Bailout Nation (37 page)

I
n 1836, Mayer Rothschild wrote, “Give me control of a nation's money, and I care not who makes the laws.” If only that prescient warning had been heeded by the Federal Reserve. It might also serve as an admonition for Ben Bernanke, the current Fed chief.

The Greenspan era lasted 20 years (1987 to 2006). The Federal Open Market Committee (FOMC) must take responsibility for following him so obsequiously, especially in the latter years of his reign. Exceptions include Edward Gramlich, whose timely warnings about subprime and early concern with predatory lending were on target and ignored. So, too, William Poole deserves credit for his many cautionary warnings about the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. To our chagrin, neither man was paid much heed by Greenspan or the FOMC.

The single biggest fault found within the Fed is its inability to fulfill its responsibilities as bank regulator. The Fed not only failed to supervise lending institutions, but it also ignored the most significant shift in lending standards in the history of human finance. The results were disastrous.

The Fed, as an institution, failed the nation. It directly encouraged mass speculation. It failed to supervise innovative new forms of lending. The inflationary spiral that sent oil soaring from $16 in 2001 to $147 per barrel seven years later, along with other commodity and food prices, is attributable to its radical rate-cutting regime.

The current chairman, Ben Bernanke, deserves partial blame for the Fed's slumber during this inflationary spike. A renowned student of the Great Depression, it was then Fed Governor Bernanke who raised warning flags about
deflation
after the tech bubble burst. He provided the framework and intellectual cover for Greenspan's ultra-easy money circa 2001 to 2003.

As Fed chair, Bernanke was terribly slow to realize the subprime mortgage crisis was anything but “contained.” By the time he did awaken to the crisis in August 2007, he responded with a series of programs that pushed the envelope of legality, dramatically expanded the Fed's balance sheet, and put the central bank's credibility at risk.

Of all the institutions that played a part in the current crisis, none had a more prominent role than the Federal Reserve.

T
he first telegraph message ever sent, “What hath God wrought,” reflected Samuel Morse's deep concern for the repercussions of his own actions. If only Phil Gramm were so similarly introspective.

While Congress deserves much blame for the crisis, no one elected official looms larger in our drama than Gramm. He was the senator behind the Commodity Futures Modernization Act of 2000 (CFMA), and spearheaded the repeal of Glass-Steagall. The legislation that overturned it bears his name (Gramm-Leach-Bliley Act). Both legislative acts were WMDs—weapons of monetary destruction. These time bombs eventually led to mass financial destruction.

Barbara Roper, director of investor protection for the Consumer Federation of America, said: “Since the financial meltdown, people have been asking, ‘Where was Congress? Why didn't they see this coming? Why didn't they provide better oversight?'” We now know the answer is that members of Congress were too busy pursuing a radical deregulatory agenda. Instead of protecting investors and defending the overall economic system, their misplaced concern was how to make life easier for Wall Street.

During the late-1990s era of deregulatory dogma, the GOP controlled the House and Senate, and Gramm was the point man on issues of deregulation. The Texas Republican was aided in his deregulatory quest in part by Senator Chuck Schumer, a New York Democrat. Perhaps Schumer represented the interests of New York's Wall Street too well.

To this day, Gramm
still
claims deregulation had no impact on the housing collapse or the credit crisis. The exempting of derivatives from all regulation—including state insurance supervision, reserve requirements, or clearing information—was not at all related to the eventual problems, according to Gramm. He remains unrepentant as to his impact. Placing any blame on deregulation was simply “an emerging myth,” the retired Texas senator has said. Deregulation “played virtually no role” in the economic turmoil engulfing the globe, Gramm claimed in November 2008.
⁴

What shameless nonsense. You will not come across a greater example of cognitive dissonance in your lifetime. Gramm's inability to recognize the results of his legislative handiwork is a function of a flawed mind protecting itself from the harsh reality. The inconsistency of his deeply held philosophy and the results thereof are logically incomprehensible to Gramm's conflicted brain. If he were ever to admit the truth, he would likely go stark, raving mad.

I'll give Alan Greenspan this much credit: At least he has come clean about the “flaw” in his philosophy. Gramm, by contrast, remains committed to his tainted brand of unregulated, free-market absolutism. Of all the players in the tragic drama that has unfolded, he alone remains unrepentant. Gramm is Bailout Nation's most intellectually bankrupt citizen. Like Greenspan, Gramm had only one idea; unlike Greenspan, he had no comprehension it was wrong.

F
rom Ronald Reagan to George W. Bush, each president of the past 25 years bears some responsibility for contributing to the belief that we can let markets govern themselves.

Of the four, President George W. Bush has the greatest culpability—not because this crisis happened on his watch, though that should be reason enough. The more significant basis of his culpability is that he shared Greenspan's and Gramm's radical belief system—that markets could police themselves, that all regulation (indeed, most government) was inherently bad. This philosophy colored all of Bush's appointments to key supervisory positions, as well as his legislative agenda.

Former Presidents Clinton, George H.W. Bush, and Reagan each have some responsibility, but far less. The first President Bush is the least culpable. Reagan chose not to reappoint Fed Chair Paul Volcker, replacing him with Alan Greenspan. Regardless of other actions, this forever taints the legacy of the Gipper. However, in many ways, Ronald Reagan is the intellectual father to what became the radical deregulatory movement. As the
Washington Post
noted, “Ronald Reagan's unwavering belief in free markets—and his distaste for regulation that put hurdles in the way of entrepreneurs—had steadily spread through the government. ‘The United States believes the greatest contribution we can make to world prosperity is the continued advocacy of the magic of the marketplace, “Reagan told a U.N. audience'” in 1986.

While some partisans have tried to paint the crisis as a purely Republican debacle, history informs us otherwise. Yes, the GOP did control Congress from 1994 to 2006. However, President Clinton, a Democrat, bears a significant responsibility also. He and his Treasury secretaries, Robert Rubin and Lawrence Summers, all bought into the deregulatory mantra. Clinton, Rubin, and Summers are right there with W. in the hierarchy of proximate causes of the debacle.

Until recently, Rubin has escaped much blame for both supporting Glass-Steagall's repeal as Treasury secretary and his participation in Citigroup's failure as a long-standing board member.
⁵
Citibank was one of the main proponents of repealing Glass-Steagall, and Rubin joined the bank's board shortly after leaving Treasury in 1999—quite an unsavory turn of events.
⁶

At Treasury, Rubin strongly supported the Commodity Futures Modernization Act. He actively opposed the concerns of Brooksley Born, then head of the Commodity Futures Trading Commission. In 1997, Born was raising alarms to Congress about unregulated trading in derivatives, such as credit default swaps (CDSs) .
⁷
Unregulated derivatives could “threaten our regulated markets or, indeed, our economy without any Federal agency knowing about it,” she testified. Born called for a variety of fixes—now being enacted after the horse is out of the barn—including greater transparency, disclosure of trades through a central clearing firm, and required reserves against losses. Born was shouted down by the likes of Greenspan, Rubin, and Summers.

President Clinton oversaw the passage of utterly ruinous legislation. He signed both the damaging Gramm-Leach-Bliley Act repealing Glass-Steagall and the odious Commodity Futures Modernization Act exempting derivatives from regulation. They may each have been sponsored by Senator Gramm, but they were both signed into law by President Clinton. He does not deserve the free pass for his misguided actions.

But it was George W. Bush's appointments who chanted the “laissez-faire, free markets reign supreme” mantra the loudest. The SEC chairs he appointed were terrible, and many of his other appointments—Office of Thrift Supervision, Federal Reserve, Treasury secretary, and other key regulatory roles—were similarly ill-advised.

Question:
What do you get when a president who doesn't believe in government appoints those who share this philosophy to key regulatory and supervisory roles?

Answer:
Neither regulation nor supervision.

Missed opportunities seem to be a hallmark of the Bush presidency: As the various crises unfolded, there were key choke points where the damage could have been contained. None were acted upon until after the crisis had fully flowered.

When appraisers petitioned the White House in 2001, complaining of inflated home appraisals filed by corrupt home inspectors, they were rebuffed. When state banking regulators recognized signs of lending fraud early on, their attempts to curtail it were prevented by Bush. The White House asserted that it was the federal agencies—and not the states—that had jurisdiction over federally chartered banks. That's a fine argument to make, until those federal agencies recognized lending problems and began proposing rules to curtail them on their own. They, too, were rebuffed by the White House—not state agencies, but the federal agencies the White House claimed had exclusive jurisdiction.

The Associated Press (AP) summed up why the very government regulators assigned to prevent abuse failed so miserably to do so: “The administration's blind eye to the impending crisis is emblematic of its governing philosophy, which trusted market forces and discounted the value of government intervention in the economy. Its belief ironically has ushered in the most massive government intervention since the 1930s.”
⁸

Let's get specific as to the sort of warnings the White House ignored: Bank regulators had proposed new guidelines for writing risky loans in 2005. These were basic administrative rules; had they been enacted, the worst of the housing and credit crisis might have been avoided. The Bush administration backed away from proposed crackdowns on the subprime, no-money down, interest-only mortgages that were critical contributors to the credit and housing crisis.

According to the AP, pressure from banks (many of which have since failed) was the prime reason:

The list of banks that lobbied most aggressively against the proposed rules reads like a who's who of bankruptcy and FDIC conservatorship, including IndyMac, Countrywide Financial, Washington Mutual, Lehman Brothers, and Downey Savings.

What was so damning was that these proposals were all stripped from the final administrative rules by the Bush White House. None required congressional approval; they did not even require the president's signature. The proposals that were removed from the administrative rules were: