Deregulation Act to Resolve Financial Crises

As financial markets continue to tumble and as national economies sink deeper into recession, it is clear that the East Asian crisis has developed into a global economic crisis. The international money managers, whose speculative activities have heavily contributed to this development, have been abetted by the IMF with its push for the deregulation of international capital flows. After having whittled away the capacity of national governments to effectively respond to such 'financial warfare', these powerful forces are working to secure even greater control of the Bretton Woods institutions and a more direct role in the shaping of the international financial and economic environment.

The crisis is not limited to South-East Asia or the former Soviet Union. The collapse in the standard of living is taking place abruptly and simultaneously in a large number of countries. This worldwide crisis of the late 20th century is more devastating than the Great Depression of the 1930s. It has far-reaching geo-political implications; economic dislocation has also been accompanied by the outbreak of regional conflicts, the fracturing of national societies and in some cases the destruction of entire countries. This is by far the most serious economic crisis in modern history.

The existence of a 'global financial crisis' is casually denied by the Western media, its social impacts are downplayed or distorted; international institutions, including the United Nations, deny the mounting tide of world poverty: 'The progress in reducing poverty over the 20th century is remarkable and unprecedented....' The 'consensus' is that the Western economy is 'healthy' and that 'market corrections' on Wall Street are largely attributable to the 'Asian flu' and to Russia's troubled 'transition to a free market economy'

The international rules regulating the movements of money and capital (across international borders) contribute to shaping the 'financial battlefields' on which banks and speculators wage their deadly assaults. In their worldwide quest to appropriate economic and financial wealth, global banks and multinational corporations have actively pressured for the outright deregulation of international capital flows, including the movement of 'hot' and 'dirty' money. Caving in to these demands, a formal verdict to deregulate capital movements was taken by the IMF Interim Committee in Washington in April 1998. The official communique stated that the IMF will proceed with the amendment of its Articles with a view to 'making the liberalisation of capital movements one of the purposes of the Fund and extending, as needed, the Fund's jurisdiction for this purpose'. The IMF managing director, Mr Michel Camdessus, nonetheless conceded in a dispassionate tone that 'a number of developing countries may come under speculative attacks after opening their capital account' while reiterating (ad nauseam) that this can be avoided by the adoption of 'sound macroeconomic policies and strong financial systems in member countries. The IMF's resolve to deregulate capital movements was taken behind closed doors (conveniently removed from the public eye and with very little press coverage) barely two weeks before citizens' groups from around the world gathered in mass demonstrations in Paris opposing the controversial Multilateral Agreement on Investment (MAI) under Organisation for Economic Cooperation and Development (OECD) auspices. This agreement would have granted entrenched rights to banks and multinational corporations overriding national laws on foreign investment as well as derogating the fundamental rights of citizens. The MAI constitutes an act of capitulation by democratic government to banks and multinational corporations.

The Savings and Loan crisis of the 1980s was a wave of savings and loan association failures in the United States in which over 1,000 savings and loan institutions failed in "the largest and costliest venture in public misfeasance, malfeasance and larceny of all time." The ultimate cost of the crisis is estimated to have totaled around USD$150 billion, about $125 billion of which was consequently and directly subsidized by the U.S. government, which contributed to the large budget deficits of the early 1990s. The concomitant slowdown in the finance industry and the real estate market may have been a contributing cause of the 1990-1991 economic recessions.

Although the deregulation of S&Ls gave them many of the capabilities of banks, it did not bring them under the same regulations as banks. First, thrifts could choose to be under either a state or a federal charter. Immediately after deregulation of the federally chartered thrifts, the state-chartered thrifts rushed to become federally chartered, because of the advantages associated with a federal charter. In response, states (notably, California and Texas) changed their regulations so that they would be similar to the federal regulations. States changed their regulations because state regulators were paid by the thrifts they regulated, and they didn't want to lose that money. This is similar to the concept of a race to the bottom.

In an effort to take advantage of the real estate boom (outstanding US mortgage loans: 1950 $55bn; 1976 $700bn; 1980 $1.2tn) and high interest rates of the early 1980s, many S&Ls lent far more money than was prudent, and to risky ventures which many S&Ls were not qualified to assess. Whereas insolvent banks in the United States were typically detected and shut down quickly by bank regulators, the Congress and the Reagan Administration sought to change regulatory rules so S&L's would not have to acknowledge insolvency and the FHLB would not have to close them down.

One of the most important contributors to the problem was deposit brokerage. Deposit brokers, somewhat like stockbrokers, are paid a commission by the customer to find the best certificate of deposit (CD) rates and place their customers' money in those CDs.

Another factor was the efforts of the federal government to wring inflation out of the economy, marked by Paul Volcker's speech of October 6, 1979, with a series of rises in short-term interest. This led to increases in the short-term cost of funding to be higher than the return on portfolios of mortgage loans, a large proportion of which may have been fixed rate mortgages.

The damage to S&L operations led Congress to act, passing a bill in September 1981 allowing S&Ls to sell their mortgage loans and use the cash generated to seek better returns; the losses created by the sales were to be amortised over the life of the loan and any losses could also be offset against taxes paid over the preceding ten years. This all made S&Ls eager to sell their loans. The buyers - major Wall Street firms - were quick to take advantage of the S&Ls lack of expertise, buying at 60-90% of value and then transforming the loans by bundling them as, effectively, government backed bonds. S&Ls were one group buying these bonds, holding $150bn by 1986, and being charged substantial fees for the transactions.

In finance, leverage (or gearing) is using given resources in such a way that the potential positive or negative outcome is magnified. It generally refers to using borrowed funds, or debt, so as to attempt to increase the returns to equity. Leverage plays very important role in the Long Term Capital management. Long-Term Capital Management (LTCM) was a hedge fund founded in 1994 by John Meriwether. On its board of directors were Myron Scholes and Robert C. Merton, who shared the 1997 Nobel Memorial Prize in Economics. Initially enormously successful with annualized returns of over 40% in its first years, in 1998 it lost $4.6 billion in less than four months and became the most prominent example of the risk potential in the hedge fund industry. The fund folded in early 2000.

The company had developed complex mathematical models to take advantage of fixed income arbitrage deals (termed convergence trades) usually with U.S., Japanese, and European government bonds. The basic idea was that over time the value of long-dated bonds issued a short time apart would tend to become identical. However the rate at which these bonds approached this price would be different, and that more heavily traded bonds such as US Treasury bonds would approach the long term price more quickly than less heavily traded and less liquid bonds. Thus by a series of financial transactions (essentially amounting to buying the cheaper 'off-the-run' bond and short selling the more expensive, but more liquid, 'on-the-run' bond) it would be possible to make a profit as the difference in the value of the bonds narrowed when a new bond came on the run. As LTCM's capital base grew, they felt pressed to invest that capital somewhere and had run out of good bond-arbitrage bets. This led LTCM to undertake trading strategies outside their expertise. Although these trading strategies were non-market directional, i.e. they were not dependent on overall interest rates or stock prices going up (or down), they were not convergence trades as such. By 1998 LTCM had extremely large positions in areas such as merger arbitrage and S&P 500 options (net short long-term S&P volatility). In fact some market participants believed that LTCM had been the primary supplier of S&P 500 gamma which had been in demand by US insurance companies selling equity indexed annuities products for the prior two years. Because these differences in value were minute — especially for the convergence trades — the fund needed to take highly-leveraged positions in order to make a significant profit. At the beginning of 1998, the firm had equity of $4.72 billion and had borrowed over $124.5 billion with assets of around $129 billion. It had off-balance sheet derivative positions amounting to $1.25 trillion, most of which were in interest rate derivatives such as interest rate swaps. The fund also invested in other derivatives such as equity options.