It’s not rocket science

Dear readers,

Please indulge me some personal reflection.

Those of us who are trying to understand the last financial crisis, so we can prevent the next one, are often told that the next crisis will be different and unpredictable.

That’s not entirely true. We just need regulators who will relentlessly control short-term financing, self dealing and fraud.  

I offer the following proof:

Thirty years ago this year I co-authored Inside Job, The Looting of America’s Savings and Loans with Steve Pizzo and Paul Muolo. McGraw-Hill published our hard-cover book in 1989, we made the New York Times bestseller list and Harper Collins published our updated paperback in 1991.

That very year, Congress decided it wanted to deregulate banks. We testified against it.

Speaking for the three of us, Steve Pizzo told the Subcommittee on Telecommunications and Finance of the House Energy and Commerce Committee on July 10, 1991:

Americans watched in horror as thrift after thrift burned to the ground, but few have gotten down on their hands and knees and actually crawled through the smoking ruins, as my co-authors and I have. That’s what makes us uniquely qualified to come before you today to say that we are absolutely certain that bank deregulation, as it is now being contemplated, will be a disaster.

Our Summary of our Written Testimony said:

If Congress allows banks to be owned by non-bank companies, to underwrite securities and insurance, and to operate interstate it will unleash on the nation a second financial holocaust which will make the costs of the first one, the S&L crisis, look like chump-change.

As was the case following thrift deregulation, for the first few years banks will appear to prosper beyond everyone’s wildest dreams. But beneath that apparent prosperity will lie the seeds of disaster.

• The number of Too-Big-To-Fail banks will multiply.
• Bank conglomerates will prefer to lend or invest with associates and affiliates, regardless of their credit worthiness.
• When a substantial portion of the assets of the nation’s banks – perhaps 30 percent – are tied up in self-serving loans and investments made by a dozen Too-Big-To-Fail banks and a network of renegade community banks, the regulatory system will be faced with the same no-win choices it faced in 1985 when the thrift industry began to melt down.
• After the implosion taxpayers and prudent community banks will have to pick up the bill, which will far exceed the $500 billion S&L loss.

It’s totally predictable.

It happened in the 1930s, when 9,000 banks failed, and it happened again in the 1980s, when 1,000 S&Ls failed, and no amount of smoke blown by the nation’s most powerful – and most unsuccessful – bankers can redirect the winds of history and or repeal human nature. There’s nothing complicated about this scenario, though those same bankers would try to make it seem so. It’s up to Congress to see through the con job and Just Say No.

We pretty much nailed it, don’t you think?

We had no idea what the next crisis would look like, and the Panic of 2008 did turn out to be very different than the S&L crisis of the 1980s. But that didn’t matter. Here’s all we needed to know:

• (1) Given the chance, some bankers will finance themselves with short-term loans because it’s profitable. S&Ls used mainly brokered deposits. Lehman et al. used mainly repos.
• (2) Given the chance, some bankers will commit self-dealing and fraud because it’s profitable. S&Ls and Lehman et al. excelled in self dealing and knowingly dealt in fraudulent loans.

When the self dealing and loan fraud crumble, the short-term lenders will run.

Banking, even by non-banks, is not rocket science.  Smart regulation and transparency are the answer.

So today I’m wondering:

• Why are regulators rethinking their regulation of brokered deposits and repurchase transactions?
  
• Are regulators checking loan files to make sure bank and non-bank lenders are denying loans to borrowers who lie about their income and their ability to repay?
  

Thank you,

Mary Fricker
Editor