Be careful what you wish for.

[flamin lib]

Citigroup announced a new round of layoffs, as many as 45,000, and the stock price fell again. The CEO, Charles Prince III, was recently forced to resign with a $40 mil bonus for losing $8 bil and driving the stock price down. Housing starts are at an all time low, foreclosures are at the highest since 1929. The ripple effect of the sub-prime market has hit just about every industry in the country. It is becoming more and more apparent that the US is sliding into a classically defined recession. Most of us in the working world have known we were in a recession for some time now but it’s finally reaching the moneyed class who use arcane verbiage about the number of quarters they lose money to define what a recession is.

How’d we get here? To answer that we’ll have to look in the file marked “Be careful what you wish for.”

After the 1929 depression a number of laws were passed regulating how the banking profession interacted with the stock market. The 1933 Glass-Steagall Act and the 1956 Bank Holding Company Act made it illegal for banks, insurance companies and stock brokerage firms to merge. A key provision was that banks couldn’t own insurance companies (largest supply of investment money) or issue stocks (one of the major contributing factors in the 1929 crash). Beginning immediately banks worked to revise those regulations. In 1999 they succeeded with banking reform legislation passed by the Republican congress and signed by Bill Clinton. It effectively repealed all the protections imposed because of the 1929 stock market crash and Great Depression.

The K Street project, born of the Contract for America launched by Newt Gingrich, raised lobbying to an art-form. Chief among the lobbyists for the banking industry was, you guessed it, Charles Prince III. He was rewarded with the leadership of Citigroup, a position paying $ millions in compensation. But I digress. Once banks could issue stocks through their in-house brokerages it made leveraging their loans much easier and less risky for the investors.

Here’s how it works; before 1999 a lender could sell a loan to another lender and each loan was scrutinized on it’s own merit. After the de-regulation of 1999 the bank owned insurance companies provided money for sub-prime loans that could be “bundled” into hedge funds. Shares in those funds sold on the open market. There was no real scrutiny of the individual loans and the risk of foreclosure was spread over a large number of loans. The money loaned was immediately available to be loaned again and bundled into more hedge funds. The banks made money on the sale of the funds and on the brokerage fees associated with those sales. With the risk spread over many loans the lender side of the bank/brokerage could make increasingly risky loans to feed the creation of hedge funds to be leveraged (borrowed against) to free up more money to make more loans.

A great many of those loans were three and five year adjustable rate mortgages. The boom began in 2000, just in time for Bush to take credit for it. Three years later the first three year ARMs began escalate and a year later, 2004, the worst of the sub-primes began to foreclose. No problemo! Foreclose and re-sell because housing values were high and money was flowing like water thanks to being able to immediately liquidate all those loans through the hedge funds. Two years later, 2006, the less risky three year ARMs and the more risky five year ARMs begin to foreclose. With all those foreclosures on the market the housing values begin to fall. It became more difficult to re-sell the foreclosures for the amount of the loans. Property values, the basis of the loans and the hedge funds, could no longer support the investments. Funds and brokerages began to fail. The rest, as they say, is history or soon will be.

Seventy years of New Deal protections were overturned and less than ten years later we slide into a very deep recession. The moral of this story is that de-regulation and competition sounds like a good idea but you better be careful about what you wish for. You might just get it.

http://www.thestreet.com/s/citi-dips-on-layoff-report/newsanalysis/banking/10391608.html?puc=googlefi Citicorp stock drops on layoff announcement.

http://money.cnn.com/1999/10/22/news/bankfolo/ banking reform 1999

[damntexdem]

1. I wish everyone would be careful what they wish for.

Oops, now I wish I hadn't wished that. ;-)