By William K. Black
Bloomington, MN: February 9, 2015
This the second in a series of columns about Jeb Hensarling and Peter Wallison – the Nation’s chief myth makers about the causes of our financial crisis. Hensarling is the Chairman of the House Financial Services Committee and a leader in the effort to gut the Dodd-Frank Act’s few effective provisions. Wallison is one of the primary architects of the three “de’s” (deregulation, desupervision, and de facto decriminalization) that made the banking environment so criminogenic that it caused the fraud epidemics that hyper-inflated the bubble and drove the financial crisis.
In this second column I focus on Hensarling’s embrace of Bill Clinton and Al Gore’s worst anti-regulatory blunders. Their overall blunder was “Reinventing Government,” a broad assault on regulation and government effectiveness. In the financial sphere, Clinton and Gore embraced a fatal concept (the regulatory “race to the bottom”), two specific legislative acts of deregulation, and the growth of systemically dangerous institutions (SDIs) that were “too big to fail.” Each of these blunders contributed to the most recent crisis and unless corrected will contribute to future crises. Hensarling celebrates each of these anti-regulatory blunders as superb policies.
Hensarling Champions the Regulatory “Race to the Bottom”
The fatal concept that Clinton and Gore championed – and Hensarling celebrates – is the regulatory race to the bottom. That race is a variant of a “Gresham’s” dynamic that causes bad ethics to drive good ethics from the government, markets, and professions
“Intended to toughen financial reporting requirements in the wake of the Enron scandal, Sarbanes-Oxley has created many needed reforms but its burden has also resulted in many companies taking their business—and their money—overseas. The result has been a flow of capital away from the U.S., capital which could have helped to shore-up American banks.”
Hensarling wrote these words in 2009, when the evidence was inescapable that the international race to the bottom with the City of London and the domestic regulatory race to the bottom among federal and state financial regulators had produced a disastrous expansion of the three “de’s.” Hensarling, however, learned no positive lessons from this experience. He remains eager, as does Wallison, to roll back Sarbanes-Oxley’s and Dodd-Frank’s protections.
Note that Hensarling, Wallison, Clinton, and all the Rubinites are ardent supporters of “free trade” and the closure of plants in the U.S. and their relocation to places like China, Bangladesh, and Vietnam. But when it is a bank that would relocate these same people act like it is a tragedy that must be avoided at any cost. It does not follow logically that if “companies tak[e] their businesses – and their money – overseas” that “American banks” will lose capital. During the run-up to the crisis, U.S. and UK banks deliberately and substantially reduced their capital levels. Hensarling is simply manufacturing a myth about capital while ignoring the disaster that his continued embrace of the regulatory race to the bottom will cause.
Hensarling Cheers for the Regulatory “Black Hole” That Enron & AIG Exploited
Hensarling then compounded his odes to the three “de’s” by praising the infamous Commodities Futures Modernization Act of 2000 (CFMA) that created the regulatory “black holes” that Enron and AIG’s controlling officers exploited to commit their abuses
“Instead of creating new regulatory hurdles, a superior approach to better protect consumers and preserve wealth-creating opportunities is to enhance and reinforce wise regulation while bolstering private sector market discipline. This belief was well articulated in March 2000, when Gary Gensler, then Under Secretary for Domestic Finance in President Clinton’s Treasury Department and currently President Obama’s nominee to chair the Commodity Futures Trading Commission (CFTC), testified before the House Financial Services Committee regarding systemic risk in our capital markets. Over the course of his remarks, Gensler explained that instead of advocating for new or increased regulations, the approach supported by Treasury emphasized the formative role of the private sector in protecting market participants….”
The CFMA was the result of a bipartisan coalition created to destroy the efforts of Brooksley Born, the Chair of the Commodities Futures Trading Commission (CFTC) to regulate financial derivatives. The Rubinites (Gensler was on of Bob Rubin’s protégés) claimed that the CFTC had to be banned from adopting rules protecting against derivatives abuses lest derivatives sales move to the City of London.
The risk of fraud was ignored or assumed out of existence by the Republican and Democratic supporters of the CFMA.
“‘Well, Brooksley, I guess you and I will never agree about fraud’ [Greenspan]
‘What is there not to agree on?’ [Born]
‘Well, you probably will always believe there should be laws against fraud, and I don’t think there is any need for a law against fraud,’ she recalls. Greenspan, Born says, believed the market would take care of itself.”
The CFMA proponents’ claim, falsified by Enron and the most recent crisis, was that “private” market discipline would prevent any fraud or abuses involving financial derivatives. But none of these facts have penetrated Hensarling’s consciousness.
Hensarling Loves the Repeal of Glass-Steagall
Glass-Steagall refers to one portion of the legislation that emerged as a result of the Pecora investigation into the causes of the Great Depression. Glass-Steagall embraced a policy that people of all political viewpoints should be able to agree with – it makes no sense to provide a federal subsidy (deposit insurance) to run commercial businesses that compete with uninsured commercial businesses. No conservative or libertarian should favor government subsidies that distort competitive markets. Glass-Steagall also worked brilliantly for decades until it suffered the death of a thousand cuts at the hands of hostile anti-regulators, principally Alan Greenspan.
“One frequent argument heard from many critics is that the Gramm-Leach-Bliley Act (P.L. 106–102), which repealed the Depression-era Glass-Steagall Act’s separation of investment and commercial banking, was somehow responsible for the current credit crisis. To the contrary, a wide variety of experts across the political spectrum have dismissed that claim as ‘a handy scapegoat’ at best. When asked in October 2008 if Gramm-Leach-Bliley was a mistake, Alice M. Rivlin, the former director of both the Congressional Budget Office and the Office of Management and Budget, testified: ‘I don’t think so, I don’t think we can go back to a world in which we separate different kinds of financial services and say these lines cannot be crossed. That wasn’t working very well. . . . We can’t go back to those days, we have got to figure out how to go forward.’’ Even former President Bill Clinton remarked in a 2008 interview that ‘I don’t see that signing that bill had anything to do with the current crisis.’”
Hensarling Proves Clinton’s Anti-Regulatory Policies Remain His Party’s Policies
Hensarling does not present the views of “a wide variety of experts across the political spectrum.” He presents the narrow views of three neo-liberal Rubinites and Pete Peterson deficit fanatics whose views have been discredited by reality. The first is the conclusory assertion by David Leonhardt that the repeal of Glass-Steagall was “a handy scapegoat” for the crisis. Hensarling provides no facts or analysis supporting Leonhard’s conclusion. Leonhardt is a Pete Peterson devotee at the New York Times.
One could make a technical argument in favor of Hensarling’s conclusion that it was not the passage of the Gramm-Leach-Bliley that was the key. It was the evisceration of Glass-Steagall at the hands of Greenspan over the course of a decade that made Glass-Steagall ineffective long before the passage of Gramm-Leach-Bliley in 1999. But that is not the argument that Hensarling is making.
Rivlin is another Rubinite and Peterson ally. Her “logic” as quoted by Hensarling is devoid of logic – “We can’t go back … we have … to go forward.” Yes, onward into the Valley of Death road the 600 for there’s was not to ask: “Why?” But our task is to ask why. After all, it was Rivlin, Rubin, Clinton, Summers, Gramm, and Greenspan who led us “back[wards]” in 1999 to return to laissez faire under the preposterous “Kumbaya” myth that granting bankers absolute power would render them not absolutely corrupt, but miraculously benign – doing “God’s work” as Goldman Sachs infamously claimed.
The third quotation is yet another Rubinite and Pete Peterson ally – Bill Clinton. What are the odds that in a 2008 interview he would say: I screwed up by repealing Glass-Steagall and contributed greatly to the worst financial crisis in 75 years?
What Hensarling has, unintentionally, demonstrated through these presenting and endorsing these three quotations about Glass-Steagall is that when he uses the phrase “across the political spectrum” of views about financial regulation he means a single point on the far right edge of that spectrum. Clinton and his team of Rubinites and Pete Petersonites occupied the same place in the political spectrum that Hensarling does today. This is why Clinton’s embrace of the three “de’s” was (and remains) so popular among ultra-right wing Republicans like Greenspan, Gramm, and Hensarling. Clinton and Gore were radically anti-regulatory and pro-banker.
Hensarling Unintentionally Demonstrates the Folly of Insuring Investment Banking
Hensarling is so desperate to prevent the re-adoption of Glass-Steagall that he issues this sad effort to defend its repeal – a defense that actually condemns the repeal.
“If anything, Gramm-Leach-Bliley has played a significant role in attenuating the severity of this crisis by allowing commercial banks to merge with floundering investment banks—like JPMorgan Chase and Bear Stearns, Bank of America and Merrill Lynch, and Goldman Sachs and Morgan Stanley—actions that would have been explicitly prohibited had the Glass-Steagall Act still been in effect.”
It is telling that Hensarling cannot understand how badly this point undercuts his conclusory repudiation of Glass-Steagall. Recall that Glass-Steagall was designed to ensure that we did not provide federal deposit insurance to investment banking. Investment banking means taking an ownership position, e.g., owning part of American Airlines. This would put all of the airline’s competitive rivals at a disadvantage. Such equity investments were a major contributor to the S&L debacle because they are superior “ammunition” with which bankers can commit accounting fraud. Combining investment and commercial banking (lending) also magnifies conflicts of interest by bankers. My book provides ample detail on both of these points. Investment banking, therefore, is a riskier activity than commercial banking and providing a federal subsidy to banks that do both investment and commercial banking is even worse.
Hensarling, unintentionally, makes this point as he (1) ignores Lehman and (2) describes the four other largest investment banks in America as “floundering.” Each of the five largest investment banks was a major contributor to causing the financial crisis – as were the largest banks in America (which also took on substantial investment banking once Glass-Steagall was effectively repealed). In sum, all the banking maladies that the proponents of Glass-Steagall warned against proved true in both the S&L debacle and the current crisis. Investment banking proved so dangerous – for reasons I discuss in the next column in this series – that all five of the largest investment banks would have failed but for massive federal bailouts from the Fed and the emergency provision of federal deposit insurance to investment banks to prevent their collapse.
Notice that the failure of all of America’s largest investment banks contradicts Hensarling’s claims that the Clinton administration was correct, in 1993, to reject financial regulation – which had just proven spectacularly successful in containing the fraud epidemics spurred by the deregulation of S&L in the Garn-St Germain Act of 1982 (which spurred a regulatory “race to the bottom” with California and Texas). Instead of increasing regulatory vigor and effectiveness, and building on this record of success in the S&L debacle and the much longer record of success of the Glass-Steagall Act, the Clinton administration inflicted the three “de’s” on America. Clinton, Gore, Rubin, and Larry Summers claimed that no regulation was required for investment banks because they were not protected by federal deposit insurance. “Private market discipline,” they claimed, would ensure that investment banks would be run far more soundly than commercial banks. Instead, every large investment bank failed. Prior to the crisis, large investment banks failed for similar reasons – “control fraud.”
Hensarling shows the wisdom of Glass-Steagall by showing the universal failure of the Nation’s largest and most elite investment banks and their resurrection through federal bailouts. Private market discipline was an oxymoron during the expansion of the bubble – because creditors rushed to lend vast sums to the investment banks as they became ever more insolvent. Recall that it was the investment banks that had the astronomical leverage (huge debt-to-equity ratios). That means that their expansion was overwhelmingly funded (not constrained) by private creditors. It was only after Lehman’s failure and the collapse of global financial markets became endemic that “private market discipline” finally appeared – indiscriminately – like a massive, rusty bear trap that finally snapped shut on everything in its path.
We did not have to repeal Glass-Steagall to provide federal deposit insurance to investment banks. Hensarling simultaneously champions investment banking as ideal because it lacked deposit insurance and purportedly had the right incentives, while stressing that every large U.S. investment bank failed.
Hensarling Warns that SDIs Cause Horrific Harms – but Opposes Ending Them
Another disastrous consequence of Clinton and Gore’s embrace of the three “de’s” was the surge in systemically dangerous institutions (SDIs) treated as “too big to fail” (TBTF) on their watch. President Bush exacerbated the trend repeatedly. President Obama claims to have ended TBTF while allowing the SDIs to grow even larger. That cannot be done. The SDIs remain TBTF. Hensarling and Wallison’s “Great Satans” are Fannie and Freddie – two SDIs. Hensarling and Wallison denounce the results of Fannie and Freddie being SDIs as catastrophic, but they do not call for ending the SDIs. This is bizarre because Hensarling and Wallison admit that SDIs receive a huge, implicit federal subsidy that (1) makes the notion of “free market competition” in banking a sick joke and (2) causes perverse incentives that will cause future financial crises. Economists also overwhelmingly believe that SDIs are far too large to manage effectively and would be far more efficient and honest if they were split up into far smaller banks that would actually compete.
Hensarling admits that allowing SDIs to operate creates a Gresham’s dynamic due to the implicit federal subsidy that distorts the SDIs’ managers’ actions in perverse ways, but also tends to cause bad ethics to drive good ethics out of banking generally by turning private incentives perverse throughout the indsutry.
“[T] entry of a subsidized financial institution into a market may motivate other firms to take on greater risks and weaken their operating results.”
Hensarling’s point is that SDIs pose not only a systemic threat to the global financial system when they fail, but also when they are highly profitable because of the perverse incentives the SDIs generate throughout the financial industry.