The Glass-Steagall Partial-Repeal Did Not Cause the Financial Crisis

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40. And you're wrong

When I see ANYONE post about banks making mortgage loans in reference to the subprime crisis, I know that person is ignorant of the actual story. That includes over-hyped spear-carriers for finance and politicians.

The crisis was in two stages. The first stage was when the subprime market locked up in late summer of 2007; the second stage was the securities based on subprime became worthless as collateral. That almost came to a head in March of the next year when Bear fell apart. Bear had problems because nobody was willing to accept its collateral or massively increased the haircut, so they weren't able to get the overnight funding to stay solvent. They were leveraged as hell and absolutely had to have cash rolling in everyday just to keep afloat. This would be exactly the same thing that killed Lehman a few months later.

When Lehman went, through the absolute stupidity of Paulson and co., it all hit the fan. Lehman was dialed into EVERYBODY. No pun intended, but bear in mind that Bear wasn't the only financial firm that was massively leveraged AND relied on the repo market to keep itself funded. That was a select group called everybody. Nobody would take their MBS as collateral anymore, or only at ridiculously discounted rates (also know as the actual market value), so all the investment banks began to collapse. This isn't in dispute.

The issue for the commercial banks was twofold: 1) they held a large amount of MBS on their books both because they couldn't move them and they'd held some back as an investment and 2) they were tied to the collapsing investment banks because they provided part of the financing for them. Oh, some of them, like BofA, had bought the originators who had actually made the loans that started everything. Those originators, Countrywide being most notable, failed in part because they had a ton of loans on their books that they couldn't move (also because of many bad loans shifted back to them under the reps and warranties). That, plus leverage, put multiple stresses on those banks.

Whenever I read about the subprime crisis on DU, I see people talking about the actual loans made and CDS. While that's cool and all, I almost never see anyone mention the actual securities (MBS or mortgage backed securities) or the collateralized debt obligations (CDO). The loans themselves are useful to discuss only in the sense that it's necessary to know the composition of the securities and the pools shed light on the actual value of those securities. CDS, or credit default swaps, are useful to understand in their role in allowing unregulated casino gambling in regard to the secondary market for mortgage loans. Neither explain the crisis adequately without looking at the securities.

Everybody securitized loans through MBS or recycled terrible tranches through CDOs. That's just a fact. It's completely ignorant to talk about "the banks making loans" because the loans weren't the issue. Those loans wouldn't have been made without the securities. Every last investment and commercial bank of size bought up loan pools, securitized those loans into MBS, and then sold the MBS to investors, usually institutional investors. The MBS were divided into slices, called tranches, based on the rating given to a sampling of a particular pool (we'll leave aside the fact that the ratings agencies were paid by the securitizers to do those ratings). Institutional investors tend to need very highly rated securities, so those sold well. The lower tranches usually didn't sell at all. With all that crap piling up, first the investment banks and then the commercial banks repackaged those terrible tranches into new securities, called collateralized debt obligations or CDOs. The CDOs, consisting of loan pools already rated as bad by the agencies, were then re-rated by those same agencies. Miraculously, many of them magically got AAA ratings, or the equivalent, in their new form! They were then eligible to be sold to the institutional investors who had to avoid them on the first go-round.

So, we've got everybody making and selling crap, while egging on the originators to keep making the raw materials. As well, we have those originators leaning on appraisers to falsely value homes in order to inflate the size of the loans. The originators make the loans then move them to the banks, both investment AND commercial, who then package them into securities and sell them to investors. We also have the banks not doing due diligence, ignoring the results of that due diligence, or doing extremely poor diligence by design. Additionally, the banks are busy lying to the investors about the quality of the pools that make up their MBS. Not a pretty picture, is it?

So, what does all this have to do with Glass-Steagall? It should be blindingly obvious by now. Had Glass-Steagall not been repeatedly undermined by the Clinton administration handing out waivers left and right before joining with Phil Gramm to finally kill it, the commercial banks couldn't have done ANY of this. Guess what? You'd have had a much smaller MBS market. You'd have had a lot less CDOs. In short, there would have been far, far less risk of a total catastrophic meltdown because the amounts would have been smaller. That's the damage Clinton, Rubin, and Summers did. You can, pardon the pun, take it to the bank.