Banks were allowed to become investment companies in 1999.
Congress passed the Glass-Steagall Act in 1933 to separate commercial and investment banking and thereby prevent banks from investing in products and firms the banks themselves had created and/or financed. In 1956, Congress expanded banking regulations by preventing banks from underwriting insurance. In the 1980s and 1990s, Congress passed three laws that undid many of these and other earlier regulations. These new laws essentially deregulated the mortgage industry.
The Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA)
The Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA) eliminated state usury laws that limited the interest rates banks could charge. This gave banks an incentive to lend to people who would not have previously qualified for mortgages. Banks could cover the greater risk in lending with a greater reward of high interest rates.
Garn-St. Germain Depository Institutions Act of 1982
Prior to the passage of the Garn-St. Germain Depository Institutions Act, also called the Alternative Mortgage Transaction Parity Act (AMTPA), in 1982, banks could only offer one type of mortgage: a fixed rate, fixed term, fully amortizing mortgage. AMTPA lifted that restriction, opening the door to a host of alternative mortgage types. The stated objective of this legislation was to allow banks to be more competitive. Initially, banks offered adjustable rate mortgages. As the housing market heated up and Congress passed additional deregulation laws, banks developed increasingly exotic mortgages, including interest-only and negative-amortization loans. Combined with the DIDMCA deregulation of interest rates, AMTPA allowed banks to offer a borrower with very poor credit a loan that might only require a minimal interest payment during an initial "teaser" period, after which time the loan would reset to require a payment the borrower would never have qualified for.
Gramm-Leach-Bliley Act of 1999
The Gramm-Leach-Bliley Act of 1999 repealed the Glass-Steagall Act. It turned back the clock to the pre-Depression era practices of banks being able to make investments with customers' deposits--investments that did not need to conform to any risk-assessment standards. Without Glass-Steagall requirements in effect, banks were even allowed to create their own investment products and make loans using any standards they deemed appropriate to companies in which the bank had made investments. Obvious conflicts arose between a bank's fiduciary responsibility to depositors and its short-term profitability on investments. There were no checks and balances between the two roles.
Bank Holding Company Act of 1956
When Congress passed the Bank Holding Company Act of 1956, preventing banks from underwriting insurance, it couldn't have anticipated banks creating a product, now known as credit default swaps, that distortedly mirrored insurance. This is because in 1956 the Glass-Steagall Act prohibited banks from also acting as investment companies. At that time, banks would have had no reason to create an end run around the insurance underwriting prohibition. But with the repeal of Glass-Steagall and the banks' re-entry into the investment markets, banks began looking for some vehicle to insure themselves against the unregulated loans they were making. Because they could not underwrite their own insurance and would never have qualified for traditional insurance because the products were so exotic, banks bought and sold a contract that acted like insurance but had no secured funds to actually pay off a debt in case of a catastrophic failure of the investment. These insurance-like products were called credit default swaps. Combined with the deregulation of interest rates, the deregulation of bank investment strategies and the deregulation of mortgage products, the creation of credit default swaps contributed to the perfect storm of mortgage melt-downs beginning in 2007.
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