Cross-posted from New Deal 2.0
This week, Robert Rubin, Chuck Prince and Alan Greenspan will testify before the Financial Crisis Inquiry Commission. We know that they will duck blame and likely slip past the courteous questions of their inquisitors.
But let us hope the commission keeps firmly in mind that all three were at the passionate greedy heart of the crisis. As head of Bill Clinton's Economic Security team and soon after Treasury Secretary, Rubin presided over an administration hell-bent on financial deregulation. The New Deal restrictions under Glass-Steagall were gradually unwound, partly by Greenspan's Federal Reserve, but with the full support of Rubin. In 1999, they were undone completely in time to allow Sandy Weill's Traveler's Insurance to finalize its merger with Citicorp and become the largest financial institution in the world, Citigroup.
That is hardly all. The Rubin administration refused to support regulation of derivatives in 1994, when some in Congress wanted to do so. It refused again in 1999, beating down the proposals of its intelligent head of the Commodities Futures Trading Commission, Brooksely Born (who sits on the Inquiry Commission). It did not seriously support proposals to require business to expense stock options to its executives. Only late in the game, its SEC chairman, Arthur Levitt decided to clamp down on the widespread and corrupt conflicts of interest between stock analysts and investment bankers, a major contributory fact to the high-technology bubble. Its Justice Department brought few criminal actions against a Wall Street steeped in corruption on its path to the Enron and WorldCom deceptions -- and by no means only those.
It took full credit for a booming economy which was far too deeply based in that very stock market bubble. The consumer demand that compensated for the steep budget surpluses of the administration was supported by borrowing heavily against stock and housing assets. What's more, even much of the budget surplus that Rubin alleged was the cause of the boom was based on one-time capital gains taxes from the absurdly high tech bubble.
Rubin then joined Citigroup and ran it with Chuck Prince after Weill stepped aside. Together, according to journalistic accounts, they cranked up the risk-taking, with particular emphasis on the mortgage business -- in part to compensate for the losses incurred in the stock market collapse and bad debt to the likes of Enron.
Citigroup became the second largest writer of mostly mortgage- based collateralized debt obligations at the height of the frenzy between 2004 and 2006. (Merrill, propelled by the still more irresponsible Stan O'Neal, rose to number one). To sell these, it often bought the lowest-rated tranches and slipped them into its own partnerships. Because they were partnerships, much of the highly risky assets did not appear on the balance sheet. More to the point, it borrowed aggressively to buy them at low interest rates, and the liabilities did not appear on the balance sheet, either. These were the now famous Structured Investment Vehicles (SIVs, and they used other conduits).
It gets worse. Citigroup then guaranteed the independent partners of the SIVs they would compensate them for any losses should the value of the CDOs fall -- a "liquidity put." By 2008, Citigroup losses reached well into the billions of dollars.
Greenspan will fall back on his ideology, a simplistic view of economic competition that is not based on the real world. Somehow he has convinced himself that his "model" worked well for forty years and then something went wrong. In fact, once deregulation took real hold, there has been financial crisis after financial crisis. Let me list most of them: the 1982 Mexican bailout; the 1987 stock market crash; the 1989 thrift bailout; the 1990, junk bond market crash; the 1994 Mexican peso crisis and U.S. bailout; the 1997 Asian financial crisis; the 1998 Russian default and the collapse of LTCM; the 2000 high-technology stock crash; the 2006-2008 housing crash and Wall Street crisis.
Greenspan may make believe all these were solved by the self-adjusting economy -- his extremist neo-classical model. In fact, government was the critical savior in each case, not least Greenspan's own actions as Fed chairman. He pushed down interest rates in each of these crises since 1987. (Volcker did so in 1982.)
It wasn't Greenspan's low rates that were the problem in the early 2000s, however, contrary to a widespread view. Low rates can be constructive, as Joe Stiglitz keeps emphasizing. It was his refusal to regulate -- subprime abuses, liquidity or capital levels of the banks, obscurity and secrecy in the pricing of CDOs and credit default swaps traded by the banks he oversaw, and on.
Few if any economists foresaw the credit crisis. It was not enough to forecast the housing bubble. It was the house of cards built on top of it that was the issue, and that is not usually economists' domain. But there were many on Wall Street who did, hedge fund managers; traders at Bear Stearns, Lehman Brothers, Deutsche Bank, and others; the inventor of mortgage-backed debt, Lew Ranieri, who was giving talks on the subject in 2006; and one set of economists indeed, those at the international Monetary Fund.
Greenspan will tell the Inquiry Commission they were just lucky to be right.
It was the regulators' job, however, to know what traders knew. Greenspan had the authority to find out and, even as house prices rose to absurd levels, and leverage on the street rose to 40-to-one, he simply looked the other way. By then banks like Citigroup owned Salmon Smith Barney, so it was Greenspan's domain. The commercial banks also had subsidiaries that were originating as many subprime mortgages. Citigroup's wrote about as many Angelo Mozilo's Countrywide. One-stop shopping, Weill called it. Greenspan no doubt liked the idea
One wonders if Rubin knew how many unsuspecting homeowners his firm was luring into mortgages they couldn't possibly pay -- or bothered to think about ? He will tell the commission that no one knew how bad things were, so don't blame him. Prince will tell the commission the same. He had his risk managers and they didn't do their job. And Greenspan will essentially say the same thing. Those who claim they knew didn't really, they were just lucky events turned out the way they anticipated. There are always a lucky few, he will say. That's how markets work. And he will of course scold the commission if they fail to understand that market competition is the best regulator, and warn them not to damage a system that has been at the heart of prosperity in America for so long. The economy of course did far better in the 1950s and 1960s when finance was sensibly restrained.
Greenspan bears more responsibility for the calamity than any single person. It is rare in the history of any major event one can make such a claim.