Financial deregulatory mania over the last three decades led directly to the current financial meltdown.
Were the deregulators acting out of principle? Perhaps.
But it couldn’t have hurt that the financial sector invested a staggering $5.1 billion in political influence purchasing in the United States over the last decade.
The money flows are laid out in gruesome detail in Sold Out: How Wall Street and Washington Betrayed America, a report that my colleague Jim Donahue and I wrote, along with a team of contributors from the Consumer Education Foundation and my organization, Essential Information. The report is available at (wallstreetwatch.org/soldoutreport.htm).
The entire financial sector (finance, insurance, real estate) drowned political candidates in campaign contributions, spending more than $1.7 billion in federal elections from 1998-2008. Primarily reflecting the balance of power over the decade, about 55% went to Republicans and 45% to Democrats. Democrats took just more than half of the financial sector’s 2008 election cycle contributions.
The industry spent even more — topping $3.4 billion — on officially registered lobbyists during the same period. This total certainly underestimates by a considerable amount what the industry spent to influence policymaking. US reporting rules require that lobby firms and individual lobbyists disclose how much they have been paid for lobbying activity, but lobbying activity is defined to include direct contacts with key government officials, or work in preparation for meeting with key government officials. Public relations efforts and various kinds of indirect lobbying are not covered by the reporting rules.
During the decade-long period:
• Commercial banks spent more than $154 million on campaign contributions, while investing $383 million in officially registered lobbying;
• Accounting firms spent $81 million on campaign contributions and $122 million on lobbying;
• Insurance companies donated more than $220 million and spent more than $1.1 billion on lobbying; and
• Securities firms invested more than $512 million in campaign contributions, and an additional nearly $600 million in lobbying. Hedge funds, a subcategory of the securities industry, spent $34 million on campaign contributions (about half in the 2008 election cycle); and $20 million on lobbying. Private equity firms, also a subcategory of the securities industry, contributed $58 million to federal candidates and spent $43 million on lobbying.
Individual firms spent tens of millions of dollars each. During the decade-long period:
• Goldman Sachs spent more than $46 million on political influence buying;
• Merrill Lynch threw more than $68 million at politicians;
• Citigroup spent more than $108 million;
• Bank of America devoted more than $39 million;
• JPMorgan Chase invested more than $65 million; and
• Accounting giants Deloitte & Touche, Ernst & Young, KPMG and Pricewaterhouse spent, respectively, $32 million, $37 million, $27 million and $55 million.
The number of people working to advance the financial sector’s political objectives is startling. In 2007, the financial sector employed a staggering 2,996 separate lobbyists to influence federal policy making, more than five for each member of Congress. This figure only counts officially registered lobbyists. That means it does not count those who offered “strategic advice” or helped mount policy-related PR campaigns for financial sector companies. The figure counts those lobbying at the federal level; it does not take into account lobbyists at state houses across the country. To be clear, the 2,996 figure represents the number of separate individuals employed by the financial sector as lobbyists in 2007. We did not double count individuals who lobby for more than one company; the total number of financial sector lobby hires in 2007 was a whopping 6,738.
A great many of those lobbyists entered and exited through the revolving door connecting the lobbying world with government. Surveying only 20 leading firms in the financial sector (none from the insurance industry or real estate), we found that 142 industry lobbyists during the period 1998-2008 had formerly worked as “covered officials” in the government. “Covered officials” are top officials in the executive branch (most political appointees, from members of the cabinet to directors of bureaus embedded in agencies), Members of Congress, and congressional staff.
Nothing evidences the revolving door—or Wall Street’s direct influence over policymaking—more than the stream of Goldman Sachs expatriates who left the Wall Street goliath, spun through the revolving door, and emerged to hold top regulatory positions. Topping the list, of course, are former Treasury Secretaries Robert Rubin and Henry Paulson, both of whom had served as chair of Goldman Sachs before entering government. Goldman continues to be well represented in government, with among others, Gary Gensler, President Obama’s pick to chair the Commodity Futures Trading Commission, and Mark Patterson, a former Goldman lobbyist now serving as chief of staff to Treasury Secretary Timothy Geithner.
All of this awesome influence buying has enabled Wall Street to establish the framework for debates in Washington, and to obtain very specific deregulatory actions, with devastating consequences.
Sold Out: How Wall Street and Washington Betrayed America details a dozen crucial deregulatory moves over the last decade — each a direct response to heavy lobbying from Wall Street and the broader financial sector, as the report details. Combined, these deregulatory moves helped pave the way for the current financial meltdown.
Here are 12 deregulatory steps to financial meltdown:
1. The repeal of Glass-Steagall
The Financial Services Modernization Act of 1999 formally repealed the Glass-Steagall Act of 1933 and related rules, which prohibited banks from offering investment, commercial banking, and insurance services. In 1998, Citibank and Travelers Group merged on the expectation that Glass-Steagall would be repealed. Then they set out, successfully, to make it so. The subsequent result was the infusion of the investment bank speculative culture into the world of commercial banking. The 1999 repeal of Glass-Steagall helped create the conditions in which banks invested monies from checking and savings accounts into creative financial instruments such as mortgage-backed securities and credit default swaps, investment gambles that led many of the banks to ruin and rocked the financial markets in 2008.
2. Off-the-books accounting for banks
Holding assets off the balance sheet generally allows companies to avoid disclosing “toxic” or money-losing assets to investors in order to make the company appear more valuable than it is. Accounting rules — lobbied for by big banks — permitted the accounting fictions that continue to obscure banks’ actual condition.
3. CFTC blocked from regulating derivatives
Financial derivatives are unregulated. By all accounts this has been a disaster, as Warren Buffett’s warning that they represent “weapons of mass financial destruction” has proven prescient — they have amplified the financial crisis far beyond the unavoidable troubles connected to the popping of the housing bubble. During the Clinton administration, the Commodity Futures Trading Commission (CFTC) sought to exert regulatory control over financial derivatives, but the agency was quashed by opposition from Robert Rubin and Fed Chair Alan Greenspan.
4. Formal financial derivative deregulation: the Commodities Futures Modernization Act
The deregulation—or non-regulation—of financial derivatives was sealed in 2000, with the Commodities Futures Modernization Act. Its passage orchestrated by the industry-friendly Senator Phil Gramm, the Act prohibits the CFTC from regulating financial derivatives.
5. SEC removes capital limits on investment banks and the voluntary regulation regime
In 1975, the Securities and Exchange Commission (SEC) promulgated a rule requiring investment banks to maintain a debt to-net capital ratio of less than 15 to 1. In simpler terms, this limited the amount of borrowed money the investment banks could use. In 2004, however, the SEC succumbed to a push from the big investment banks—led by Goldman Sachs, and its then-chair, Henry Paulson—and authorized investment banks to develop net capital requirements based on their own risk assessment models. With this new freedom, investment banks pushed ratios to as high as 40 to 1. This super-leverage not only made the investment banks more vulnerable when the housing bubble popped, it enabled the banks to create a more tangled mess of derivative investments — so that their individual failures, or the potential of failure, became systemic crises.
6. Basel II weakening of capital reserve requirements for banks
Rules adopted by global bank regulators—known as Basel II, and heavily influenced by the banks themselves—would let commercial banks rely on their own internal risk-assessment models (exactly the same approach as the SEC took for investment banks). Luckily, technical challenges and intra-industry disputes about Basel II have delayed implementation—hopefully permanently—of the regulatory scheme.
7. No predatory lending enforcement
Even in a deregulated environment, the banking regulators retained authority to crack down on predatory lending abuses. Such enforcement activity would have protected homeowners, and lessened though not prevented the current financial crisis. But the regulators sat on their hands. The Federal Reserve took three formal actions against subprime lenders from 2002 to 2007. The Office of Comptroller of the Currency, which has authority over almost 1,800 banks, took three consumer-protection enforcement actions from 2004 to 2006.
8. Federal preemption of state enforcement against predatory lending
When the states sought to fill the vacuum created by federal non-enforcement of consumer protection laws against predatory lenders, the Feds—responding to commercial bank petitions—jumped to attention to stop them. The Office of the Comptroller of the Currency and the Office of Thrift Supervision each prohibited states from enforcing consumer protection rules against nationally chartered banks.
9. Blocking the courthouse doors: Assignee Liability Escape
Under the doctrine of “assignee liability,” anyone profiting from predatory lending practices should be held financially accountable, including Wall Street investors who bought bundles of mortgages (even if the investors had no role in abuses committed by mortgage originators). With some limited exceptions, however, assignee liability does not apply to mortgage loans, however. Rep, Bob Ney (R-Ohio)—a great friend of financial interests, and who subsequently went to prison in connection with the Abramoff scandal—worked hard, and successfully, to ensure this effective immunity was maintained.
10. Fannie and Freddie enter subprime
At the peak of the housing boom, Fannie Mae and Freddie Mac were dominant purchasers in the subprime secondary market. The Government-Sponsored Enterprises were followers, not leaders, but they did end up taking on substantial subprime assets—at least $57 billion. The purchase of subprime assets was a break from prior practice, justified by theories of expanded access to homeownership for low-income families and rationalized by mathematical models allegedly able to identify and assess risk to newer levels of precision. In fact, the motivation was the for-profit nature of the institutions and their particular executive incentive schemes. Massive lobbying—including especially but not only of Democratic friends of the institutions—enabled them to divert from their traditional exclusive focus on prime loans.
Fannie and Freddie are not responsible for the financial crisis. They are responsible for their own demise, and the resultant massive taxpayer liability.
11. Merger mania
The effective abandonment of antitrust and related regulatory principles over the last two decades has enabled a remarkable concentration in the banking sector, even in advance of recent moves to combine firms as a means to preserve the functioning of the financial system. The megabanks achieved too-big-to-fail status. While this should have meant they be treated as public utilities requiring heightened regulation and risk control, other deregulatory maneuvers (including repeal of Glass-Steagall) enabled them to combine size, explicit and implicit federal guarantees, and reckless high-risk investments.
12. Credit rating agency failure
With Wall Street packaging mortgage loans into pools of securitized assets and then slicing them into tranches, the resultant financial instruments were attractive to many buyers because they promised high returns. But pension funds and other investors could only enter the game if the securities were highly rated.
The credit rating agencies enabled these investors to enter the game, by attaching high ratings to securities that actually were high risk—as subsequent events have revealed. The credit rating agencies have a bias to offering favorable ratings to new instruments because of their complex relationships with issuers, and their desire to maintain and obtain other business dealings with issuers.
This institutional failure and conflict of interest might and should have been forestalled by the SEC, but the Credit Rating Agencies Reform Act of 2006 gave the SEC insufficient oversight authority. In fact, the SEC must give an approval rating to credit ratings agencies if they are adhering to their own standards—even if the SEC knows those standards to be flawed.
From a financial regulatory standpoint, what should be done going forward? The first step is certainly to undo what Wall Street has wrought. More in future columns on an affirmative agenda to restrain the financial sector.
None of this will be easy, however. Wall Street may be disgraced, but it is not prostrate. Financial sector lobbyists continue to roam the halls of Congress, former Wall Street executives have high positions in the Obama administration, and financial sector propagandists continue to warn of the dangers of interfering with “financial innovation.”
Robert Weissman is editor of the Washington, D.C.-based Multinational Monitor (multinationalmonitor.org) and director of Essential Action (essentialaction.org). Comment at www.multinationalmonitor.org/editorsblog.
From The Progressive Populist, April 15, 2009
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