Dr. Susmit Kumar
Although elected leaders claim to work for the common people, in reality they work for the ultra-wealthy people and corporations as they need money to win elections. In reality, the “invisible hand” of Adam Smith is the hand of the ultra-wealthy and corporations behind the government and this has a self-destructive effect on capitalism. In this section, we will see how elected leaders formulated rules in favor of financial firms that led to the economic melt down in 2008, how casino games played by these firms play havoc with the common people.
Deregulation, the mantra promoted by the Republicans since the 1980s is behind the 2008 economic meltdown. After numerous bank failures during the Great Depression, the Glass-Steagall Act of 1933 established the Federal Deposit Insurance Corporation (FDIC) and introduced banking reforms like separation of banking and other financial companies. The 1999 Gramm-Leach-Bliley Act repealed part of the Glass-Steagall Act of 1933, allowing a bank to offer investment, commercial banking, and insurance services. The 1999 Gramm-Leach-Bliley Act allowed firms like Citigroup and Bank of America to offer investment and insurance services apart from banking after their acquisition and merger with other financial firms which would have been illegal before.
In 2004, at the request of big investment banks, the Security and Exchange Commission (S.E.C.) reduced requirements so that they could pile up debts. Although at the same time, the S.E.C. was given supervisory power to look into those banks risky investments. But the S.E.C. assigned only seven people to examine financial firms – which in 2007 had combined assets of more than $4 trillion. Since March 2007, the office has not had a director. As of October 2008, the office had not completed a single inspection since it was reshuffled more than a year and a half ago. The few problems the examiners preliminary investigations uncovered about the riskiness of the firms’ investments and their increased reliance on debt – clear signs of trouble – were all but ignored.
Derivatives exacerbated the 2008 global economic crisis. Derivatives are financial contracts whose values are derived from the value of something else. A derivative is basically a side bet, (i.e. a bet on loans, bonds, commodities, stocks, residential mortgages, commercial real estate, loans, bonds, interest rates, exchange rates, stock market indices, consumer price index, or even on weather conditions) without owning it. It is similar to the bet a person, who is not a player or does not own the team, makes with someone on the outcome of a baseball game. Therefore if a person is certain that mortgage securities would fail, he would place the bet against them without owning them, making millions and even billions of dollars. For an example, a credit default swap (CDS) is a credit derivative contract between two parties. In mid-1990s, CDS was invented by a JP Morgan Chase team.
Brooksley E. Born, the then head of the Commodity Futures Trading Commission, was for regulating the derivative market, but the wishes of Federal Reserve Chairman Alan Greenspan, Treasury Secretary Robert E. Rubin and Securities and Exchange Commission Chairman Arthur Levitt Jr. prevailed. Ms. Born left the CFTC in June 1999. The Commodity Futures Modernization Act of 2000 made it illegal to regulate the derivative market. These can be termed as modern financial casino games. After the 2008 Wall Street banking crisis, in his Congressional testimony Alan Greenspan said that he was wrong in his support of de-regulating the derivative market.
Warren Buffett famously described derivatives bought speculatively as "financial weapons of mass destruction." George Soros avoids using the financial contract known as derivatives “because we don’t really understand how they work.” Felix G. Rohatyn, the investment banker who saved New York from financial catastrophe in the 1970s, described derivatives as potential “hydrogen bombs.”  For an example in October 2008, trading in Gulf Bank, one of the largest lenders in Kuwait, was halted after a major customer defaulted on a currency derivative contract, a bet on the euro that dived against dollar in the previous ten days. It was reported that losses were as much as 200 million dinars or nearly $750 million.
In mid 2008, the global derivatives market was close to $530 trillion. The global CDS market increased from $900 billion in 2000 to $62 trillion in 2008. According to Eric Dinallo, the insurance superintendent for New York state, about 80 percent of $62 trillion in credit default swaps outstanding in 2008 were speculative. In comparison, the value of the New York Stock Exchange was $30 trillion at the end of 2007 before the start of the 2008 crash. American International Group (AIG), the world's largest private insurance company, had sold $440 billion in credit-default swaps tied to mortgage securities. When the housing bubble burst, the CDSs tied to mortgage securities began to send shock waves throughout the global market. To prevent a chain reaction, the U.S. government had to rescue AIG and get a $700 billion fund from the U.S. Congress to bailout Wall Street firms, as AIG and several others were running out of money after being downgraded by credit-rating agencies because of mounting losses, which triggered a clause in its credit-default swap contracts to post billions in collateral. AIG, an insurance firm, is considered “too big to fail”, so the US government had to save it. The failure of AIG would send a shockwave through the finance industry as it had insured assets of financial firms all over the world.
1 Labaton, Stephen, “Agency’s ’04 Rule Let Banks Pile Up New Debt,” The New York Times, October 2, 2008.
2 Goodman, Peter S., “Taking Hard Look at a Greenspan Legacy,” The New York Times, October 8, 2008.
3 Jolly, David, “Global Financial Troubles Reaching Into Gulf States,” The New York Times, October 26, 2008.