By William K. Black
Bloomington, MN: February 8, 2015
I am writing a series of columns about the Republican fantasy team of apologists for the elite banksters. Jeb Hensarling (R, TX), chair of the House banking committee that is taking the lead in trying to further deregulate banking and Peter Wallison, one of the chief architects of the most recent banking crisis, are teaming up to flog Wallison’s book. The book attempts to convince its readers that Wallison’s leadership of the effort to push the three “de’s” – deregulation, desupervision, and de facto decriminalization – played no role in creating the criminogenic environment that produced the three most destructive epidemics of financial fraud in history. Hensarling is hosting Wallison’s book unveiling.
They are the perfect fantasy team because they inhabit a fantasy world of their own construction that rests on a foundation of non-facts with appalling logical leaps. This first column begins with a brief introduction to how crazy Hensarling is – and recall that he is the Republican Party’s leader on financial issues. George Akerlof and Paul Romer, in their classic 1993 article “Looting: The Economic Underworld of Bankruptcy for Profit,” explained that the 1982 federal deregulation law was “bound to produce looting.”
“Neither the public nor economists foresaw that the [S&L deregulations] of the 1980s were bound to produce looting. Nor, unaware of the concept, could they have known how serious it would be. Thus the regulators in the field who understood what was happening from the beginning found lukewarm support, at best, for their cause. Now we know better. If we learn from experience, history need not repeat itself” (1993: 60).
The Garn-St Germain Act of 1982 prompted a deregulatory (and desupervisory) “race to the bottom” that was “won” by Texas and California. Together, the S&Ls located in these two states caused over 60% of total losses. Absent Federal Home Loan Bank Board Chairman Edwin Gray’s prompt, vigorous elimination of the three “de’s” the epidemic of accounting control fraud that he inherited from his predecessor embrace of the three “de’s” would have caused trillions of dollars of losses and produced a financial crisis and Great Recession. I detail these facts in The Best Way to Rob a Bank is to Own One (2014).
The S&L debacle, therefore, refutes Henarling and Wallison’s thesis. Here is Hensarling’s fantasy description (in 2009) of how regulation relates to the savings and loan debacle.
“Twenty years ago, in response to the failure of 1,600 commercial banks in the savings and loan crisis, the federal government enacted the Federal Deposit Insurance Corporation Improvement Act of 1991 (Pub. L. No. 102–242) (FDICIA), which significantly tightened bank and S&L regulation in an attempt to generate stability. However, the tougher restrictions of FDICIA did not fix the problem, and the savings and loan crisis ended up costing American taxpayers over $120 billion” (p. 57).
Congressional Oversight Panel, Special Report on Regulatory Reform: Modernizing the American Financial Regulatory System: Recommendations for Improving Oversight, Protecting Consumers, and Ensuring Stability, at 54-89 (Jan. 29, 2009). Dissent of CONGRESSMAN JEB HENSARLING AND FORMER SENATOR JOHN E. SUNUNU.
Put aside the innumeracy of thinking that 1991 was “twenty years ago” when writing in 2009. Henarling is the Chair of the House Financial Services Committee, so there’s no reason he needs to be numerate.
Put aside the fact that “commercial banks” did not fail in “the savings and loan crisis.” He’s only the Chair of the House Financial Services Committee, so there’s no reason he needs to be able to distinguish between a “bank” and an “S&L.”
Garn-St Germain was enacted in 1982, and California’s deregulation became effective on January 1. 1983. Texas soon super-charged its regulatory race to the bottom. How was a law enacted nine years later (in 1991) supposed to “fix the problem” of an epidemic of accounting control fraud led by S&L CEOs triggered by the passage of the Garn-St Germain Act of 1982? If, beginning in 1982, you had nine years of unprotected sex with multiple partners and ended up with three children and five STDs – and then started wearing condoms in 1991 – it would not “fix the problem[s]” that arise from unprotected sex. You would still have three kids and five STDs. Hensarling apparently thinks that this proves that condoms are useless as a means of reducing undesired pregnancies and STDs because they don’t work retroactively.
By 1983, as a result of the Richard Pratt’s destruction of effective regulation and supervision, there were 300 S&L frauds growing at an annual rate of 50% or more. There were hundreds of distressed real estate developers acquiring or starting new S&Ls by 1983. Gray began reregulating the S&L industry in November 1983. If Gray had not acted, if he had continued his predecessors embrace of the three “de’,” S&L losses would have climbed into the trillions of dollars years before the 1991 FDICIA legislation became law. Ending the three “de’s” is precisely what “fix[ed] the problem.” It fixed it so well that the S&L debacle did not cause even a minor recession or minor impairment of financial markets.
The Competitive Equality in Banking Act of 1987 (CEBA), the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA), the Crime Control Act of 1990 (CCA), and FDICIA (1991) were enacted largely because we ended the three “de’s.” CEBA was designed to gut our efforts against the three “de’s.” CEBA demonstrated the still extraordinary lobbying power of the control frauds and their identification of our efforts to end the three “de’s” as their gravest threat. By 1989, we had demonstrated that the S&Ls that the prominent politicians had allied with against us were being looted by their CEOs. Speaker Wright and the “Keating Five” were in retreat. FIRREA significantly increased our enforcement powers. The CCA substantially increased funding for U.S. attorneys (AUSAs) and FBI agents dedicated to bringing the elite S&L frauds to justice. FDICIA put into law some of the ideas that academics and Gray had championed (to the extent possible with our critically limited funds), particularly “prompt corrective action.” The earliest of the legislative reregulatory acts (FIRREA) occurred in 1989 – seven years after the Garn-St Germain Act of 1982 started the regulatory race to the bottom – and six years after Gray began ending the three de’s in 1983.
Our civil, enforcement, and criminal cases transformed what had been intense opposition from the Reagan administration and Congress (Democrats and Republicans) to our ending of the three “de’s.” Our cases demonstrated that the crisis was driven by S&L CEOs looting “their” S&Ls. Our cases put facts in the public record and led to thousands of articles spreading throughout the public the understanding that the crisis was driven by an epidemic of elite fraudsters assisted by their powerful political allies.
The re-supervision dramatically reduced the rate of the expansion of a raging fraud epidemic, but it could not make the losses disappear and nothing can stop instantly 300 S&Ls growing over 50% annually. That is particularly true when (1) the frauds are reporting record profits, (2) they have political protection, (3) the regulator has far too few staffers, and (4) the regulator lacks the financial resources in the insurance fund to close more than a small portion of the frauds (and that portion falls rapidly as the frauds grow). Containing the fraud epidemic in these circumstances at a point where the losses caused no recession and no systemic crisis was an extraordinary accomplishment brought about by countering the three “de’s.”
The S&L regulators then pulled off something equally impressive. A new loan product, then called “low documentation” (low doc) loans, first became material in 1990 in Orange County. Our examiners in the field promptly recognized that the loans, because they did not verify the borrower’s income, inherently produced severe “adverse selection” and losses. Only CEOs leading accounting control frauds would make such loans. We agreed with our examiners and in 1991 we began driving such loans out of the S&L industry.
Those loans are now called “liar’s” loans. They are the loans that hyper-inflated the residential real estate bubbles that drove our most recent crisis. That epidemic of liar’s loans was made possible because our successors embraced the three “de’s.”
The S&L debacle allowed multiple tests of the effects of the three “de’s” and the effects of countering them. There were two major embraces of the three “de’s” under Richard Pratt and Danny Wall and two major efforts to counter them under Gray and Timothy Ryan. Pratt and Wall’s embrace of the three “de’s” proved disastrous and Gray and Ryan’s countering of the three “de’s” produced the three greatest successes in modern financial regulatory history. Gray contained the raging fraud epidemic he inherited. Under Ryan we stopped the incipient epidemic of liar’s loans and built on Gray’s work to produce over 1,000 elite felony convictions.