In the early evening of Friday, December 15, 2000, with Christmas break only hours away, the U.S. Senate rushed to pass an essential, 11,000-page government reauthorization bill. In what one legal textbook would later call "a stunning departure from normal legislative practice," the Senate tacked on a complex, 262-page amendment at the urging of Texas Sen. Phil Gramm.
There was little debate on the floor. According to the Congressional Record, Gramm promised that the amendment -- also known as the Commodity Futures Modernization Act -- along with other landmark legislation he had authored, would usher in a new era for the U.S. financial services industry.
"The work of this Congress will be seen as a watershed where we turned away from an outmoded Depression-era approach to financial regulation and adopted a framework that will position our financial services industry to be world leaders into the new century," Gramm said.
Watershed indeed. With the U.S. economy now battered by a tsunami of mortgage foreclosures, the $30-billion Bear Stearns Companies bailout and spiking food and energy prices, many congressional leaders and Wall Street analysts are questioning the wisdom of the radical deregulation launched by Gramm's legislative package. Financial wizard Warren Buffett has labeled the risky new investment instruments Gramm unleashed "financial weapons of mass destruction." They have fed the subprime mortgage crisis like an accelerant. While his distracted peers probably finalized their Christmas gift lists, Gramm created what Wall Street analysts now refer to as the "shadow banking system," an industry that operates outside any government oversight, but, as witnessed by the Bear Stearns debacle, requiring rescue by taxpayers to avert a national economic catastrophe.
While the nation's investment bankers are paying a heavy price for their unbridled greed (in billions of dollars of write-offs), Gramm has fared quite nicely. He currently serves as a vice president at UBS AG, a colossal, Swiss-owned investment bank, the post, no doubt, a thank you for assiduously looking out for Wall Street interests during his 23 years in public office. Now, with the aid of his longtime friend Arizona Sen. John McCain, Gramm may be looking at a quantum leap in power and influence.
Gramm serves as co-chair of the McCain 2008 presidential campaign. As one of the candidate's chief economic advisers, he is mentioned as a possible secretary of the treasury in a McCain administration. Their friendship was forged in the Senate as they worked against the Clinton health care proposal, and cemented when McCain served as national chairman of Gramm's own (ill-fated) 1996 presidential bid.
During McCain's rocky road to the nomination, it was Gramm as much as anyone who helped smooth the way. Last July, when it looked as though McCain's campaign would go bankrupt, Gramm, who once called money "the mother's milk of politics," advised him to slash his costs and assisted him with fundraising. Throughout the marathon primary season, Gramm has made numerous appearances with McCain and served as an ambassador to conservative groups. This spring, when conservative commentators attacked McCain as too liberal, McCain shored up his conservative bona fides by (according to The Huffington Post) bringing Gramm to a meeting with the editorial board of The Wall Street Journal.
But ask Gramm about his influence with McCain and it's clear that the former senator has not lost his talent for political spin. "My position [with the campaign] is, I am the senator's friend," he aw-shuckses in a telephone interview. "It would be a mistake to call me an economic adviser." Calling himself "a private citizen," Gramm claims ignorance of McCain's appearance two days earlier on Jon Stewart's The Daily Show.
"I'm so out of it, I don't even know who Jon Stewart is," he says in his trademark Georgia drawl.
It's hard to imagine that anyone remotely connected to politics is unaware of Stewart, but the remark fits well with the homespun persona that Gramm has carefully crafted for public consumption. Despite his false modesty, Phil Gramm remains a powerful force in Republican politics. Here in Texas, his many protgs -- most notably Gov. Rick Perry, the beneficiary of a whopping $612,000 in campaign donations from Gramm's Senate campaign reserves -- give him significant reach in Lone Star public policy.
Gramm might be interested in downplaying his role with the McCain campaign because, while the alliance might help with conservatives, it's at odds with the maverick image McCain has worked so hard to project. Gramm is more closely aligned with the kind of influence-peddling represented by the Keating Five scandal, in which McCain intervened with federal regulators on behalf of a campaign contributor with a failing savings and loan. The scandal shredded McCain's reputation and convinced him of the efficacy of reform.
In Gramm, McCain has chosen for a campaign adviser a former senator who espouses free market, conservative principles, but whose actions in public office served wealthy contributors and even himself. Exhibit A: Gramm's cozy Enron Corp. connections. Not only did CEO Ken Lay chair Gramm's 1992 re-election campaign, but Gramm's wife, Wendy, earned $50,000 a year as an Enron director from 1993 to 2001 (not counting perks that included stock options). Meanwhile Gramm pushed the company's aggressive -- and ultimately self-defeating -- political agenda to escape government scrutiny.
That Gramm is now advising the Republican nominee for president on economic matters "shouldn't give people a lot of comfort," says University of Maryland law professor Michael Greenberger, a senior official at the Commodity Futures Trading Commission in the late 1990s. "Gramm has been a central player in two major economic crises -- the credit crisis and the incredibly high price of energy. Ã¢â‚¬Â¦ He's got his fingerprints all over legislative efforts that led to this."
Nonetheless, Gramm holds fast to his ideology. "I've never seen any evidence that opening up competition among banks and insurance companies in any way contributed to this," he says with the patience of the college prof he once was. "You've got a lot of people trying to rewrite history. You've got people with an ax to grind. They always wanted more government regulation, and when you have a problem, they want the government to regulate more."
His critics say that Gramm's anti-regulatory rhetoric failed the bulk of his constituents -- which included thousands of hapless Enron employees who lost their life savings -- but lavishly rewarded a few wealthy pals, like Ken Lay. University of Texas economist James Galbraith says Gramm is "not against government at all. His career has been finding ways to make money for his friends. It's a predator relationship. [Government] is his food supply."
When Gramm retired from the U.S. Senate in 2002, Texas Democrats celebrated that a powerful nemesis would no longer be a force on the national scene. Wrote Molly Ivins: "Gramm both looks like a snapping turtle and has the personality of one. When he ran for president in 1996 and finished fifth in Iowa, all the profiles written of him included the line 'Even his friends don't like him.'" She concluded: "We'll sure miss that sweet style." Clearly Molly's jubilation was premature.
It's easy to understand why Democrats were so eager to say goodbye to Gramm, who began his political career when he was elected to Congress in 1978 as a Democrat -- and then quickly broke ranks with his party.
Gramm often jokes that he "didn't go to Washington to be loved, and was not disappointed." In his telling, his lack of popularity stemmed from his uncompromising stand on issues. Democrats who served with him, however, felt deeply betrayed by his actions as co-author of Ronald Reagan's austere first budget.
Former House Speaker Jim Wright recalls in his memoir, Balance of Power, that he learned to his "chagrin and sorrow" that Reagan sought counsel from a fellow Democrat who "was the beneficiary of my help and recipient of my nave faith. His name was Phil Gramm."
In 1981, Gramm pleaded with fellow Texan Wright to help him win a seat on the powerful House Budget Committee, a privilege he had been denied by his Democratic peers, who found him unreliable. "Phil Gramm promised me ... that if he were favored by a Budget Committee assignment, he would make his arguments within the committee and then would close ranks and back whatever budget resolution the committee majority approved," the former speaker wrote. "That sounded fair enough." Later, Wright would be "flabbergasted" to learn that Gramm met clandestinely with Reagan budget guru David Stockman to strategize and defeat a Democratic budget plan. Reagan's "Gramm-Latta" budget would prevail.
Having led the charge for a Republican president's budget plan that, among many other things, drastically cut Social Security benefits, Gramm resigned in 1983 and forced an election for his House seat, which he won as a Republican. In a 1984 special election hastily called by then-Gov. Bill Clements, he waltzed to victory in the contest for longtime Republican John Tower's seat in the U.S. Senate.
When his new party won control of the Senate, Gramm rose to chairman of the Senate Banking Committee, where he was able to put his anti-regulation views into law. The Gramm-Leach-Bliley Act of 1999 repealed laws put in place after the Great Depression setting up protective barriers between commercial banks, investment banking firms, and insurance companies.
Consumer groups strenuously opposed the landmark legislation. "It was strongly deregulatory and ... did not address safety and soundness," says lobbyist Ed Mierzwinski of the public interest group U.S. PIRG.
But more powerful interests were pushing for the law, and they had a deadline. In 1998, Citicorp Inc. purchased Traveler's Insurance Group. Under the old law, the new company had a two-year grace period to divest either its insurance or banking functions. Instead, it went to Washington, D.C., and got the law changed -- with Gramm's help.
"Some people jokingly refer to it as the Citigroup Relief Act," says University of North Carolina law professor Lisa Broome. "Normally, they would have had to spin off their insurance activities."
Another beneficiary: Gramm's future employer, UBS, which was able to absorb the brokerage house Paine Webber. (As of March 31, UBS employees and company-related PACs have given the McCain campaign $82,865, according to the Center for Responsive Politics.)
Banks had been chipping away at the barriers through Federal Reserve rules for decades. But Gramm's sweeping deregulation "stripped away restraint," says Broome.
While Gramm denies any link between the current subprime mortgage crisis and his legislative efforts, Mierzwinski, Broome, and even some Wall Street analysts trace a direct connection.
Michael Panzner, a Wall Street veteran and author of Financial Armageddon, says the massive deregulation encouraged "aggressive, swashbuckling, high-risk practices that might have been frowned upon in the banking industry, but which were viewed as typical, say, on Wall Street." Eventually, those practices "became the modus operandi throughout the financial services industry."
Panzner also believes that Gramm-Leach-Bliley "may have even set the stage for both the collapse and the subsequent 'rescue' of Bear Stearns by the Federal Reserve." The deregulated financial services industries were "encouraged to push the envelope in terms of risk-taking, and were not entirely dissuaded from thinking that the public purse would be available if things went horribly wrong."
Still others blame Gramm's Commodity Futures Modernization Act. Prior to its passage, they say, banks underwrote mortgages and were responsible for the risks involved. Now, through the use of credit default swaps -- which in theory insure the banks against bad debts -- those risks are passed along to insurance companies and other investors.
Maryland law professor Greenberger believes credit default swaps "were a key factor in encouraging lenders to feel they could make loans without knowing the risks or whether the loan would be paid back. The Commodity Futures Modernization Act freed them of federal oversight."
Before passage of the modernization act, the Commodity Futures Trading Commission was attempting to regulate the swaps market through rule-making. The modernization act, Gramm noted in his remarks on the Senate floor, provided "legal certainty" for the growing swaps market. That was necessary, Greenberger says, because at the time, "banks were doing these trades in direct violation of federal law."
Greenberger has also been critical of former Clinton Treasury Secretary Robert Rubin, who supported Gramm's banking deregulation. But Greenberger insists that it was Gramm's slick legislative move that prevented government regulators from halting the spread of the risky financial instruments.
"Without Phil Gramm adding that 262-page bill onto an 11,000 page appropriations bill in 2000, it never would have seen the light of day," Greenberger says. "It was a lame duck Congress ... racing off to Christmas recess. It was not an orderly process."
A more notorious feature of the modernization act was the "Enron loophole," which allowed energy trading to escape federal oversight. It was Enron's electronic trading that led to the California electricity crisis of 2000 and 2001, as well as Enron's own demise.
The issue of regulating electronically traded energy futures had been a pitched battle at the Commodity Futures Trading Commission throughout the '90s. One chairman advocated so passionately for deregulating energy futures that she persuaded her fellow commissioners to agree to a rule exempting them from oversight. Who was that? Wendy Gramm, the senator's wife, who served on the commission from 1988 to 1993. Shortly after her resignation, she was welcomed onto the Enron board of directors, where she would ensconce herself on the happily deaf-blind-and-mute audit committee.
The exemption received broad criticism from an array of sources -- including the President's Working Group on Futures Markets, and then-chairman of the Federal Reserve, Alan Greenspan, who believed it contributed to market volatility.
Efforts to reverse the policy became moot when Gramm's amendment on that December evening gave the exemption the force of law -- at a time when his wife served on the board of the one company that would ultimately most abuse it.
The impact of the "Enron loophole" has been enormous. Since its passage, the Senate Permanent Subcommittee on Investigations has concluded that the loophole contributed to inflated energy prices for American consumers. In 2006, its report found credible expert estimates that the loophole -- by encouraging speculation -- accounted for $20 of the price of a barrel of oil, then at $70. In 2007, the same committee blamed the loophole for price manipulation of the natural gas market by a single hedge fund, Amaranth Advisors.
After Enron's demise, Wendy Gramm ultimately participated in a $13-million settlement personally paid by Enron directors for insider trading, when they collectively sold some $276,000 worth of stock early in the company's decline. Consumer advocacy group Public Citizen has reported that Enron paid Wendy Gramm between $915,000 and $1.85 million from 1993 to 2001 in salary, attendance fees, and stock options.
Last September, Michigan Democratic Sen. Carl Levin introduced legislation to close the loophole, citing two congressional reports blaming it for excessive speculation that has "unfairly increased the cost of energy in the United States."
In announcing his legislation on the Senate floor, Levin noted that the Enron loophole was "inserted at the last minute, without any opportunity for debate, into commodity legislation that was attached to an omnibus appropriations bill ... in the waning hours of the 106th Congress.
"The loophole has helped foster the explosive growth of trading on unregulated electronic energy exchanges," Levin said. "It also rendered the U.S. energy markets more vulnerable to price manipulation and excessive speculation with resulting price distortions."
Asked about Levin's legislation, Phil Gramm expresses ignorance. "I don't know what provision in the law he's talking about."
Gramm apparently has long been touchy about the subject. When Enron collapsed, law professor Greenberger remarked to an interviewer that "all that [unregulated electronic energy trading] was made permissible by Gramm." A few days later, the phone rang.
"He called me up at my home to tell me I was wrong," Greenberger says. "I was sitting in my study preparing for classes. He started arguing with me that I was wrong. I said, if you insist on believing that, then you don't know what your own legislation did. I had to terminate the call because he would have kept me on the phone forever."
Similarly, Gramm today denies any linkage between the subprime crisis and his deregulatory legislation. "I wouldn't blame [swaps] for the problem. You could make the argument that without them, things would have been worse," he says. Congress should "look at the lessons of the subprime problem and learn what we can learn -- loan generators and how they are compensated, what banks ought to be required to find to lend a variable rate," he says. "I'd be open to look at those things."
Says Greenberger, "I am quite confident Phil Gramm didn't understand what his legislation did. It was written by the banks and hedge funds."
Increasingly, many Wall Street titans agree that Gramm's efforts should be reversed. In May, Richard C. Griffin, founder of the $20 billion hedge fund Citadel Investment Group, told The New York Times that "fixing" Wall Street would require more regulation.
"Investment banks should either choose to be regulated as banks or should arrange to conduct their affairs to not require the stopgap support of the Federal Reserve," Griffin said. He also told the Times he sees a need for "new government oversight of the arcane world of credit default swaps, a business with a notional value and risk of $50 trillion."
Said the Times: "It was the interlocking relationships between thousands of investors and banks over credit default swaps that pushed the Fed to help rescue Bear Stearns."
Gramm isn't one to engage in mea culpas, regardless of the evidence against him. Take for example, his reaction when California was plunged into an energy crisis in 2001 by Enron traders manipulating the energy markets. Mimi Swartz recounts in her book, Power Failure, that Gramm exploded to the Los Angeles Times: "As [Californians] suffer the consequences of their own feckless policies, political leaders in California blame the power companies, deregulation and everyone but themselves, the inevitable call is now being heard for a federal bailout. I intend to do everything in my power to require those who valued environmental extremism and interstate protectionism more than common sense and market freedom to solve their electricity crisis without short circuiting taxpayers in other states."
Greenberger predicts that the fallout from Gramm's legislation will continue to grow, with capital drying up for all kinds of borrowing, including student loans. Meanwhile, Wall Street firms have begun considering a voluntary clearinghouse system for swaps and derivatives, an acknowledgement, Greenberger says, that some sort of policing is lacking.
Ironically, one of the big losers in the subprime mortgage crisis has been UBS, Gramm's new employer, which has announced losses of $19 billion and acknowledged that number could grow.
Gramm was recently quoted in The Washington Post as saying he was unaware that the company had invested in subprime mortgage instruments. "That's like Claude Rains [in Casablanca] saying he was 'shocked, shocked' to find out gambling was occurring in his establishment," says UT's Galbraith.
Perhaps Gramm has been distracted by politics. Since last July, of course, he has been investing considerable time in another enterprise -- the McCain campaign.
Crony capitalism is not the only arena in which Gramm's record might tarnish McCain's campaign. While McCain has promised to end congressional earmarks, Gramm, the legislator, once bragged, "I'm carrying so much pork, I'm beginning to get trichinosis." And there's the question of whether McCain, who wants to appeal to moderates and independents, needs political coaching from a man who once told The Dallas Morning News, "I know a political zealot when I see one. I am one."
Yet ideologically the two largely agree, whether it's on free trade or slashing government services. Given Gramm's free market philosophy, in a McCain administration he can be expected to continue his push for privatization of important government functions, particularly Social Security. McCain now says he would favor "maybe giving people the option" of personal retirement accounts, opting out of the Social Security system.
If a federal appointment fails to materialize for Gramm, there is always Texas. Much like the late Lt. Gov. Bob Bullock, Gramm has nurtured a "farm team" of younger Republican elected officials with whom he confers frequently.
Says Texas Secretary of State Phil Wilson, who served as state director of Gramm's Senate office, "Gramm in many ways really built the Republican Party in this state. He would actively recruit candidates to run. He would go to a fundraiser for anybody who would ask. He would do endorsements for people who were elected officials or who wanted to be elected officials, from county commissioner to state rep. to state senator."
More importantly, he showed them how to raise money. "By being there to help them raise the money, that spoke in volumes about credibility, because you can't run an effective campaign without being able to do television advertising," Wilson notes. Republican U.S. Rep. Jeb Hensarling of Athens is another former Gramm staffer, as is Republican nominee for Congress Pete Olson, who is challenging Rep. Nick Lampson for Tom DeLay's old seat.
Still, Gramm's first foray into lobbying at the state level bombed: His efforts to sell so-called "dead peasants" insurance to the Teacher Retirement System of Texas went nowhere. Under the dead peasants scheme, UBS would have sold TRS annuities and life insurance policies on retired teachers and kept the proceeds when teachers died.
His company's proposal to sell the Texas Lottery is still alive. His protg Perry (Aggies Gramm and Perry became close when both bolted the Democratic Party in the early 1980s) startled legislative leaders in 2007 when the governor proposed selling the lottery to private investors for between $14 billion and $20 billion. By investing that money, UBS argues, the state could earn hundreds of millions more in interest than the $1 billion earned annually now.
Perry first learned of the idea from Wilson, who, according to The Dallas Morning News, passed along Gramm's interest in the subject. There are other UBS connections as well: The investment bank employs Perry's son, Griffin, and retains former Perry spokesman Ray Sullivan as a lobbyist.
In 2007, lawmakers ignored the lottery sale idea. But Lt. Gov. David Dewhurst gave interim charges to both the State Affairs and Finance committees to study the proposal. And Texas House Appropriations Chair Warren Chisum, a Republican from Pampa, has told reporters "[proponents of the sale] are already here visiting with folks to lay out their case." Senate State Affairs Chairman Robert Duncan, the Lubbock Republican who plans to hold hearings in August, confirmed this, saying lobbyists are "circling their wagons since the issue is in play."
A huge obstacle will be making the numbers work -- which, according to a recent report by campaign watchdog Texans for Public Justice -- would require a huge expansion of gambling operations.
UBS estimated that the Texas Lottery could be worth between $10 billion and $16 billion if per capita sales increased 2 percent a year; a 7 percent annual growth would make the lottery's value as high as $24 billion. But the group's report noted, "These projections assume that Texas could match the per capita sales rates of lotteries in Maryland, Georgia, and Virginia. Yet part of what drives higher sales in those states are games now prohibited in Texas. Ã¢â‚¬Â¦ The UBS proposal also suggests the Texas Lottery could boost sales by moving into interactive television and the Internet." In short, the Wall Street consensus is that maximizing the value of the Texas Lottery requires an expansion of gambling into new games and new venues, and even into cyberspace.
While convincing the Legislature to expand gambling is an enormous crapshoot, if anyone is connected enough to do it, it's Gramm. No one can tout a free market ideology that happens to benefit friends and family better than he.
On January 10, Gramm introduced Perry at the annual banquet of the Texas Public Policy Foundation, a conservative think tank.
At first blush, Gramm's homage might seem to be the obligatory appearance of a dutiful husband (Gramm's wife, Wendy, serves as the foundation's board chair), or a loyal Perry friend.
Gramm's remarks at Austin's Sheraton Hotel to a friendly crowd of 500 loyal conservatives revealed just how deeply involved and powerful the former senator remains in the Perry administration and the Republican Party, both in Texas and nationwide. Pronouncing Perry the "greatest governor" of his lifetime, Gramm ticked off a list of reasons that spoke volumes about not only his subject, but himself.
Predictably, he praised Perry for no new taxes and passage of the Republican redistricting bill.
More revealing was his praise of Perry for seeking "private sector solutions" to government problems. Translation: cha-ching.
Perry was equally effusive about Gramm when he responded to his old friend's introduction. "Americans made a huge mistake in 1996," he declared. "I can't fathom where we would be ... had Phil Gramm led this country for eight years."
When it comes to the economy, a McCain victory in November might make that dream come true.
Patricia Kilday Hart