Cruz seeks eco­nomic wis­dom in the wrong place

The Pak Banker - - OPINION - Barry Ritholtz

SOME peo­ple look at sub­prime lend­ing and see evil. I look at sub­prime lend­ing and I see the Amer­i­can dream in ac­tion.-- for­mer U.S. Sen­a­tor Phil Gramm, Nov. 16, 2008. The rea­son I bring up the for­mer sen­a­tor from Texas is that Gramm has been brought on as a se­nior eco­nomic ad­viser to Repub­li­can pres­i­den­tial can­di­date Ted Cruz. This isn't a promis­ing devel­op­ment for Cruz, or the prospect that should he be­come pres­i­dent he will come up with sen­si­ble poli­cies to ad­dress the U.S.'s eco­nomic chal­lenges. Why do I say that? Be­cause of what hap­pened in the 1990s and early 2000s when the U.S. lis­tened to Gramm.

But first, a more re­cent trip down mem­ory lane. Gramm, re­mem­ber, was brought on as an ad­viser to the pres­i­den­tial cam­paign of John McCain in 2008. As the econ­omy was stum­bling that sum­mer, Gramm said:

You've heard of men­tal de­pres­sion; this is a men­tal re­ces­sion. We may have a re­ces­sion; we haven't had one yet. We have sort of be­come a na­tion of whin­ers. You just hear this con­stant whin­ing, com­plain­ing about a loss of com­pet­i­tive­ness, Amer­ica in de­cline.

At that point, the fi­nan­cial cri­sis was gath­er­ing head­way: fore­clo­sures had dou­bled in the span of a year, 1.6 mil­lion more peo­ple were un­em­ployed than a year ear­lier, the stock mar­ket had plunged 25 per­cent and the na­tion was al­ready eight months into the wors tre­ces­sion since the Great De­pres­sion. McCain, in a vain ef­fort to res­cue his cam­paign, had to im­me­di­ately dis­avow the re­marks. Gramm, mean­while, re­fused to re­tract his com­ments. He was gone from the McCain cam­paign a few days later. Not to put too fine a point on it, but I be­lieve -- as do many oth­ers -- that Gramm was one of the ma­jor fig­ures who helped set the stage for the cri­sis. My book "Bailout Na­tion" in­cluded a list of "Who is to Blame for the Cri­sis" that put Gramm at No. 3 af­ter for­mer Fed­eral Re­serve Chair­man Alan Greenspan and the Fed it­self. I'm not alone:Time mag­a­zine placed him at No. 2, while CNN ranked him No. 7.

Just to be clear, Gramm was but one player in the de­ba­cle and blame for the fi­nan­cial cri­sis is spread far and wide, ex­tend­ing to ma­jor fig­ures in both po­lit­i­cal par­ties.

But Gramm is the topic today, so let's start with a list of par­tic­u­lars.

Gramm was a key spon­sor of the Fi­nan­cial Ser­vices Mod­ern­iza­tion Act of 1999, also known as Gramm-Leach-Bliley Act, which ef­fec­tively re­pealed the piece of the Glass-Stea­gall Act that had forced com­mer­cial banks to shed their in­vest­ment bank­ing op­er­a­tions dur­ing the Great De­pres­sion. The end of this sep­a­ra­tion didn't so much lead to the fi­nan­cial cri­sis as re­move a key fire­break, al­low­ing the con­fla­gra­tion to rapidly spread through­out the bank­ing sys­tem. Re­call ear­lier events be­fore the re­peal: the shock caused by the 1987 stock-mar­ket crash was con­fined to Wall Street, while the sav­ings and loan cri­sis of the late 1980s did lit­tle harm to the broader econ­omy.

The dam­age caused by rolling back GlassStea­gall pales com­pared with what re­sulted from the Com­mod­ity Futures Mod­ern­iza­tion Act of 2000. Gramm was a co-spon­sor of the leg­is­la­tion, which ex­empted many de­riv­a­tives and swaps from reg­u­la­tion. Not only was the law prob­lem­atic, but it veered into po­ten­tial con­flict-of-in­ter­est ter­ri­tory.

At the time the leg­is­la­tion was un­der con­sid­er­a­tion, Gramm's wife, Wendy, was on the board of En­ron, which as we now know was one of the great­est ac­count­ing fi­as­cos in his­tory. Wendy Gramm served on the au­dit com­mit­tee, over­see­ing the fi­nances of the en­er­gy­trad­ing giant. En­ron, of course, in late 2001 filed the big­gest cor­po­rate bank­ruptcy in U.S. his­tory up un­til then. Be­fore join­ing En­ron, she had served as chair­man of the Com­mod­ity Futures Trad­ing Com­mis­sion, from 1988 to 1993, where her ten­ure was the sub­ject of some con­tro­versy.

En­ron, a once-sleepy util­ity, was an early adopter of de­riv­a­tives and swaps. Brook­sley Born, chair­man of the CFTC in the late 1990s, had rec­og­nized early on the po­ten­tial danger these things posed. She rightly pressed for her agency to have reg­u­la­tory over­sight of de­riv­a­tives. It wasn't to be so be­cause of Gramm's leg­is­la­tion. But there was more. At Wendy Gramm's urg­ing, then-Sen­a­tor Gramm in­serted what be­came known as the En­ron loop­hole into the Com­mod­ity Futures Mod­ern­iza­tion Act. This al­lowed En­ron to avoid most reg­u­la­tion in its en­ergy-trad­ing busi­ness.

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