William K. Black answers the question, "Why is 'Wall Street' not in the Financial Crisis Inquirity Report?"

"Why are we suffering recurrent, intensifying crises? To answer this question we must find not only the causes of the crises, but also (and even more importantly) why we fail to learn the correct lessons ... and keep making even worse policy mistakes. The answer to the second part is dogma. The definition of dogma is that it cannot be examined or changed – except to become even purer."

Friday, January 28, 2011
How can the Architects of the Crisis Investigate it?

By William K. Black

The Financial Crisis Inquiry Commission (FCIC) issued its report today on the causes of the crisis. The Commissioners were chosen along partisan lines and the Republicans, one-upping the Republicans’ dual responses to President Obama’s State of the Union address, have issued three rebuttals. The rebuttals follow a failed preemptive effort by the Republicans to censor the report – they insisted on banning the use of the terms “shadow banking system” (the virtually unregulated financial sector that conducts most financial transactions), “Wall Street,” and “deregulation.” The Republicans then issued their first rebuttal last month, their “primer.” The primer, following the lead of the censorship effort, ignored the contributions that the shadow banking system, Wall Street, and deregulation made to the crisis. The combination of the demand that the report be censored and the primer’s crude apologia critical role that the unmentionable Wall Street, particularly its back alleys (the unmentionable “shadow banking system”), and the unmentionable deregulators played in causing the crisis was derided by neutrals. The failure of their preemptive primer has now led the Republican commissioners to release two additional rebuttals to the Commission report. Again, they issued their rebuttals before the Commission issued its report in an attempt to discredit it.

The primary Republican rebuttal was issued by Bill Thomas, a former congressman from California and the vice chairman of the commission; Keith Hennessey, who was President George W. Bush’s senior economic advisor, and Douglas Holtz-Eakin, who was an economic advisor to President Bush on the regulation of Fannie and Freddie and principal policy advisor to the Republican nominee for the President, Senator McCain.

Republican Commissioner Peter Wallison felt his Republican colleagues’ dissent was insufficient, so he drafted a separate, far longer dissent. Wallison is an attorney who was one of the leaders of the Reagan administration’s efforts to deregulate financial institutions and later became the leader of the American Enterprise Institute’s (AEI) deregulation initiatives. His bio emphasizes his passion for financial deregulation.

From June 1981 to January 1985, he was general counsel of the United States Treasury Department, where he had a significant role in the development of the Reagan administration’s proposals for deregulation in the financial services industry….

[He] is co-director of American Enterprise Institute's ("AEI") program on financial market deregulation.
Each of the Republicans commissioners was a proponent of financial deregulation and was appointed to the Commission by the Republican Congressional leadership to champion that view. Three of the Republican commissioners were architects of financial deregulation. For example, the Republican congressional leadership appointed Wallison to the commission because they knew that he was the originator and leading proponent of the claim that Fannie and Freddie were the Great Satans that had caused the current crisis. The fourth member, Representative Thomas, voted for the key deregulatory legislation when he was in Congress and was a strong proponent of deregulation.

The Republican commissioners’ desire to ban the use of the word “deregulation” in the Commission’s report is understandable. There was no chance that they would support a report that explained the decisive role that deregulation and desupervison played in making the crisis possible. Wallison was a major architect of three successful anti-regulatory pogroms (primarily, but not exclusively, led by Republicans) that created the criminogenic environments that led to our three most recent fraud epidemics and financial crises (the S&L debacle, the Enron era frauds, and the current crisis). The Republican congressional leadership appointed Wallison to the Commission in order to place the nation’s leading apologist for deregulation in a position where he could defend it. President Bush appointed Harvey Pitt to be SEC Chairman because he was the leading opponent in America of the SEC Chairman Levitt’s efforts to make the SEC a more effective regulator. In each case, “mission accomplished.”

Each of the Republican commissioners was in the impossible position of having to investigate and judge their own culpability for the crisis. The Republican politicians who selected them for appointment to the Commission knew that they were placing them in an impossible position and ensuring that the Commission would either give deregulation a pass or split along partisan lines and lose some of its credibility. The proverbial bottom line is that the Commission would fail to identify the real causes of the crisis and the control frauds that drove it would continue to be able to loot with impunity.

In contrast, only one of the six Democratic commissioners was involved in financial institution regulation or deregulation. None of the Democrats was known as a strong proponent of any particular view about the causes of the crisis prior to their appointment. Brooksley Born was head of the Commodities Futures Trading Commission (CFTC) under President Clinton. She famously warned of the systemic risks that credit default swaps (CDS) posed. Her efforts to protect the nation were squashed by the Commodities Futures Modernization Act of 2000, which deliberately created regulatory “black holes” by removing the CFTC’s authority to regulate many trades in financial derivatives. Enron exploited one of these black holes to create the California energy crisis of 2001. The largest banks and AIG exploited the black hole to trade CDS. While the squashing of Brooksley Born was a bipartisan effort (Senator Gramm and Alan Greenspan were the most prominent Republicans in the effort), it was led by the Clinton administration – Messrs. Rubin and Summers at their arrogant, anti-regulatory worst.

By appointing Born to the Commission, the Democrats were admitting their error and ensuring that one of the Democratic Party’s great embarrassments – passage of the Commodities Futures Modernization Act – would be exposed. The Democrats were fostering rather than seeking to forbid discussion of their dirty laundry by appointing someone with a proven track record of taking on her own party.

In 1999, Born resigned as CFTC Chair. She retired from her law firm in 2002. She did not influence or seek to influence regulatory policy role during the crisis. She was not active in making comments about the causes of this crisis prior to her appointment to the Commission.

The next, nastier stage in the Republican apologia for Wall Street and the anti-regulators has already begun. Bloomberg reports that House Oversight Committee Chairman Issa claims to be:

“looking into allegations of partisanship, mismanagement and conflict of interest at the commission. The California Republican and two other lawmakers sent a letter yesterday renewing a demand for documents on the panel’s spending, its use of media consultants and its staff turnover.”
Issa is a deeply committed anti-regulator. He will not be investigating the allegations of partisanship and conflicts of interest by the Republican commissioners who have exemplified partisanship and who are in the impossible position of having to examine their own culpability for the crisis. He will seek to discredit any report and any expert who explains why financial deregulation and desupervision are criminogenic.

The most important question we must answer about our financial crises is actually a two-part question: why are we suffering recurrent, intensifying crises? To answer it we must find not only the causes of the crises, but also (and even more importantly) why we fail to learn the correct lessons from the crises and keep making even worse policy mistakes. The answer to the second question is dogma. The definition of dogma is that it cannot be examined or changed – except to become even purer. The ever purer anti-regulatory dogma creates the ever more intensely criminogenic environments that produce intensifying crises. The Commission’s report makes that clear. For example, Alan Greenspan claimed that markets automatically exclude fraud. He did so after the most notorious “accounting control fraud” of the S&L debacle (Charles Keating) used him to praise his fraudulent S&L, leading to the most expensive failure in the entire debacle. Greenspan learned nothing useful from the S&L debacle. He concluded that there was no reason for the Fed to use its unique authority under HOEPA to stop the pervasively fraudulent “liar’s” loans that were hyper-inflating the real estate bubble and leading us to a crisis. Greenspan ignored the FBI’s September 2004 warning that mortgage fraud was becoming “epidemic” and would cause an “economic crisis.” This anti-regulatory dogma that Greenspan exemplified spread through much of the Western world, and the resultant crises have done the same.

We are witnessing in the multiple Republican apologias for their anti-regulatory policies an example of why we fail to learn the correct lessons from the crises. The groups most in the thrall of the dogma appoint true believers in theoclassical economics to the body that is supposed to find the truth. These anti-regulatory architects of the crisis then purport to be impartial judges of the causes of the crisis that they helped create. The Republican House leadership now openly threatens to use aggressively its subpoena authority to bash anyone who dares to oppose the dogma and the Republican effort to censor the decisive role the anti-regulators play in causing our recurrent, intensifying crises.

The Commission is correct. Absent the crisis was avoidable. The scandal of the Republican commissioners’ apologia for their failed anti-regulatory policies was also avoidable. The Republican Congressional leadership should have ensured that it did not appoint individuals who would be in the impossible position of judging themselves. Even if the leadership failed to do so and proposed such appointments, the appointees to the Commission should have recognized the inherent conflict of interest and displayed the integrity to decline appointment. There were many Republicans available with expertise in, for example, investigating elite white-collar criminals regardless of party affiliation. That was the most relevant expertise needed on the Commission. Few commissioners had any investigative expertise and none appears to have had any experience in investigating elite white-collar crimes. These Republicans, former Assistant U.S. Attorneys (AUSAs) and FBI agents would have played no role in the financial regulation or deregulation policies in the lead up to the crisis. They would not have had to judge their own policies and they would have brought the most useful expertise and experience to the Commission – knowledge of financial fraud schemes and experience in leading complex investigative and analytical skills.