again?…

Posted on Monday 1 December 2008

At the end of the 19th century, there were places called Bucket Shops that looked like the Stock Exchange, with Stock boards or ticker tape machines, but the were really Casinos. You could bet on the performance of a Stock, or an Index – almost anything. While nothing of real value was traded, lots of money was lost nonetheless. Wild speculation in these Bucket Shops contributed to a Panic and Stock Market Crash in 1907, the one that resulted in the formation of the Federal Reserve Bank. States began campaigns to to ban them, and they were finally made illegal in 1920. Public participation in the Bucket Shops antedated the popularity of the Stock Market during the Roaring Twenties.

In a Bucket Shop, one is betting on something in the future. Of course, there have long been other Markets where one buys something in the future – the Commodities Markets. They’re a betting game as well, but something real changes hands and the Market benefits buyer and seller. The Commodities Markets have a different history from the Stock Market, in part because Commodities have changed over time. With Stocks, the Securities and Exchange Commission [S.E.C.] that regulates them came into existence all at once as part of the New Deal. The regulation of Commodities has evolved more slowly. Finally, in 1974, the Commodity Exchange Authority in the Department of Agriculture was replaced by the Commodity Futures Trading Commission which regulates all commodity futures trading. In negotiations between the S.E.C. and the C.F.T.C. to divide up the turf, there was one area they couldn’t agree on. So in 1982, the Shad-Johnson Accord was an agreement that prohibited the trading of single-stock futures and narrow-based indices [I don’t know what they are either, but it’s very close to the futures betting like in the Bucket Shops, in that nothing changes hands.]. The idea was to ban this trading until the S.E.C. and the C.F.T.C. figured out who would regulate this Market. They never got around to it.

And then at the end of 2000, Senator Phil Gramm introduced the Commodity Futures Modernization Act, that repealed the Shad-Johnson Accord and did a few other things. Here’s David Corn‘s description in Mother Jones [Foreclosure Phil]:
… Gramm’s most cunning coup on behalf of his friends in the financial services industry—friends who gave him millions over his 24-year congressional career—came on December 15, 2000. It was an especially tense time in Washington. Only two days earlier, the Supreme Court had issued its decision on Bush v. Gore. President Bill Clinton and the Republican-controlled Congress were locked in a budget showdown. It was the perfect moment for a wily senator to game the system. As Congress and the White House were hurriedly hammering out a $384-billion omnibus spending bill, Gramm slipped in a 262-page measure called the Commodity Futures Modernization Act. Written with the help of financial industry lobbyists and cosponsored by Senator Richard Lugar (R-Ind.), the chairman of the agriculture committee, the measure had been considered dead—even by Gramm. Few lawmakers had either the opportunity or inclination to read the version of the bill Gramm inserted. "Nobody in either chamber had any knowledge of what was going on or what was in it," says a congressional aide familiar with the bill’s history.

It’s not exactly like Gramm hid his handiwork—far from it. The balding and bespectacled Texan strode onto the Senate floor to hail the act’s inclusion into the must-pass budget package. But only an expert, or a lobbyist, could have followed what Gramm was saying. The act, he declared, would ensure that neither the sec nor the Commodity Futures Trading Commission (cftc) got into the business of regulating newfangled financial products called swaps—and would thus "protect financial institutions from overregulation" and "position our financial services industries to be world leaders into the new century."

It didn’t quite work out that way. For starters, the legislation contained a provision—lobbied for by Enron, a generous contributor to Gramm—that exempted energy trading from regulatory oversight, allowing Enron to run rampant, wreck the California electricity market, and cost consumers billions before it collapsed. (For Gramm, Enron was a family affair. Eight years earlier, his wife, Wendy Gramm, as cftc chairwoman, had pushed through a rule excluding Enron’s energy futures contracts from government oversight. Wendy later joined the Houston-based company’s board, and in the following years her Enron salary and stock income brought between $915,000 and $1.8 million into the Gramm household.)

But the Enron loophole was small potatoes compared to the devastation that unregulated swaps would unleash. Credit default swaps are essentially insurance policies covering the losses on securities in the event of a default. Financial institutions buy them to protect themselves if an investment they hold goes south. It’s like bookies trading bets, with banks and hedge funds gambling on whether an investment (say, a pile of subprime mortgages bundled into a security) will succeed or fail. Because of the swap-related provisions of Gramm’s bill — which were supported by Fed chairman Alan Greenspan and Treasury secretary Larry Summers — a $62 trillion market (nearly four times the size of the entire US stock market) remained utterly unregulated, meaning no one made sure the banks and hedge funds had the assets to cover the losses they guaranteed
It’s not like the shady way in which this Bill was passed meant that it stayed under the radar everywhere. In a speech a few months later [What’s New in the Land of Regulation?], acting S.E.C. Chairman Laura Unger was fairly clear about the implications of this, and Gramm’s other deregulation offering, the 1999 Gramm-Leach-Bliley Financial Services Modernization Act:
As you can tell, both the CFMA and GLB call for unprecedented joint supervision among regulators in overseeing new financial entities and new financial products. From the Commission’s standpoint, we must contemplate how these new financial entities and new products will impact market integrity, investor protection and overall competition. Our challenge is to find an effective way to coordinate with other regulators and try to arrive at a single effective regulatory approach that will address their concerns and ours while encouraging marketplace growth and competition.
But alas, if they "contemplate[d] how these new financial entities and new products will impact market integrity, investor protection and overall competition," that’s all they did – contemplate – because these Bills opened up a black hole in the financial cosmos that threatens to engulf us all. It took them only 20 years to undo the financial history of the 20th century.
What these four pieces of legislation did was unravel the wisdom of the reforms put in place over the first thirty years of the last century. In essence, they returned us to the days of the Bucket Shops where speculators bet on anything. The credit default swaps unleashed by CFMA had a legitimate place in the financial world.
    If one buys a bond, one might enter a credit default swap contract to pay a premium for insurance on the bond. If it pays off, you lose your premium. If it fails, the insuror makes good on your investment.
In this example, the credit default swap is a future, and, properly regulated, a legitimate financial instrument. But that’s not what happened. You could buy the "insurance," without owning the bond. That’s not insurance, that’s a bet, a speculation. Worse, the people selling credit default swaps were Banks. The careful definition of Banks in the Glass-Stegall Act of 1933 were already gone in the first three pieces of legislation. And the worst of all, none of this was regulated – meaning there was no oversight requiring proof of assets to back up the sale of these contracts.

So, our current Financial crisis isn’t only the Housing bubble. In fact, that’s the more managable piece of the story. And it’s not the defaulted loans themselves. It’s the credit default swaps, the bets placed on the Mortgage Market, that are the black hole. It’s why Bush’s Bailout Plan was idiotic. Bailing out the Banks just gives them money to pay off their credit default swap contracts, and does nothing for the mortgage holders or the credit market. Presumabely, that’s being straightened out in response to the primal moan from the economists.

But the saddest thing about this story is that there was no reason to create this monster. We didn’t need credit default swaps. We’d done fine without them. The motive was simply greed, nothing more. Phil Gramm said, they would "protect financial institutions from overregulation" and "position our financial services industries to be world leaders into the new century" – yet another failed Project for the New American Century. One hundred years after the Bucket Shops and the Crash of 1907, we repeated the same thing. Only this time, the Banks themselves were the betting parlors…
 
  1.  
    December 1, 2008 | 4:59 PM
     

    If there is some Devil’s Hall of InFamy for the worst public figures, Phil Gramm should be the first inductee. His name seems to crop up more than any other in all the schemes that led to the mess we’re in now.

    And to think that he was John McCain’s choice as his economic adviser and would likely have been his Treasury Secretary had he been elected — and had Gramm’s own Scrooge-ness not disgraced him when he called us all a nation of whiners.

  2.  
    December 1, 2008 | 5:24 PM
     

    Yeah. Regan’s ‘deregulation talk’ was theoretical, so what he did was allow banks to merge, and he unleashed the Savings and Loans to self destruct [and take a lot of us with them] in a short few years. When they plugged that hole, they didn’t look at what the rest of their loosening the constraints on Banks might do.

    Gramm’s 1-2 punch essentially repealed the rest of the constraints on Banks, and opened the door for Banks to trade “derivitives” like the credit default swaps, with no oversight. Only the husband of the former chairman of the CFTC and an Enron Board member could have even understood what he was doing – meaning that he knew what he was doing. And when they later plugged the Enron loophole, they didn’t look at the rest of CFMA, which is what brought down the house.

  3.  
    December 1, 2008 | 8:28 PM
     

    I’ll bet not 5% of the public knows who Gramm is or what he did. I just hope that the leaders in Congess and the Obama team are keeping all this in mind. I know that Obama says we’ve got to move quickly to put controls back on place — but it’s imperative that they actually do it.

  4.  
    April 15, 2010 | 12:49 AM
     

    […] were buying stocks and bonds, but the ticker tape was just something to bet on. They were Casinos [again?…]. By 1920, they were shut down. The derivatives markets are similar, buying and selling contracts […]

  5.  
    November 14, 2010 | 9:26 PM
     

    […] Bucket Shops: At the end of the 19th century, there were places called Bucket Shops that looked like the Stock Exchange, with Stock boards or ticker tape machines, but they were really Casinos. You could bet on the performance of a Stock, or an Index – almost anything. While nothing of real value was traded, lots of money was lost nonetheless. Wild speculation in these Bucket Shops contributed to a Panic and Stock Market Crash in 1907, the one that resulted in the formation of the Federal Reserve Bank. States began campaigns to to ban them, and they were finally made illegal in 1920. Public participation in the Bucket Shops antedated the popularity of the Stock Market during the Roaring Twenties. […]

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