The financial crisis of 2008 cost millions of people their jobs, their savings, and their homes. Conventional wisdom has it that the collapse was the result of President George W. Bush’s economic policies. But there’s one problem with that idea: it’s not true. Bush was a sitting duck. Two of President Bill Clinton’s decisions were the primary causes of the global economic crisis of 2008.
The Bank Holding Company Act
The Bank Holding Company Act was passed in 1956 under President Dwight Eisenhower. It prohibited a bank holding company — a company that owns a bank, either directly or indirectly — headquartered in one state from owning a bank in another state. Effectively, this prevented too big to fail banks from forming.
The parts of the Bank Holding Company Act that prevented too big to fail banks from spawning were repealed with the signing of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. The act wasn’t passed over Clinton’s veto. To the contrary, Clinton himself expressed strong support for the bill, saying he was “honored” to sign it.
Clinton’s repeal of the Bank Holding Company Act created “banks of mammoth size”, according to Albert E. DePrince Jr., a professor of economics and finance at Middle Tennessee State University. And Simon Johnson, a professor of global economics and entrepreneurship at the Massachusetts Institute of Technology’s Sloan School of Management, told Congress that “perceptions that certain financial institutions were ‘too big to fail’ played a role in encouraging reckless risk-taking in the run-up to the financial crisis” because there was an implicit guarantee by the federal government that they wouldn’t be allowed to fail since they were so important to the stability of the global financial system.
In other words, some of the banks were so big that, if just one of them were to have failed, it would have taken the rest of the financial system down with it. The too big to fail banks understood they operated with implicit government backing, so they took risks they otherwise wouldn’t have.
In Inside Job, Frank Partnoy, a professor of Law and Finance at the University of California, San Diego, explained the thought process that helped cause the crisis: “You’re gonna make an extra $2 million a year — or $10 million a year — for putting your financial institution at risk. Someone else pays the bill [if things go downhill]; you don’t pay the bill. Would you make that bet? Most people who worked on Wall Street said, sure, I’d make that bet.”
This type of thinking existed solely because of Clinton’s repeal of the Bank Holding Company Act. If he hadn’t repealed it, banks would not have gotten to be too big to fail in the first place. And they wouldn’t have operated with implicit federal backing, so they wouldn’t have taken on anywhere near as much risk. Banks knowing that they were too big to fail played a huge role in causing the crisis, and Clinton was directly responsible for the formation of too big to fail banks.
But it was Clinton’s decision to not regulate derivatives that played the largest role of any policy in causing the financial crisis. Derivatives are contracts two companies enter into wherein, if something happens, company A owes company B money. You can think of them as possible debt.
By the end of June of 2000, outstanding derivative contracts — again, possible debts — were worth a total of $94 trillion, while the GDP of the world was $31.6 trillion. And for some reason, even though derivatives were worth nearly three times the size of the world’s economy in 2000, Bill Clinton decided to not regulate them in any way, shape, or form.
In fact, in 1998, when Brooksley Born, then the Chairwoman of the Commodity Futures Trading Commission, issued a proposal to regulate derivatives, she soon got a phone call from Larry Summers, then the Deputy Secretary of the Treasury, telling her, in a “bullying” tone of voice, to stop pushing for the regulation of derivatives. And soon after that, Alan Greenspan, then the Chairman of the Federal Reserve, Robert Rubin, then the Secretary of the Treasury, and Arthur Levitt, then the Chairman of the SEC, put out a joint press release that condemned Born and recommended legislation to prevent derivatives from ever being regulated. So not only did Bill Clinton decide to not regulate them, but the people at the highest levels of his administration actively fought against their regulation.
Needless to say, the Commodity Futures Modernization Act of 2000, which ensured that nobody, unless a new law be enacted, could regulate derivatives, was not passed over Clinton’s veto. From the very beginning, the bill had the support of some of the highest and most influential members of the Clinton administration.
Eight years later, AIG, then the world’s largest insurance company, collapsed because of this Clinton decision. During the run-up to the crisis, the company entered into more than $500 billion of derivative contracts, more than four times as much as AIG itself was worth. Following the bankruptcy of Lehman Brothers, the company was on the hook for $13 billion. And because derivatives were not regulated, AIG had not been forced to set aside any money in the run-up to the crisis — none whatsoever — in case something horrible was to happen. Thus AIG failed.
Again, this was a direct result of Bill Clinton’s decision to not regulate derivatives. Sensible policy — regulating derivatives, possible debts worth almost three times the size of the world’s economy when the decision to not regulate them was made — would have prevented the crisis. But Clinton decided not to, causing a crisis that destroyed millions of peoples’ jobs, savings, and homes. Despite that, almost 70 percent of Americans think highly of him.
And that makes no sense.