Past money mistakes come back to haunt us

By now, we all know the main causes of America’s credit crisis: lenders who made home loans to unqualified borrowers; borrowers who could not repay the loans; Wall Street investment bankers who packaged the loans into toxic mortgage-backed securities (MBS) that were sold worldwide; and institutional investors who gorged on MBS without regard to risk.

Below are other, less well known causes of the credit crisis that you may not have heard about.

1. Failure to Regulate After LTCM.

Long-Term Capital Management was a hedge fun that blew up in 1998 after losing $4 billion investing in complex derivatives, necessitating a federal bailout.

A movement quickly began to regulate derivatives like MBS through the Commodity Futures Trading Commission, but then-Fed Chairman Alan Greenspan, then-Treasury Secretary Robert Ruben and others blocked those efforts, which helped set the stage for the 2008 meltdown.

2. Repeal of the Glass-Steagall Act.

In 1999, Congress repealed the Glass-Steagall Act of 1933 after the financial services industry gave more than $80 million in campaign contributions to members of Congress on both sides of the aisle. The repeal eliminated the separation of commercial and investment banking mandated after the Great Depression. This allowed big banks to get even bigger and subjected depositors to the risk of a whole new array of speculative investments, such as MBS and other derivatives.

3. Failure to Reign in Fannie Mae and Freddie Mac.

Fannie Mae and Freddie Mac are private companies backed (and now owned) by the federal government that buy home mortgages from lenders who originate them, thus providing liquidity to the U.S. mortgage market. These companies also created, sold and invested in billions of dollars of MBS and, more than any other player, fueled the MBS market.

In 2005, after an accounting scandal at the companies, Congress sought to more closely regulate Fannie Mae and Freddie Mac and prohibit them from owning MBS. The bill failed to pass. Fannie Mae and Freddie Mac then increased their costly participation in the MBS market, which eventually led to their takeover by the federal government.

4. SEC Let Banks Pile Up New Debt.

In 2004, the five largest Wall Street investment banks convinced the SEC to exempt their brokerage units from an old regulation (the “net capital rule”) that limited the amount of debt they could take on. This unleashed the Wall Street firms to borrow billions of dollars to invest in MBS, credit default swaps and other risky, exotic securities.

Bear Stearns, for example, was leveraged 33 to 1 when it melted down – for every $1 in capital it had $33 in debt. Lehman Brothers’ $613 billion in debt made its bankruptcy the largest in U.S. history – 10 times larger than Enron.

5. Abuses of the Community Reinvestment Act. Congress passed the Community Reinvestment Act in 1977, and revised it in 1995, to encourage banks to make home loans to lower-income customers, in part to expand home ownership. The intentions were good, but abuses led to unsafe lending practices, which led to many defaults and contributed to the 2008 credit market meltdown.

Past does not have to be prologue if we learn from our mistakes.