The American financial industry was regulated from 1940 to 1980, followed by a long period of deregulation. At the end of the 1980s, a savings and loan crisis cost taxpayersabout $124 billion. In the late 1990s, the financial sector had consolidated into a few giant firms. In March 2000, the Internet Stock Bubble burst because investment banks promoted Internet companiesthat they knew would fail, resulting in $5 trillion in investor losses. In the 1990s, derivatives became popular in the industry and added instability. Efforts to regulate derivatives were thwartedby the Commodity Futures Modernization Act of 2000, backed by several key officials. In the 2000s, the industry was dominated by five investment banks (Goldman Sachs, Morgan Stanley, Lehman Brothers,Merrill Lynch, and Bear Stearns), two financial conglomerates (Citigroup, JPMorgan Chase), three securitized insurance companies (AIG, MBIA, AMBAC) and the three rating agencies (Moody’s, Standard &Poors, Fitch). Investment banks bundled mortgages with other loans and debts into collateralized debt obligations (CDOs), which they sold to investors. Rating agencies gave many CDOs AAA ratings.Subprime loans led to predatory lending. Many home owners were given loans they could never repay.
Part II: The Bubble (2001-2007)
During the housing boom, the ratio of money borrowed by aninvestment bank versus the bank's own assets reached unprecedented levels. The credit default swap (CDS), was akin to an insurance policy. Speculators could buy CDSs to bet against CDOs they did not own.Numerous CDOs were backed by subprime mortgages. Goldman-Sachs sold more than $3 billion worth of CDOs in the first half of 2006. Goldman also bet against the low-value CDOs, telling investors they werehigh-quality. The three biggest ratings agencies contributed to the problem. AAA-rated instruments rocketed from a mere handful in 2000 to over 4,000 in 2006.
Part III: The Crisis