Client Number 9 And The Myth of Deregulation

“Everyone is entitled to their own opinions, but they are not entitled to their own facts.” — Daniel Patrick Moynihan

So Friday night, I leave on HBO after a preview of Cowboys and Aliens… Film looks great, but big mistake for not hitting the power button after the preview was over…

Eyes blood shot and in the final sentences of my graduate thesis, I look up. There’s Bill Maher sitting with three guests representing the nation’s political spectrum.

I shake my head when FreedomWorks’ Matt Kippe struggles to explain his Tea Party’s stance on spending prior to TARP. I roll my eyes when Republican Margaret Hoover can’t get any numbers right on the national debt…

And then, the real prize…

Representing the Democrat brand is Eliot Spitzer, a former Wall Street regulator, turned New York Governor, turned john, turned TV host, turned unemployed talking head.

And while defending the President and praising Bill Clinton for leaving a surplus (at the peak of another financial bubble… he leaves that part out), Spitzer blames Bush for the current debt problem…

Of course.

Forget that we’re 30 months into Obama’s first term and $4 trillion deeper in debt.

No… According to Client Number 9, our current crisis is the result of Bush giving America “the deregulatory craziness that led us over the cliff.” My eyebrows rise. I stop typing. I lean in.
Moments later, Spitzer tells the other panelists something even more perplexing… He is an “old school Democrat” because he knows and “believes in facts.”

Irony abounds. The mind reels. Spitzer is rewriting history and fueling the greatest myth of the financial crisis.

Now I’m no Bush apologist, believe me… but W is not responsible for “deregulatory craziness.” And the debate ends quickly when you know the facts and don’t make them up to fit your talking points.

The Web of Myth

Spitzer’s trapped in a myth for two reasons: First, the deregulatory efforts that fueled the financial downturn came in two Acts passed in 1999 and 2000, before George W. Bush entered office. This can’t be disputed because Bill Clinton’s handwriting is on the Financial Services Modernization Act of 1999 (FSMA) and the Commodity Futures Modernization Act of 2000 (CFMA).

Bill Clinton is not George Bush… and George Bush is not Bill Clinton. One is a Democrat, and the other a Republican… One has an affinity for cigars; the other, a preternatural ability to mispronounce words.

Glass-Steagall (The Banking Act of 1933) largely banned proprietary trading by Wall Street banks with only a few exemptions 80 years ago. But the FSMA repealed Glass-Steagall provisions and allowed banks to invest their own money in whatever they wanted: Other banks… risky loans…credit swaps… skulls… probably arms trading… I mean really, who even knows anymore? We’re still finding these things out as we sort the carnage of balance statements.

The CFMA on the other hand guaranteed that the government would not regulate derivatives, those pesky financial instruments that helped sink Lehman Brothers, Bear Stearns, AIG, Citigroup and a slew of hedge funds and financial institutions. That bill was a different monster brought forth by champions of the mid-90s.

In 1997 Clinton’s ex-Treasury secretary, Robert Rubin and super friends Alan Greenspan and Larry Summers, led the charge against Brooksley Born to prevent the Commodities Futures Trading Commission (CFTC) from monitoring derivatives markets. Greenspan eventually won a bitter war of words. Born left the CFTC in 1999, shipped out of Washington on a rail. Meanwhile, as Time magazine put it, Rubin and his team went on to “Save the World” during the Asian and Latin American crises.

So, isn’t it ironic that 10 years later, while Rubin was the Chairman of the Board at Citigroup, the company lost more than $50 billion on subprime derivatives trades? And now Citigroup represents the third largest individual bailout and loan guarantee in U.S. history at $280 billion?

I suppose you have to save the world, before you can destroy it. Still, Rubin went on to pocket $126 million in eight years… which is a fitting, yet average, payday for a former Goldman Sachs Co-chair.
But according to Eliot Spitzer, all of this is the sole fault of George Bush… because… Spitzer needed to set up Maher for a punch line about the Tea Party?

The “deregulation” that put the brick on the pedal on the car on the road that accelerated off the cliff? These Acts were signed by Bill Clinton and had overwhelming support from a bipartisan Congress…
And the argument could end there.

But that’s just part one of the George W. Deregulation myth… It’s the second part where Spitzer really gets it wrong. And here is what is so incredibly bizarre about Democrats constantly claiming that Bush’s deregulatory practices sank the economy.

Prior to the Swiss cheese that is the Dodd-Frank Act, the biggest regulatory effort in 70 years occurred under Bush in the passage of the Sarbanes Oxley Act. Now say what you want about Sarbanes Oxley, and then I’ll go even further. It was a terrible, costly, backward-looking piece of regulation that was designed in haste to reduce illicit accounting practices at public companies… And it failed miserably.

One of the principle problems during the crisis were illicit off-balance accounting practices at Lehman, Bear, and Citigroup (among others), which allowed companies to turn massive debts into report footnotes and shield their derivative exposures and leverage from the markets and their own investors. Sarbanes Oxley should have prevented these practices… but auditors never held companies accountable and the regulation never addressed the off-balance accounting standards that had been a part of nearly every crisis dating back to the early 1990s.

But failure or not, Sarbanes Oxley was not a “deregulatory effort.” In fact, SOX and Eliot Spitzer himself were the two greatest agents of Wall Street regulation since Roosevelt.

Before Eliot Spitzer became New York’s 54th governor, he was Eliot Spitzer, Attorney General and Sheriff of Wall Street. He himself was a part of the biggest litigation effort in the nation’s financial history, so his argument is dismissed by his own actions. Spitzer made a name for himself by tackling Wall Street firms under the 1921 Martin Act. This antifraud statute is so ambiguous that the state government didn’t even require Spitzer to demonstrate criminal intent before investigating stock inflation schemes. Anyone was guilty before being investigated.

Spitzer rose to fame as an aggressive regulatory champion, one who legally bludgeoned costly settlements out of numerous firms and shelled stock prices in the process. Specifically, he targeted Wall Street’s bread-and-butter business of underwriting initial public offerings. There was a craze of those in the Dotcom Era, right around the time that Bill Clinton was giving America those surpluses. But Spitzer’s efforts years later, combined with SOX, has made it far less enterprising and far more expensive to underwrite IPOs…

And as a result, we’ve had fewer IPOs than in the pre-Bush years on the backs of these efforts. Still neither can be called “deregulation.”

The only time during Bush’s tenure that we can actually say markets were “deregulated” was in 2004 when the SEC lifted the cap on how much leverage a bank can use. At the time, the SEC was being run by William Donaldson, a former Nixon adviser who is actually older than the Security Exchange Commission itself…

Though people blame Bush for his SEC’s decision, and it is damning, that’s practically impossible because no one at the SEC has had any clue what they doing for 80 years… Plus, the person who earns the most blame, according to Dylan Rattigan of all people, is Henry Paulson for leading efforts to make this possible for a decade…

But while SOX and Spitzer took an axe to the Wall Street IPO engine and drove off business to London, Spitzer’s actions and government intervention diverted Wall Street capital from stocks to the housing sector.

But deregulation hasn’t been the housing market’s problem in the past decade and a half. It’s been overregulated toward damn near centralized planning. Three decades of government tinkering (Fannie and Freddie, the Community Reinvestment Act, Tax Subsidies for Second Mortgages) placed incredible pressures and perverse incentives on lenders to reduce loan standards and increase credit availability.

But make that factual argument and Barney Frank will step out of an alternative universe and brand you a liar… In a Democrat’s world, this is the fault of Bush’s deregulatory blood lust.

I’m not even sure if Spitzer or half the people who voted for any of these bills know what “deregulation” actually means anymore. Deregulation should be defined as the elimination of government barriers to entry in a sector… not forcing banks to make loans through wishful social engineering. The Bush Administration, if anything, helped fueled government stimulation in the housing markets.

And what’s worse, the Obama administration recently pushed initiatives to drive increased lending to under-qualified buyers… again. What is the definition of insanity, by the way?

The new administration that blames Bush for deregulation doesn’t see the lesson from government involvement in the private housing sector… It thinks government can fix this… it’s doubling down on failed policies.

I’ve spent three years of my life investigating the root causes of this financial crisis. A Lexus worth of student loans says that I’m not here just trying to get a degree because I’m a glutton for academia… When the world melted down around me in New York in 2008, I had no clue what had happened. So I checked into grad school and wrapped my head around the past 20 years of this economic drama … Tonight, I’m submitting my thesis on the impacts of the housing crisis on public policy and corporate leadership.

My research dates all the way back to the New Community Reinvestment Act of 1995 and the Taxpayer Relief Act of 1997… Two more faulty, centralized initiatives under President Clinton that helped fuel Wall Street speculation while two other bills predating Bush deregulated the behavior of banks… The 2004 increase in leverage standards was the final gallon of gas on a bonfire built in the Clinton years as a strong wind created by crippled IPO operations and government mandates stoked the flames of crisis…

So, if I get anything out of this experience, let it be that I can tell you with full confidence that “Bush is responsible for this deregulatory craziness” is the most inaccurate thing I’ve heard out of a former politician’s mouth since… well… Friday morning.

But, then again… I’m not on TV, and Spitzer is. So his version will live on… Why let facts get in the way of a successful talking point?


Garrett Baldwin
for Whiskey & Gunpowder

The Daily Reckoning