Tired of the old singsong 8 years of failed policy that "got us into this mess"-Try 38 years

There is an article in the Jan 31 Time Magazine that explains how we "got into this mess" in easy to understand terms.

....Starting in the early 1970s, banks began funding less of their lending with old-fashioned deposits. Bank deposits backed 90% of all loans four decades ago; today they back 60%. Where does the rest of the loan money come from? From the bank's past earnings and the money given to it by its investors. Using the house's money has generated higher profits — with significantly higher risks.

Regulators have long had a lower capital requirement on loans that are not backed by deposits. But in 2004, the Securities and Exchange Commission (SEC) removed rules that capped leverage at 15 to 1 for investment-banking firms like Goldman Sachs. That allowed the firms to vastly expand their lending activities without raising a single new dollar of capital. One big backer of the rule change was reportedly former Treasury Secretary Henry Paulson, who was then Goldman's CEO. By that time, the regulatory separation between investment banks and traditional banks had long since been removed, so traditional banks such as Citigroup and Bank of America shifted more and more of their lending operations to their investment-banking divisions, and leverage took off. By the end of 2007, many banks were lending $30 for every dollar they had in the vault. "Changing the net-capital rule was an unfortunate misjudgment by the SEC," says former SEC official Lee Pickard. "It's one of the leading contributors to the current financial crisis." (See who else is to blame.)

Another way banks sought to boost their profits — at least those available to shareholders — was through stock buybacks. Investors cheer buybacks, because they shrink the number of outstanding shares, boosting a company's profits per share and usually its stock price. But corporate stock purchases also decrease banks' capital, because their earnings are used to purchase shares rather than being retained as cash. Worse, sometimes banks borrow money in order to buy back shares, upping their leverage and lowering their capital at the same time. In the past four years alone, the nation's largest banks, as defined by Standard & Poor's, have spent $300 billion buying back stock.

TARP does nothing to patch the hole in the banking system. And it certainly doesn't do anything to encourage banks to make more loans. Yes, banks have gotten nearly $300 billion in money from the government, and that's a lot of dough. But it's not free dough. In return for federal cash, the government has taken preferred-stock shares as the firm's markers. Unlike common stock, which is the kind you or I would buy from a broker, preferreds have to eventually be paid back, so they are really loans, not additional capital. (See which country has the best bailout plans.)

Say a bank has $5 in capital and $100 in loans. Now the government gives the bank an additional $100 in preferred shares and says, "Go make more loans." Well, the bank might then have $200 in loans, but it still has only $5 in common shareholders' equity. The result: if just 2.5% of its loans go bad, the bank's shareholders are wiped out. Wisely, the largest banks in the nation lent less in the fourth quarter of 2008 than in the previous three months — a strategy that has drawn some complaints. But that hasn't removed the pressure on their shares. That's because the banks have had to continue to take loan losses. And banks don't have the option to pass those losses off on the new money they got from the government. They have to write down their common stockholders' equity first. And as that capital falls, so go the bank's shares. Some are alarmingly close to zero.

No bank's stock has fallen more in value during the past four months than Bank of America's. The combined value of its shares is now $37 billion. That's $123 billion less than they were worth at the end of September. In the third quarter, BofA was forced to write down $4.4 billion in loans, or about 1.8% of its loan portfolio. Compared with what some of its competitors wrote down, that wasn't a heck of a lot; Citigroup, for instance, had a $13.2 billion charge in the same quarter, primarily related to loan losses. But the relatively small loss took BofA's thin tangible equity, the type of capital that matters most to shareholders, down to a ratio of just 2.6% of loans, according to FBR. By that measure, Bofa was a weaker bank than any of its rivals, including Citigroup. But since the market was so focused on bad loans and the charge-offs banks had to take, no one seemed to notice BofA's faults.

That is, until the fourth quarter. In mid-September 2008, in a deal pushed by regulators, BofA agreed to buy Merrill Lynch. The acquisition actually boosted BofA's capital ratios, but it also added losses to an already fragile capital structure; Merrill Lynch lost $15 billion in the fourth quarter alone. Knowledge of the impending losses forced BofA CEO Ken Lewis to ask the government for an additional $20 billion in TARP funds — on top of the $25 billion it had already received — as well as about $100 billion in loan guarantees. Without the government assistance, BofA says, it couldn't have closed the merger.

The Merrill losses, which weren't publicly revealed until early January, have angered shareholders, some of whom have sued the company for not informing them sooner. And last week, the losses also led Lewis to ask Merrill's top executive, John Thain, to resign for failing to keep BofA officials apprised of his firm's bottom-line problems. Thain says Lewis knew all along. (See pictures of TIME's Wall Street covers.)
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