The Great American Stick-Up: How Reagan Republicans and Clinton Democrats Enriched Wall Street While Mugging Main Street
Editor's note: Excerpted from the book The Great American Stick-Up: How Reagan Republicans and Clinton Democrats Enriched Wall Street While Mugging Main Street, by Robert Scheer, by arrangement with Nation Books, a member of the Perseus Books Group. Copyright © 2010.
Ronald Reagan called her his favorite economist, and Wendy Lee Gramm seemed to deserve the praise. Both while she was an academic economist and after Reagan appointed her to various regulatory positions in his administration, she excelled in articulating antiregulatory rhetoric that marked her as a true believer in what would later be labeled the “Reagan Revolution.”
Reagan himself had risen in politics after six years of tutelage as a spokesman for the General Electric Company, from 1954 to 1962. It was a time of conversion, as he described it, from being a “hemophiliac liberal” Hollywood actor to a cold-blooded Big Business conservative. Carrying the company’s banner, Reagan came to absorb the message that government regulation developed during the New Deal had become a chokehold on economic growth. Although as governor of California and later in the White House Reagan would preside over massive government budgets and even expand them, he found in Gramm an ideological “small government” soul mate. The Mercatus Center, an antiregulation think tank based at George Mason University from which Gramm has proselytized mightily, proudly boasts in her website biography that the Wall Street Journal “called her ‘The Margaret Thatcher of financial regulation.’”
However, unlike the former British prime minister, neither Gramm nor President Reagan was able to bring about much change in the balance between government and the private sector. While his administration did funnel hundreds of billions of dollars in new Cold War military spending to corporate contractors -- hugely expanding the national debt in the process -- Reagan was not able to deliver to Wall Street a parallel windfall.
For Wall Street, the holy grail was not cash handouts but a deconstruction of the complex public-private partnership ushered in by Franklin Roosevelt’s New Deal to restrain capitalism’s most self-destructive patterns. For these so-called FIRE firms -- Finance, Insurance, and Real Estate -- this half-century-old regulatory system, modest as it was, was an irritant that limited their ability to gamble and leverage their dominant positions.
While the companies just wanted to be free of restraint to profit at will, Reagan and Gramm were true believers, arguing that the regulatory status quo was outmoded and onerous -- even socialist -- hobbling business growth. The top target in their sights was the New Deal-enacted Glass-Steagall Act of 1933, signed into law by President Roosevelt, which regulated the financial services industry. Key to its effectiveness was the seemingly simple wall it erected between the commercial banks entrusted with depositors’ funds -- and insured by the government’s Federal Deposit Insurance Corporation (FDIC), the agency created by Glass-Steagall -- and the wilder antics of basically unregulated Wall Street investment banks like Goldman Sachs.
In 1982, Reagan signed the Garn-St. Germain Depository Institutional Act, easing regulation of savings and loans and, in the eyes of critics such as Paul Krugman, paving the way for the S&L collapse in the 1980s as well as the subprime housing crisis decades later. Nevertheless, Reagan made clear even then that this was not the biggest target on his list:
Unfortunately, this legislation does not deal with the important question of delivery of other services, including securities activities by banks and other depository institutions. But I’m advised that many in the Congress want to put this question at the top of the banking deregulatory agendas next year, and I would strongly endorse such an initiative and hope that at the same time, the Congress will consider other proposals for more comprehensive deregulation which the administration advanced during the 97th Congress.
Reagan’s timeline, however, was overly optimistic; economic problems, particularly the savings and loan meltdown and the spiraling national debt, made politicians of both parties cautious. Yet, in one of the grand twists of American politics, the proposals he sought would eventually be signed into law more than a decade later by a Democratic president with a reputation of being a liberal child of the 1960s. In fact, at the end of Reagan’s presidency, Congress passed legislation that toughened rather than weakened financial industry regulation. As Time magazine reported on August 17, 1987:
Ronald Reagan’s dream of carrying out a sweeping deregulation of the US economy has stirred a powerful backlash on Capitol Hill. Never has that been more apparent than last week, when Congress passed its first comprehensive piece of banking legislation since 1982. The White House had hoped the bill would remove many of the governmental shackles that inhibit competition between banks, securities firms and other institutions in the burgeoning field of financial services. In fact, it does just the opposite.
Reagan signed the bill, the Competitive Equality Banking Act of 1987, only after criticizing it for not only failing to tear down the Glass-Steagall walls but, worse, temporarily extending “the 1933 Glass-Steagall Act restrictions on securities activities to state-chartered, non-member banks for the first time.” He made it clear he was signing the bill despite his quite vociferous objections because it contained provisions for funding for local banks in trouble. It was at once a statement of the enormous importance he attached to decimating Glass-Steagall and an admission that he would come to the end of his last term without accomplishing that goal.
So legislatively his administration was a bust when it came to reversing the New Deal. Yet rhetorically it was an enormous success in propagandizing a view that so-called big government was the cause of America’s late-twentieth-century crisis of economic confidence. He managed to popularize and make palatable the heretofore fringe belief that government regulation of the financial sector, rather than saving capitalism from itself, was an irrational hindrance to individual profit and even a threat to our national power. Speaking at the signing of the 1987 bill, Reagan noted, “These new anti-consumer and anti-competitive provisions could hold back a vital service industry at a time when competition in the international capital markets increasingly challenges United States financial institutions, and they should be repealed.”
With great political irony, this speech would be repeated almost word for word a dozen years later, when Democrat Bill Clinton reversed a half century of his party’s core economic principles to argue for the repeal of Glass-Steagall. Clinton’s public rationale for this watershed shift was that if regulation of Wall Street were not “modernized” -- political code for weakened or eliminated -- the United States would lose out to foreign competition in capital markets.
Much of the groundwork for Clinton’s break was laid by the diligent Republican Wendy Lee Gramm and her husband, Senator Phil Gramm, also a Texas Republican. The high priestess and priest of financial deregulation met at a conference in New York, where Wendy Lee, a PhD student in economics, was interviewing with Phil Gramm for a position at Texas A&M University, where he was a senior professor. Wendy Gramm would later tell interviewers that as Professor Gramm was helping her on with her coat at the interview’s conclusion, he expressed interest in dating her if she came to Texas. She told the New York Times her response to him was “Oh, yuck,” but Gramm persisted, and six weeks after she arrived on campus, they wed.
His bold self-confidence might have helped carry the duo as apostles of an unabashedly Big Business creed then increasingly gaining currency in academic economic circles and within both political parties. Back in 1976, in fact, Jimmy Carter, now known mostly for his postpresidency activism on behalf of Third World democracy, Middle East peace, and ending poverty in America, was a strong advocate of business deregulation. As Georgia’s governor, Carter had been a fiscal conservative who, in the tradition of conservative Southern Democrats, shunned Northern liberalism.
Phil Gramm, too, came out of that tradition. After obtaining his doctorate in economics from the University of Georgia in 1967, the year after Carter lost his first bid to be that state’s governor, Gramm moved on to Texas A&M and taught economics for twelve years before jumping into politics. Gramm was elected to Congress as a Democrat in 1978; just three years later, he would become the epitome of a “Reagan Democrat” by cosponsoring the Gramm-Latta budget that implemented Reagan’s economic program. Proudly, at his retirement from the Senate, Gramm cooed, “in 1981, I wrote the first Reagan budget.” Gramm then abruptly resigned from the U.S. House of Representatives on February 12, 1983, forcing a special election for his seat, and the next month was elected to that seat as a Republican. After serving a third term, he completed his meteoric rise by being elected to the Senate in 1984. Until he retired, he would prove to be arguably the most influential Republican on financial issues.
As chair of the Senate’s Banking, Housing, and Urban Affairs Committee from 1995 to 2000, he was in a position, with Clinton’s support, to finally make Reagan’s commitment to radical deregulation of the financial markets a reality. This was accomplished with two signature pieces of legislation that he -- surely more than anyone else -- was responsible for putting into the law books: the Financial Services Modernization Act of 1999 and the Commodity Futures Modernization Act of 2000.
Certainly there were many other legislators and bureaucrats pushing for what was euphemistically called “banking reform.” By now the FIRE industries were pumping hundreds of millions of dollars into each major election cycle to lobby both parties to support the reversal of Glass-Steagall’s regulatory provisions and similar regulations, and so they had plenty of eager helpers. With union membership on the decline in America, Democrats decided they no longer could let Wall Street money flow in such unequal measure to Republicans; under Clinton’s lead, the floodgates of campaign payola were now fully bipartisan.
Senator Gramm’s committee status and long-term persistence on the matter, however, gave him alpha status: The legislation that finally would reverse the venerable Glass- Steagall laws would carry his name first: the Gramm-Leach-Bliley Act, which would be signed into law as the Financial Services Modernization Act of 1999. However, some years before Glass-Steagall was dismantled, Phil’s wife played a key role, as a member of both the Reagan and the Bush I administrations, in shaping the rapid changes in the financial markets brought about by internationalization, computer-driven trading, and the introduction of a whole new discipline of “risk management,” whereby Wall Street wizards deployed complex mathematical models to create a vast array of new financial products, such as the now infamous credit default swaps and collateralized debt obligations.
As was seen throughout the Reagan and later the Bush I and Bush II administrations, the Republicans had realized they could impose de facto deregulation of Big Business by appointing to influential federal commissions and agencies “watchdogs” who were sympathetic to the corporations they were supposed to be monitoring. Of course, this end run around congressional authority was probably not as satisfying or foolproof as wiping out the regulation altogether, yet it proved quite effective in pleasing CEOs, who had spent the 1970s complaining about red tape and overzealous government investigators.
Thus it was that professional deregulation activist Wendy Gramm came to be appointed by Reagan as chair of the Commodity Futures Trading Commission in 1988, which was the governmental arm most likely to regulate those newfangled investment devices that seemed so much like futures. Gramm, who would never think of questioning any of these clever “modern” gimmicks, saw them as an unmitigated blessing.
Rather than destabilizing the world economy, as they would prove to do two decades later, these products were supposed to be a win-win that would increase market efficiency by bringing order to pricing and the management of risk. Greater productivity, lower prices, and enormous new sources of wealth would inevitably follow. Of course, the top echelon of Wall Street insiders would skim the cream off, but, the argument went, the rest of the country would benefit as well. Not only would the economy be stronger, but American individuals, pension plans, and charities could all ride this dragon skyward, through investments and through donations from the mega-rich looking for tax shelters. It is no accident, then, that in each of the recent economic collapses, from Enron to Bernie Madoff, arose the ever-present laments from charities that were suddenly defunded.
The derivatives and swaps involved buying and packaging financial risk and selling it based on a system of corresponding grades. So a bank might buy up a collection of mortgages or credit card debts from lenders, who could then take this capital to bankroll even more loans. The buyers of this securitized debt would sort and slice it into levels of predicted risk; the more risk, the higher the return, of course. A buyer in this still small but expanding market could then “insure” this risk -- for a price.
The end result by the turn of the century was a massive casino in which bettors poured money into huge gambles on expected gain or to hedge against a loss if conditions changed. Think Las Vegas -- only this market was unregulated instead of being supervised by government agencies, the same way we regulate bets made on gambling tables or the future price of products such as wheat, pork bellies, or oil on regulated commodity exchanges. Such regulations increase transparency and accuracy in the description of the commodity, the terms of trade in their future, and the accountability of the parties involved.