But the federal courts
have dismissed these challenges on very narrow procedural grounds,
namely that plaintiffs lack standing because the courts say they cannot
show they were directly injured by the Fed. It's ludicrous, and Congress
has the power to change the Fed's structure and make it more accountable
to a wider range of interests and perspectives."
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Tim Canova's article on "The Legacy of the Clinton Bubble:"

http://www.dissentmagazine.org/article/?article=1229

A few excerpts:

The real action was not CRA renewal but the demise of the Glass-Steagall
firewalls. Banks were suddenly free to load up on riskier investments as
long as they did so through affiliated entities such as their own hedge
funds and special investment vehicles. Those riskier investments included
exotic financial innovations, such as the complex derivatives that were
increasingly difficult for even experts to understand or value.
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In 1998, the sudden meltdown and bailout of the Long-Term Capital Management
hedge fund showed the dangers of large derivative bets staked on borrowed
money. But by March 1999, Greenspan was once again praising derivatives as
hedging instruments and as enhancing the ability "to differentiate risk and
allocate it to those investors most able and willing to take it."

In 1993, the Securities and Exchange Commission (SEC) had considered
extending capital requirements to derivatives, but such proposals went
nowhere, and Wall Street lobbied to prevent any regulation of derivatives.
Then in December 2000, in his final weeks in office, Bill Clinton signed
into law the Commodity Futures Modernization Act, which shielded the markets
for derivatives from federal regulation.

Since then, derivatives have grown in size and become gigantic wagers on the
movement of interest rates, commodity prices, and currency values. First
came the CDO bubble, which acted as a transmission belt by which the
subprime mortgage cancer metastasized and spread through financial
institutions around the globe. Warren Buffett, legendary investor and chair
of Berkshire Hathaway, would soon refer to such derivatives as "weapons of
mass destruction."

Since the collapse of the CDO market, the next derivatives bubble may be the
market for credit default swaps, which are credit insurance contracts
designed to cover losses to banks and bondholders when companies fail to pay
their debts. Today the notional amount of the credit default swap market is
at least $45 trillion, about half the total U.S. household wealth and about
five times the national debt.

When Bear Stearns melted down this past spring, it was holding $2.5 trillion
in credit default swaps that were worth perhaps $40.3 billion in fair market
value. The run on Bear Stearns was largely caused by the collapsing mortgage
and CDO markets. But it was the market for credit default swaps that may
have led the Federal Reserve to intervene. If Bear Stearns had been allowed
to fail, countless counterparties on these credit default swaps would have
faced enormous losses. The shock waves could have taken down major insurance
companies.

This is why George Soros, billionaire hedge-fund manager, has voiced his
fears about the unregulated market for credit default swaps. According to
Soros, the prospect of cascading defaults hangs over the financial system
like a sword of Damocles. He has not called for outlawing the market but for
its regulation by establishing a clearinghouse or exchange for the market,
capital requirements, and strict margin requirements for all existing and
future credit default swap contracts.
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Vision2020 Post: Ted Moffett
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