[BigV]

Originally Posted by dar512

As I discovered this weekend, the mortgage side of the current problem is only half the story. The other part is the practice of credit default swaps. This is a practice that has never been regulated or had oversight -- and should have.

You're right, dar. Let's explore that a bit, shall we?

Credit default swaps, a kind of insurance policy I don't completely understand, were legislated to be free from the shackles of regulation by Phil Gramm. Read this story for details of the jailbreak in 2000.

In the early evening of Friday, December 15, 2000, with Christmas break only hours away, the U.S. Senate rushed to pass an essential, 11,000-page government reauthorization bill. In what one legal textbook would later call “a stunning departure from normal legislative practice,” the Senate tacked on a complex, 262-page amendment at the urging of Texas Sen. Phil Gramm.

There was little debate on the floor. According to the Congressional Record, Gramm promised that the amendment—also known as the Commodity Futures Modernization Act—along with other landmark legislation he had authored, would usher in a new era for the U.S. financial services industry.

“The work of this Congress will be seen as a watershed where we turned away from an outmoded Depression-era approach to financial regulation and adopted a framework that will position our financial services industry to be world leaders into the new century,” Gramm said.

Watershed indeed. With the U.S. economy now battered by a tsunami of mortgage foreclosures, the $30-billion Bear Stearns Companies bailout and spiking food and energy prices, many congressional leaders and Wall Street analysts are questioning the wisdom of the radical deregulation launched by Gramm’s legislative package. Financial wizard Warren Buffett has labeled the risky new investment instruments Gramm unleashed “financial weapons of mass destruction.” They have fed the subprime mortgage crisis like an accelerant. While his distracted peers probably finalized their Christmas gift lists, Gramm created what Wall Street analysts now refer to as the “shadow banking system,” an industry that operates outside any government oversight, but, as witnessed by the Bear Stearns debacle, requiring rescue by taxpayers to avert a national economic catastrophe.

Panzner also believes that Gramm-Leach-Bliley “may have even set the stage for both the collapse and the subsequent ‘rescue’ of Bear Stearns by the Federal Reserve.” The deregulated financial services industries were “encouraged to push the envelope in terms of risk-taking, and were not entirely dissuaded from thinking that the public purse would be available if things went horribly wrong.”

Still others blame Gramm’s Commodity Futures Modernization Act. Prior to its passage, they say, banks underwrote mortgages and were responsible for the risks involved. Now, through the use of credit default swaps—which in theory insure the banks against bad debts—those risks are passed along to insurance companies and other investors.

Maryland law professor Greenberger believes credit default swaps “were a key factor in encouraging lenders to feel they could make loans without knowing the risks or whether the loan would be paid back. The Commodity Futures Modernization Act freed them of federal oversight.”

Before passage of the modernization act, the Commodity Futures Trading Commission was attempting to regulate the swaps market through rule-making. The modernization act, Gramm noted in his remarks on the Senate floor, provided “legal certainty” for the growing swaps market. That was necessary, Greenberger says, because at the time, “banks were doing these trades in direct violation of federal law.”

"legal certainty" == legal immunity.

So Phil Gramm was the father of the unregulation of credit default swaps. What else do we know about Phil Gramm? He's McCain's principle economic advisor. Gulp.

Gramm was always Wall Street's man in the Senate. As chairman of the Senate Banking Committee during the Clinton administration, he consistently underfunded the Securities and Exchange Commission and kept it from stopping accounting firms from auditing corporations with which they had conflicts of interest. Gramm's piece de resistance came on Dec. 15, 2000, when he slipped into an omnibus spending bill a provision called the Commodity Futures Modernization Act (CFMA), which prohibited any governmental regulation of credit default swaps, those insurance policies covering losses on securities in the event they went belly up. As the housing bubble ballooned, the face value of those swaps rose to a tidy $62 trillion. And as the housing bubble burst, those swaps became a massive pile of worthless paper, because no government agency had required the banks to set aside money to back them up.

The CFMA also prohibited government regulation of the energy-trading market, which enabled Enron to nearly bankrupt the state of California before bankrupting itself.

From here.

I'm very unhappy with this pattern of decisions and choices.