{"id":402,"date":"2010-12-04T22:46:25","date_gmt":"2010-12-05T05:46:25","guid":{"rendered":"http:\/\/fiduciarydutiesblog.com\/?p=402"},"modified":"2010-12-04T22:46:25","modified_gmt":"2010-12-05T05:46:25","slug":"thomas-schoenbaum-on-the-causes-of-global-financial-crisis-%e2%80%93-part-1","status":"publish","type":"post","link":"https:\/\/fresnolawyerblog.com\/?p=402","title":{"rendered":"Thomas Schoenbaum on the Causes of Global Financial Crisis \u2013 Part 1"},"content":{"rendered":"

Professor Thomas Schoenbaum from George Washington University<\/a> has written a paper discussing the worldwide financial crisis.\u00a0 His paper entitled \u201cSaving the Global Financial System: International Financial Reforms and United States Financial Reform, Will They Do the Job?\u201d, identifies 12 factors as triggering the financial crisis.<\/p>\n

The first six are as follows (the second six are discussed in part 2).<\/p>\n

1. The diminished authority of the United States Securities Exchange Commission<\/strong>.\u00a0 This constituted a regulatory failure.\u00a0 States Prof. Schoenbaum,\u00a0 \u201cbeginning in the 1980’s, the once-feared SEC<\/a> became largely toothless due to rule-revisions, exceptions, and leaders that discouraged fraud investigations and enforcement actions.\u201d<\/p>\n

Such failure continued for two decades, but not without warning.\u00a0 \u201cOne of the most egregious of SEC failure occurred on April 28, 2004, when the SEC voted to exempt investment companies from the SCC\u2019s net capital rule . . . During this meeting, Harvey Goldschmid, one of the Commissioners, remarked, \u2018If anything goes wrong, its going to be awfully big mess.\u2019\u201d<\/p>\n

2. Failure to Regulate the Derivatives Market<\/strong>.\u00a0 Another regulatory failure.\u00a0 The derivative market is enormous, yet it operated for years without effective oversight.\u00a0\u00a0 Again, there were warnings.\u00a0 The Commodities Futures Modernization Act of 2000<\/a> specify exempted derivatives and swaps from supervisory oversight by the Commodity Futures Trading Commission, \u201cdespite warning from its chairman that unregulated derivatives \u201ccould threaten our regulated markets or, indeed, our economy without any Federal agency knowing about it.\u201d<\/p>\n

3. Lax Regulation of Financial Institutions<\/strong>.\u00a0 Here, the author cites the Federal Reserve and the Comptroller<\/em> <\/em>of the Currency<\/a> as failing to exercise proper oversight of the U.S. banking industry.\u00a0 Thus, \u201cthe persons in charge of bank regulations were totally obvious to the dangers of the extensive use of derivatives such as MBS\u2019s.\u00a0 Accordingly, the use of MBS\u2019s allowed financial institutions to profit from transactions that involved unreasonably low capital requirements.\u201d<\/p>\n

This point could be stated in slightly different terms.\u00a0 The players in the financial markets, especially in derivatives, were permitted to gamble with other people\u2019s money.\u00a0 The oversight in the banking industry was absent in the derivatives market.\u00a0 Such easy access to such excessive leveraging encouraged Wall Street to take unreasonable and dangerous \u2013 desperately dangerous \u2013 risks.<\/p>\n

\"abandoned<\/a><\/p>\n

4. Financial Institutions That Took on Too Much Leverage<\/strong>.\u00a0 The authors cites this factor as a private sector abuse,\u00a0 stating \u201ca key cause of the Crisis was the fact that key financial institutions, especially the investment banks, took on far too much leverage<\/a>, risking vast qualifies of borrowed capital so that they were unable to withstand a down turn in asset prices.\u201d<\/p>\n

What kind of leveraging was going on?\u00a0\u00a0 \u201cAfter the SCC exempted investment banks from the \u2018net capital\u2019 rule in April 2004, leverage increased dramatically to levels in excess of 40 to 1.\u201d\u00a0 This meant the investment banks could make a $40 bet with only $1 in actual assets.\u00a0 Is this a recipe for disaster?\u00a0 You bet it is.<\/p>\n

5. Mismanagement by Bond and Securities Ratings Agencies<\/strong>.\u00a0 As explained by Prof. Schoenbaum, \u201chearings in the Congress and the European Union have established a sloppy and misleading ratings practices that causes most of the now \u2018toxic\u2019 derivatives to be given triple A ratings.\u00a0 Only after the Crisis began did the ratings agencies downgrade these securities.\u00a0 The credit ratings agencies were among the enablers of the Crisis.\u201c<\/p>\n

See, the vast tradings in the investment banking world were really a shadow financial system, running parallel to the banking industry.\u00a0 The banks were heavily regulated and were backed by the FDIC.\u00a0 The investment banking world had no such official guarantees, so they invested the insurance provided by companies such as AIG.\u00a0 At present, \u201cAIG has benefitted for governmental largesse amounting to a total of $182.5 billion<\/a>.\u00a0 None of this funding has been repaid.\u201d<\/p>\n

That means that the U.S. taxpayers bailed out the bets that were made by Goldman Sachs and other investment banks to the tune of $182 billion that has never been repaid.\u00a0 It\u2019s one thing to take risks with your own money; it\u2019s entirely different when the government steps in to save private industry in the amount of $182 billion.\u00a0 Oversight and accountability must be established, otherwise the taxpayers just gave away $182 billion to the bankers.<\/p>\n

6. Low Saving Rates and High Borrowing by American Consumers<\/strong>.\u00a0 This is a social factor.\u00a0 Explains the author, \u201cas of 2007, the U.S. savings rate touched zero, which means that as a group Americans were spending every penny of income.\u00a0 Moreover, many Americans were deeply in debt, now only for home mortgages but on credit cards and other consumer loans.\u00a0 The American economy was overheated<\/a> and riding for a fall.\u201d<\/p>\n

Part 2 follows next week.<\/p>\n

Uniform Commercial Code Law Journal<\/strong>, Vol. 43, No.1 (October 2010) page 479.<\/p>\n","protected":false},"excerpt":{"rendered":"

Professor Thomas Schoenbaum from George Washington University has written a paper discussing the worldwide financial crisis.\u00a0 His paper entitled \u201cSaving the Global Financial System: International Financial Reforms and United States Financial Reform, Will They Do the Job?\u201d, identifies 12 factors as triggering the financial crisis. The first six are as follows (the second six are […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[6],"tags":[],"class_list":["post-402","post","type-post","status-publish","format-standard","hentry","category-economics"],"_links":{"self":[{"href":"https:\/\/fresnolawyerblog.com\/index.php?rest_route=\/wp\/v2\/posts\/402"}],"collection":[{"href":"https:\/\/fresnolawyerblog.com\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/fresnolawyerblog.com\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/fresnolawyerblog.com\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/fresnolawyerblog.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=402"}],"version-history":[{"count":0,"href":"https:\/\/fresnolawyerblog.com\/index.php?rest_route=\/wp\/v2\/posts\/402\/revisions"}],"wp:attachment":[{"href":"https:\/\/fresnolawyerblog.com\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=402"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/fresnolawyerblog.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=402"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/fresnolawyerblog.com\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=402"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}