During an other-wise deathly boring year spent covering this debate, I learned to derive some entertainment from watching politicians scramble to give floor speeches about financial reform without disclosing the fact that they didn't have the first fucking clue what a credit-default swap is, or how a derivative works. This was certainly true of Democrats, but the Republicans were way, way better at it. Their strategy was brilliant in its simplicity: Don't even bother trying to figure out the math-y stuff, and instead just blame the entire crisis on government efforts to make homeowners of lazy black people. "Private enterprise mixed with social engineering" was how Sen. Richard Shelby of Alabama put it, with a straight face, not long before the bill passed.
The argument favored by Wall Street lobbyists and Obama's team of triangulating pro-business Democrats was more subtle. In this strangely metaphysical version of recent history, the economy was ruined by bad luck and a few bad actors, not by any particular law or policy. It was the "guns don't kill people, people kill people" argument expanded to cover global financial fraud. "There is an assumption that math is evil," insisted Keith Hennessey, a member of the Financial Crisis Inquiry Commission, at a hearing in June. "Credit-default swaps are things, and things can't be culprits."
Both of these takes were engineered to avoid an uncomfortable political truth: The huge profits that Wall Street earned in the past decade were driven in large part by a single, far-reaching scheme, one in which bankers, home lenders and other players exploited loopholes in the system to magically transform subprime home borrowers into AAA investments, sell them off to unsuspecting pension funds and foreign trade unions and other suckers, then multiply their score by leveraging their phony-baloney deals over and over. It was pure financial alchemy – turning manure into gold, then spinning it Rumpelstiltskin-style into vast profits using complex, mostly unregulated new instruments that almost no one outside of a few experts in the field really understood. With the government borrowing mountains of Chinese and Saudi cash to fight two crazy wars, and the domestic manufacturing base mostly vanished overseas, this massive fraud for all intents and purposes was the American economy in the 2000s; we were a nation subsisting on an elaborate check-bouncing scheme.
And it was all made possible by two major deregulatory moves from the Clinton era: the Gramm-Leach-Bliley Act of 1999, which allowed investment banks, insurance companies and commercial banks to merge, and the Commodity Futures Modernization Act of 2000, which exempted the entire derivatives market from federal regulation. Together, these two laws transformed Wall Street into a giant casino, allowing commercial banks to act like high-risk hedge funds, with a whole new galaxy of derivative bets to lay action on. In fact, the laws made Wall Street even crazier than a casino, because in a casino you have to put up actual money to make bets. But thanks to deregulation, financial companies like AIG could bet billions, if not trillions, without having any money at all to back up their gambles.
Dodd-Frank was never going to be a meaningful reform unless these two fateful Clinton-era laws – commercial banks gambling with taxpayer money, and unregulated derivatives being traded in the dark – were reversed. The story of how the last real shot at reining in Wall Street got routed tells you everything you need to know about how, and on whose behalf, our government works. It was Congress at its most cowardly, deceptive best, with both parties teaming up to subject reform to death by a thousand paper cuts – with the worst cuts coming, literally, in the final moments before the bill's passage.
The first of the two final battles coalesced around an effort by Sens. Carl Levin of Michigan and Jeff Merkley of Oregon to implement the so-called "Volcker rule," a proposal designed to restore the firewall between investment houses and commercial banks. At the heart of Merkley-Levin was one key section: a ban on proprietary trading.
"Prop trading" is just a fancy term for banks gambling in the market for their own profit. Thanks to the Clinton-era deregulation, giant commercial banks like JP Morgan Chase were not only allowed to serve as investment banks, accumulating mountains of privileged insider information, they were allowed to play the markets themselves. That meant that the prop-trading desk at Goldman Sachs could bet heavily against Greek debt not long after the bank had saddled Greece with toxic interest-rate swaps. It also meant that if any of these "too big to fail" banks went bust, American taxpayers would be expected to bail them out. The Volcker rule – pushed by Paul Volcker, the former Fed chief and current Obama adviser – aimed to lay down a simple law for big banks: If you want to gamble like a drunken sailor, fine. Just don't expect us to mop up the mess after you puke your guts out.
If Obama's team had had their way, last month's debate over the Volcker rule would never have happened. When the original version of the finance-reform bill passed the House last fall – heavily influenced by treasury secretary and noted pencil-necked Wall Street stooge Timothy Geithner – it contained no attempt to ban banks with federally insured deposits from engaging in prop trading. But that changed when Scott Brown, the Tea Party darling from Massachusetts, blindsided the Democrats by wresting away the seat of deceased liberal icon Ted Kennedy. With voters seething over Wall Street's rampant thievery and fraud, the Democrats suddenly got religion about reckless gambling by the financial industry.
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