First, understand the recent legislative and regulatory changes, which were summarized in this New York Times article, Don’t Blame the New Deal:
"But the failures that have landed us in the mess we are in today are not mainly structural. To assert that they are masks deeper failings and sets false terms for the upcoming debate on regulatory reform.Then there was the development and enormous recent growth of CDOs (colateralized debt obligations) and CDSs (credit default swaps). A rule change made by the the Securities and Exchange Commission in 2004 under a Republi-con President and Congress is the primarily reason these new financial instrument spun out of control. See:
Under a law passed in 1994, for example, the Federal Reserve was obligated to regulate banks and nonbank lenders to curb unfair, deceptive and predatory lending. Alan Greenspan, the former Federal Reserve chairman, ignored his responsibility, even as junk mortgage lending proliferated in plain sight.
Mr. Greenspan later said the law defined “unfair” and “deceptive” too vaguely. If so, he should have asked Congress for clarification. Instead, he did nothing — and the Republican-led Congress did not question him. When Ben Bernanke took over as Fed chairman in early 2006, the negligence continued. It was not until mid-2007, after the housing bubble had begun to burst, that federal regulators offered guidelines for subprime lending.
The systematic dismantling of laws that called for regulation also contributed to the current crisis.
In 1995, Congress passed a law that restricted the ability of investors to sue companies, securities firms and accounting firms for misstatements and pie-in-the-sky projections. That helped inflate the dot-com bubble and contributed to the Enron debacle. It also engendered a sense of impunity that helped to foster the excessive risk-taking so prevalent in the mortgage mess.
Then, in 1999, Congress dismantled the Glass- Steagall Act, a pillar of the New Deal, which separated commercial and investment banking. That enormous change was undertaken with no thought or effort — or desire — to regulate the world that it would help to create. Now we know that an entire “shadow banking system” has grown up, without rules or transparency, but with the ability to topple the financial system itself.
But perhaps no deregulatory effort had more catastrophic effect than the 2000 law that explicitly excluded derivatives, including those credit default swaps, from regulation under the Commodity Exchange Act of 1936.
And there is probably no greater missed opportunity than the reform of Fannie Mae and Freddie Mac passed by the House in 2005. If the law had been enacted, the takeover of those companies may have been avoided. It failed in large part because President Bush wanted to fully privatize them and feared that if they were adequately reformed, privatization would lose steam.
Indeed, it was in the Bush years that antiregulation and deregulation found full expression, fueled by an ideology that markets know best, government hampers markets, and problems will magically fix themselves."
- New York Time, Agency’s ’04 Rule Let Banks Pile Up New Debt, and Risk
You can listen to the associated audio Back Story with The Times's Stephen Labaton, which includes excerpts from the SEC meeting in April 2004, or even an audio recording of the whole meeting, and hear meeting participants laughing about the risk.
These changes were made based on a faulty assumption, that the financial institutions and regulators understood and properly evaluated the risk(s) involved. As we now know, that was not true. See:
Deliberately ignorant assumptions and stupid decisions to reach a desired conclusion and objective, does that remind you of anything? Can you say Iraq?
But of course, the Rebubli-cons never had much concern for objective reality. So something must be done. See:
- Washington Post, Thanks to the Wing Nuts