So you voted to repeal Glass-Steagall…

…and you want to defend yourself. Then point out that it wasn’t even the stupidest regulatory policy reversal of the age. (I’m obviously coming late to the action here if it’s the point the New York superintendent of insurance is making … for the second time.)

The bank panic of 1907 is remembered for J.P. Morgan forcing all the bankers to stay in a room until they agreed to contribute to fixing the crisis. What has been forgotten is one major cause of the crisis ­– unregulated speculation on the prices of securities by people who did not own them. These betting parlours, or fake exchanges, were called bucket shops because the bets were literally placed in buckets.

The states responded in 1908 by passing anti-bucket shop and gambling laws, outlawing the activity that helped to ruin that economy.[…]

But there was serious concern that swaps violated the old bucket shop laws. Thus, the Commodity Futures Modernisation Act of 2000 exempted credit default swaps from these laws. The act also exempted them from regulation by the Commodities and Futures Trading Commission and the Securities and Exchange Commission. Unregulated, the market grew enormously.

Thus, one of the major causes of the financial crisis was not how lax our regulation, or how hard we enforced, but what we chose not to regulate.

Sadly, Eric Dinallo doesn’t quite make clear in what ways the market for CDS fell foul of bucket-shop laws. Obviously, it should have raised an alarm that the law could see something in these apparently sensible and useful derivatives that looked like a casino. From links here and here, the reason is that the CDS buyers didn’t have to prove they owned Lehman Brothers bonds (as you would if you insured your house) and the sellers didn’t have to set aside capital to make good on the bet (as you would have to if you were an insurance company).


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