What's Wrong with Wall Street

What's Wrong with Wall Street
by Devilstower
Sun May 02, 2010 at 10:00:03 AM PDT

There's been a lot of discussion about the complexity of the current markets and the instruments being passed around Wall Street. Certainly what happened at Goldman Sachs is twisted enough that I've lost all certainty about following the course of the deals being investigated.

But the truth is, you don't need to know every detail of their derivative trading. It's not necessary have to a full and detailed understanding of how Goldman, or Paulson, or Merrill Lynch, or Magnetar or any of the other investment banks and hedge funds were structuring their particular way to game the system. Because the specifics of any deal are not the problem. It's the system that's broken.

The deep flaw in the current system was on direct display in last week's hearings.

Levin cited a "fundamental conflict" in Goldman's selling to clients home-loan securities that company e-mails showed its own employees had derided as "junk" and "crap" — and then betting against the same securities and not telling the buyers.
"They're buying something from you, and you are betting against it. And you want people to trust you. I wouldn't trust you," Levin told Blankfein.

How did it happen that Goldman Sachs, and the other large investment banks, came to be playing both ends of the same deal? It happened like this.

In 1999, the Gramm-Leach-Bliley Act was passed. The act repealed part of a law dating back to 1933 called the Glass-Steagall Act. That's a lot of names in a short time, but the quick version is that Glass-Steagall was passed to control the rampant speculation that had helped cause the collapse of banking at the outset of the Great Depression. Glass-Steagall specifically divided the banking industry so that banks issuing loans, insurance firms providing coverage, and firms offering investments were strictly separated.

Gramm-Leach-Bliley removed those limitations. It also knocked down rules that had placed some limits on bank size, allowing banks to grow larger through acquisition and mergers. Which is why some of these banks became such economy twisting monsters. But the size limits wouldn't have mattered without the fuel that allowed the banks to grow so large. That fuel was provided by tearing down the walls between loans, insurance, and investments. It's this, not any single incident at Goldman or anywhere else, was the core reason for the Great Recession.

Because of Gramm-Leach-Bliley, banks were put on a course in which it was inevitable that they would work against their own customers. In the case of a deal like that at Goldman, there were mortgages, bundled mortgages, derivative instruments against those bundled mortgages, credit default swaps offered as insurance against the mortgages (and the bundles, and the derivatives), and derivative instruments built on top of the swaps. Every single one of those transactions had its own set of customers. Every single deal that Goldman swung through this mess had winners and losers among its own customer base.

Without the bright lines separating loans, investment, and insurance a modern investment bank must work against its own customers. The gamma-radiation Hulk-inducing juice that Gramm-Leach-Bliley provided these banks was the ability to capture and recapture funds at every level of investment. That "fundamental conflict" mentioned by Senator Levin is built into the system, not just at Goldman, but at every investment bank in the country.

Every time you go to look for a home loan, you're facing an institution that's not weighing the validity of your loan not as an arrangement between you and the bank, but as potential a chunk of some "tranche" that will snap into a derivative ordered up from above. Every city or state looking to issue bonds, every pension fund searching for a safe place to invest their contributors' retirement, every small business out to expand is working with a bank that views their deal as an opportunity to feed something larger, and larger, and larger.

Add to the damage done by Gramm-Leach-Bliley another act also from the poison pen of Phil Gramm: the Commodity Futures Modernization Act of 2000. It was the CFMA that allowed instruments like credit default swaps to morph from being sensible protection into giant casino chips tossed around by people with no interest in the original instruments. It helped move derivatives from being openly traded on regulated markets, to something that could be move secretly as part of an in-house transaction with little scrutiny. It massively increased the ways these new bank-assurance-brokerages could structure their deals. It created the "complexity" that allowed every side in a deal to hide their real motivations.

It's tempting to look for villains on Wall Street, and when you see guys like the "Fabulous Fab" laughing over how they've fooled "widows and orphans" and you see billions handed out as bonuses for people who have intentionally stolen from their own clients, it's not hard to find them. But those folks on Wall Street are only well-paid henchmen. The list of would-be Snidley Whiplashes may get longer every day, but the people who enabled Wall Street, the men who gave them the black capes, top hats, and permission to use their whips freely, were Phil Gramm and the others who signed onto the legislation he authored.

What caused the Great Recession, what brought on the bail outs, what sent millions out of their jobs and millions more out of their homes was a dedication to deregulation in the name of the "free market." Deregulation was the cause for the disaster that is still unfolding, and no amount of trying to chase down where the dollars went should make us forget that.

Until those boundaries are put back in place, it's more than legitimate to ask do investment banks do anything that helps America, and it's very easy to answer. No. No, they don't. If we don't find a way to change that result, we'll be facing fiscal disaster again, and soon. Because the Phil Gramm economy, is an economy designed to fail.

No matter what other regulations are put in place, no matter how many consumer watchdogs are created or SEC investigators are forced to put down their porn, without the lines drawn by Glass-Steagall, the fundamental conflict that drives Wall Street to cannibalize their own clients will remain.

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