May 16 2010
Senator Tom Carper
When the once venerable Wall Street firm Lehman Brothers declared bankruptcy in September 2008, economies around the world went into a tailspin, and the ensuing panic nearly plunged us into another Great Depression.
Delawareans quickly learned that the unregulated, overleveraged institutions on Wall Street were so intertwined with each other and the broader economy that more failures threatened jobs, businesses, and retirement funds on Main Street.
As a result, the federal government was forced to make a heretofore unimaginable choice: Either allow the sickness on Wall Street to spread, creating a second Great Depression, or ask taxpayers to rescue Wall Street to prevent an economic disaster?
As federal officials weighed that decision, millions of Americans began to ask, "How did we get into this mess anyway?" By identifying how our economy came to the brink of collapse, we hope to avoid repeating the mistakes that led us there. So let's take a moment to do just that.
The 2008 financial crisis was rooted in the failure of market discipline. Financial actors -- from mortgage brokers, banks, rating agencies, to investment banks -- bore relatively little risk. To put it another way, too few of them had any "skin in the game." For example, imprudent mortgage lending standards, combined with appraisals often not worth the paper they were written on, allowed many mortgage brokers to originate home loans for unqualified borrowers without verifying their income.
Banks then loaned money to those borrowers to purchase homes and oftentimes turned around and sold those mortgages to Fannie Mae, Freddie Mac or to investment banks, which bundled these mortgages into mortgage-backed securities. The major credit rating agencies stamped a AAA credit rating on these investments, which were "sliced and diced" and sold to investors around the world.
As long as housing prices continued to rise and homeowners met their mortgage payments, this house of cards continued to stand. But when housing prices began to drop, interest rates for adjustable rate mortgages began to climb and unemployment rates began to rise, our housing bubble burst.
Many of these mortgage-backed securities became illiquid, and credit markets began to freeze up. Panic set in. Wall Street was on the brink of collapse.
It soon became clear that without bold action our entire economy could fail, causing unemployment to skyrocket. Congress took the extraordinary step, at the urging of the Bush administration and many economists, of authorizing a $700 billion emergency rescue package called TARP -- or Troubled Asset Relief Program -- to prevent the crisis on Wall Street from causing a depression on Main Street.
Eighteen months later, our economy is beginning to recover and taxpayers are starting to see returns on our emergency investments, but I have no interest in ever facing again the difficult choice that we faced in the fall of 2008.
What are some of the steps we should take now to dramatically reduce the chances that it might happen again? Enacting financial reform legislation that protects jobs, and strengthens our economic recovery is essential to achieving that goal. The legislation being debated in the Senate creates a powerful regulatory council, called the Financial Oversight Stability Council, to better ensure that the collapse of a single, large financial institution won't bring down the entire economy. This council will identify risks before they grow out of control, while requiring institutions to increase capital and liquidity to serve as cushions. In addition, this new council's job is to proactively monitor the overall financial stability of the United States to prevent threats to the economy from spiraling out of control.
If the failure of a large, complex firm does jeopardize the broader economy, a mechanism is needed to safely "wind down" such companies when bankruptcy is not an option. The Senate reform bill authorizes the Federal Deposit Insurance Corporation to unwind complex institutions through an orderly liquidation process. Financial institutions -- not taxpayers -- will bear all the costs associated with failure.
We also need to modernize financial rules and oversight by providing transparency and oversight with respect to -- among others -- derivatives and hedge funds. We ought to make sure that all the relevant players have skin in the game, too.
Additionally, ending our patchwork quilt of regulations and drawing clear lines of responsibility for regulators will help prevent financial institutions from "regulator shopping," a practice that allowed banks like Washington Mutual to escape more rigorous oversight by opting to be regulated instead by the more lenient Office of Thrift Supervision.
Finally, the Senate measure will establish a Consumer Financial Protection Bureau to empower consumers to make better-informed decisions, create a level playing field for all companies offering financial products, and make sure other regulators don't fall asleep at the switch.
In the days ahead, my colleagues and I will continue to work to strengthen and improve this critical legislation. If we send a financial reform bill to the president that re-establishes market discipline, creates a 21st century regulatory framework, and improves transparency, Congress will have taken a big step toward restoring the American public's trust in our financial system and in our government.
More important, we will protect thousands of jobs in the First State -- and millions of jobs across the country -- by ensuring that the mistakes on Wall Street won't be allowed to wreak havoc on Delaware's -- and America's -- Main Streets.