Read this article before proceeding. If you find it a bit complicated or opaque, I think I can help by defining a few terms and giving a simple explanation of what’s going on here.
“Regulatory Capital Relief” refers to a method currently utilized by banks to skirt the Dodd-Frank requirement that they keep enough real assets to cover their losses if they make bad loans. The riskier the loan, the more cash they are supposed to keep in reserve.
“Credit default swaps” are insurance policies issued by hedge finds and other criminal enterprises that promise to pay a creditor if a borrower defaults on an insured loan. Banks buy credit default swaps instead of putting cash aside in case risky loans go bad. They do it because the cost for the insurance is less than the cost of putting the money aside, just as it’s cheaper for you to buy auto insurance than to put money in the bank to cover your liability should you cause a horrible accident. The difference between you and the banks is that you honestly expect your insurance company to make good if you cause an accident, while the banks have no such expectations about the crooks that issue credit default swaps. Also, the likelihood of you causing an accident pales in comparison to the likelihood that the banks will crash the economy.
Anyone can issue a credit default swap. I could do it if I wanted to, and the banks were willing to pay me a premium. Banks are well aware that credit default swap issuers will most likely not be able to pay up if the insured loans go bad, just like AIG wasn’t able to pay up in 2008. However, the banks don’t care because 1) pretending that the swaps are on the up and up frees up more money for them to play with, and 2) they know that if the loans go South the government will step in again and save their bacon.
It’s nice to know that the SEC has been aware of this issue for years; not so nice to know they have no intention of doing anything about it.
The more time passes after 2008, the more admiration I have for FDR and the folks who dealt with the fallout from the Depression. They made some mistakes for sure, but they at least learned from history. As soon as we could, we took steps to make sure that if history didn’t repeat itself, it would certainly rhyme.
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