Thirty-Year History of Deregulation

By William K. Black, New Economic Perspectives

The imminent passage of the fraud-friendly JOBS Act caused me to reflect on the fact that the worst anti-regulatory travesties in the financial sphere have had broad, bipartisan support.  The Garn-St Germain Act of 1982, which deregulated savings and loans (S&Ls) and helped drive the debacle, was passed with virtually no opposition.  The Texas and California S&L deregulation acts – the two states that “won” the regulatory “race to the bottom” – passed with virtually no opposition.  Texas S&L failures caused over 40% of total S&L losses and California failures caused roughly 25% of total losses.  In 1984, a majority of the members of the House of Representatives, including Newt Gingrich and most of the leadership of both parties, co-sponsored a resolution calling on us to cease our reregulation of the S&L industry.  

The Competitive Equality in Banking Act of 1987 (CEBA) was the product of two cynical political deals.  The context was that the Reagan administration refused to allow the Federal Savings and Loan Insurance Corporation (FSLIC) to admit that there was a crisis requiring governmental funds and refused to allow FSLIC to draw any funds on its Treasury credit line.  We had spent all but $500 million in the FSLIC fund closing some of the worst S&L control frauds.  The S&L industry had over $1 trillion in liabilities and was deeply insolvent, so we were running the insurance fund on fumes and dreading a potential nationwide run.  Treasury and FSLIC ginned up a convoluted means of FSLIC receiving the proceeds of a $15 billion (FICO) bond issuance.  The repayment of the FICO bonds rested in large part on taking capital and future earnings from the Federal Home Loan Banks (FHLBs).  The industry owned the FHLBs, so the S&Ls’ interest in the FHLBs’ capital was treated on their financial statements as an asset.  Using the FHLBs’ capital to “defease” the FICO bonds reduced every S&L’s reported capital.  The exceptionally powerful S&L trade association (the “League”) opposed the plan.  It preferred that the government, rather than the healthier members of the industry, pay to resolve failed S&Ls.  Trade associations also do not want to lose members through government closures.

The S&L control frauds saw the FSLIC recapitalization bill as an opportunity.  They had disproportionate political power because political interference was their best guarantee of delaying our closure of their S&L.  My contemporaneous joke was that the frauds’ always obtained their highest return on assets from their political contributions.  The frauds’ priorities were to make it far harder for the regulators to take action against them and to get FSLIC to use its funds to bail out failed S&Ls rather than close them.  A large FSLIC recapitalization could be a very good thing for the frauds if the funds were given to “their” S&Ls while they remained in control.

The first political deal was between the frauds and the League.  It was called the “Faustian bargain.”  The League agreed to support “forbearance” provisions drafted by the frauds’ lawyers that were cleverly designed to make it difficult for us to take enforcement actions and appoint receivers.  The frauds agreed to stall passage of the bill and to support the League’s proposed reduction in FICO bond issuances to $5 billion.  (The contemporaneous joke was that if we flew into DFW rented a car and drove towards downtown Dallas we would exhaust the $5 billion closing the failed S&L we passed en route before we made it to Dallas.)  The S&L frauds in Texas had exceptional political power.  The Faustian bargain worked.  Speaker of the House James Wright held the FSLIC recapitalization bill “hostage” to extort regulatory favors for a series of Texas S&L frauds and a huge bankrupt borrower from the frauds.  Charles Keating, who controlled Lincoln Savings, had already used Alan Greenspan as a lobbyist (plus large political contributions) to recruit the five Senators (Cranston, DeConcini, Glenn, McCain, and Riegle) who would become infamous as “the Keating Five.” They made a secret bipartisan effort in April 1987 to prevent the agency from taking enforcement action against Lincoln Savings’ massive, fatal violation of the rules restricting direct investments.  (Speaker Wright later joined their effort.)  Senator Cranston, at Keating’s behest, put a secret “hold” on the FSLIC recapitalization bill in 1986.  The combined efforts of the frauds’ political cronies prevented passage of the bill in 1986.

The second cynical deal was struck in 1987 by the Reagan administration and Speaker Wright.  Wright agreed to withdraw his opposition to the $15 billion size of the FICO bond issuance.  Treasury Secretary Baker agreed that the administration would not reappoint Edwin Gray as Chairman of the Federal Home Loan Bank Board (Bank Board) and that the administration would not oppose the forbearance provisions, drafted by the frauds’ lawyers, which the House had added to the bill.  To no one’s surprise, Wright paid only lip service to the deal.  He gave a speech announcing that he now supported the $15 billion FICO issuance, but his minions spread the word that he actually supported the version of the bill that allowed only a $5 billion FICO issuance.  The League deployed its crisis reaction force in support of the Speaker.  Five hundred senior S&L executives, each a significant political contributor on a first name basis with members of the congressional delegation, agreed to be in DC walking the halls of Congress within 48 hours of receiving the League’s call for grassroots lobbying.  My psyche still bears the scars of this combined onslaught.  It was the political equivalent of being on the receiving end of a B 52 Arc Light (carpet bombing) mission in Vietnam.  We were crushed in the House on the effort to get authority to issue $15 billion in FICO bonds.  We lost a majority of Republicans, including much of the leadership, and almost all the Democrats.

In 1993, “Reinventing Government” had total bipartisan support.  Vice President Al Gore led the Clinton administration effort.  Reinventing government was premised on the view that government was a failure and the private sector was a success that the public sector should emulate.  I will mention only two of the anti-regulatory policies that it led to in banking.  In 1993, the Clinton administration killed the Bank Board’s loan underwriting rules that had proven successful and essential in stopping the S&L debacle and suing and prosecuting the control frauds that drove the crisis.  The old rule is what we used in 1990-1991 to stop S&Ls that were making liar’s loans.  This was the single most destructive rule change in banking rules in the most recent financial crisis.

“Reinventing” proponents ordered the banking regulators to refer to banks as our “clients” and to think of them as clients we were to serve.  Texas Governor George Bush shared Gore and Clinton’s passion for the “Reinventing Government” movement and expanded their anti-regulatory policies.  There is no more destructive regulatory mindset short of outright corruption than viewing the industry as your “client.”  It makes effective regulation impossible.

The Public Securities Litigation Reform Act of 1995 passed with sufficient bipartisan support to override President Clinton’s veto.  The Act was designed to make it vastly more difficult for the victims of securities fraud to sue the fraudsters.  It succeeded, which has made the financial sector more criminogenic because it makes it easier for the CEOs to loot with impunity.  (The 1998 amendment to the PSLRA made it substantially more hostile to fraud victims.  It passed with the support of Clinton, a majority of Democrats, and only one negative vote by a Republican.)

The Gramm-Leach-Bliley Act of 1999, which repealed the Glass-Steagall Act, passed with overwhelming support and the active sponsorship of the Clinton administration and the Congressional leadership of both parties.  The Glass-Steagall Act was adopted because we investigated the causes of the Great Depression, principally through the Pecora investigation, and found that combining investment and commercial banking led to conflicts of interest that produced recurrent abuses and helped trigger the crisis.  The Glass-Steagall Act worked brilliantly.  America prospered, as did our commercial and investment banks.  Recessions became far less common and far less severe.

In the late 1990s, Brooksley Born, the head of the Commodities Futures Trading Commission (CFTC), realized that credit default swaps (CDS) posed a potential severe danger and sought to review whether the CFTC should adopt regulation to respond to the danger.  The Clinton administration, Alan Greenspan, and the congressional leadership of both parties rushed to adopt the Commodities Futures Modernization Act of 2000.  The 2000 Act passed with overwhelming support and created a regulatory black hole that Enron exploited to cause the 2001 California energy crisis and AIG executives exploited to become wealthy and drive AIG insolvent.

We can now add to this list of bipartisan financial deregulatory disasters the JOBS Act of 2012.  I have explained in prior articles that the Act is the product of a feeding frenzy by lobbyists who are finally able to enact every fraud-friendly provision they ever dreamed of making law.  The only kind of financial bill that can pass with overwhelming support is an anti-regulatory bill.  The Republicans and Democrats share two key characteristics. The finance industry is the leading political contributor to both parties and both parties’ views of finance are largely shaped by neoclassical economic views that are false, destructive, and so dogmatically held that they have remained immune to repeated falsification by reality.

Any overall discussion of our financial crises should be framed by this question:  why do we suffer recurrent, intensifying crises.  The question has two parts.  First, what is causing our crises?  Second, why do we learn the wrong lessons from prior crises?  The embrace of the three “de’s” by both parties – deregulation, desupervision, and de facto decriminalization – has created ever more criminogenic environments that cause crises to become more severe.  The epidemics of accounting control fraud generated by the three de’s drive the financial crises that lead to recessions.  If the government exposes and sanctions the elite frauds that drive the crisis it can create (briefly) the political space for real reform legislation.  If, however, the government fails to expose and hold accountable the elite frauds that political space for real reform will not be crated and any reform bills may be large, but they will not be fundamental.  The finance industry will exploit any severe financial crisis and recession by arguing that it is essential to embrace the three de’s in order to spur a recovery.  The finance industry makes different arguments when times are good.  It argues then that the banks are so profitable and losses so low that it is perverse to prevent the banks from engaging in their total wish list of activities while reducing or eliminating any restrictions the banks fine onerous.  The finance industry in the U.S. and the U.K claims that their nation must win the regulatory “race to the bottom” so that they can out-compete residents of the other financial center.  In good times or bad finance has only one position – a more passionate embrace of the three de’s is vital.

We are living with a public policy for financial regulation that closely resembles a ratchet.  With rare exceptions immediately following fraud epidemics that become scandals, regulatory policy only moves in one direction further loosening restrictions.  The more crises these failed anti-regulatory policies create, the looser the regulations become and the more severe the crises become.  We are destroying our economy and other nations, particularly in Europe, are following our lead with equally self-destructive results.

We have trashed a regulatory system that was the envy of the world.  It helped bring us prosperity, far greater economic stability, fewer and less severe recessions, and reduced income inequality.  It made freer enterprise possible because the regulatory cops on the beat helped limit the Gresham’s dynamic in which bad ethics drives good ethics out of the marketplace.  When frauds prosper honest businesses are among the victims.  The three de’s have brought us recurrent, intensifying financial crises, the end of any material gains by the middle class, losses for the working class, the expansion of poverty and extreme inequality, and the domination of our political system by crony capitalism.  Elite fraud and corruption are now common in America.

Related Articles

Analysis Blog articles about fraud

About the Author


William K. Black is the author of The Best Way to Rob a Bank Is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.

Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Networkauthor page and at the blog New Economic Perspectives.

Follow him at: @WilliamKBlack

Share this Econintersect Article:
  • Print
  • Digg
  • Facebook
  • Yahoo! Buzz
  • Twitter
  • Google Bookmarks
  • LinkedIn
  • Wikio
  • email
  • RSS
This entry was posted in Government and tagged , , , , . Bookmark the permalink.

Make a Comment

Econintersect wants your comments, data and opinion on the articles posted.  As the internet is a "war zone" of trolls, hackers and spammers - Econintersect must balance its defences against ease of commenting.  We have joined with Livefyre to manage our comment streams.

To comment, just click the "Sign In" button at the top-left corner of the comment box below. You can create a commenting account using your favorite social network such as Twitter, Facebook, Google+, LinkedIn or Open ID - or open a Livefyre account using your email address.