Critiquing Phil Gramm’s explanation of the financial crisis

  • Share
  • Read Later

My previously referenced piece on Phil Gramm is here. I wrote it very quickly at the Caribou Coffee just down the street from the American Enterprise Institute, where Gramm spoke. (I shared a table and a power outlet with a young woman who was lining up guests for What’s Going on Around, a  show on WILX-TV in Lansing, Mich., in which area doctors and come on air to talk about what’s, you know, going around. It sounds totally brilliant. I mean, wouldn’t you want to know what’s going around?)

Anyway, I thought Gramm was going to be defensive and pretty predictable. Instead, he seemed to be genuinely interested in figuring out what went wrong—which, along with the way he sort of looks like a turtle, made him a far more endearing figure than I expected. That doesn’t mean he’s right about everything, though.

1)  Gramm says Glass-Steagall repeal couldn’t have been the problem, because continental Europe has never had a Glass-Steagall-like separation of banks and investment firms, and yet they didn’t have a mortgage mess (although of course some of their banks have gotten caught up in our mortgage mess). I’m sympathetic to this argument. In fact, I’ve made it myself. But there are a couple of obvious limitations to it. One is that sudden repeal of a long-standing restriction can unleash effects that never having had the restriction would not—people who had gotten used to working within certain bounds might react in strange ways to having those bounds removed. The other is that the securities side of Europe’s universal banks has traditionally been clearly subordinate to the banking side. That was not the case at all at Citigroup—and Gramm’s employer UBS seems to have had some problems with out-of-control investment bankers as well.

2) The Commodity Futures Modernization Act was only about keeping the Commodity Futures Trading Commission’s hands off swaps, not about preventing any regulation whatsoever. “Nothing in the bill limited the ability to regulate swaps. It  just said they couldn’t be regulated as futures. They could be regulated as securities or bank products.” I’d never heard it put that way. But the SEC and bank regulators didn’t choose to regulate credit default swaps. Just-departed SEC chairman Chris Cox said in the fall that the law didn’t give him the authority to do so. Gramm said he thought Cox was wrong about that. I dunno. Cox is the lawyer. He oughtta know.

3) The opacity of the credit default swaps market has been a problem, but the instruments themselves are good things. Gramm: “They have proven to be a better predictor of underlying creditworthiness than the rating agencies. They have never lost liquidity. I’m not saying they’re perfect, but it impossible in my opinion to make the case that they caused this problem.” I think he may right about that. Although I don’t know about the word “impossible.”

4) Glass-Steagall repeal and the Commodity Futures Modernization Act weren’t backdoor deals that Gramm snuck through Congress, but subjects that had gotten a fair hearing. This was in response to some pretty hostile questions from David Corn about the CFMA. I know from personal experience as an American Banker reporter that Gramm’s telling the truth about Glass-Steagall—although of course the many Congressional hearings on the subject over the course of the 1990s were mostly attended by bank lobbyists and reporters for trade publications. And in the case of the CFMA, while the way the bill was passed in a special session near the end of 2000 was not a textbook case of open government at work, it was again a topic that had been discussed pretty exhaustively ever since the CFTC’s Brooksley Born had tried to get herself into the business of swaps regulation after the collapse of Long-Term Capital Management in 1998. But it was of course mostly a discussion among directly interested parties.

5) The Fed blew it in 2001-2002. Not because Greenspan’s an idiot, but because it was a different sort of recession than all the other post World War II recessions (a bubble deflation as opposed to an inventory cycle) and so the standard Fed response of cutting interest rates wasn’t the right move because much of the economy wasn’t in a recession. “We inadvertently stimulated an industry that was already in boom conditions,” Gramm said. “This changed everything. It changed consumption behavior, it changed lending behavior.” There’s something to this, but I think the distinction between types of recessions is a little glib. We’re now in the middle of another collapsed-bubble recession, and cutting interest rates doesn’t seem to have been the wrong thing to do. It just hasn’t been nearly enough.

6) The decades-long push from Washington to increase home ownership metastasized into a de facto government mandate to make bad loans. Gramm told this story really well. He mentioned the Community Reinvestment Act as an element of this push, but immediately dismissed the argument—made by lots of Republicans during the election campaign—that it was decisive. “Don’t get subprime lending confused with lending to poor people,” he said at one point. “There’s not any evidence to substantiate that subprime lending was worse among poor people than not among poor people.” He was somewhat more accepting of the argument that Fannie Mae and Freddie Mac were big-time culprits, making the prediction that “by the time we have worked through this period the biggest cost of this bailout will be Freddie and Fannie.” But again, he depicted  them as just an element of what wrong, and said lending quotas imposed on them by Congress starting in 1992 were behind most of their problems. The biggest issue, he seemed to be saying, was that by the early 2000s regulators and Congress and the White House had all basically embraced the idea—whether they meant to or not—that there was no such thing as a bad mortgage loan. And he didn’t exempt himself from culpability for that.

6) UBS’s troubles aren’t his fault. “I don’t run UBS. I’m an investment banker. I have extended no credit. The deals I’ve been involved with we’ve gotten paid for.” Maybe so, but he’s still an overpaid Wall Streeter. Plus, he’s a lobbyist as well as an investment banker. So basically, no, UBS’s troubles aren’t his fault. But his choice of post-Senate career and employer have diminished his credibility.

7) Some financial markets need regulation. Gramm went through a whole laundry list on mortgages. His free-market-guy side led him to carve out an exception for loans that banks hold onto their books, but he now thinks all securitized loans and all federally guaranteed loans need to meet some basic standards: 5% (he’d prefer higher) down payments, an end to 100% up-front compensation of mortgage brokers (he wants their compensation on a loan spread out over five years), limits on home equity loans that wouldn’t allow them to reduce equity to below 10% of the home value, etc. He never got into a philosophical discussion of why mortgage markets couldn’t come up with these standards on their own. There was clearly the implication that deep government involvement had screwed up the mortgage business, but a couple years ago Gramm (and Alan Greenspan) seemed to think that the magic of modern financial markets would compensate for all that government meddling. Now they don’t.