Lack Of Regulation Was Mandated

This article notes that the recent economic crisis didn't happen because of poor or lax regulation of the shadow banking industry, but because regulation was banned altogether:

Thanks to the The Commodity Futures Modernization Act of 2000 (CFMA), the universe of structured derivatives were completely exempt from ALL regulation. Whether it was Collateralized Debt Obligations (CDOs) or Credit Default Swaps (CDSs), the CFMA put them into the world of shadow banking.

How? The CFMA mandated it. No supervision was allowed, no reserve requirements for potential future payouts were mandated, no exchange listing requirements were put into effect, all capital minimums were legally ignored, there was no required disclosures of counter-parties. Derivatives were treated differently from every other financial asset — stocks, bonds, options, futures. They were uniquely unregulated.

Indeed, even state insurance regulators were prevented from oversight — including normal reserve requirements. That was how AIG Financial Products was able to ramp up their derivative exposure to more than three trillion dollars. This was directly due to radical deregulation.

Even the most basic reserves would have kept their derivative exposure to much more modest numbers. With absolutely zero capital requirements, AIG FP went wild. Tom Savage, the president of FP, summed up what the lack of reserve requirements meant to the firm: “The models suggested that the risk was so remote that the fees were almost free money. Just put it on your books and enjoy.”

To the tune of $3 trillion dollars.

All in all, this wasn’t so much a case of Washington DC failing to keep up with Wall Street, rather, it was a case of DC actively granting what Wall Street (Enron, AIG and other derivative traders) wanted — precisely zero oversight.