Mnuchin's Latest Production: A Regulatory "Back To The Future"

15/02/2017 12:25

Steven Mnuchin as Treasury Secretary? Surely, this is a good thing, a man who knows the markets, a hard headed hedge-fund manager and successful businessman is exactly what Trump's cabinet needs to inject a sense of business realism. If anything, ex-Goldman men like Mnuchin and his associates are not likely to be as protectionist or trigger happy as Bannon and his ilk? These are comforting thoughts, but are sadly wrong. Mnuchin is precisely the type of appointment Trump would make to further (not ameliorate) his extremist economic agenda.

Mnuchin as Treasury Secretary will implement Trump's vision of rolling back Dodd-Frank and releasing the financial industry from the weak shackles placed on it in the immediate aftermath of the 2008 financial crisis. Mnuchin and his associates, such as Jim Donovan and Justin Muzinich, are precisely the people to launch America back to the future of deregulation. What was that like, you wonder? You may be excused for forgetting, it has been a decade since the sub-prime mortgage market collapsed after all. Let us take a trip down memory lane then and remember what brought us to the brave new world of the worst financial crash since the Great Depression.

President Trump is a self-confessed admirer of Glass Steagall, but it was exactly the repeal of that statute that his Treasury team benefited from. By 1998 the Glass Steagall Act and the Bank Holding Company Act of 1956, both enacted with memories of the Great Depression present in people's minds had been weakened almost to extinction. The model of finance to emerge after the demise of Glass Steagall was based on securitisation and became known as the 'originate and distribute' model. A securitisation can be described a financial transaction in which assets are pooled together and financial products representing interests in the pool are made available to buyers. Under the so-called 'originate and distribute' model, financial institutions would issue financial assets (such as mortgages) then repackage them and sell them to investors. The resulting funds would be used to originate more assets which in turn would be re-repackaged and sold, recommencing the cycle. This model of banking is seen by many as recreating the institutional framework that had led to the crash of 1929. By allowing banks to lend not on the basis of deposits but on the strength of the money markets, the way was opened for the financial sector to depart from the fundamentals of the real economy, creating the fictional wealth that hedge funds are famous for.

Launching the new economy centred on finance, the Gramm-Leach-Bliley Financial Modernization Act repealed several Depression era safeguards in 1999, aided by the Commodity Futures Modernization Act of 2000. Glass Steagall was finally dead. The industry did not hesitate to take advantage of its liberation from burdensome regulation. At the beginning of the noughties, same as now, the road was opened for finance to work its magic. And some magic it worked. The new freedom of financiers quickly found fertile ground in the US housing and consumer loan markets. Packaging diversified portfolios of mortgages, consumer loans, credit card and student debts allowed the creation of segmented products that offered attractive rates (for the more risky tranches) and a range of credit ratings. A series of asset-backed securities (ABS) could be bundled together into a collateralised debt obligation (CDO) that had a series of tranches which investors could buy. Each tranche had a rating representing an assessment as to its risk of default and offered interest at a corresponding level. The more products (or tranches of products) with higher risks one could produce, the higher the price these could command in an environment where higher returns were desperately sought by investors. Hence the phenomenon of lower quality products being turned out in increasingly higher volumes. Finance firms like Goldman Sachs excelled in creating these layer cakes, selling slices and insurance products on the back of those slices. All the while, risks involved in holding securities stemming from the sub-prime housing market were seriously underestimated. We all know how all this ended, it ended badly in 2008. But some of the key players in the sub-prime saga not only survived, but became richer since.

Countrywide was a major player in the sub-prime swamp. It failed in 2008. Guess who bought some of its pieces and made a fortune selling underlying assets (most linked to people's mortgages and homes)? It was the hedge fund run by Mnuchin. His subsequent chairing of OneWest Bank, specialising in the housing market, earned him the title of 'Foreclosure King'. Munchin is a competent financier who will implement Trump's plans. Great news for his former employers at Goldman Sachs, but perhaps not such great news for Americans.