[R-G] [BillTottenWeblog] Foreclosure Phil

[Bill Totten]

Years before Phil Gramm was a McCain campaign adviser and a lobbyist for
a Swiss bank at the center of the housing credit crisis, he pulled a sly
maneuver in the Senate that helped create today's subprime meltdown".

by David Corn

MotherJones.com (May 28 2008)


Who's to blame for the biggest financial catastrophe of our time? There
are plenty of culprits, but one candidate for lead perp is former
Senator Phil Gramm. Eight years ago, as part of a decades-long
anti-regulatory crusade, Gramm pulled a sly legislative maneuver that
greased the way to the multibillion-dollar subprime meltdown. Yet has
Gramm been banished from the corridors of power? Reviled as the villain
who bankrupted Middle America? Hardly. Now a well-paid executive at a
Swiss bank, Gramm cochairs Senator John McCain's presidential campaign
and advises the Republican candidate on economic matters. He's been
mentioned as a possible Treasury secretary should McCain win. That's
right: A guy who helped screw up the global financial system could end
up in charge of US economic policy. Talk about a market failure.

Gramm's long been a handmaiden to Big Finance. In the 1990s, as chairman
of the Senate banking committee, he routinely turned down Securities and
Exchange Commission chairman Arthur Levitt's requests for more money to
police Wall Street; during this period, the sec's workload shot up
eighty percent, but its staff grew only twenty percent. Gramm also
opposed an sec rule that would have prohibited accounting firms from
getting too close to the companies they audited - at one point,
according to Levitt's memoir, he warned the sec chairman that if the
commission adopted the rule, its funding would be cut. And in 1999,
Gramm pushed through a historic banking deregulation bill that decimated
Depression-era firewalls between commercial banks, investment banks,
insurance companies, and securities firms - setting off a wave of merger
mania.

But Gramm's most cunning coup on behalf of his friends in the financial
services industry - friends who gave him millions over his 24-year
congressional career - came on December 15 2000. It was an especially
tense time in Washington. Only two days earlier, the Supreme Court had
issued its decision on Bush vs Gore. President Bill Clinton and the
Republican-controlled Congress were locked in a budget showdown. It was
the perfect moment for a wily senator to game the system. As Congress
and the White House were hurriedly hammering out a $384-billion omnibus
spending bill, Gramm slipped in a 262-page measure called the Commodity
Futures Modernization Act. Written with the help of financial industry
lobbyists and cosponsored by Senator Richard Lugar (Republican of
Indiana), the chairman of the agriculture committee, the measure had
been considered dead - even by Gramm. Few lawmakers had either the
opportunity or inclination to read the version of the bill Gramm
inserted. "Nobody in either chamber had any knowledge of what was going
on or what was in it", says a congressional aide familiar with the
bill's history.

It's not exactly like Gramm hid his handiwork - far from it. The balding
and bespectacled Texan strode onto the Senate floor to hail the act's
inclusion into the must-pass budget package. But only an expert, or a
lobbyist, could have followed what Gramm was saying. The act, he
declared, would ensure that neither the sec nor the Commodity Futures
Trading Commission (cftc) got into the business of regulating newfangled
financial products called swaps - and would thus "protect financial
institutions from overregulation" and "position our financial services
industries to be world leaders into the new century".

It didn't quite work out that way. For starters, the legislation
contained a provision - lobbied for by Enron, a generous contributor to
Gramm - that exempted energy trading from regulatory oversight, allowing
Enron to run rampant, wreck the California electricity market, and cost
consumers billions before it collapsed. (For Gramm, Enron was a family
affair. Eight years earlier, his wife, Wendy Gramm, as cftc chairwoman,
had pushed through a rule excluding Enron's energy futures contracts
from government oversight. Wendy later joined the Houston-based
company's board, and in the following years her Enron salary and stock
income brought between $915,000 and $1.8 million into the Gramm household.)

But the Enron loophole was small potatoes compared to the devastation
that unregulated swaps would unleash. Credit default swaps are
essentially insurance policies covering the losses on securities in the
event of a default. Financial institutions buy them to protect
themselves if an investment they hold goes south. It's like bookies
trading bets, with banks and hedge funds gambling on whether an
investment (say, a pile of subprime mortgages bundled into a security)
will succeed or fail. Because of the swap-related provisions of Gramm's
bill - which were supported by Fed chairman Alan Greenspan and Treasury
secretary Larry Summers - a $62 trillion market (nearly four times the
size of the entire US stock market) remained utterly unregulated,
meaning no one made sure the banks and hedge funds had the assets to
cover the losses they guaranteed.

In essence, Wall Street's biggest players (which, thanks to Gramm's
earlier banking deregulation efforts, now incorporated everything from
your checking account to your pension fund) ran a secret casino. "Tens
of trillions of dollars of transactions were done in the dark", says
University of San Diego law professor Frank Partnoy, an expert on
financial markets and derivatives. "No one had a picture of where the
risks were flowing". Betting on the risk of any given transaction became
more important - and more lucrative - than the transactions themselves,
Partnoy notes: "So there was more betting on the riskiest subprime
mortgages than there were actual mortgages". Banks and hedge funds,
notes Michael Greenberger, who directed the cftc's division of trading
and markets in the late 1990s, "were betting the subprimes would pay off
and they would not need the capital to support their bets".

These unregulated swaps have been at "the heart of the subprime
meltdown", says Greenberger. "I happen to think Gramm did not know what
he was doing. I don't think a member in Congress had read the 262-page
bill or had thought of the cataclysm it would cause". In 1998,
Greenberger's division at the cftc proposed applying regulations to the
burgeoning derivatives market. But, he says, "all hell broke loose. The
lobbyists for major commercial banks and investment banks and hedge
funds went wild. They all wanted to be trading without the government
looking over their shoulder."

Now, belatedly, the feds are swooping in - but not to regulate the
industry, only to bail it out, as they did in engineering the March
takeover of investment banking giant Bear Stearns by JPMorgan Chase,
fearing the firm's collapse could trigger a dominoes-like crash of the
entire credit derivatives market.

No one in Washington apologizes for anything, so it's no surprise that
Gramm has failed to issue any mea culpa. Post-Enron, says Greenberger,
the senator even called him to say, "You're going around saying this was
my fault - and it's not my fault. I didn't intend this."

Whether or not Gramm had bothered to ponder the potential downsides of
his commodities legislation, having helped set off an industry
free-for-all, he reaped the rewards. In 2003, he left the Senate to take
a highly lucrative job at ubs, Switzerland's largest bank, which had
been able to acquire investment house PaineWebber due to his banking
deregulation bill. He would soon be lobbying Congress, the Fed, and the
Treasury Department for ubs on banking and mortgage matters. There was a
moment of poetic justice when ubs became one of the subprime crisis' top
losers, writing down $37 billion as of this spring - an amount equal to
its previous four years of profits combined. In a report explaining how
it had managed to mess up so grandly, ubs noted that two-thirds of its
losses were the fault of collateralized debt obligations - securities
backed largely by subprime instruments - and that credit default swaps
had been "key to the growth" of its out-of-control cdo business. (Gramm
declined to comment for this article.)

Gramm's record as a reckless deregulator has not affected his rating as
a Republican economic expert. Senator John McCain has relied on him for
policy advice, especially, according to the campaign, on housing
matters. The two have been buddies ever since they served together in
the House in the 1980s; in 1996, McCain chaired Gramm's flop of a
presidential campaign. (Gramm spent $21 million and earned only ten
delegates during the gop primaries.) In 2005, McCain told a Wall Street
Journal columnist that Gramm was his economic guru. Two years later,
Gramm wrote a piece for the Journal extolling McCain as a modern-day
Abraham Lincoln, and he's hailed McCain's love of tax cuts and free
trade. Media accounts have identified Gramm as a contender for the top
slot at the Treasury Department if McCain reaches the White House. "If
McCain gets in", frets Lynn Turner, a former chief sec accountant,
"we'll have more of the same deregulatory mess. I like John McCain, but
given what I know about Phil Gramm, I wouldn't vote for McCain."

As a thriving bank exec and presidential adviser, Gramm has defied a
prime economic principle: Bad products are driven out of the market. In
John McCain, he has gained an important customer, so his stock has gone
up in value. And there's no telling when the Gramm bubble will burst.

_____

David Corn is Mother Jones' Washington, DC bureau chief.

_____________________

Subprime 1-2-3
_____________________

Don't understand credit default swaps? Don't worry - neither does
Congress. Herewith, a step-by-step outline of the subprime risk betting
game.  - Casey Miner

Subprime borrower: Has a few overdue credit card bills; goes to a
storefront lender owned by major bank; takes out a $100,000 home-equity
loan at eleven percent interest

Lending bank: Assuming housing prices will only go up, and that
investors will want to buy mortgage loan packages, makes as many
subprime loans as it can

Investment bank: Packages subprime mortgages into bundles called
collateralized debt obligations, or cdos, then sells those cdos to eager
investors. Goes to insurer to get protection for those investors, thus
passing the default risk to the insurer through a "credit default swap".

Insurer: Thinking that default risk is low, agrees to cover more money
than it can pay out, in exchange for a premium

Rating agency: On basis of original quality of loans and insurance
policy they are "wrapped" in, issues a rating signaling certain slices
of the cdo are low risk (aaa), medium risk (bbb), or high risk (ccc)

Investor: Borrows more money from investment bank to load up on cdo
slices; makes money from interest payments made to the "pool" of loans.
No one loses - as long as no one tries to cash in on the insurance.

_____

This article has been made possible by the Foundation for National
Progress, the Investigative Fund of Mother Jones, and gifts from
generous readers like you.

(c) 2008 The Foundation for National Progress

http://www.motherjones.com/news/feature/2008/07/foreclosure-phil.html


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