Phil Gramm, McCain, deregulation, and financial messes

interesting stuff

thanks jason, I had some doubts people would find this interesting.

Are the moderate Democrats that are gaining seats in Congress against regulation? The Executive branch doesn't have to like a single thing, except enforcing past and present legislation.

I see this as non-partisan.

Tim- i think a certain amount of this should be nonpartisan, but we seem to be in a situation where Republicans stand for deregulation. Dems are a mixed bag, mostly defending the concept of regulation- but in certain situations and with certain constituencies they will jump over into the deregulation column. Voters usually find all of this boring and most of it happens completely under the radar, because goofy headline-grabbing things like Terri Schiavo or Reverend Wright usually distract us from it. But the Enron mess, for example, took the life savings of a lot of people. the deregulation made it so that none of them had any real recourse. One day, all the money disappeared and they were all SOL.
That kind of thing cuts into your "pursuit of happiness" pretty deeply.

thanks for sharing great article

thanks jennifer- baby is cute as ever!

I share your perspective on deregulation. The savings and loan mess went back to the Reagan Administration and the resulting deregulation resulted in the American taxpayer bailing out the banks. I was in Texas at the time and the number of insolvent banks were legion. I share your perspective on Phil Gramm, he is only out to fill the pockets of himself and his cronies.

thanks Robert, it is important to have a memory when it comes to politics, isn't it. I do not want to get too personal about Gramm, but I could never happily listen to him make a speech, he always sounded so sure of himself on every last detail. Then his ideas got enacted and it did not work out according to plan.

Regualtions are not the most efficient way to run an economy, but stability is more important than efficiency. The idea is not to make it as easy as possible to make money (deregulation), but to make it less likely to lose money. Speculation is just not good for the economy- long term investment is. The biggest part of the economy is people's impression of the economy- if my job, home value and 401k are not secure, I wont want to spend money, and stocks go down. Ya gotta have balance.

Ed- that's a pretty keen economic analysis, which I think I can live with. I associate Gramm with the Wall Street Journal crowd, who sometimes appear to favor get rich quick schemes over Warren Buffet style investing which stresses patience and sound fundamentals rather than influence peddling and deal cutting.
I share your dislike of speculation. A bunch of people are getting rich that way this year, apparently, but it is not investing.

in other words, I think speculators and people who whine about regulations sometimes give investors a bad name.

Factual Errors, Omissions, and Addenda: You've certainly picked the right target here. In a choice of who has been worse, Greenspan or Gramm, I definitely vote for Gramm. His list of financial catastrophes is long and horribly expensive, and it grows longer as I write. Still, a number of your facts are a bit off, and you've left out a number of key items.

First (and this is just my opinion), you've chosen Gramm-Leach-Bliley over Commodities Futures Modernization as Gramm's "capstone", but I think when all the lost dollars are finally tallied, the Commodities Act will win hands down. The California energy crisis, the collapse of Enron, the Louisiana gas crisis, and the subprime/CDO meltdown do not happen without it. (Per Michael Greenberg, if Christmas had come two weeks earlier in 2000, Enron would still be alive.) And we are still waiting for it's next victim, the $65 trillion meltdown of the CDS market.

As for Phil's wife Wendy, she joins the board of Enron in 1993 after being the "deregulation is God" head of the Commodities Futures Trading Commission (CFTC). She stays until the Enron meltdown, never noticing even as a member of the board's Audit Committee that anything is going wrong with the books. She is compensated between $800 thousand and $1.8 million during this time. However, after the meltdown, a lawsuit is filed against her and 15 other directors. This suit is settled when 10 of the board members pay $10 million out of their personal funds. Wendy Gramm was one of the payees, so we can take comfort in the fact that she pretty much ended up giving back whatever Enron had paid her. Criminal charges perhaps would have been better, but that would have been dicey, as stupidity and ignorance are generally not considered illegal. (Note: Both Wendy and Phil have PhDs in Economics. Not everyone, it seems, benefits intellectually from a good college education.) Wendy then goes on to a professorship at the right wing Mercatus Center of George Mason University, a center originally funded by (guess who?) Enron. She is still listed there, but has not published anything for the last several years.

As for the Commodities Act (a.k.a., the "Enron loophole"), Phil introduces it into the Senate in mid-2000, and it is also introduced into the House. Neither bill makes it out of committee. It is then late December of 2000 when someone secretly attaches Phil's act on the back of an 11,000 page appropriation bill (Phil denies he did this), and it is passed into law without most legislators even knowing it was there. This act specifies (among other nasty things) that energy futures are not to be regulated, and this in turn leads directly to the California energy crisis, the Enron collapse, the Louisiana gas crisis, and the current oil crisis. In late 2002 as the Enron fiasco is playing out, Phil leaves the Senate and joins the Swiss bank, UBS, as a vice chairman, and UBS purchases the energy trading operation of the now defunct Enron. Small world. And yes, Phil did claim this wasn't his fault, something (as we will see) he is fond of doing whenever his crap hits the fan.

But the Commodities Act also had another gem: it also deregulated the then fairly new and expanding markets for exotic risk management products being created and traded by large investment banks. It should be noted here that neither these nor energy futures were being regulated at this time, but this was because of administrative decree by the CFTC. (And yes, Wendy had issued this decree while she was still leading the CFTC.) So why was this act needed at all? Well, given that this was done by decree, that decree could have been reversed at any time, and this fact was holding back those playful speculators. The Act then simply insured that this policy could not be reversed without considerable notice and a new commodities act by Congress. This gave the speculators the confidence and breathing room needed to go wild, and that is exactly what they did.

Now, the first of these exotic products was Collateralized Debt Obligations (CDOs), which allowed the monetization of mortgages. Essentially, mortgages could be packaged and then bought, sold, traded, and most importantly be used as collateral for further borrowing by their holders. This separated mortgage originators from their traditional risk assessment duties, and because of the lack of regulation, failed to inform the buyers of those risks. This in turn led to a frenzy of writing crappy mortgages like the subprimes, which were hardly the only crappy debt that was issued (hence more and likely bigger problems are coming with debt). And of course, Phil also denies that this is his fault. If fact, he claims that the problem wasn't deregulation at all, but rather not enough deregulation! Huh, you ask? Wasn't everything deregulated already? Well, not quite. Remember redlining? When the banks refused to write mortgages in lousy (Read: Black) neighborhoods? Well Phil tried (but failed) to can the legislation that stopped that, and now Phil blames the subprime crisis on all those bad black people, even though the numbers clearly show that those neighborhoods fared no worse than other comparable (but non-redlined) neighborhoods.

The other exotic (and unregulated) product that is now facing meltdown is Credit Default Swaps (CDSs). As I mentioned, this is a $65 trillion market, and as such quite is larger than the "crappy debt" problem. These are essentially insurance policies that banks write on each other which say that if this or that investment defaults, the writing bank will cover the loss out of the premiums they received for writing these policies. The banks claimed that these policies effectively spread the risk so thin as to virtually eliminate it, something that seemed true so long as real estate prices continued to soar. Ooops!

Now, there are lots of problems with these, and all of them are now coming into play. First, remember how the real risks of CDOs were being lost as they were bought and sold? Well, that meant that premiums collected for these policies were insufficient to cover a down market. Second, when you write insurance, you are supposed to hold "reserves" for the risks you are covering. These reserves are what claims are eventually paid out of. But since there were no regulations, no one was making sure sufficient reserves were ever kept. And with insufficient reserves, claims of course cannot be paid. (A lawyer's field day here.) Finally, and in what has to be called way too clever, CDSs (by other even more exotic names) started being written on CDSs! This not only is leading to a tangled legal nightmare, it actually resulted in banks unknowingly buying back (and selling again, over and over) debt that they had already passed off. A veritable circular firing squad. One bank fails, and the others fall like dominos. (Think: Bear Sterns bailout.) Why did they do all this? Because the premiums were fantastic, and the commissions for the sales people were otherworldly. Successful sales people of these products routinely "earned" multimillion dollar annual paychecks, and you didn't even have to be a high school grad to sell them. Nice work if you can get it … and have no conscience.

And yes, the worst is yet to come. All thanks to the deregulatory ax of Phil Gramm. And yes, you and I will be paying for this all. And Phil Gramm still drools over the thought of being the next Treasury Secretary.

Benedict- you seem to have paid attention to this topic! I will go with you and concede that the commodities futures act is the big one.
isn't it remarkable how much damage can be done by a legislator who has some seniority and no conscience whatsoever? My first question about McCain was how could he be worse than Bush, but here is the possible answer: mcCain will be the plaything of the right wing powers-that-be. He has made a deal with the devil to get his blessing.

As for speculators, I think you are actually referring to something else. There really isn't much wrong with speculation.

Speculators do two things. First, they provide liquidity to their markets, something often critical for some necessary markets to function effectively. Second, they try to "out-think" their markets, and place bets when they believe they have. Sometimes they win; sometimes not. But when they win, they only win what their counterparty (the other side of the bet) loses. Similarly, when they lose, only their counterparty wins. Purely a zero sum game.

This is not to be confused (as I think you may have) with market manipulation. True, the manipulators use the same vehicles to ply their trade, but their methods are totally different. First, the manipulators come with HUGE quantities of cash, and add to this with extreme leveraging (17-to-1 in some cases). They establish positions (using loopholes) far in excess of those allowed to speculators. But then they add to this a technique whereby they constantly "roll over" their positions, opening new positions exactly as old positions expire. In this fashion, they never have to suffer loses, and ride these positions as high (or as low) as they can until their market overheats and melts down. And then they quickly sneak off into the darkness with all their hoards of new-found cash, leaving legitimate businesses, honest speculators, and you and I to pick up the pieces.

This is what we are seeing now in both oil and food markets. But it is important to separate speculation from manipulation. The first is just fine, and can often improve markets. The second is simply a grand ponzi scheme where you and I are simply the last entrants.

So the billion dollar question is, how do we unravel this mess? How can we gain control of this pandoras box of greed and deception that the deregulation left us drowning in? Even if congress got the guts, what can the regs do about the deals in progress?

i think that is a good question Ed. My perception is that he who cleans up the mess will be at risk of getting more of the blame for the mess than he who dealt it. You know that if ANYTHING goes wrong about re-regulating finance, if it even happens at all, the neocon money crew will be all over it saying hey everybody was rich and happy back when we ran things. Not true, but they will say it.
Too late for Enron, too late for Bear Stearns, too late for the foreclosure folks,yes the deals already signed are immune to regulations. Not too late for the rest of us maybe but it is like climbing out of a hole in the ground with no ladder.