Thursday, September 5, 2013

Movers, Shakers and Regulators

Chapter 5

Movers, Shakers and Regulators: Behind the Financial Seismic Shock


We saw in the previous chapter how essential financial innovation has been for economic advance; and also some of the potential pitfalls of the multitude of new financial products arising over the past four decades. In this chapter the role of the key players will be explored; the bankers, Wall Street, bureaucrats, politicians and regulators, who took advantage of the new financial tools to promote “housing justice” and who did very well for themselves in the process. While both political parties must share in the blame for the financial debacle, it has clearly been the Democrats who were the prime movers. Indeed insofar as anyone raised red flags it was Republicans, not Democrats. And, surprising though it may be, those who run the country’s financial institutions lean toward the Democrats; and they have done so for almost three decades. Moreover, the leadership of the Democrat party has done just as well, if not better, playing at crony capitalism as has any Republican; and they continue to do so even in the era of “hope and change”.


With all of their political clout why did the banks not do more to resist the government mortgage mandate? One answer to that question is that their leadership was also part of the 60s long march through the institutions and they shared the liberal ideological imperative and commitment to diversity and affirmative action. Another reason is given by financial commentator Arnold Ahlert:  “Wall Street is beholden to government, not the other way around. That is not to say Wall Street is innocent, only that it is forced to operate within the parameters, no matter how reckless and tainted by corruption, government sets for it.”[1] Moreover, the new financial instruments along with cooperative monetary authorities and regulators allowed the financial leadership to postpone the inevitable day of reckoning a good long while and, in the meantime,  to do quite well by doing ‘good’.


Myth of the Republican Banker


“One of the great media fallacies is that Wall Street is a bastion of right-wing politics.”[2] This myth persists despite the fact that in 2008 most of its leaders supported the Democrats and Obama. Small business and main street Republicans, in fact, tend to distrust the big city slickers of Wall Street and their cozy relationship with big government. There are, of course, some notable exceptions on the Street and within the investment community, but even these exceptions prove the rule. They tend to be “squishy” liberal Republicans from the Rockefeller wing of the party and not modern day stereotypical versions of Mr. Potter conspiring against the poor and downtrodden.  One such is Henry Paulson, a fervent supporter of environmental causes, who was distrusted by the Republicans in the House. Another is Paul Singer, founder and CEO of the hedge fund Elliott Management who donates to the Republican Party, but also to the Harvard Graduate School of Education. This Wall Street Republican, like Paulson hardly fits the mean-spirited stereotype. He supports gay rights, helped push gay marriage through the New York State legislature and contributes to a number of liberal causes. However, unlike Paulson, he did at least foresee the coming financial meltdown. One supposedly conservative exception was Jimmy Cayne of Bear Stearns. But even the pot-smoking Cayne was hardly a pillar of up-tight Republican rectitude; in addition most of his associates were liberal Democrats and he was not above greasing the campaign palms of powerful Democrats like Charles Rangel and Chuck Schumer.[3]


A Fish Dinner in Washington


A dinner at a trendy seafood restaurant in Washington DC in June of 2007 should explode the myth that Wall Street is composed solely of greedy hard-nosed Republican types. Here a cast of characters from the Street gathered to make the acquaintance of freshman Senator Barack Obama. Present were Richard Fuld CEO of ill-fated Lehman Brothers, Greg Fleming second in command at Merrill Lynch, Larry Fink head of the hedge fund Blackrock, Paul Volcker avuncular former Chairman of the Federal Reserve Board, Gary Cohn a senior executive from Goldman-Sachs and  Warren Spector, Jimmy Cayne’s top lieutenant, at  Bear Stearns. Like most senior executives on the Street these were committed Democrats, media myth to the contrary notwithstanding. This clique of rabid limousine liberals was initially supporting Hillary Clinton. Her supporters additionally included Goldman’s Lloyd Blankfein and a former Republican, John Mack of Morgan Stanley.[4]


Wall Street Friends of Democrats and Obama[5]


The fact is that support for liberal Democrat causes, and also for the candidacy of Barack Obama runs deep in the financial community. Warren Spector, an attendee at the fish dinner viewed Obama as a friend of the Street and someone who appreciates the good that Wall Street has done for the promotion of social justice by pioneering such financial innovations as mortgage bonds. He was well known as a liberal Democrat who contributed exclusively to Democrat campaigns and ultimately assumed an active role in the Obama campaign. Other Bear-Stearns Democrat enthusiasts and Obama supporters were Ace Greenberg, one-time head of Bear and wealthy investor Vincent Tese who was on the Bear Board.


Morgan Stanley was well represented among the Obama enthusiasts. CEO John Mack was a one-time Bush supporter; he was friends with Joshua Bolten a former Goldman executive who was Bush’s chief of staff. However Mack, a longtime advocate of national health insurance, became a Hillary Clinton supporter before switching to Obama. In recent years Mack’s political donations to Democrats have been twice that given to Republicans. During the controversy concerning the renewal of bonuses on Wall Street, he was concerned enough to ask Lawrence Summers for advice. Mack’s concern, quite different from the rest of the Wall Street clique, especially those at Goldman Sachs, does do him credit as it indicates that he has at least some conscience and judgment.  Tom Nides, a top executive at Morgan Stanley, was the one who persuaded Mack to switch his support to Obama; Nides held Obama fund raisers within Morgan Stanley headquarters. After the Obama victory, Nides put his influence to good use in lobbying the new administration. James Gorman, Mack’s successor as CEO had a history of making almost all of his political contributions to Democrat candidates.


Greg Fleming, former president and COO of Merrill also attended the fish dinner. His recent donations run thirty to one in favor of Democrats. His boss, Stan O’Neal, the highest ranking African American on the Street, contributed to the Obama campaign; however he does hedge his bets by donating smaller amounts to Republicans. Lehman Brothers CEO Richard Fuld also an attendee at the Washington fish dinner had never been particularly political but finally entered the Democrat camp.

A number of hedge fund magnates and major investors were also firmly in Obama’s camp.  Larry Fink of Blackrock, a lifelong staunch Democrat and fish dinner participant helped persuade his Wall Street colleagues that Obama was a moderate. He was later rewarded with contracts to manage the assets of the defunct Bear Stearns and bankrupt AIG; the access to market information from these firms was possibly even more valuable to Blackrock than the fees earned. Another such was investment banker and “Barack bundler” Mark Gallogly a longtime executive at private equity company Blackstone; Gallogly, like Obama, was a believer in “social justice”.  Orin Kramer another hedge fund manager was a major Democrat fund raiser. Jacques Leviant a successful investor was a moderate conservative who contributed to both parties and also introduced Obama to his neighbor the billionaire George Soros.  Penny Pritzker heiress to the Hyatt Hotel fortune became an Obama supporter and his national finance chair based on his promise of “hope and change”. In September 2008 she made her Hyatt facilities available for a dinner honoring Iranian president Ahmadinejad. Another Hyatt heiress with quite progressive leanings is Rachel Pritzker Hunter a Democracy Alliance board member. Contrary to popular mythology there are numerous inheritors of vast wealth, sometimes referred to as “trust fund Trotskyites” that are quite progressive in their beliefs and donations.


The big New York banks are hotbeds of support for liberal causes. Citigroup executives, in particular, have been heavy Democrat contributors. Sanford Weill, one time CEO of Citigroup partnered with Jesse Jackson and helped fund and promote his Wall Street Project. Weill, a heavy Democrat contributor hired former Clinton Treasury Secretary Robert Rubin for a high paying position as a reward for helping to repeal Glass-Steagall. Charles Prince, Weill’s successor as CEO was a heavy Democrat donor. Robert Wolf a senior executive at UBS (Union Bank of Switzerland), was one of the “Barack bundlers”; he has personally bundled more than $500,000 for Obama, dating back to Obama’s Illinois Senate days.  He became a member of Obama’s inner circle despite the fact that UBS was under investigation for tax fraud as a major player in the subprime market.


Another major bank executive, Jamie Dimon, CEO of JP Morgan Chase and quintessential limousine liberal became a major Obama supporter and one of his most important economic advisers. Recently he was called to testify before a Senate committee investigating speculation by JP Morgan Chase resulting in large trading losses. Dimon, the grandson of Greek immigrants opposed any measures for the control of illegal immigration. He has also called for increased spending on inner city schools and new infrastructure. Dimon has been a supporter of Democrat Senator Kirsten Gillibrand for whom he held a series of fundraisers. Dimon, however, was quite capable of downplaying his liberalism when profits were at stake. He excoriated the Neighborhood Assistance Corporation when they asked for relief on some loans they had taken out at JP Morgan Chase; no group rights allowed if it would cost his bank. Despite his political preferences he was quite capable of chewing out two of his favorite Senators, Schumer and Gillibrand when he thought their rhetoric might be used against himself and his fellow bankers. As was the case for Citigroup, JP Morgan executives had a much higher rate of support for Democrats than for Republicans. Mike Cavanagh, Dimon’s second in command, was delegated to hold a fund raiser for Obama; Dimon as a member of the Board of the Federal Reserve Bank of New York could not make a direct contribution. 


Progressive Investors, Speculators and Financial Manipulators: The Real One Percent


A number of major investors and hedge fund managers who profited from shorting the housing market during the subprime meltdown were contributors to Obama, the Democrat party and other progressive causes. John Paulson, the billionaire investor, tried to short sell a CDO that Goldman Sachs was pushing; a fact that Goldman neglected to inform its own clients about. Paulson in recent years contributed seven times as much to Democrats as to Republicans.[6]  Charles Ledley, a principal in Cornwall Capital who made tens of millions of dollars betting against mortgage bonds was a college volunteer for the Bill Clinton campaign in 1992.[7] Another housing shorter was Stan Druckenmiller who along with George Soros "broke the Bank of England" when they shorted the British pound  in 1992. Druckenmiller, a longtime donor to progressive causes such as the Children's Scholarship Fund, Harlem Children's Zone, New York City AIDS walk and the Environmental Defense Fund, usually hedged his bets by contributing to both parties. However, in 2008 his contributions leaned in favor of the Obama campaign.[8]  Phil Falcone billionaire investor, founder of the hedge fund Harbinger Group, also made billions from shorting the housing market.[9] Falcone, an Obama friend and campaign contributor, has also made large cash contributions to the Democratic Senatorial Campaign Committee. He has recently obtained favorable treatment from the Obama FCC for his high-tech company LightSquared despite objections from the Air Force that Lightsquared's proposed wireless network would disrupt U.S. satellite communications.[10]


George Kaiser is another billionaire investor and Obama donor. He is best known for his recent investment in the now bankrupt green energy company Solyndra the recipient of largesse from the Obama administration.  “He and the other private investors of Solyndra will recoup their losses ahead of taxpayers. And while they blast their GOP opponents, double-standard Democrats will remain AWOL on the glaring tax-avoidance strategies of the wealthy Kaiser Family Foundation.”[11] Other administration subsidized green energy investors and Obama supporters include William Capp of recently bankrupt Beacon Power, John Rowe of Exelon and Frank Clark, a major Obama fundraiser, who runs ComEd. In addition to his contribution to the Obama campaign, Capp has a history of supporting left-wing Democrats in New England; his chief lobbyist was once an aide to the late Sen. Ted Kennedy. High ranking Obama operatives David Axelrod and Rahm Emanuel found lucrative employment as consultants to Exelon.[12]


Another who expected to profit from Obama’s green agenda was Jeffrey Immelt CEO of General Electric. This one-time Republican became an Obama supporter and sits on the jobs advisory board. GE became another financial corporation welfare recipient when the new administration granted its financial arm bank status along with TARP money. He also helped his new friend Vikram Pandit of Citigroup in obtaining favorable treatment from the new administration.[13] Immelt recently moved GE’s 115-year-old X-ray business to Beijing. Another member of the Obama team is famed billionaire investor and tax advocate Warren Buffett. While Buffett may advocate higher tax rates for others he studiously avoids paying them as far as his own Berkshire Hathaway is concerned; recently Berkshire has been engaged in a legal battle to avoid paying some $1 billion In back taxes.


Another left-leaning financier is David Gelbaum, co-founder of the hedge fund Sierra Enterprises Group. Gelbaum, in addition to his avid environmentalism has a great fondness for immigrants, both legal and illegal. He made a large donation to the Sierra Club on the condition that they never address immigration as an environmental issue.[14] Gelbaum was a talented financial engineer, helping to found Princeton/Newport Partners, a pioneer in the use of mathematical formulas and algorithms to price stocks and derivatives. The firm itself collapsed following the indictment of top executives in connection with a scheme to create illegal tax losses; an event in which Mr. Gelbaum was not personally implicated.


New York lawyer Herbert Sandler and his wife, Wall Street analyst Marion Sandler, purchased a California thrift in 1963 which ultimately grew into Golden West Financial. They built their financial powerhouse on adjustable rate mortgages sold aggressively to unsophisticated home buyers. Wachovia Bank, in what turned out to be a horrendous investment bought their S&L holding company in 2006 for $24 billion. This predatory lending and financial wrecking power-couple were also committed progressive Democrats giving millions to the Center for American Progress, Soros’ Democracy Alliance and the 2004 anti-Bush 527.[15] Despite Golden West’s profitable use of ARMs, the Sandler Family Foundation supported the fight against predatory lending giving ACORN at least $525,000. The Sandlers have also given hundreds of thousands to Democrat campaigns and some $2.5 million to[16]


The Sandlers are close to billionaire speculator George Soros, the mastermind behind numerous leftwing organizations who in the 1990s broke the British pound by massively shorting sterling. Soros had also been accused by Malaysian Prime Minister Mahathir Mohamad of undermining the Malaysian currency during the 1997 Asian crisis. However, the two of them have recently “buried the hatchet”.[17] Perhaps their mutual dislike of the United States has brought about a reconciliation. Soros had also been convicted of insider trading by a French court. Economist Paul Krugman, a well-known progressive, has summed up Soros and his activities as follows:


Nobody who has read a business magazine in the last few years can be unaware that these days there really are investors who not only move money in anticipation of a currency crisis, but actually do their best to trigger that crisis for fun and profit. These new actors on the scene do not yet have a standard name; my proposed term is 'Soroi'.[18]


Soros has assembled a collection of so-called “527 groups”, nominally independent organizations that promote progressive and Democrat party causes. The most famous of these are the Center for American Progress, MoveOn.Org, Human Rights Watch and Media Matters. Other billionaire social justice activists who have joined Soros as donors are Peter Lewis of Progressive Insurance and Herbert and Marion Sandler; these have also joined forces to found the Democracy Alliance. Other members of the Alliance include Soros’ son Jonathan, businessman and film producer Steven Bing, software entrepreneur Tim Gill, Washington, D.C. real estate developer Herb Miller, Davidi Gilo and wife Shamaya high-tech entrepreneurs, Alan Patricof co-founder of private equity firm Apax Partners, Bren Simon president of MBS Associates LLC whose husband, Melvin, ranks on the Forbes list of the world’s richest people, financier and philanthropist Lewis Cullman, former portfolio manager for Soros’s Quantum Fund Rob Johnson, Steven Gluckstern a founding managing director of investment banking firm Azimuth Alternative Assets and Robert Dugger onetime chief economist at the American Bankers Association and managing director of Tudor Investment Corporation. In addition to such financial and business moguls the Democracy Alliance incudes the actor Rob Reiner best known for his role as the “meathead” on All in the Family and heiresses such as Rachel Pritzker Hunter of the Hyatt fortune,  Anne Bartley the daughter of Winthrop Rockefeller and Patricia Stryker granddaughter of businessman Homer Stryker.[19]


Goldman Sachs: the Liberal Vampire Squid


“The first thing you need to know about Goldman Sachs is that it's everywhere. The world's most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.”[20] Goldman-Sachs may be a vampire squid, but it is a Democrat vampire squid. Goldman executives give Soros and friends a run for their money as a Democrat financial power center. Gary Cohn, president and later COO of Goldman Sachs attended the Obama fish dinner; his political contributions have gone almost exclusively to Democrats. In recent years Cohn had been busy in helping to devise a scheme to disguise Greek debt.[21] Lloyd Blankfein, Goldman Sachs CEO, is known as a staunch Democrat and has also given their candidates almost all of his political donations. During 2009 Blankfein had his lobbyists hard at work focusing on limiting the severity of whatever reform legislation was being pushed by his Democrat friends.[22] David Viniar, the Goldman CFO who helped to design their infamous strategy of shorting mortgage bonds in 2007, has donated only to Democrats in recent years.[23]


Total contributions of Goldman Sachs executives to the Obama campaign was nearly $1 million, not including donations to other Democrats and soft money for the Party. Blankfein and company continued their support for Obama in 2009 with contributions weighted heavily in favor of Democrats. And their efforts were not unrewarded. In addition to helping shape new reform legislation in the most favorable way politically possible, Goldman earned $13.4 billion in 2009 due to the policies of the new administration; $13,400 in profit for every dollar invested in Democrats. Furthermore, although Blankfein had to take a pay cut that year he still made some $9 million.[24]


The Revolving Door


Members of the financial elite have found their way easily into government office and the political arena; they passed with great ease from business to government and out and in again. More often than not they have found a comfortable home within the confines of liberal politics and Democrat administrations; it was a mutually profitable arrangement for both politicians and Wall Street. “For decades Wall Street’s interests had been safeguarded by the coterie of bureaucrats who survived administrations, passing back and forth from Wall Street to Washington”.[25] The leader amongst these peripatetic bureaucrats is undoubtedly staunch Democrat Robert Rubin. As Chairman of Goldman Sachs he was mentor to such future political leading lights as Jon Corzine and consultant Rahm Emanuel. Rubin went on to be Clinton’s Treasury Secretary where his policies helped to ignite a massive bond rally to the benefit of Wall Street and most especially Goldman Sachs. He also pushed for the disastrous repeal of Glass-Steagall which had insulated commercial banking from the more risky investment banking. This was a move that Sanford Weill, the Citibank empire builder had long sought.  After Rubin left the Treasury Department, Weill gave him the very lucrative job of Citigroup vice chairman. When he was at the Treasury Rubin also orchestrated a bailout which benefitted the large banks during the Mexican peso crisis of 1994. The consequent assurance of government support encouraged the banks to take still further risks. Rubin was not above playing to anti-immigrant sentiment in the southwest arguing that a peso collapse would incite a massive illegal flow of immigrants fleeing the collapsing Mexican economy.[26]  When it comes to helping out their Wall Street friends, the Democrats will even play the anti-immigrant card; something that at all other times they vehemently denounce. Rubin’s son, Jamie, followed in his father’s footsteps; after a stint in the Clinton administration he found a job with a private equity firm. In 2008 young Rubin switched loyalties from the Clintons to Obama.


Goldman Sachs must certainly be awarded first place on the revolving door list. Phil Murphy the one time head of Goldman’s Asia Region became National Democrat Committee chairman and later ambassador to Germany. Rahm Emanuel, much better known as a political operative, also benefitted from a Goldman Sachs connection. In the early 90s he was a Goldman political consultant who used his Chicago connections to help the firm secure government business. He also was friends with other Wall Street powers such as Jamie Dimon and Tom Nides of Morgan Stanley. It is believed that Robert Rubin helped him obtain his job in the Clinton administration. It also appears that as Obama’s chief of staff he was able to deliver for his many Wall Street friends.[27] One of these friends Steve Koch, the co-chairman of mergers and acquisitions at Credit Suisse Group AG, has recently joined Chicago Mayor Emanuel’s team. Koch, who spent three decades at Credit Suisse, has been appointed Chicago deputy mayor.[28] It appears that the Republicans are not the only ones to have a well-heeled Koch.


Goldman has maintained a useful relationship with the Federal Reserve Bank of New York (FRBNY), a quasi-public institution charged with major regulatory and oversight responsibilities over the Street. Bank president Gerald Corrigan left his position to work for Goldman Sachs in 1994. Corrigan was just the most high profile example of the long time weakness of the FRBNY in its incestuous relationship with Wall Street. He is also a liberal Democrat who once was touted as a possible Treasury Secretary following Clinton’s first electoral victory. One Rubin protégé at the FRBNY was Timothy Geithner. Although Geithner never held a position at Goldman, while president of the New York Fed, prodded by Rubin, he reduced its oversight of Wall Street.[29]


Rahm Emanuel was not the only Democrat elected to office who had lucrative ties to Goldman. Congressman Richard Gephardt was once employed by Goldman Sachs, a company representing many Chinese business clients, to work on public finance issues.[30]  Ironically Gephardt had once built his reputation as a champion of American manufacturing and its workers. However, it was one-time Goldman Sachs head Jon Corzine who achieved the greatest electoral success as the liberal Democrat Senator and then Governor of New Jersey. Defeated for re-election, Corzine returned to the Street as CEO of MF Global which promptly lost a major bet buying the debt of the EUs financially troubled Mediterranean member nations. Corzine and MF Global are under investigation for misusing clients’ money for such speculation. Corzine is a bundler for the Obama campaign; MF Global is one more Democrat financial stronghold whose employees have contributed in excess of $100,000 for Obama; one Republican trader reportedly gave $2,500 to the Romney campaign.[31] 


Goldman Sachs may dominate the government-Wall Street shuttle, but they are not the only player. The big banks are also in the game. Michael Froman a Citigroup banker and law school friend of Obama became deputy assistant for international economic affairs in the Obama administration. The powerful Daley family of Chicago has longstanding ties to Jamie Dimon. Michael Daley, brother of Chicago mayor Richard Daley was a principal in the law firm hired by Dimon as political advisers to Citigroup when Dimon was there as Weill’s number two. Bill Daley, Gore’s 2000 campaign chairman, was later hired by Dimon as vice chairman of JP Morgan Chase; no doubt to help influence the Obama administration. Bill Daley ultimately replaced Emanuel as the Obama chief of staff.[32] General Electric, unlikely as it seems, has also been declared a bank owing to its ownership of some financial subsidiaries. Chairman Jeffrey Immelt doubles up as head of the Obama administration’s Economic Advisory Board. Robert Wolf of Swiss financial giant UBS sits on Obama’s Economic Recovery Advisory Board and the presidential Council on Jobs and Competitiveness.


Hedge funds were also represented by rotating government office-holders.  Long-time Democrat Larry Summers, another Rubin protégé helped build the Wall Street – Washington alliance and helped repeal Glass-Steagall. He reportedly earned an easy $8 million at the D.E. Shaw hedge fund primarily for his speechmaking skills and later became one of Obama’s economic advisers. He was at one time president of Harvard; Summers is a highly successful example of someone who navigates the academic – Wall Street – government complex.[33] John Edwards, onetime Senator and vice presidential candidate also found joining a hedge fund to a profitable endeavor; he is an example of someone whose movement was from Democrat elective politics into the world of high finance. In 2006 he was hired by Fortress Capital who followed Goldman in the mortgage bond shorting strategy. This liberal champion of the little man, like his equally liberal counterparts at Goldman Sachs “saw nothing wrong with profiting off the demise of the American economy as Fortress, too, was making money betting against the subprime market.”[34]


Other investment banks also had rotating executives. One, Tom Nides, a top executive at Morgan Stanley, held various jobs within the Democratic Party alternating with his work on Wall Street. The head of Lehman, Richard Fuld, became a powerful figure on the Street when he assumed a seat on the Board of the New York Fed which gave him access to top regulators. As we will see following page 200 below this obvious conflict of interest was not uncommon at the Federal Reserve Bank of New York; and among other regulatory agencies as well. Unfortunately for Fuld, his influence was not sufficient to save his company when the financial elite panicked and scrambled around in search of a scapegoat. Mary Schapiro, lifelong Democrat was at the helm of the Financial Industry Regulatory Authority (FINRA) the self-regulatory organization of Wall Street, a position that paid her millions in salary which was financed by the member firms’ dues. She became SEC chief in the Obama administration.  In this case however the new political exigencies pitted one group of finance industry Democrat supporters against another. Vowing to turn things around she went after Goldman Sachs and despite her previous exorbitant compensation on the Street she also went after high executive pay.[35]


Any discussion of the ‘revolving door’ would not be complete without examining the Federal housing agencies, Fannie Mae and Freddie Mac. These quasi-private corporations served to reward favored Democrat operatives and office-holders with a quick road to riches. Probably the greatest such beneficiary was Franklin Raines, White House budget director for the Clinton administration. From 1999 to 2004 he was Chairman of Fannie Mae when he was forced to resign following SEC mandated accounting corrections. By tying executive compensation to earnings growth the executives at the agency reaped astronomical amounts in bonuses. The originator of Fannie Mae’s dual strategy of expanding home ownership, while enriching its top management, was James Johnson another Democrat Party supporter who became chief executive in 1991. Between 1991 and 1998 Johnson drew some $100 million in compensation; in his five years as CEO Raines amassed almost as much.[36]


Other leading Democrats who were rewarded with major positions at Fannie Mae include Jack Quinn who served as Clinton’s counsel from November 1995 to February 1997 and Eli Segal who served as Assistant to the President from January 1993 to February 1996. There was also Jamie Gorelick who while serving in the Justice Department under Janet Reno reportedly helped to erect the wall between the FBI and CIA which impeded investigation of terrorist plots prior to the 911 attacks. With her high positions at Justice and in the agency that was instrumental in causing the housing meltdown and the great recession, Gorelick must be accounted an extremely costly bureaucrat. Freddie Mac was another agency that allowed Democrat operatives to pad their bank accounts. Rahm Emanuel, during time spent on the Freddie Mac Board between 2000 and 2001, left with some $320,000 in compensation plus up to $250,000 from selling Freddie stock. In addition to the great work performed for the Democrat Party It was, undoubtedly, Emanuel’s experience at Goldman Sachs and also in the mortgage market that made him such an invaluable addition to the Freddie Mac board. He also served at the Chicago office of investment bank Dresdner Kleinwort Wasserstein, working on mergers resulting in thousands of laid off workers, as well as for deals funding subprime loans. He left with $18 million after some two years.[37] 


The executives and directors at the agencies were quite skilled in finding friends and defenders to protect their high paying sinecures. Lawrence Summers while deputy Treasury secretary, buried a department report recommending that Fannie and Freddie be privatized. Fannie Mae hired Republican attorney and famed Whitewater investigator Ken Starr to bury the requests of one Congressman to find out exactly how much its top executives’ were receiving in compensation.[38] Thus, members of both political parties had the chance to obtain fat paychecks from these quasi-private agencies.


Furthermore, many Republicans also passed through the revolving door between government and the financial industry as a whole; the difference being that the big Wall Street firms have a larger number of Democrats and that it was liberals who were more apt to piously pontificate on the sins of Wall Street even as they served the interests of the financial companies. Alan Greenspan, a conservative influenced by the libertarian theories of Ayn Rand, during his tenure as chairman of the Federal Reserve always made sure to benefit Wall Street by lowering interest rates or pumping up the money supply in response to the needs of the Street. The ubiquitous Goldman Sachs was always well represented when Republicans held power. In addition to Treasury Secretary Henry Paulson other one time Goldman Sachs executives holding positions in the Bush administration included chief of staff Josh Bolten and World Bank president Robert Zoellick.


It is also true that support for the Democrats and for Obama was mainly found among the largest financial institutions. In contrast to Goldman and the other big Wall Street firms the attitudes of the smaller players were somewhat different. For example, financier Ken Langone and veteran investment banker Joe Perella were never enchanted by the Obama fetish prevalent on the Street. Both were different in that they did not depend on big government largesse and ran small brokerages and investment banks. After the 2008 election as some former Obama enthusiasts began expressing reservations they were, in effect, reminding their colleagues that they had tried to warn them.[39]


Business as Usual


Changes in administration over the last two decades have made little difference to the power brokers of Wall Street. It has been pretty much business as usual under Clinton, Bush and now Obama. During the Clinton administration the large players most often got their way. Officials and advisers such as Rubin and Summers served the interests of Goldman Sachs, Citigroup and the rest of the large firms. During the Clinton administration, deregulation, in particular the repeal of Glass-Steagall was a priority for the big banks and Rubin with the help of Summers got it done. Wall Street found ready supporters in Congress such as Barney Frank whose committee approved many pieces of deregulation.[40] Regulatory agencies were also glad to help out the big firms in their quest for deregulation. David Viniar the CFO of Goldman Sachs expressed his appreciation to the SEC for its efforts in developing "a regulatory framework that will contribute to the safety and soundness of financial institutions and markets by aligning regulatory capital requirements more closely with well-developed internal risk-management practices.” [41]


Business as usual continued under the Bush administration. Wily Goldman Sachs was the most adept of all the firms in pursuing its own advantage. When they detected the approach of the housing crisis the smooth operators at Goldman shorted the same mortgage bonds that they had previously sold to clients. If one of its clients wanted to take a long position in some mortgage securities and Goldman’s research indicated that those securities are overvalued they would first sell those to the client and then short them. They stood to make money from the fee and, if the securities declined, from the short. Although Goldman executives insisted that their firm was simply better at hedging and trading there was evidence that they reveled in profiting off of the shortsightedness of their clients. Furthermore the subsequent government bailout of AIG was, in reality, a bailout of Goldman, the holder of AIG’s credit default swaps.[42]


Rivalry within Goldman Sachs illuminates both the cutthroat nature of the business and the ease of influence peddling that characterized Goldman in particular and the rest of the Street in general. Jon Corzine became CEO of Goldman in 1994; his protégé was John Thain. Following the Long Term Capital Management debacle in 1999, Thain joined up with Henry Paulson to push Corzine out of his CEO position. Soon afterward the Goldman traders led by Lloyd Blankfein contrived a coup d’état to drive out Thain and CEO Paulson. While Thain escaped to become head of the NYSE, a private association with its own oversight and regulatory responsibilities, Paulson left to become Treasury Secretary.[43] Paulson, although nominally a Republican, continued in his new office, to maintain a friendship with Democrat congressional leaders Barney Frank and Nancy Pelosi.[44] The net result of such maneuvering is that one Goldman Sachs bigwig was pushed out only to become Senator and then Governor. Still another was sent packing but managed to become Treasury Secretary and a third found a new position as the head of the New York Stock Exchange, the chief market overseer. Remarkably Goldman managed to have its one-time top executives assume the office of Treasury Secretary under both Clinton (Rubin) and Bush (Paulson).


During the 2008 election, as we have seen, the Wall Street leadership played a vital role in assisting and financing the Obama campaign. In September 2008, the peak of the crisis, Goldman gave $596,000 to Democrats, eight times what it gave Republicans. JP Morgan Chase gave $239,000 to the Democrats, over two times what it gave Republicans.[45] Both companies benefited from their largesse once the new administration took office.[46] An immediate payoff was the appointment of Timothy Geithner as the new Treasury Secretary. Geithner, a well-known supporter of Wall Street and of Goldman Sachs, played an important role during the financial crisis. Thus there has been a succession of secretaries, one after another transcending politics and administrations, with strong ties to the banks and to the Street.


During 2009, the large firms continued in their support for the new Democrat administration. Goldman, in particular, gave nearly four times as much to Democrats as it gave to Republicans. Goldman also employed lobbyists who were once staff members for Barney Frank and other Street-friendly lawmakers. At the same time they contracted with Republican-oriented public relations firm Public Strategies to defend against criticism of their role in the AIG bailout.  Goldman was, thus, set to help shape the inevitable reform legislation by plucking “the most politically connected people to run its lobbying department.”[47]


With former Goldman Sachs executives spread throughout the regulatory apparatus and with other bureaucrats hopeful of working at Goldman following their tenure in government (a process that was known at Tammany Hall a century ago as ‘honest graft’) Goldman escaped with a relatively modest fine from the SEC.[48] By 2009, Goldman and the big banks were returning to profitability but still had to deal with public outrage. Therefore, it was necessary for the Street’s government accomplices to make a good public show. The new president began to publicly denounce Wall Street greed. But privately Democrat Senate leaders reassured Goldman Sachs executives that the CEOs of the big firms would have to undergo a little public humiliation; however in reality their past and present support was really much appreciated.[49] Despite some whining about Obama’s post-election bashing of Wall Street, Goldman and others understand it as a necessary political ploy and not a matter of conviction. One senior Goldman executive was quoted: “Obama couldn’t give a shit about all this anti-Wall Street stuff. He needs to bash us to get his bullshit financial reform through Congress.”[50] Wall Street leaders recognized that some show penalty will have to be paid; however they also recognize empty rhetoric when they hear it. And above all they know that Obama would inevitably come calling on them again for future campaign financing support.


In the meantime Wall Street and the big banks continued to benefit from the Fed’s low interest rate policy, Obama’s continuation of the “too big to fail” policy with its attendant moral hazard, the dropping of the mark to market rule, and the continued purchasing of bank debt by the Fed at Geithner’s prompting.[51] Furthermore, by early 2010 there was no longer any discussion of reviving Glass-Steagall. Wall Street was not overly concerned at the prospect of the financial reforms being discussed; while there might be some things the Street wouldn’t like the benefits of big government would continue.[52]  Obama’s “green agenda” promised to generate billions in profits for favored big business as well as for Wall Street investment banks, while his high tax agenda did not bother the Street since that would be offset by the greater amount of money they would make under his administration.[53]  Above all the Fed policies and government guarantees were like having a convenient put option with the taxpayer on the other side.


It must be said that Obamanomics had in some sense reduced the big bankers to the status of government bureaucrats. But in compensation to their wounded pride they were extremely well paid bureaucrats.[54] Of course it should be added that they had already been extremely well paid for several decades to carry out government policy. Obama, the Clintons and Democrats in general like the big Wall Street firms because they share the progressive ideology and implement ‘social justice’ policies. In this respect, having observed the failure of centralized top-heavy socialism, these progressive Democrats have moved away from classical Marxism and have adopted a model closer to the one pioneered in Fascist Italy. Therefore it is not surprising that the Democrat leadership does not like the small white entrepreneurs of Main Street, or the smaller banks, who are harder to direct and control; these are disparaged as the ‘bitter clingers’.


These small businesses are not protected by the cozy crony capitalism relationship with government that the large Wall Street firms and major banks have. They are doing the rational thing in times of great uncertainty by hoarding cash, cutting employment and not making new investments. While small business and average citizens worry about the massive debt issued by the Obama administration Wall Street has been silent about this debt and the new spending programs. Wall Street and the large banks stand to profit from handling these credit needs. Thus while mandatory health care reform may be burdensome to small business, Wall Street clients will be relatively unaffected. These large businesses as in the big pharmaceutical and insurance companies are even profiting from these fiscal policies and new spending.[55]


Therefore, the policies of the Federal Reserve along with government guarantees benefit Wall Street at the expense of small businesses and entrepreneurs. Wall Street is able to borrow nearly free of charge to carry out its business of trading and brokering; at the same time loans are denied to small businesses. While the big banks and Wall Street have benefitted, ordinary Americans with their wealth diminished and facing high unemployment continued to suffer. Moreover, as Charles Gasparino observes: “Wall Street is one of the few places where failure of great magnitude is an accepted way of life: Almost no CEO of a major Wall Street firm was forced out over the events that led to the 2008 financial collapse.”[56]


Foibles of the New York Financial Elite: Liberals Behaving Badly


The members of the liberal financial elite pride themselves on their philanthropy and concern for ‘social justice’. But while they purport to worry about the poor, the underprivileged and various discriminated against minorities their actions in pursuit of their self-interest belie such professions of concern. Indeed they appear to be characterized by an enormous self-involvement and an almost total lack of self-reflection. Thus, walled off from their liberal progressive ideology is their actual behavior. As we have seen, these liberals of the financial world have cheated their own clients and freeloaded off middle and working class taxpayers. They have taken good care of their own finances, accumulating billions, through cheating and lying. Their actions include deceiving unsophisticated home buyers on mortgages and then rushing to foreclose, which was the road to wealth of the Sandlers and Golden West Financial.

MF Global led by the ultra-liberal Jon Corzine has put its small farmer clients at risk. Currency speculators, like the godfather of progressive organizations George Soros, think nothing of undermining currencies thereby bringing economic chaos into the lives of lower class foreigners. This clique lives insulated from the problems they often help to create while engaging in social and environmental hypocrisy; imposing rules on others that don’t apply to themselves. They are champions of mass cheap labor immigration undermining American workers’ wages and displacing the very minorities they preach about helping. Their globalist policies also include the outsourcing of U.S. jobs thereby enriching and empowering foreign despotic regimes. And all of this is facilitated by corrupting bureaucrats and politicians. And at the same time they generously set standards of behavior for the other members of society. The fewer conservative members of the financial leadership may not act any better but at least they are less hypocritical.


In addition to such major scandals and conflicts of interest there are a number of instances of personal eccentricities and foibles characteristic of the Wall Street financial elite. The remarkable self-involvement of the liberal financial leadership, particularly those among the New York set is worthy of several Seinfeld comedy episodes. The following are just a few illustrative examples. Drug use, particularly marijuana and cocaine, is common among the New York financial community as it is elsewhere. Jimmy Cayne of Bear Stearns, as we have seen was known in the financial industry as a heavy user of pot. He was also the victim of a less insidious addiction; Cayne was such a fanatical bridge player that he was away at a tournament at the time of the collapse of the Bear Stearns hedge funds. It is true that Cayne was a Republican; however he was so lacking in partisanship as to be on good terms with his Democrat associates and to contribute to the campaigns of ultra-liberals Chuck Schumer and Charles Rangel.  Another CEO of Bear Stearns was a staunch liberal. Ace Greenberg, for many years head of Bear Stearns “had once donated $1 million to a hospital so homeless men could enjoy sex by having access to free Viagra.” And he proudly announced this bizarre charitable endeavor in the New York Times.[57]


Donating for homeless sex may be strange and amusing, but at least it is a straightforward expression of liberal ideals. Hypocrisy is a rather more troubling aspect on the part of the liberal financial elite, as illustrated in the following tale from nursery school. To obtain the support in a boardroom fight from one of his executives, Jack Grubman, Sandy Weill contributed $1 million from Citigroup to an elite Upper East Side nursery school that Grubman was trying to get his twin children into. Hedge fund manager and former investment banker Richard Bookstaber comments on the affair: “The competitive nursery school phenomenon is a New York singularity that is difficult for normal folk to fathom. Many of those parents fiercely competing for spots for their children are simultaneously pushing for diversity, affirmative action, and social equality on many fronts; it’s just that the public school down the street is not one of them. … The focus is on entering the exceptional parent body and the privilege of paying $20,000 or more a year to connect to the high-society play date underground.”[58]


Another instance involves a jet-setting foreigner who, with frequent trips to New York must be accounted an honorary member of the New York liberal financial leadership. Dominique Strauss Kahn, a French economist, lawyer, politician, and member of the French Socialist Party became Managing Director of the International Monetary Fund in 2007. Long time socialist Strauss Kahn became a darling of liberals as he sought to reform the IMF and make it much friendlier to developing nations. Liberal economist Joseph Stiglitz was one of those who heaped praise on the new IMF director. Stiglitz asserts that under Strauss Kahn the IMF began the reform of its lending process finally recognizing the need for Keynesian stimulus policies. “Its managing director explicitly talked about the risks of premature removal of stimulus”.[59] Given the scandal of Strauss Kahn’s tryst with a maid in a New York hotel in 2011, Stiglitz’ choice of words proved to be particularly prescient. The ironies in this tale are wondrous to behold. A jet-setting liberal international financial bureaucrat becomes head of the IMF, sets out to end its unfairness to developing countries including the impoverished nations of Africa and is lionized by his fellow liberals in finance. While visiting New York on IMF business he has an encounter with an African hotel maid, one of many immigrants admitted to the U.S. on rather dubious asylum claims, who subsequently accuses him of rape. Truth is indeed stranger than fiction among the high finance set.


Ideology in Action


The kingpins of finance, as much as any other leadership elites, are characterized by the long march through the institutions. Wall Street may not be as much inclined to liberal notions as Hollywood or academe, but these all share the worldview prevalent among students of the 60s, 70s and 80s. With varying degrees of dislike for American culture Wall Street executives, along with many others in the corporate elite are enthusiastic proponents of diversity, multiculturalism and affirmative action. In addition the commitment to globalism is one that unites the liberal elite with that of their mainstream conservative counterparts. Financial leaders along with their friends in government are happy to promote policies that serve their own personal interests in terms of fashionable clichés. Thus, Bill Clinton, commenting on the repeal of Glass Steagall eagerly pointed out how it was designed to help the new information age globalization economy.[60] Everything must be cast into these terms, no matter how much in reality these may serve the financial interests of the elites. There was great idealism expressed by the Sandlers, Angelo Mozilo and others as they spoke in lofty terms of how their new innovations were in the service of social justice while in reality these were in the service of their own bank accounts. The wealth should indeed be spread, as long as it is not their own. Other characteristics that typify this class are the failure to learn through experience, cognitive dissonance, self-censoring of unacceptable thoughts, self-righteousness and, of course, a large dose of liberal guilt.


Long March from the 60s


On Wall Street, as elsewhere, the new left student generation followed the prescriptions of Alinsky and Gramsci who advocated a "long march through the institutions” to capture the media, universities, foundations and legal system; also included were the major corporations. The new generation of Wall Street leaders considered themselves to be capitalists, but also progressives willing to use their money to support the left wing agenda. In fact, the current Wall Street executive class has a lot in common with Obama’s idealistic young supporters; they are far more progressive than their predecessors of previous years. The only thing that may distinguish them from their liberal peers “is that they rarely shy away from an opportunity to turn a profit, especially when turning that profit allows them to satisfy their social consciences at the same time.”[61] One illustration of this marriage of business and progressivism occurred in 2011 at the Obama White House. CEO of the Business Roundtable John Engler, CEO of Cargill Greg Page, COO of Facebook Sheryl Sandberg, former Republican Senator from Florida and current JP Morgan Chase executive Mel Martinez were all present to discuss ways of building support for a new illegal alien amnesty.[62] The presence of Martinez shows the continuing commitment to ‘diversity’ on the part of Dimon and JP Morgan Chase, as well as the adoption of the progressive outlook by supposedly conservative Republicans.


In the long march from their student days to the executive suites, the progressive business elite has followed the strategy set forth by radical thinker Saul Alinsky who urged them not to reject middle class values but to transform them. “If the same predatory drives for profits can be partially transmuted for progress then we will have opened a whole new ball game. I suggest here that this new policy will give its executives a reason for what they are doing – a chance for a meaningful life.”[63] So the drive to end poverty and discrimination has been adopted by many if not most of those who have climbed the ladder to the top of the corporate structure. Furthermore, the “writing of middle-class organization had better be on the walls by 1972.”[64] And indeed that year marked the effective end of graduation for the 60s radical collegians and also marked the beginning of their migration into positions of institutional power. And they were soon joined by additional radicalized cohorts throughout the 70s and into the early 80s. As it turned out converting many middle class Americans to the new progressive outlook, particularly the lower middle class of skilled workers was no easy task. So to speed things up the new radical elite also embarked on a simpler strategy – elect a new people.


Affirmative Mortgages


A policy that directly evolved from the collaboration between the liberal bankers, politicians and regulators, and was the precipitating factor in the financial meltdown, was affirmative action in home ownership. As we have seen the Wall Street crowd loves big government and the profits it brings them. And there was much profit to be made from the Clinton administration’s prodding for the expansion of mortgages.


The profit potential in subprime affirmative mortgages was seen early on by Angelo Mozilo CEO of Countrywide Financial. Mozilo was a particular friend of Barney Frank and Chris Dodd, providing them with sweetheart mortgages but did tilt slightly to Republicans in his contributions. Mozilo created his own mutual fund company as an investment vehicle for his clients. He also pushed to expand the subprime market to include more working-class neighborhoods, particularly in California, Nevada and Florida. He “believed that working-class families, many of them minorities and immigrants were truly shafted by Wall Street.”[65] Barney Frank was able to secure approval of many pieces of deregulation which were beneficial to Mozilo and his fellow mortgage financiers. One might surmise that the deal the politicians made with the Street and the GSEs was to deliver deregulation in return for subprime mortgages.


Fannie Mae and Freddie Mac were allied with Mozilo, Dodd and Frank; the GSEs, in addition to guaranteeing and securitizing mortgages, and with the protection of Dodd and Frank held large amounts on their books.[66] It was an ingenious three way trade; Mozilo provides sweetheart deals to Dodd and Frank who in turn allow the GSEs to hold large amounts of mortgage debt originated by Mozilo and other mortgage bankers on their books. There was also a tight web of personal relationships connecting Fannie with Citigroup, the New York Fed, the Federal Reserve, the Treasury and, of course the ever-present Goldman Sachs.  Arnold Ahlert outlines these connections:


In 1996, Fannie added Stephen Friedman, the former chairman of Goldman Sachs, to its board. In 1999, Johnson [onetime CEO of Fannie] joined Goldman’s board. That same year Henry M. Paulson Jr. became the head of Goldman and was in charge when the firm created many of its most disastrous securities–while Geithner’s New York Fed looked the other way. As the Treasury secretary under George W. Bush, Paulson would oversee the taxpayer bailout of Fannie Mae, Freddie Mac, Goldman, Citigroup, other banks and the giant insurer American International Group (A.I.G), on which Goldman had relied. As head of the New York Fed, and then as the Treasury secretary, Geithner would also oversee the bailout.[67]  


As we have seen Angelo Mozilo leaned toward the Republicans but he was either of the liberal or else of the Bush/Rove compassionate conservative variety. Democrats were the major players in the affirmative mortgage game but were assisted by a number of Republican enablers. Jack Kemp HUD secretary in the George HW Bush administration was the first to push the idea of ‘empowerment zones.’ His successor under Clinton, Henry Cisneros pushed that initiative much further as he used the housing agencies to help the poor obtain mortgages. He was determined to eradicate poverty by “mandating laws to force banks to lend to those most in need and with the least ability to pay.”[68] The ‘compassionate conservatives’ of the George W. Bush administration echoed the Clinton policies as they attempted to pander to groups previously hostile to them. Bush and his advisor Karl Rove also labored under “our reigning ideology of multiculturalism and diversity” thereby contributing to the “minority mortgage meltdown.” As blogger and one-time financial analyst Steve Sailer put it: “You might think, therefore, that the way to help minorities make higher wages would be to alleviate competition for their jobs by cracking down on legal and illegal immigration. Bush and Rove didn't have a plan for helping minorities earn more. Instead, they had a plan for helping minorities borrow more.”[69]


The leaders of Wall Street were well aware that the housing crisis was the result of government policies pushing homeownership.[70] Nevertheless, they understood that it was necessary for their accomplices in government to make a public show of outrage with investigations and financial reform proposals.  Thus, Congresswoman Maxine Waters, whose husband owned stock in a bank that received a taxpayer bailout, lashed out at a group of bank CEOs appearing before her house committee. “The irony of Waters’ vitriol is that she, with other class-warfare types, was maybe just as responsible as the Wall Streeters for starting the crisis she was now investigating” as “a huge proponent of the Community Reinvestment Act and other measures that forced banks to lend to poor communities for housing.”[71]


Wall Street and Diversity


It was obvious to anyone working on the Street or in any institution dealing with the Street and the major banks that diversity has been an obsession for at least thirty years. Any reasonably intelligent and presentable African-American or other minority was worth his weight in gold on the Street. The same applies to recent immigrants and to women.  Charles Gasparino tells an illuminating tale about the adverse impact of the ideology of diversity on the once prestigious Merrill Lynch. Having worked in the 80s and 90s at the Federal Reserve Bank of New York I have seen similar examples of such affirmative action favoritism, though of less obvious impact.


Stan O’Neal, grandson of a slave, grew up in the segregated south where he experienced racism and segregation. An excellent student he worked at the General Motors finance department before he was recruited into the investment banking division of Merrill Lynch in 1986. Smart, aggressive and capable of much charm he advanced rapidly through the ranks of management eventually becoming CFO. However, he believed that he was being held back and would often either not show up at work or threaten to quit; each time he was given a raise and induced to stay. Finally in 2001 O’Neal was named president by CEO David Komansky. He had proved himself an effective manager, cutting costs and increasing productivity. “The bad part, to Komansky, was that O’Neal had made it known that Mother Merrill – a culture he considered more racist than paternalist – would be out the minute he was named CEO.”[72]


Building a base of support on the Merrill Board O’Neal succeeded Komansky as CEO in 2003. He set about attacking Merrill’s traditional white working class Irish Catholic culture that went back almost a century. As early as 2000 he began firing many workers in the brokerage departments; in addition to resenting their presumed racism, O’Neal with a Harvard MBA was an elitist determined to bring in more highly educated technocrats. “O’Neal believed that Mother Merrill was not just idealized and ill suited to modern  times but bred a certain degree of racism at the firm and hampered the firm from being what it needed to be in order to survive: a truly modern, international, meritocratic company. “[73]


O’Neal ignored the advice of Merrill market analysts and the head of global wealth management Robert McCann who saw that the housing market was in a bubble. “In O’Neal’s mind … McCann represented … the dark years when Merrill Lynch had eschewed risk, instead selling stocks through its brokers, while the firm was run by a club of Irish-American drunks … who had gotten their jobs through the patronage of ‘Mother Merrill’ and who could barely contain their racism as an outsider like O’Neal rose through the ranks to become the first African American to run a major Wall Street firm.”[74] To help him carry out his ambitions of entering the lucrative mortgage bond business and to turn Merrill into a diverse multicultural institution O’Neal promoted Dow Kim a trader from Korea to head the bond department and Osman Semerci a young salesman of Turkish descent to head fixed income. His most important appointment was that of Egyptian-born quant, Ahmass Fakahany who became his chief operating officer and principal adviser. The lack of experience and thin resumes of this diverse new team was a cause for concern to the firm’s old guard. One of Fakahany’s first acts was to attack Merrill’s traditional white Euro-based culture by turning the dining room into an Asian restaurant.[75] Although his new initiatives met with resistance from the old guard, “O’Neal was unimpressed by them all, in fact by just about anything that is, except for himself, which made his tenure as CEO of Merrill Lynch … one of the strangest, most volatile, and ultimately most disastrous that Wall Street had ever seen.”[76]


O’Neal and his diversity protégés were very well paid for their maladministration.  In 2006 O’Neal earned a $50 million bonus with Fakahany and Dow Kim not far behind. None were required to repay their bonus money after the great meltdown took Merrill with it.[77] Their war against the white middle class was very profitable. Furthermore it was the taxpayers who ultimately paid for their remuneration; in this particular case it was just another cost of diversity. When the crunch came O’Neal blamed one of Merrill’s long-time senior risk managers, who in this case was simply the messenger bearing bad news. But the ones who were more to blame were O’Neal for his overall strategy plus Fakahany, Semerci and Dow Kim with direct responsibility for faulty risk management.[78] O’Neal scapegoated the tech who actually knew what he was doing instead of his own ‘rainbow’ upper management.


The final irony to this sad history came when Henry Paulson hearing of O’Neal’s resignation was effusive in his praise telling O’Neal that he should be proud of his attempts to change the firm’s culture and make it more competitive.[79] Coming from the ‘Republican’ Hank Paulson such praise is quite illuminating; diversity trumps all even making the bankruptcy of an old prestigious firm and the economic catastrophe it helped bring about irrelevant. O’Neal was a man with a strong grievance regarding alleged racism combined with a sense of entitlement which his superiors were all too eager to appease. Seventeen years was certainly not a long time to rise to the head position despite his incessant complaining. All indications, however, are that O’Neal was a highly intelligent, effective and competent CFO. But he was totally unsuited to the chief position at Merrill given his racial resentments and outsize ego. His advancement was the result of affirmative action as was the choice of his chief aides; all of which resulted in disaster for a venerable and once respected firm.


Lehman Brothers was another Wall Street firm that was ill served by diversity hiring and promotion practices in the time just before the meltdown. Joe Gregory, second in command under CEO Fuld made an ill-fated hiring decision. He “believed a senior executive named Erin Callan was the complete package: smart, loquacious, and very attractive. She mixed well with clients and she was also a woman, something Gregory saw as an asset in terms of diversity given the male-dominated world of Wall Street. More than anything she bled Lehman green, meaning she shared Fuld’s and Gregory’s enthusiasm for risk, and Gregory trusted her. Gregory let it be known that Callan, currently the head of hedge fund sales, was going places. Within a few months she was named CFO of Lehman.”[80] Callan had no background in quantitative risk management techniques. However with her charisma and movie-star appearance she was useful to Fuld in his spin job as he attempted to keep Lehman from imploding. But the mask was soon removed as some experienced market analysts realized how lacking in experience and substance she really was. At an interview with analyst David Einhorn, Callan struggled to “answer simple questions about the firm’s financial condition.”[81]


A less well known example of Lehman’s (and the Street’s) diversity hiring obsession is the case of a Haitian immigrant who began working as a telemarketer at 18 and then joined Lehman Brothers becoming a VP before she actually finished her degree. She “had an illustrious 20-year career that included leadership of innovative programs to enhance diversity and inclusion. She retired from Lehman Brothers in 2008.”[82] Having helped Lehman rearrange its diversity deckchairs just before it struck its financial iceberg, the onetime student telemarketer, in a fortuitous case of excellent timing, left Lehman just before the bust. Also worthy of note is that the story was written totally without a sense of irony.


Citigroup had its own ‘Erin Callan’ when Sandy Weill appointed Sallie Krawcheck to the CFO position “despite her lack of experience”.[83] A final illustrative example, as previously discussed, is the case of Franklin Raines who earned some $90 million in the 6 years between 1998 and 2004 as Fannie Mae head. An accounting scandal brought his tenure to an end with very little press outcry since Fannie was working for social justice.[84] The fact that Raines is black also helped, no doubt, in his original appointment as well as in his favorable press coverage. The preceding examples, to reiterate, are typical of the widespread diversity practiced by all of the financial firms and regulatory authorities.


Remember Everything and Learn Nothing


It is true that there has been some unease on the part of the financial community with the Obama administration given both the state of the economy and the continuing anti-Wall Street rhetoric. Nevertheless, support for the current administration is still very strong on the Street. Following the election, donors from Wall Street paid almost $5 million to underwrite Obama’s inauguration.  Among Obama’s most prominent 2012 bundlers are the scandal-ridden Jon Corzine, Azita Raji, a former investment banker for JP Morgan; and Charles Myers, an executive with the investment bank Evercore Partners .[85] Top finance industry connected fundraisers also include UBS executive Robert Wolf, hedge-fund manager Orin Kramer and former chief of staff, William Daley.[86] Kramer and Wolf, as we have seen are long-time Obama loyalists; Daley as previously noted has served as a bridge between the Chicago Democrat machine and JP Morgan Chase.


So far Obama has retained persistent support from many of his former financial and banking sector contributors. Obama’s fundraising reach even extends to Romney’s one-time turf, Bain Capital where he has outraised Romney by two to one.[87] Employees of bankrupt MF Global, loyally following their chairman, have raised over $100,000 for the Obama campaign; one MF Global trader broke with the pack by sending the Romney campaign a $2,500 check. Another major current source of cash for the Obama campaign is Chicago-based Chopper Trading, which employs a controversial high-frequency trading technique thought to increase market volatility and to be the cause of the 2010 market “flash crash.” Its head Raj Fernando recently held a fundraiser with Vice President Biden raising at least $200,000 for the Democrats. Employees of Credit Suisse, under investigation for alleged tax evasion schemes, have contributed almost $50 thousand to the Obama campaign.[88]


Furthermore, just as many on Wall Street are continuing their support of ‘progressive’ politicians, their friends in government have failed to learn the lessons of the subprime meltdown. The Department of Justice is once more pressuring banks to make risky mortgage loans to minority applicants. A new DOJ agency, the Fair Lending Unit, has been created toward that end and has already achieved results in strong-arming banks to provide minority mortgage set-asides. The banks continue to be caught in a double bind. “On one hand, it is against the law for banks to compile data on race, gender or age for nonmortgage loan applications. On the other hand, the Home Mortgage Disclosure Act requires the compilation of such data.” The DOJ expects the banks to collect the very data that will be turned against them. As one regulatory risk consultant observes: ”If we do an analysis and it suggests that fair-lending risk exists, those analyses can themselves be risks.”[89] It appears that the stage is being set for further trouble in the mortgage market.


Politicians, Crony Politics and Capitalism


Crony capitalism is nothing new in American economic and political life. As explained already, Wall Street and the large banks have for the most part had their way in the political process for the two decades preceding the financial crisis and also in the years since. The government sponsored housing agencies, Fannie Mae in particular, were the crony capitalist corporations par excellence in the years leading up to the crisis. In the mid-1990s the Clinton administration initiated a partnership between the private mortgage sector and Fannie and Freddie to encourage home ownership. Government backing, a de facto subsidy, enabled the agencies to pursue that objective while simultaneously enriching top management. Fannie management was assisted in that by such political friends as deputy Treasury Secretary Lawrence Summers, the apt pupil of master government-financial industry go-between Robert Rubin, and also by Republican operative Kenneth Starr, the former solicitor general. To assure continued cooperation between the agencies and government Clinton in his final year stacked the agencies with prominent Democrat political operatives; Rahm Emanuel, Harold Ickes, Dwight Robinson at  Freddie Mac and Jack Quinn, Eli Segal, Jamie Gorelick, Franklin Raines at Fannie Mae.


Favors being exchanged between politicians and management at government sponsored corporations are not unexpected. However, much of Wall Street and banking was turned into one big Fannie Mae with financial corporations carrying out government policy in exchange for favors accompanied by a back and forth flow of personnel. When Wall Street and the banks wanted deregulation they found friends on both sides of the aisle willing to assist. We have seen how Robert Rubin helped Sandy Weill of Citigroup achieve his desired repeal of Glass-Steagall which was an obstacle to Weill’s ambitions to expand his reach into financial trading.  Rubin found an ally in Republican Phil Gramm, chairman of the Senate Banking Committee from 1995 through 2000. In 1999 the Gramm-Leach-Bliley Act repealed Glass-Steagall which dates from the early Depression-era and which separated commercial from investment banking. Gramm followed up by supporting another favored Clinton initiative the Commodity Futures Modernization Act which, among other things, exempted over-the-counter derivatives transactions, notably credit default swaps from government regulation. It was no great surprise when Gramm moved into a position with a major financial firm, UBS AG, in 2009. Gramm’s economist wife, Wendy, headed the Commodity Futures Trading Commission from 1988 to 1993. During her tenure the CFTC exempted Enron from regulation in the trading of energy derivatives; soon afterward she left the CFTC and accepted an appointment to Enron’s board of directors.


Financial Reform


Following the financial meltdown the political class tried to distance themselves from their one-time Wall Street friends; even such a useful tool as Senator Schumer attempted to tie the greedy bankers to the Republicans. Talk of reform was in the air; one proposal was that the firms spin off their derivatives units. However, worries on the Street were premature. As the legislation took shape it was apparent that there would be no breaking up of the banks and no mandate for the big banks to spin off their trading units. Banks would be required to hold greater capital reserves against the possibility of systemic risk. Banks would also be given breaks on capital required to be held for community based socially responsible lending and Fannie and Freddie would be relatively untouched.[90] Clearly no lessons were drawn from the subprime collapse.


Furthermore, the Fed was to be given overall regulatory control with expanded powers; the bureaucrats at the Fed were to be given a second chance despite their failure to use their existing powers prior to the meltdown; the SEC was also given enhanced regulatory authority.[91] That failure was, as we have seen, a result of the incestuous relationship between the regulators and the firms; the crony regulatory agencies will be treated in greater detail below. Wall Street ultimately backed the bill understanding that the new regulation can be molded to protect the powerful. Also implicit in the legislation was the ‘too big to fail’ loophole so beloved by Wall Street and the big banks. In addition the much touted Volcker rule would still allow the firms to earn hefty management fees.[92]


It was ironic that subprime pushers Dodd and Frank had their names on the new bill, and that Freddie and Fannie were untouched by the reform and slated for revival. Gasparino sums up the post meltdown spirit of ‘reform’ as follows. “In other words, on Wall Street the nanny state lives, no matter how many times the protection of the financial sector by the federal government has been at the heart of the massive risk taking that has led to thirty years of booms and busts, and ultimately the recent great recession that may not be felt on Wall Street, but continues to squeeze the lives on Main Street.”[93]


Friends in Democrat Places


Crony capitalism between the financial community and government has reached new heights under the current liberal administration. Vikram Pandit, CEO of Citi, by cultivating the friendship of administration favorite Jeffrey Immelt and by endorsing the administration’s proposed limits on executive pay helped steer his bank back to profitability. In addition JP Morgan, headed by Obama supporter Dimon, and Wall Street in general were also able to work with the administration.  In this they found a friend in Tim Geithner, the protégé of master crony Robert Rubin. Geithner, one of the architects of the 2008 bank bailout was so loved on Wall Street that his selection as Treasury Secretary sparked a stock market rally. The Street viewed this bureaucrat who spent his whole career in lower Manhattan with favor recalling that he always had a soft spot for Wall Street and the banks in spite of his lack of actual business experience.[94] Geithner’s sympathies did not extend to smaller businesses on which he was all too willing to raise taxes. While I had already left the New York Fed before Geithner began his ascension there, I am quite familiar with his “type”. The executives at the New York Fed were once aptly described to me by a long time staff member as a “bunch of smoothies.”


Federal subsidies for select favored friends in business are illustrated in the government – ‘green power’ complex. Democratic donor and frequent White House guest, billionaire investor George Kaiser received a half-billion-dollar stimulus subsidy for solar energy company Solyndra. Kaiser and the other wealthy Solyndra investors were put ahead of the taxpayers in the queue for recouping money from the bankrupt firm. Another bankrupt solar company Beacon Power received some $43 million in loan guarantees from the Energy Department. Beacon CEO William Capp was a major Obama and Democrat campaign contributor. Also included among the favored Greens were John Rowe of Exelon who has close ties to Obama advisors David Axelrod and Rahm Emanuel and Frank Clark of ComEd; Clark was an Obama campaign advisor and major fundraiser.[95]

The Social Justice Brigade

The most important set of actors who set the stage for the great subprime meltdown and subsequent recession were the true believers in ‘social justice’ in government and in non-profit advocacy groups. Unlike the financial community liberals and those passing through the government-Wall Street revolving door, this group of bureaucrats and advocates spent most of their careers outside of the business sector. Moreover, many of these did not reap outsize financial rewards.  Despite their apparent good intentions, it was greed of another sort that motivated them; the greed for power.
The Government Connection: High profile culprits
Among the highest ranking housing bureaucratic culprits were Janet Reno, Henry Cisneros, Eric Holder, Andrew Cuomo and Mel Martinez. Reno, Clinton’s Attorney General was the first to enforce the Community Reinvestment Act (CRA) by intimidating banks with threats of legal action if they did not give loans to unqualified borrowers. Her deputy, Eric Holder, helped Reno in her war against the banks. HUD Secretary Cisneros pushed the CRA initiative by using the housing agencies to help the poor obtain mortgages. Cisneros was one bureaucrat who did rather well after leaving office; he received more than $5 million in stock sales and board salary from Countrywide. Maggie Williams, Hillary’s chief of staff was another bureaucrat who did well in the mortgage industry; she went on to make $200,000 serving on the board of soon to be bankrupt subprime lender Delta Financial Corporation.[96]  Of course, compared to other high ranking former bureaucrats like Raines, their remuneration was rather modest.
However, it was Andrew Cuomo, Cisneros’ successor who made the most crucial decisions that gave rise to the mortgage meltdown. He pushed Fannie and Freddie into the subprime markets and turned the Federal Housing Administration mortgage program into a sweetheart mortgage lender. Cuomo was close to the Mortgage Bankers Association; these had the long-time goal of pressuring the GSEs into supporting more affordable housing. Cuomo helped out his mortgage banker supporters by enabling their use of yield-spread premiums, payments to brokers based both on the borrower’s actual rate and the going rate that they would otherwise pay. This boon to his supporters shows that Cuomo was willing to put his political pragmatism above his principles. He cultivated support for his New York political ambitions with Harold Ickes, former Clinton chief of staff and a Democrat power broker who was on the Freddie Mac board and Tom Downey, a former New York congressman who was a Fannie lobbyist. Cuomo’s political pragmatism is also shown by his friendship with an equally protean New York politician from across the aisle. Former Republican Senator Al D'Amato helped push Cuomo’s appointment through the Republican controlled Senate; D'Amato was a consultant at Fannie.[97] At present New York Governor Cuomo is trying to establish a niche for himself as a fiscally responsible Democrat; no doubt with future high office in mind.
Cuomo’s HUD successor, Republican Mel Martinez continued to push these housing goals by carrying out the Bush/Rove policy of putting greater emphasis on Hispanic immigrants as affordable housing beneficiaries. The end result of these initiatives by the Justice Department and Housing and Urban Development was that the GSE’s were forced to carry out the policies of Washington elected officials. The mortgage bankers such as Angelo Mozilo made out quite well. The politicians were rewarded with easy votes and the GSE management was, of course, very well compensated for complying. The banks and Wall Street did quite well, for a while at least, devising new instruments and trading strategies for spreading the risk around.
Second Tier Bureaucrats
None of these marvels would have been possible were it not for the diligent work of a number of second tier government bureaucrats. One such was John Trasvina, the highest ranked Hispanic in the Reno Justice Department who is now, as HUD assistant secretary, pushing the banks and the GSEs to return to ‘fair lending’ practices.[98] Michael Waldman was a community activist hired by the Clinton administration to coordinate housing strategy with groups such as ACORN. Eugene Ludwig, an advocate of a ‘democratization of credit’ database and former Clinton classmate became Comptroller of the Currency.  A one-time law partner in Holder’s law firm, he now advises the Obama administration.  Paul Hancock was chief of housing and civil enforcement inside the Reno Justice Department; he originated the fair-lending enforcement program. Following his doing ‘good’ in the Clinton administration he did quite well for himself as an attorney helping lenders deal with the very regulations he helped to set up. William Apgar was Cuomo’s senior advisor; following the crisis he is once again an advisor on mortgage finance at HUD where he proposes extending the CRA to other financial institutions involved in lending. Allen Fishbein, Apgar’s assistant, criticized the Bush administration for not cracking down on the very Fannie and Freddie subprime mortgages that he helped set up in the first place. Phil Angelides, in a case of the fox guarding the henhouse, was made Chairman of the Financial Crisis Inquiry Commission. Previously he was California State Treasurer where he pushed California public employees’ retirement systems to invest in urban communities, a policy that resulted in substantial losses.[99] The theory behind the governing class giving that role to Angelides was very much like the appointment of Jamie Gorelick to the 911 Commission; who better to cover up a crisis than someone who helped to enable it. Clearly Angelides and the others are all members of the permanent government.
Two more important diversity bureaucrats were Roberta Achtenberg and Alicia Munnell. Achtenberg, a onetime radical gay activist and product of the UC Berkeley law school was HUD assistant secretary in the Clinton administration. She zealously cracked down on ‘racist’ banks; she set up a “strike force” to root out discrimination.[100] She stretched civil rights laws beyond their elastic limit going after banks and intimidating private citizens opposed to her various low income housing initiatives.
Achtenberg cited the work of Munnell in support of her view that the banks were hotbeds of racism.  Alicia Munnell, another stalwart of the diversity gang was a long time Boston limousine radical. Economist Munnell was a Wellesley college graduate married to a corporate lawyer. She was a believer in punitive taxation, although it is probable that such taxation would be selectively directed against the American middle class and not against well-heeled Bostonians. She actually proposed a 15% tax on private pension assets and retirement accounts to help redistribute wealth. A friend of Hillary Clinton who served on the Clinton health care task force, Munnell became director of research at the Federal Reserve Bank of Boston where she authored the notorious Boston Fed housing discrimination study. This study, to be discussed in more detail in the next chapter, was one of the foundation stones of the affirmative mortgage initiatives. Federal Reserve Governor Lawrence Lindsey pushed banks to accept her Boston Fed study; Cuomo later cited her report as supporting the goals he imposed on the mortgage lenders.[101]
Advocates, Activists and Organizers
Community organizers, academics and other non-profit entities have been the most important advocates for ‘housing justice’. There was an unusually large concentration of these activists, in and out of government in the Boston region. Wade Rathke, of ACORN attended the elite Massachusetts Williams College. Other elite members of the privileged Harvard/Boston/ academic white elite in this camp include the above cited Alicia Munnell a Wellesley grad and later professor at Boston College; and Elizabeth Warren from the Harvard law faculty who is now a candidate for the Senate. It is also noteworthy that these advocates’ best friend in Congress, Barney Frank is from upscale Newton Massachusetts. The following are the major subprime-pushing nonprofits; their impact has been aptly characterized by Paul Sperry as follows: “The banking industry has forked over billions to these race-baiting parasites.”[102]
The Neighborhood Assistance Corporation of America and its founder Bruce Marks believes that owning a home is a ‘right’; they have been quite successful in shaking down banks. Another successful bank shakedown group is the National People’s Action Network based in Chicago one of whose founders is Obama mentor, Northwestern University professor John McKnight. One of their actions was the picketing of Cuomo’s offices; he was not sufficiently zealous in pursuing housing justice for their taste. The Greenlining Institute was a San Francisco based advocacy group. They induced California state treasurer and future chairman of the Financial Crisis Inquiry Commission, Phil Angelides to persuade California public employees’ retirement systems to invest in urban communities. Many of these investments resulted in ruinous losses; thus the chairman helped fuel the very financial crisis he was tasked with investigating. Another activist group was the National Community Reinvestment Coalition which successfully lobbied the GSEs to increase their low-income mortgage targets. The group was founded by John Taylor who later earned hundreds of thousands of dollars as chairman of a mutual fund which invested in such mortgages.[103] It appears that this housing activist turned into one of the much hated ‘banksters’.
Perhaps the best-known of these activist organizations is the now disgraced ACORN. This organization used intimidation tactics to force banks to lower credit standards.  ACORN's Democrat friends in Congress assisted them in inducing Fannie and Freddie to increase subprime lending. It was largely due to the influence of ACORN and other advocacy groups along with the Democrats in Congress and the Clinton administration in pursuing housing  ‘fairness’, that the subprime contagion spread throughout the entire financial system.[104]  ACORN first attacked the banks for not lending and afterward accused them of predatory lending; Wells Fargo and HSBC were their particular targets. One HSBC bank executive said of them: “They drove us into minority communities and now they say we’re too aggressive.”[105]

Sins of the Regulators

Failure on the part of the agencies tasked with financial regulation was another major contributing factor underlying the economic meltdown. The Securities and Exchange Commission, created in 1934, is charged with the responsibility of regulating the securities industry and the nation's stock and options exchanges. In the 1930s the Agriculture Department was given regulatory authority over commodities options and futures markets. In 1974 the Commodities Futures Trading Commission was established to assume authority over the commodities markets. In 1981 an accord was reached between the SEC and CFTC dividing jurisdiction over financial futures and options. The Federal Reserve System, established in December 1913, also has broad regulatory jurisdiction over both banks and financial markets. The Federal Reserve Board supervises and regulates the operations of the Federal Reserve Banks, and the U.S. banking system in general. It also has the authority to set margin requirements on securities. The Federal Reserve Bank of New York is charged with broad regulatory authority over the important New York financial markets.
The task of regulation has always been difficult; in recent years globalization, rapid trading and tightly coupled markets have made it more so. Given internationalization and modern technology regulation can easily drive markets to relocate abroad. “The Fed and other regulators face the delicate task of ensuring and promoting the stability of the financial system while not choking off a profitable line of business for many banks.”[106] In the new financial environment systemic risk has become the major concern. “A failure of one counterparty to meet the terms of its contract … may threaten the solvency of its counterparty. The threat would be significant in a situation in which many counterparties, hit by a severe macroeconomic shock like a sudden large drop in asset prices, are unable to fulfill their obligations. In the extreme, this development could set off a domino effect of defaults that could trigger a financial panic or collapse.”[107]
Capital Adequacy
Holding sufficient reserves of capital is the sine qua non for minimizing systemic risk. Banks are always seeking ways of minimizing capital which is tied up in reserves and not contributing to profit. Off-balance sheet activities are one means of evading capital requirements. These include letters of credit and guarantees, as well as new innovations outlined in the previous chapter: swaps and derivatives. Their increased importance beginning in the 1980s attracted the attention of bank regulators whose   concerns centered on credit exposure, interest rate and currency risk. Off-balance sheet and derivative operations can worsen market instabilities arising from maturity and currency mismatches. Bank regulators have been particularly concerned about the possibility that widespread defaults would occur in a bank’s swap portfolio. The bank as swaps dealer loses if a rise in interest rates leads to a default by the floating rate payer or if a fall in interest rates leads to a default by the fixed rate payer. The regulators “have recognized that many institutions under their supervision take on large market risks, primarily interest rate and currency exposure, in making markets and trading in swaps.”[108] Structured Investment Vehicles were another means through which banks could avoid rigid capital requirements by moving the debt off of their balance sheets. These large bond funds allowed short-term paper to be sold to investors as a way of financing holdings of mortgage debt; Citigroup among others had billions of dollars of debt hidden in SIVs.[109] Moreover in the decade of the 90s the development of new futures contracts on such exotica as air pollution, shipping rates, major market indices and interest rate swaps were approved by the CFTC, adding to regulatory concerns.
The high degree of international interbank depositing implies that the problems of a single bank can systemically spread world-wide. In 1974 the failure of a number of banks severely affected the international financial markets. In response eleven major countries set up the Basel Committee under the aegis of the Bank for International Settlements (BIS). In 1983 the Committee called for sharing of information on banks by the various national regulatory authorities. They recommended that loopholes be closed, that regulatory agencies monitor foreign subsidiaries and branches and that better data be collected on multinational bank balance sheets.  In those pre-internet times at the Federal Reserve Bank of New York a data transmission link with the BIS was implemented; a New York Fed officer was assigned to the BIS in Basel to coordinate the cooperative sharing of information.
Persuading the different central banks and regulators to act in concert was not always an easy road to travel. In the early 80s the Federal Reserve failed to persuade the other members of the Basel Committee to impose reserve requirements on Eurocurrency.  Finally prompted by the Federal Reserve and the Bank of England the Basel Committee commenced negotiations culminating in the capital adequacy standards adopted in 1988. The Basel accord recognizes that off-balance sheet and derivative operations can worsen market instabilities arising from maturity and currency mismatches. The 1988 agreement provided for a transitional period until 1992 before going fully into effect. Such off balance sheet items as derivatives, standby letters of credit, and commercial paper guarantees were subject to capital ratio requirements.  In addition there was the requirement that banks devise effective checks in systems for recording foreign exchange transactions and positions and that these apply to all OTC trading markets in which banks participate. However, as financial economist Jane D’Arista observed: “The weakness in the strategy is its emphasis on the individual firm. It reinforces the lack of market transparency and increases the likelihood that … gaps in a firm’s recording and monitoring system may go unnoticed, resulting in large losses (Daiwa) or failure (Barings) and increasing the potential for systemic repercussions.” Furthermore, such capital adequacy regulations are likely to be useless in a liquidity crisis and also dangerously pro-cyclical by supplying capital to the banks in a boom and withholding it in a downturn.[110] An illustration of the provisions is the requirement that banks maintain 8% capital against their risk-weighted balance sheet and off-balance sheet items. The weights are zero for riskless assets, cash and government securities and 20% for bank CDs; home mortgages receive a 50% weight. Considering how risky the latter turned out to be, this weight was clearly too low. Some of the details of the Basel requirements along with an overview of the methodology used at the New York Fed to obtain these are given in Appendix 5.
Thus, the basic idea behind the new BIS regulations was that the central banks including the Fed would force their banks to hold more equity capital; the banks would be required by their own central bank to see that swap and foreign exchange positions were well managed.  However, the system was continually evaded by rogue traders. “Large-scale money center banks routinely had hundreds of billions of dollars of contingent liabilities on their books as a result of swaps.  These amounts often dwarfed the banks’ combined capital and assets. Traders knew that these contingents would only become real liabilities if they were forced to assume the entire principal amounts of their swap partners, which was an extremely unlikely possibility.”[111] In April 1993, following the year that the Accord was fully implemented several changes were proposed. Capital requirements were applied to trading positions in equities, debt securities, foreign exchange and derivatives. On the other hand the regulatory restrictions that helped in the past promote the growth of the Eurocurrency markets were reduced.  The Accord was adopted by over one hundred countries promoting worldwide standardized and consistent regulations.[112]
Although the BIS regulations placed some pressure on the smaller banks they also sparked the entry into the swap and derivative markets of non-bank financial institutions unaffected by the regulations. These were primarily insurance companies such as Prudential Global Funding, Mercadian, General Reinsurance and the soon to be notorious AIG Financial Products. Highly rated banks took advantage of their ratings and of the exit of lower rated more weakly capitalized banks, to enter these markets; these included Deutsche Bank, Credit Suisse Financial Products and some Japanese banks.[113] Additional shortcomings of the new regulations continued to come to light with the passage of time. New York Fed president Gerald Corrigan continued to emphasize the need to review the regulation of off balance sheet activities, derivatives in particular. One criticism leveled at the Accord was its failure to fully address the means by which institutions manage risk in light of Modern Portfolio Theory which uses hedging and diversification. According to one of the leading experts on swaps the approach was one of “seeking protection against extremely large adverse moves in market factors rather than consistent and realistic norms for the probable movement in market factors.”[114] This was the viewpoint held by many working on the Street who, as future events would make clear, had a bit too much confidence in their valuation models.
In the years following the Basel Accord the world financial system has witnessed considerable turbulence. The 1994 Mexican bond crisis followed by the Asian instability and Russian bond crisis of 1998 led to the creation under the G7 of the Financial Stability Forum and the World Bank-IMF Financial Sector Assessment Program. Despite the Accord there were a number of massive corporate losses involving derivatives including a large loss by Paine Webber in mortgage based notes and, later on, the LTCM debacle which necessitated a Fed sponsored bailout. Critics pointed to a lack of comprehensive regulatory requirements and reporting on derivatives deals. In addition there were significant gaps in the regulation of securities firms, investment banks and the derivatives units of insurance companies.[115] Another area of neglect was the growth of asset securitization structures which distorted the measurement of the real risk undertaken by banks. Much future harm could have been avoided had some of these early warnings been heeded.
To address some of these concerns the Basel Committee in 1999 introduced a new capital adequacy framework. This consists of minimum capital requirements based on the original accord but also allowing large sophisticated banks to make use of their own credit ratings and portfolio models. The revised proposal also allowed for a supervisory review of capital adequacy which would encourage early supervisory intervention.  Finally, the approach will require market discipline to encourage higher disclosure standards and enhance the role of market participants in encouraging the banks to hold adequate capital.[116] Subsequent events revealed the woeful shortcoming of these initiatives. Even Bernanke in 2006 noted the inadequacy of the Basel capital standards in controlling the complexity caused by the growth of structured investment vehicles and other off balance sheet contrivances which played a major role in speculative excesses.[117]

Regulatory Failure
The failure to oversee and regulate the financial markets was a key factor in the subprime meltdown. On the macro level the Federal Reserve Board is charged with regulating the money supply.  A broad consensus among economists on both the right and left was that Greenspan’s rate cuts enabled the housing bubble to grow. Failure to curb excess liquidity combined with new ingenious methods of leverage caused the explosion in the balance sheets of banks. There was also wide agreement that the Board failed to use its powers to rein in subprime lending. Edward Gramlich, a Fed Governor, warned as early as 2004 that trouble was building up in the subprime market. [118] He was one of the few officials to recognize the problem at a relatively early date.
On the other hand, Greenspan continued to defend his policies even after the crisis. He commented in his memoir that while he recognized the increased financial risk of subprime borrowing and subsidized home ownership he believed that “the benefits of broadened home ownership are worth the risk. Protection of property rights, so critical to a market economy, requires a critical mass of owners to sustain political support.”[119] This reflects the viewpoint of cheap labor business interests. Not willing to curb massive Hispanic immigration as a source of cheap labor, Greenspan like members of the Bush administration offered them this bribe in return for votes; needless to say the strategy didn’t work. Van Overtveldt sums up this regulatory failure:
It is highly questionable whether the benefit of broadened home ownership sufficiently compensates for the costs brought about by the subprime meltdown and the subsequent financial crisis: recession, job loss, financial distress, debt overburden, and ironically, reduced home ownership due to foreclosures.  … Intelligent regulatory interventions could have substantially reduced the outstanding amounts of subprime lending.[120]
There was much accurate hindsight among various high regulatory officials following the onset of the crisis. Tim Geithner was one of those who had such great hindsight: “Our current system has evolved into a confusing mix of diffused accountability, regulatory competition, an enormously complex web of rules that create perverse incentives and leave huge opportunities for arbitrage and evasion, and create the risk of large gaps in our knowledge and authority.” Another high Fed official Janet Yellen, president of the San Francisco Fed, observed that “Financial supervisors and regulators including the Federal Reserve, were behind the curve as well. We missed some of the risky developments that were unfolding.  … And we took too long to ramp up some supervisory policies in the face of mounting risks.” Laura Kodres, a division chief at the IMF’s Monetary and Capital Markets Department, said “Supervisors had insufficient information and clout to halt the proliferation of overpriced securities.”[121] It was all well and good for these senior officials to have such post-meltdown insights, but none of them acted to build up the appropriate regulatory apparatus before the fact; Geithner, the former head of the agency most closely involved with Wall Street had been particularly clueless. However, almost none of those responsible for managing the nation’s money and credit foresaw the impending disaster.
It was in the area of such micro-regulation that the failure was even more pronounced. The failure of monetary policy combined with a neglect for timely regulation and an eager solicitude for the banks and financial companies helped the FIRE sector expand at the expense of an increasingly hollow real economy. The new Fed chairman Ben Bernanke had some awareness of these problems as he stressed the need for prudential supervision and regulation to address the problem of moral hazard ensuring that financial institutions manage their liquidity before a crisis; and for countercyclical capital adequacy rules so that institutions increase capital coverage during booms and decrease it during weak credit conditions.[122] Despite the indications that some regulators have since become more aware of the problems, one leading economist still has reservations: “Though there was often some reference to ‘systemic risk’ in explaining why some institutions got bailed out and others didn’t’, it was clear that the Fed and the Treasury had insufficient appreciation of what systemic risk meant before the crisis, and their understanding remained limited even as the crisis evolved.”[123]
The hedging innovations of the 80s did provide for increased liquidity and safety for managers of funds; however the problem of providing effective regulation increased. One emerging problem was the moral hazard created by insolvency. Leading financial economists of one regulatory unit, the Federal Reserve Bank of Atlanta observed:
Economically insolvent organizations have a great incentive to take large risks; such a bank will capture much of the gains while the FDIC incurs most of the losses if a venture fails. … The ease of buying and selling many assets, such as securitized mortgages, combined with the low cost of entering into off-balance sheet transactions, makes it possible for an institution’s exposure to change dramatically in a very short time.[124]
It would have been useful if their colleagues at the Federal Reserve and the regulatory agencies had followed up on that insight. On the contrary somnolence characterized the regulators during the decade of the 90s. It is true that the SEC investigated fraudulent activities in the municipal bond market but at the same time small investors were sold stock in dot com companies through misleading reports. Also the SEC and its chief Arthur Levitt was silent about the end of Glass-Steagall, a misguided act of deregulation which led to a massive increase in leverage on the Street culminating in the LTCM crisis.[125] And what might be said about the SEC was true of all of the regulatory authorities. In the 90s there was an acceleration of financial scandals due to malfeasance, poor judgment, moral hazard, complacent regulators and rogue traders as will be detailed below.
The rise of Structured Investment Vehicles (SIVs) was a prime example of regulatory failure. These are large highly leveraged bond funds sold by the big banks to finance holdings of mortgage debt. Citigroup and other large banks stashed billions of dollars of debt in these funds. In 2007 under the new mark to market ruling by the SEC, Citi had to disclose large losses in its SIVs. The regulators finally swung into action doing something that should have done long before these damaging losses. SIVs were part of the ‘shadow’ banking sector; a way of evading required capital by moving debt off the balance sheet. Analysts and economists at some leading financial institutions, as well as at the New York Fed had long warned about the risks of shadow banking. However, the leadership at both national and international regulators ignored these warnings. Under securitization and shadow banking risk became less visible and the tried and true system that financial institutions had developed for managing risk broke down under the weight of complex financial engineering. Also the rating agencies rated these new funds and instruments without proper modeling and assessment of their quality. Systemic risk was endemic in these instruments which were highly correlated with each other.[126]
Regulatory Arbitrage
In a larger context the SIVs are one example of 'Regulatory Arbitrage’. These resulted in large part from the capital requirements imposed by the Basel I agreements and a lack of a well thought out regulatory framework.[127] Regulatory arbitrage may be defined as exploiting loopholes in regulations through a variety of methods including business restructuring, relocation to more favorable business environments and the invention of new financial products. Renowned Wall Street economist Henry Kaufman points out that regulation encourages financial innovation which can be quickly put into place and spread with extreme rapidity. The growth of the Euromarkets, the expansion of financial centers and such new financial instruments as options, index futures, options on futures, and options on indexes were all a result of regulatory arbitrage on the part of the banks and Wall Street.[128]
The success of regulatory arbitrage may be summed up as follows:
As in so many other cases that would arise in the twentieth century, the markets proved themselves much more flexible and adaptable than regulators in reacting to new developments. Restricting old practices or products would simply effect new practices or products that Congress and the agencies would then have to learn at the risk of falling even further behind.[129]
Indeed, the success of regulatory arbitrage has often been cited to advance the argument for financial deregulation. However, regulatory arbitrage on the part of the banks enabled them to evade regulations by shifting risk and helped to fuel the subprime calamity. Thus the argument should be for more intelligent regulations as well as more knowledgeable and dedicated regulators.
Regulators to the Rescue: a Chronicle of Financial Crisis and Scandal
Financial scandal accompanied by regulatory failure which ultimately resulted in the rescue of important financial players is not a new phenomenon. However, in the two decades leading up to, and even prefiguring, the great subprime meltdown, these appear with increasing frequency; a sample of such failure follows. The resulting moral hazard played an important part in the events leading up to the crisis.
Municipal treasurers and managers became involved with Wall Street purveyors of complex financial products such as swaps. It never occurred to these public officials that they were playing in the big leagues with Wall Street employed academic specialists who had a level of sophistication beyond that of ordinary money managers. Nor were the Wall Street firms eager to divulge information regarding these products. The complex mathematical models they used were beyond the purview of both local officials and many regulators as well. In 1984 the San Jose municipal government presided over a $60 million loss in a reverse repo strategy. In 1987 an investment pool in West Virginia sued brokers for misleading advice causing a $300 million loss in derivatives trading. At the same time Auburn Maine announced a loss in the derivatives market amounting to 40% of the city’s funds. One official with an extremely overblown opinion of his own financial acumen was Orange County treasurer Robert Citron. With Merrill Lynch as broker he entered into a repurchase agreement with securities dealers resulting in a loss of $1.7 billion in 1994.[130] To defend itself before the SEC, Merrill claimed that it had simply served as a middleman for Citron and had no responsibility to impede his scheme. To the outrage of one SEC official Merrill was allowed to get off with no more than a slap on the wrist.[131] As we will see this was simply one example of the reciprocal relationship between the Street and the regulatory agencies.
That same year another scandal rocked the Street when Procter & Gamble and Gibson Greeting Cards sued Bankers Trust over losses from inappropriate derivatives trading at the bank’s advice. The crux of the matter concerned the amount of profit that was built into the complicated structure of the bank’s bid-offer spread.   One Bankers Trust trader, as outlined in a report issued by the CFTC, SEC, Fed and New York State Banking Department, was said to have used his mathematical ability to derive a formula that obscured the amount of leverage embedded in the derivatives.[132]
Meanwhile, across the pond the losses incurred by another rogue trader, a 25 year old employed by Baring Brothers, wiped out the venerable firm’s capital requiring that the Bank of England arrange its sale to a Dutch insurance group. The total loss amounted to some $1.3 billion. The problem was that Baring, as well as many of its counterparties did not understand derivatives. “The most startling part was that when the meeting was called at the Bank of England to sort out the mess, its senior bankers and regulators had no idea that a problem even existed until they were informed of it.”[133] Of course, the same lack of technical knowledge which characterized the Bank of England was also true of U.S. regulators. Nevertheless, the fact that cluelessness was not confined to American regulatory authorities is of some slight comfort.
The culminating financial debacle of the 1990s involved a firm run by sophisticated financial theorists. Long-Term Capital Management was founded in 1993 by John Meriwether, a former vice chairman at Salomon Brothers along with the Salomon alumni Lawrence E. Hilibrand and Eric R. Rosenfeld. He also recruited big time financial theorists and economics Nobel laureates Robert Merton and Myron Scholes. Another principal from the financial ‘old boys’ network was Fed former vice-chairman David Mullins. LTCM ultimately accumulated a portfolio worth $90 billion. The end began for LTCM in 1998 when the Asian crisis led to a Russian bond default. LTCM had devised a strategy of shorting Treasuries while going long on bonds from Russia and other developing countries. Following the flight to quality in the wake of the Russian default Treasuries rose and the yields diverged, thereby eroding LTCM’s capital. With the exposure of the major banks and Goldman Sachs as LTCM counterparties, Greenspan and the Fed swung into action. Firms were summoned to the offices of the New York Fed, an appropriate meeting place given that the Federal Reserve Bank of New York had notably failed to provide warnings regarding LTCM as well as past financial crises. Under the persuasion of the Fed, a cash infusion for LTCM of more than $3.5 billion, from a consortium of commercial banks and investment firms, was put together.
Henry Kaufman remarked regarding LTCM: “Surprisingly the firm’s analytical wizards apparently did not take into account some financial market fundamentals … that sizeable positions in individual securities cannot always be liquidated quickly, especially when the obligations are of weaker credit quality. And they misconstrued the complexities of convergence trade.” Furthermore, regarding the Russian default, this “was credit without a guardian. There’s the illusion that it has a market, that you can sell it and pass the risk to someone else.” And the same, of course might have been said of the upcoming subprime crisis. As for Scholes and Merton one observer quipped “they precipitated a world financial crisis. Previous distinguished economists have only managed to destabilize individual economies.” [134] The role of the Fed in this crisis was widely questioned but critics “failed to recognize that LTCM had created a major problem for the banks that would require a strong regulatory hand to correct. However, the overriding concern that emerged was the absence of a viable derivatives regulator.”[135] The SEC and other regulators had been silent during the process of repealing Glass Steagall and were equally silent about the massive increase in leverage on the Street that resulted in LTCM’s fall.[136]
LTCM was a spin-off of a famous investment bank that, earlier in the decade, had engendered its own financial debacles. In 1991 Salomon was caught in a Treasury securities scandal. They attempted to evade the 35% limit on bidding on government securities dealers in the hope of cornering the market on a particular issue. Trading records were tampered with so as to make it look like Salomon’s customers had simply sold back securities they had already received. In September 1991 FRBNY President Corrigan was furious and asked Salomon CEO Gutfreund for a full report within 10 days. John Meriwether resigned as a result of his role in the scandal and, as we have seen, took some of Salomon’s brightest stars to his new Long Term Capital Management. Others on the Street followed Meriwether’s example and entered the high-paying world of the hedge funds.[137] It is evident from the interval between the time of the first irregularity, December 1990 and September 1991 that Corrigan and the FRBNY were inclined to give Salomon every benefit of the doubt before being forced to act. Furthermore, the failure of the FRBNY to adequately monitor Salomon set a precedent as they also inadequately monitored Salomon’s offspring LTCM.
Shortly thereafter, in 1994 Salomon Brothers lost over $100 million on ‘Interest Only’ securities in the wake of the February Fed rate shock. These securities were a result of the financial engineering process of separating the interest and principal components of fixed income instruments.  Salomon Brothers was not alone in losses due to the “toxic sludge” that resulted; the Granite Fund lost some $500 million. “The IO essentially contains a concentrated version of the so-called toxic waste that runs through a mortgage security’s prepayment option.” Although these highly leveraged products have significant profit potential, when all traders try to dump these at once the opportunities to trade close down resulting in severe losses.[138] As a result of these scandals the venerable ninety year old firm was eventually sold off to Citigroup which effectively put an end to its existence.
Citigroup was not, of course, immune from its own set of horrendous financial misjudgments. Citigroup had given its investors the right to sell their CDOs back to the bank at full price. Yet this ‘put’ was just a footnote in the financial statements and wasn’t even clear to top management. As long as the markets were running smoothly these puts were never exercised. But by 2007 with the implosion in the CDO market there was a massive cashing in of the puts and large losses to the bank.[139] Thus was recorded one more failure in risk management and regulatory oversight.
Citi’s misjudgments at some times did not preclude its engaging in cunning and shady maneuvers at others. Citigroup Global Markets structured and marketed a mortgage-related CDO and then took a proprietary short position against those same mortgages without disclosing to investors both its role in the asset selection process and its short position. Following the default of the CDO while investors were stuck with the loss Citigroup made $160 million in fees and trading profits. Citigroup, of course, was not alone in this clever strategy. Nineteen other Wall Street companies have been repeat offenders in similar cases in recent years: American International Group, Ameriprise, Bank of America, Bear Stearns, Columbia Management, Deutsche Asset Management, Credit Suisse, JP Morgan Chase, Merrill Lynch, Morgan Stanley, Putnam Investments, Raymond James, RBC Dain Rauscher, UBS and Wells Fargo/Wachovia and, of course, the most cunning and successful of all Goldman Sachs.[140]
There were instances where a serious lack of knowledge and judgment on the part of regulatory authorities was the direct cause of financial crises. Hank Greenberg the head of insurance giant AIG, with possibly the best judgment of any Wall Street leader, had kept AIG from involving itself in excessive risk as in the issuance of CDSs. However, Greenberg had become the target of yet another ambitious New York politician, Attorney General Elliot Spitzer.  In early 2008 “it was pretty clear that Spitzer’s decision to oust Greenberg back in 2005 might have been among the most costly actions taken by any regulator in the past decade.” After Greenberg was forced out risk taking soared at AIG.[141]  Spitzer thus joined his successor as Attorney General and Governor, Andrew Cuomo as an architect of financial disaster. Eventually AIG had to be bailed out by the Fed and the Treasury; the details of which were kept hidden by the Federal Reserve Bank of New York and the SEC.
Another severe regulator caused crisis occurred in California where energy regulations were written in such a way as to prohibit utilities from hedging against future price hikes by purchasing forward contracts. Energy suppliers eventually took advantage of this faulty policy by shutting down their plants for “maintenance” thus keeping their capacity low relative to demand. The result was to force utilities to purchase electricity in the spot market where they paid exorbitant rates to the suppliers.[142] Here is a case of clueless regulators stifling the appropriate use of financial derivatives.
Regulatory Capture: The Regulator Industry Complex
An important factor in the poor record of regulation is that both regulators and the regulated share the same outlook. And the same revolving door between Washington and the financial industry works as well, or better, between the industry and the regulatory agencies. The risk and leverage mania that infected Wall Street also infected government, the SEC, the Fed and the rating agencies. Fannie and Freddie with the help of Angelo Mozilo and pushed by HUD grew their balance sheets from $1.4 trillion in 1995 to $4.9 trillion in 2007.[143] The machine was pumping out still more securitized and subprime loans in a positive feedback loop. And yet the regulators were inclined to do or say nothing; lack of disclosure made it impossible to know exactly how much mortgage debt was held by the firms. They were in a conflict of interest with both the companies and the politicians, doing what both want, not raising alarms, and passing through the revolving door from the agencies to government or business and back again. One motivating factor may have been the fat bonuses doled out by the big banks and Wall Street. More than $60 billion were distributed by Goldman, Morgan Stanley, Bear and Lehman alone in 2006.[144] The prospect of passing through the revolving door to partake in such abundance represented a great conflict of interest and temptation for regulators. “SEC staffers can’t wait to leave government to work on Wall Street or Wall Street law firms. This conflict of interest may make the SEC a good training ground for a career at a brokerage firm, but it makes for a pretty lousy investigator.”[145] The same can be said for regulators in all of the agencies. Of course, regulatory capture and conflict of interest began long before the post 2000 housing frenzy.
The Federal Reserve and its branch banks, particularly the FRBNY have been afflicted for many years with conflict of interest, a collaborative mentality and willful cluelessness about the institutions they are tasked with overseeing. One amusingly ironic instance of the clueless and accommodating attitude exhibited by Federal Reserve officials occurred in a 1993 report out of the Atlanta Fed. Referring to Madoff Investment Securities they approvingly note how the “firm has set itself up in direct competition with NYSE specialists. Madoff makes a market in 350 of the S&P 500 stocks by attracting mainly retail trades from brokers.” They applaud his low overhead costs and low commissions and note how his firm now accounts for some two percent of NYSE daily volume.[146] Such admiring remarks about a future convicted swindler are a revealing demonstration of the willful gullibility of the regulators. This was written about the same time as the SEC had botched a number of investigations of Madoff and after the Ponzi scheme had been hatched. It is also interesting to note that Madoff was one more Wall Street ‘progressive’ who had made major contributions to Democrat politicians including Senators Dodd and Schumer.
Officials at the various branches of the Fed often found themselves at cross purposes as they attempted to balance their duties as regulators with their past and potential future loyalties to the financial companies. Freddie Mac CEO Richard Syron was president of the Boston Federal Reserve Bank and endorsed its study of mortgage discrimination when it came out in 1992. A few years later Freddie, as well as Fannie had embraced those findings setting the stage for their plunge into the subprime market. Freddie under Syron embarked on extensive subprime lending despite warnings from Greenspan; one of those occasions when the Fed chairman had it right. A Fed official who moved between the Federal Reserve Board, the Bush administration and Wall Street was Lawrence Lindsey who became a consultant at the soon to be defunct Lehman Brothers. Gerald Corrigan, president of the New York Fed from 1985 until 1993 began sounding the alarm regarding the systemic risk inherent in the misuse of swaps and derivatives. It was probably not a coincidence when he abruptly changed his tune on leaving the FRBNY for Goldman Sachs stating that “When I say I don’t think legislation is needed, I’m not saying that I’m satisfied with the status quo. But the things that need to be done can be done under existing legislative authority.”[147] Liberal Democrat Corrigan was just the most high profile example of the long time weakness of the FRBNY in its incestuous relationship with the Street and in its faulty personnel policies.
High Fed officials were comfortable with the increased complexity and resulting lack of transparency of the financial companies’ dealings. At first Ben Bernanke advocated more transparency but ultimately came to share the same deregulatory philosophy as Chairman Greenspan. And both would agree with New York Fed president Geithner that the Fed was correct in giving the New York banks billions to make up for the losses they incurred in their obscure and opaque maneuverings.  And this lack of transparency continued even after the great meltdown. “Congress was supposed to approve all government expenditures, but subterfuges through the Federal Reserve and FDIC became the rule of the day, providing funds in ways free from the kind of scrutiny that Americans have come to expect as an essential part of their democracy.”[148]
Geithner also promoted the sweetheart deal by which JP Morgan Chase, whose CEO was on the New York Fed Board, acquired Bear Stearns. Citibank is another Fed client owing its survival to taxpayer dollars. AIG and one of its principal counterparties Goldman Sachs also got bailed out courtesy of Tim Geithner. Geithner’ successor as the new president of the New York Fed, William Dudley, is another Goldman Sachs man. Treasury Department officials joined those at the Federal Reserve in regulatory collusion along with the banks, the Wall Street firms and the GSEs. In the 90s the head of the CFTC called for regulating derivatives; a proposal which took on new life after the FRBNY organized the LTCM bailout of 1998. But Federal Reserve and Treasury officials including Greenspan, Rubin and Summers successfully opposed the idea.
The Securities and Exchange Commission was also rife with conflicts of interest and collusion with the supposed objects of its regulation. The SEC, although supposedly an apolitical agency, has its leaders appointed by the president and they tend to follow the policies favored by major administration officials. And, as remarked on page 176, many of those high officials have come from and will return to Citibank, Goldman Sachs and other major firms. In addition the lure of a lucrative career on the Street will tend to influence the actions of any SEC employee. Thus when Citigroup bet against its own investors in one of its CDOs, the response of the SEC was rather tepid. And the same goes for many other firms accused of malfeasance. When Goldman Sachs wiped out its investors in a similar kind of deal and admitted to a failure to keep these investors sufficiently informed the SEC responded with a slap on the wrist. To be sure the resulting $550 million fine was the largest penalty ever paid by a brokerage firm but it amounted to just two weeks’ worth of profit for Goldman; hardly a deterrent to future malfeasance. The excuse given by the SEC is that it was better to settle instead of risk losing in court. But the more likely reason is that at least 219 high officials have left the SEC and returned as representatives of a client with business before it. Roberta Karmel, a former SEC commissioner noted the usefulness financial firms found for one time SEC staffers who understood how to navigate through the complex web of agency regulations. Senator Charles Grassley, a member of the committee investigating the affair noted that the present system impedes the SEC’s ability to effectively regulate Wall Street and observed that the “SEC’s revolving door seems more active than ever”.[149]
Regulator-industry collaboration was at full speed with the repeal of Glass-Steagall; the culminating event of the 90s wave of deregulation. This repeal Involved active cooperation between the Fed, the Treasury, the GSEs, Goldman and Citigroup as well as the silent assent of the SEC. Even before the repeal went into effect Greenspan gave a temporary waiver unilaterally authorizing the new financial/banking combine which became Citigroup. It was the peripatetic Robert Rubin with the support of his protégé Tim Geithner who pushed through the repeal and also induced the New York Federal Reserve Bank to reduce its oversight of Wall Street. There were many other players involved in the repeal of Glass Steagall and the deregulation that contributed to the subprime crisis including James Johnson of Fannie Mae, Henry Paulson and Stephen Friedman of Goldman Sachs. Blurring the line between commercial and investment banking along with the moral hazard of deposit insurance was an action certain to encourage reckless risk taking.
The influence that the financial industry exerts on government does not imply that government bears no responsibility for any abuses. Wall Street and the banks “operate within the parameters, no matter how reckless and tainted by corruption, government sets for it.”[150] And the primary responsibility for inventing and enforcing those parameters fell to the regulatory agencies. Gasparino aptly summarizes the agencies failure in that regard when he states that “the derivatives market was the modern-day version of boomtowns in the Wild West; with few sheriffs around to keep order.”[151] Furthermore, the new reforms will simply end by reinforcing the too big to fail philosophy, weakening the smaller banks and giving government bureaucrats and their big finance allies more power to allocate capital. William Greider, a long-time critic of the Federal Reserve observes:
This road leads to the corporate state--a fusion of private and public power, a privileged club that dominates everything else from the top down. This will likely foster even greater concentration of financial power, since any large company left out of the protected class will want to join by growing larger and acquiring the banking elements needed to qualify. Most enterprises in banking and commerce will compete with the big boys at greater disadvantage, vulnerable to predatory power plays the Fed has implicitly blessed.[152]

The Expertise Gap


When it came to the financial regulatory agencies too little knowledge was a dangerous thing. There was a chronic failure to cultivate in-house expertise. Complicating this problem is that regulators must be as smart as those they regulate. To be able to use innovation as it should be used to increase market efficiency, reduce economic costs and further economic opportunities it is essential to have a sophisticated, honest and effective regulatory apparatus.


Indeed, one response to a lack of sophistication on the part of regulators is to simply ban certain financial innovations, even ones that have great utility in risk management and market efficiency. In 1978 something like that occurred when the CFTC banned options trading since it “did not have the staff necessary to monitor a new market successfully.” Finally in 1982 the CFTC, not wanting to stand in the way of progress, gave the go-ahead for the CBOT to begin trading options on futures.[153] This was a rather startling admission of its own inadequacy on the part of a regulatory agency. The expertise gap was to worsen. By the mid-80s financial engineering was on the rise in all markets especially in fixed income. Specialized boutique firms headed by big-name researchers and academics sprang up designing new instruments, strategies and packages. Mathematical models were the norm at these houses and less quantitatively sophisticated participants, including the regulators, were left behind. The rise of the SIVs resulting from the Basel I capital requirements was accompanied by the regulatory knowledge gap as the regulatory agencies were unable or unwilling to retain risk analysts with expertise in this area. SIVs and the entire shadow banking sector developed in plain sight of the national and international regulators; if only they had cared to look.


As we have seen above the problem with Baring and its rogue trader was that the counterparties, the senior bankers and the Bank of England did not understand derivatives. Nor were the BOE’s U.S. counterpart regulators of much help in sorting out the mess. Later in the decade repeal of Glass-Steagall had made the need for effective regulation even more important. “Yet instead of enhanced oversight, the new capital rules were met with less regulation, not more. The Fed, which had been the eyes and ears of systemic risk for years, had now abdicated their responsibility to the SEC, which, despite its enhanced powers had no idea what it was doing, its ranks depleted by years of defections of longtime officials to higher-paying jobs on Wall Street.” But as one high official at the SEC admitted: “We didn’t have a sophisticated enough staff. The sad part is, we should have been getting that information on the risk they were taking, but we didn’t know what to ask for.”[154] And what was true of the SEC was true of the Fed where its principal eye on the Street and on the major banks, the FRBNY, was unable to build and hold a staff capable of understanding these risks, but was instead loaded with air-headed economists of the type at the Boston Fed that were so instrumental in instigating the subprime lending torrent. Indeed when the head of the CFTC called for regulating derivatives, a call that should have become more urgent after the FRBNY sponsored LTCM bailout, Fed and Treasury officials effectively squashed such proposals.


The knowledge gap was exacerbated by the increased importance of computer models. The rise of personal computing in the 1980s enabled quantitative financial analysts to develop financial models with speed and flexibility as they were no longer reliant on the secretive guild of mainframe computer programmers. Two developments beginning in the late 1980s spurred the use of computer modeling. Hedge funds, investment partnerships with few investors and high minimum investment requirements rose to take advantage of the bull market following the 1987 crash while avoiding SEC scrutiny. These funds often rely on the arbitrage of small price differentials and are heavily reliant on computer modeling.[155] Another post 1987 spur to computer modeling was the emergence of Value at Risk (VAR) a portfolio risk measurement technique. However as well understood by the Wall Street quants, this tool which was based on historical trends and well-behaved statistical distributions had limitations. As a result many of these models overvalued the banks’ mortgage assets. (See the following discussion of ‘fat tails’.)


Both the hedge funds and the VAR technique passed muster with the SEC; the SEC amended its procedures so as to allow VAR to be used to measure risk. At the same time another SEC initiative permitted all triple-A securities to be treated the same. This provided Wall Street with an incentive to carry CDOs and even CDO squareds on their books. The SEC was now in the business of endorsing massive risk taking. Even so these changes might have been beneficial if the SEC “had the bodies and brains to carry out its new mandate.”[156] Clearly, as it turned out, that was not the case.


It was the case, however, that even many of the Wall Street financiers themselves were lawyers and other types untrained in the mathematics of modeling.[157] The same was true of the regulators who became complacent with the increase in leverage that was encouraged by the models. Wall Street, the banks and the regulators were all oblivious to the systemic risk arising from the correlation caused by the banks acting similarly. Stiglitz rightly observes that by using equivalent models the banks took the same positions and ended up in the same difficulty when the markets turned against them.[158] However, what he ignores is that it was the government itself that pushed all banks into being blind to borrowers default risk while the regulators, in addition to protecting their revolving door to high paying jobs, also carried out the wishes of the politicians. The regulators did their best to make both the holders of power and the dispensers of goodies happy.


Other actors with significant financial market oversight responsibilities were the rating agencies. These non-governmental organizations were also lacking in expertise and riddled with conflict of interest. The agencies were paid quite well on the volume of business they brought in and processed; some of their analysts received Wall Street type salaries. The Street would shop around for the most cooperative agencies to give them high ratings so that the incentive for pleasing the financial firms was considerable. During the housing boom the ratings agencies made record profits based on sheer volume. Their managers, oriented toward the interests of their large clients overruled their own analysts to make sure that high ratings were awarded. From 2002 to 2007 Wall Street underwrote some $3.2 trillion of dubious home loans which were bundled into CDO investment pools that received AAA ratings. Just as S&P completely missed the 2008 housing meltdown and the Bear Stearns bankruptcy, so previously they missed the Enron scandal.[159]  Moreover the activities of the ratings agencies often have a ‘pro-cyclicality’ effect. It was observed, for example, that before the Asian crisis they did not downgrade Asian securities and during the crisis they did so thereby intensifying it. The activities of the agencies like that of the use of computer modeling increased systemic risk. “The public sector should be wary of doing anything that encourages blind reliance on rating agencies, value-at-risk models, or indeed any specific formula that could encourage ‘herding’ among financial institutions.”[160]

Thus it appears that everyone in the path up from the original mortgage was feasting well from the transaction:  “the home owner who purchased a house with no money down and a subprime mortgage, to the bank that issued the mortgage, pocketed the fees, and sold it to an investment bank, to the investment banker who packaged that mortgage into debt, to the investor who feasted off of the bond’s high interest rates, and now to the formerly geeky bond rater who became a millionaire rating the debt.”[161] And the ones who ultimately paid for these riches was not, as popular leftist myth would have it, the poor subprime homeowner who lived quite above his means for a long period of time and who had little or no stake in his property, but the taxpayers of the middle class who ultimately footed the bill while often losing their livelihoods. And still another class of beneficiaries were the political class; politicians and high level bureaucrats most of them Democrats along with some progressive Republicans who made out very well in wealth and in votes.


Finally, wrong knowledge, even more than too little knowledge, is a dangerous thing. This was certainly demonstrated in the 1992 study by the Boston Fed which, supposedly, showed that banks discriminated against minority mortgage applicants. The study concluded that mortgage denial was based largely on race and that credit score and loan to home value ratio standards were discriminatory. It was assumed that even though minorities may have bad credit scores they also had jobs and could, therefore, repay the mortgages. The report was produced by a well-connected product of elite schools, the type that is typically advanced at the regulatory agencies. They were well versed in statistical methods but were lacking in any relevant analytical knowledge of risk. Although these researchers made liberal politicians happy, they never applied any systemic risk analyses to the consequences of the policies they did so much to foist on the nation.


Fat Tails and Black Swans


The failure of the models to accurately assess risk was due to assumptions which did not reflect the real world movement of returns and values. The first definitive indications that this was so came with the various crises in the 80s and continued thereafter. “Randomness was a lesson that Wall Street as a whole would fail to understand over the next two decades – only this time the losses would no longer be measured in ‘just’ hundreds of millions of dollars.”[162] According to a recently favored metaphor a ‘black swan’ is an event that is of high-impact, is hard-to-predict, is rare beyond any realm of normal expectations and comes as a complete surprise. It has been observed that according to the standard models, the kind of stock market crash that occurred in October 1987, could have only  occurred in, a length of time longer than the estimated 14 billion year life of the universe. The LTCM debacle has also been described as resulting from a black swan, although in reality the failure of their models were due to their being based on the efficient market paradigm, and therefore no account was taken of history, flights to quality and sudden market collapses. Such models relied too much on past data and did not consider that the variance of the distributions might not be constant over time.


Quantitative analysts have, in the past, attributed such events to the more mathematically tractable problem of ‘fat tails’. Much work has been done on the assumption that changes in securities prices, foreign exchange rates and investment returns are normally distributed. But in fact these distributions have fatter tails and higher peaks than does the normal distribution. This phenomenon, referred to as leptokurtosis, implies that the probability of substantial losses due to extreme movements in the markets would be quite large. These have a greater proportion of very large deviations from the mean. These changes may be drawn from stable distributions with infinite variance as in what is known as the Cauchy distribution. The fat tails problem and Cauchy distribution are discussed in Appendix 5C.

Federal Reserve Bank of New York: Case Study in Regulator Ineptitude
I was employed at the New York Fed as a systems analyst and financial economist from 1980 to 1993, the critical period in the rise of financial innovation and the resulting regulatory response. As such I witnessed firsthand the failure of regulation and oversight; a failure which was also characteristic of the other important regulatory bodies. The Bank is in a unique position to peak “under the hoods of the big banks and investment houses.” The FRBNY is “the largest of the nation’s twelve Federal Reserve Banks, but more than that, it influences the country’s monetary policy through something called open-market operations. In other words, the New York Fed controls the nation’s money supply by adding credit to or subtracting it from the system.”[163] Unfortunately due to its own defective policies the New York Fed lacked the tools to really see what was going on under those hoods.
It is true that there were members of the Bank staff who were long troubled by some of the potentially risky developments in the financial markets. In the early 1980s a senior economist in the Foreign Department raised concerns about the explosion in the off-balance sheet activities of the banks. Although his focus was on international banking, the expressed concerns were also relevant to the domestic banking sector. Together we developed reporting systems for foreign branch activity and on the off-balance sheet contingent liabilities of the large banks. Although there was a brief flurry of activity by Bank management in establishing a capital markets surveillance unit to follow up on this work, the endeavor ultimately went nowhere. Apparently, senior officials at the Bank, the Federal Reserve Board and the Treasury did not want too much light shed on these lucrative activities as shown by the squelching of proposals for regulating derivatives following the LTCM bailout.  Members of the new capital markets staff, sometimes in conjunction with the Bank of England and the Basel Committee, developed credit exposure risk and capital adequacy guidelines for, swaps, options, and other derivatives. (See page 187 above and Appendix 5B.) Unfortunately, the FRBNY elected not to pursue such research; quantitative analysts on the staff were soon dispersed. Its abandonment of the use of quantitative methods to price derivative and off-balance sheet risk was followed within a few years by a number of financial crises.
Thus senior management at the New York Fed were totally unprepared for the LTCM crisis and then by the slowly building and ultimately exploding subprime meltdown. Moreover, although some useful Basel Committee guidelines resulted from these studies with credit exposure translated into amounts comparable to on-balance sheet loans, there was a major loophole left in place; these standards did not apply to U.S. investment banks or insurance companies. The prospect of moving on to higher paying positions on the part of FRBNY senior management may well account for the puzzling lack of support for staff members who understood quantitative risk and derivatives. It is true that president Gerald Corrigan began warning about the dangers of the esoteric derivatives market in 1992. He was concerned about the off-balance sheet nature of many of these derivatives. However, while Corrigan may have talked a good game at that point, he did precious little to see that the FRBNY had the tools and policies for effective surveillance and supervision and was soon off to greener pastures at Goldman Sachs. As we have seen (p. 193), the year prior to Corrigan’s warning the Salomon bond trading scandal occurred. It was the failure of the FRBNY to adequately monitor Salomon that ultimately led to the LTCM bailout.
In the years following the LTCM bailout analysts and economists at leading financial institutions continued to warn about the risks of derivatives and the shadow banking sector. In March of 2006 the Federal Reserve Bank of New York announced a new initiative by major market participants, other U.S. regulators and international industry supervisors to improve the functioning of the derivatives markets. This followed years of inadequately dealing with non-transparent accounting and complex derivatives. And as the Lehman Brothers collapse just a few years later shows the new initiative was less than successful. As one financial columnist concludes from the Lehman debacle:
Almost two years ago to the day, a team of officials from the Securities and Exchange Commission and the Federal Reserve Bank of New York quietly moved into the headquarters of Lehman Brothers. The new mystery is why it took this long for anyone to raise a red flag. …  Indeed, it now appears that the federal government itself either didn’t appreciate the significance of what it saw (we’ve seen that movie before with regulators waving off tips about Bernard L. Madoff). Or perhaps they did appreciate the significance and blessed the now-suspect accounting anyway. … The problems at Lehman raise even larger questions about the vigilance of the S.E.C. and Fed in overseeing the other Wall Street banks as well.[164]
The New York Fed is in theory a private corporation but one that is less constrained by the bottom line. Thus, their woeful lack of savvy regarding risk analysis was accompanied by a wasteful squandering of resources. This was particularly the case in the area of computer systems. In the early 1980s the Systems Development Department pushed the idea of a Generalized Statistical System (GSS) that was to run all of the massive data reporting systems throughout all branches of the Federal Reserve. GSS was to be implemented on a Burroughs mainframe that was already obsolete. After the expenditure of much effort GSS ended by processing just a handful of minor data reporting systems before the effort was abandoned. The Bank staff was dependent on another inefficient system developed in-house.  This was Risk Analysis Language (RAL) which imitated APL, a powerful matrix oriented interpretive programming language once much beloved of econometricians and actuaries. Versions of APL were at one time used at various banks and Wall Street firms such as Morgan Stanley and Union Bank of Switzerland.  Morgan Stanley investment banker, Richard Bookstaber notes that these APL interpreter type languages cannot deal efficiently with looping, a technique essential for accurately pricing derivatives and swaps. In 1994 UBS ultimately failed by losing money on swaps and on hedges designed to protect against swap losses; these losses were exacerbated by APL’s programming shortcomings.[165] The FRBNY’s even more inefficient APL imitator, RAL, was run on the obsolete Burroughs mainframe, and consisted of a hodgepodge of APL type commands combined in an inefficient manner with database and statistical routines. RAL, fortunately, fell by the wayside with the rise of powerful desktop PCs in the late 80s. In 1988 bank management plunged into another systems fiasco contracting with a Boston based computer communications firm to build a state of the art Market Information and Trading Support computer system. The design which made use of IBM 3270 emulation and DG equipment was flawed and obsolete from the beginning given the advances being made in desktop computers. Shortly thereafter the vendor filed for bankruptcy causing all of the preliminary work and expense to be wasted; one more indication of the FRBNY management’s  failure to properly vet technical vendors and the projects proposed by its own Systems Development Department. These boondoggles were foisted on the rest of the bank by a self-regarding cadre of officers and economists who lacked, without realizing that they lacked, the expertise to evaluate these projects.  
The pattern of collaboration, conflict of interest and cognitive capture where the regulators think in exactly the same way as the regulated is also endemic at the New York Fed. Stiglitz discussing the problems at the Federal Reserve System takes particular note of the New York Bank. “As bad as these governance problems are, those in the Federal Reserve Bank of New York, which assumed a particularly large role in the bailout, are even worse. The officers of the Fed are elected by its board, which in turn consists of banks and businesses in the area. Six of the nine directors are elected by the banks themselves.”[166] In 1994 then FRBNY president William McDonough made a stab at reform when he cracked down on perks and gifts that Bank officers were in the habit of accepting. He had an internal study conducted that uncovered some 51 cases in the previous year in which outsiders paid for the bank’s executives meals at expensive restaurants and their acceptance of free tickets to sporting events. The investigator insisted on maintaining his anonymity.[167] His insistence on keeping his identity hidden comes as no surprise to anyone who has worked at the Bank.
The cluelessness of the New York Fed with respect to derivatives and the shadow banking sector is a direct result of their failure to cultivate and retain a staff of knowledgeable analysts. For years Wall Street had specialized in developing obscure accounting techniques and complex off-balance sheet products designed to confuse both regulators and investors. Quantitative methods of risk management were the only cost effective way of assessing possible losses from these complex instruments, particularly in periods of financial turbulence. It is true that there were a few economists at the Bank who, beginning in the early 1980s recognized the growing importance of financial derivatives and off balance sheet contingencies. They began to build a strong program of research on financial markets and instruments as a supplement to the Bank’s traditional banking studies emphasis. However there were several reasons that the Bank management did not follow up on, or make effective use of these research initiatives. For one thing their personnel policies encouraged large staff turnover and loss of expertise. The New York Reserve Bank was a combination training ground for graduates of elite schools, on the way to bigger things on the Street, and an affirmative action factory. A typical pattern was for a bright eager young graduate to be recruited, trained and rapidly advanced only to leave for a more lucrative position on the Street within a few years. Some more experienced quantitative analysts left the FRBNY with its myriad of regulatory responsibilities for equivalent but less demanding jobs elsewhere in the Fed system or at other agencies; some were encouraged to leave the system altogether. Another reason there was so little support for the quantitative analysts on the FRBNY staff who understood derivatives was the opposition of top management due to their incestuous relationship with those they were supposed to regulate.
To be sure, the New York Fed was not devoid of dedicated and knowledgeable staff members. One was the senior economist mentioned above who established a special unit which, following an initiative of the Bank of England, tracked the accumulation of U.S. assets by OPEC and other foreign nations and then began to track the steeply increasing international borrowing and lending of the major banks. He expanded this work to examine the steep growth in bank off-balance sheet items and contingencies. In 1985 the International Capital Markets Division was founded as an extension of his work. A few years after the formation of the new division its principal founder was forced out to find greener pastures at the IMF.
One knowledgeable staff member who had a much abbreviated term of service was the New York Federal Reserve Bank's deputy general counsel who was forced to resign in July 1995 after a month’s service.  He wrote an Op-Ed article opposing the repeal of Glass-Steagall contending, rightly as it turned out, that such legislation would be catastrophic; no regulator was capable of effectively monitoring international full-service financial institutions.[168] The very same senior management that effectively dismantled the quantitative analysis capability at the Bank was also not inclined to tolerate any opposition to deregulation. A final example of the New York Fed’s ill-considered personnel outlook occurred at the most senior level. In January 2009 William Dudley was named Geithner’s successor as president of the Bank.  Mr. Dudley was a former chief economist at none other than Goldman Sachs, and has forged strong relationships within both the financial community and Washington. He joined the FRBNY only two years before after nearly 20 years at Goldman. One of his chief rivals for the job was Terrence Checki.[169] Mr. Checki’s varied career at the Bank has included a number of key posts in the Bank’s corporate, bank supervision, foreign and international affairs areas, as well as in the office of the president. Terry Checki was a career employee at the FRBNY for over 30 years; it figures that this highly qualified individual would be passed over in favor of a member of the Wall Street old boys club. My own experience is that he was a dedicated executive and was universally respected by the staff members who worked with him.
In contrast to the above capable staff members there were many who followed a less dedicated path. There were, of course, many instances of staff members who, understandably, capitalized on the training and connections they had developed at the Bank to obtain high paying positions in the banking sector or on Wall Street. However, these included not just junior staff members but very high ranking officials; the same revolving door to riches and power through which many in government and on the Street passed was open to them as well. One such was a senior officer and economist, an expert in financial markets and financial engineering who after a long career left the bank in 1993 to work in the financial industry. In 1996 he joined AIG’s market risk division. This was just about the time that AIG was set to embark on such risky ventures as credit default swaps, despite the misgivings of its chairman Hank Greenberg. The insurance giant was apparently putting together a team of experts in financial modeling and engineering to assist in its plunge into the profitable but risky new world resulting from the innovations of Wall Street. At this time AIG was developing its financial products group which was to be instrumental in the firm’s bankruptcy and that was to prove very costly to the U.S. taxpayer. As it turned out the economists and financial experts that AIG was assembling did not deter AIG from embarking on its ill-starred endeavor in insuring increasingly complex mortgage securities through credit default swaps.  
The revolving door swung open in both directions. Senior executives from the big banks and the Street joined the New York Fed bringing with them their pro-industry biases. Later on many of these would follow the example of Rubin and Summers and pass back into the industry as consultants or to assume high executive positions. The following are two examples, among many others, obtained from the Bank’s press releases. In 1999 Jamie Stewart was appointed first vice president after resigning as vice chairman of the Mellon Bank Corporation. Prior to joining Mellon, he was a senior vice president of the Bank of America and before that was executive vice president of Crocker National Bank. In 2004 the revolving door swung open again with Mr. Stewart becoming President and CEO of the Federal Farm Credit Banks Funding Corporation. In 2005 Edward Murphy left a senior position with JP Morgan Chase to become the New York Fed Executive Vice President.
There were also cases of those who, after brief stints of being trained at the Bank, left only to become involved in legal entanglements. One instance concerns a senior economist and quantitative financial modeling expert who, after just a few years at the Fed left for greener pastures ultimately ending up at a hedge fund. He ultimately became embroiled in an intellectual property dispute with the firm regarding a trading model he developed; the dispute required a court decision to resolve.[170] In another instance, a former bank examiner for the Federal Reserve Bank of New York was arrested and accused of stealing documents from the Fed about member banks and giving them to his next employer, Fuji Bank Ltd.[171] A recent case was that of a contract programmer who was accused of stealing software code valued at nearly $10 million from the Bank according to a criminal complaint filed in United States District Court.[172]
As we have seen the Federal Reserve Bank of Boston had a core group of progressive idealists who were less inclined toward seeking pecuniary advantage but, nevertheless, did a fair amount of damage to the financial system. The Federal Reserve Bank of New York also had its share of these. One, who elicited some controversy on being nominated for a high position in the Obama Labor Department, is Erica Groshen, a vice president in the FRBNY Regional Analysis Function.  Before joining the Bank in 1994, Ms. Groshen was an assistant professor of economics at Barnard College and was an economist at the Federal Reserve Bank of Cleveland. She has, like many members of the elite, expressed open hostility toward small business co-authoring a 1998 report titled, “Small Consolation: The Dubious Benefits of Small Business for Job Growth and Wages,” under the aegis of the leftwing Economic Policy Institute.[173] One might think that having an individual with such animus toward small business in a senior position at an institution such as the New York Fed is inappropriate, to say the least.
Two FRBNY presidents illustrate the regulator cognitive capture and conflict of interest endemic among the financial regulatory agencies. One, who has been discussed at length, is Treasury Secretary, Timothy Geithner. Geithner was a virtual globalist diaper baby spending most of his childhood abroad, learning Mandarin and Japanese. He worked for Kissinger Associates in Washington before joining the Treasury Department International Affairs Division in 1988. With mentors Rubin and Summers he became Under Secretary of the Treasury for International Affairs in 1998. In 2003 at the young age of 42 he was named president of the New York Fed. As such he did not see the subprime crisis just as his predecessors and Fed colleagues did not see the coming of the Mexican bond crisis or the LTCM bankruptcy. In the same way as Geithner embodied the globalist mentality par excellence, he also manifested the Wall Street world view. Financial columnists Becker and Morgenson describe Geithner’s relationship to Wall Street as follows.
His actions, as a regulator and later a bailout king, often aligned with the industry’s interests and desires, according to interviews with financiers, regulators and analysts and a review of Federal Reserve records. The New York Fed is, by custom and design, clubby and opaque. It is charged with curbing banks’ risky impulses, yet its president is selected by and reports to a board dominated by the chief executives of some of those same banks. Traditionally, the New York Fed president’s intelligence-gathering role has involved routine consultation with financiers, though Mr. Geithner’s recent predecessors generally did not meet with them unless senior aides were also present, according to the bank’s former general counsel.
By those standards, Mr. Geithner’s reliance on bankers, hedge fund managers and others to assess the market’s health — and provide guidance once it faltered — stood out.
He ate lunch with senior executives from Citigroup, Goldman Sachs and Morgan Stanley at the Four Seasons restaurant or in their corporate dining rooms. He attended casual dinners at the homes of executives like Jamie Dimon, a member of the New York Fed board and the chief of JPMorgan Chase.
Mr. Geithner was particularly close to executives of Citigroup, the largest bank under his supervision. Robert E. Rubin, a senior Citi executive and a former Treasury secretary, was Mr. Geithner’s mentor from his years in the Clinton administration, and the two kept in close touch in New York.
Mr. Geithner met frequently with Sanford I. Weill, one of Citi’s largest individual shareholders and its former chairman, serving on the board of a charity Mr. Weill led. As the bank was entering a financial tailspin, Mr. Weill approached Mr. Geithner about taking over as Citi’s chief executive.[174]
Gerald Corrigan spent his career in various branches of the Federal Reserve System. He began at the New York Federal Reserve Bank, served as a Special Assistant to Chairman Volcker and became president of the Federal Reserve Bank of Minneapolis from 1980 to 1984. In 1985 he returned to the FRBNY as president serving until 1993. Corrigan was a firm supporter of the Basel Committee capital adequacy initiatives and often expressed concerns regarding off balance sheet and derivative risk. This career Federal Reserve regulator became abruptly mute on this issue when he accepted a high-profile position at Goldman Sachs in 1993.[175] At the New York Fed, Corrigan dealt frequently with foreign central bankers and ministers, developing relationships that were undoubtedly useful to Goldman Sachs. In his new position Corrigan maintained a close relationship with Geithner frequently lunching together at Goldman headquarters.
No other financial regulatory body has such a large concentration of conflict of interest and divided loyalty as the Board of Directors of the Federal Reserve Bank of New York. Some directors are elected by the member banks; others are appointed by the Board of Governors. Members of the FRBNY Board are, or were invariably connected with the very companies they are supposed to regulate or oversee. Board members generally continue in their positions with major financial corporations or other large companies based in the New York district. Members frequently come from the largest and most powerful banks; these often rotate as members of the Board. In 2001 Sandy Weill, chairman and chief executive officer of Citigroup was elected to the board of directors. He succeeded Walter Shipley, retired chairman of Chase. Five years later Chase was once again represented with the election of president and chief executive officer Jamie Dimon. Directors may have held positions at a number of major financial companies. Jill Considine, re-elected to the Board in 2005, was chairman and chief executive officer of The Depository Trust Company; her prior experience included senior positions at American Express Bank, Bankers Trust Company and Chase Manhattan Bank. Also in 2005 Richard Fuld, chairman and chief executive officer of the soon to be defunct Lehman Brothers was named to the Board. The conflicts of interest inherent in these appointments are sometimes quite evident. In 2000 T. Joseph Semrod, chairman, chief executive officer and president of Summit Bancorp, had been elected to the Board. This occurred shortly after the FRBNY approved Summit’s acquisition of NMBT Corp and its bank subsidiary.
Some members of the Board may be brought out from retirement. One such was Gerald Levin, former chief executive of AOL Time Warner who became member of the Board in 2002. His appointment also shows that non-financial company executives are sometimes appointed. Another such was Jeffrey Immelt, chairman of the board and chief executive officer of General Electric Company, who was named to the Board in 2005.
Chairmen and CEOs of banks, investment houses or insurance firms are commonly appointed by the Board of Governors of the Federal Reserve System as New York Fed chairman or vice chairman. In 1996 John Whitehead chairman of AEA Investors Inc., was named chairman and Thomas Jones, vice chairman, president and chief operating officer of the Teachers Insurance and Annuity Association-College Retirement Equities Fund was named deputy chairman. Conflict of interest may affect the holders of these positions just as they do ordinary directors. In 2009 New York Fed Chairman Stephen Friedman was forced to resign after questions were raised about his ties to his former employer, the omnipresent Goldman Sachs whose request to become a bank holding company had just been approved.
Members of the Board are also selected from nonprofit institutions, presumably to represent the general public interest; often the heads of major academic institutions are chosen. In fact, these leaders of cutting edge liberal institutions whose staffs are busy reforming, undermining and reshaping the ‘evil’ American society to fit their utopian vision, are one part of a financial-academic-government complex. Thus, in 2007 the president of Columbia University, and promoter of political correctness, Lee Bollinger was appointed for a three-year term. Four years previously New York University president John Sexton was named deputy chairman of the New York Fed. Dr. Sexton is a particularly interesting case study of how a member of the liberal elite sells out his principles to big finance. His most recent project is the bulldozing of large parts of New York’s historic Greenwich Village in order to add the equivalent of an Empire State building to the NYU campus. NYU’s plan would overwhelm and oversaturate a residential neighborhood, turn it into a twenty-year construction zone and eliminate public park space. In addition it appears intended to open up the Village for the future designs of the real estate developers. The latter are of course closely tied to the very Wall Street bankers that Sexton hobnobbed with during his tenure on the Board.
Universities such as Columbia and NYU have been among the principal supporters of immigration policies to replace American workers with lower paid immigrants. These “special handling” policies were “applied to extremely small numbers of unskilled workers until the Association of American Universities (AAU) applied special handling to the importation of unlimited numbers of college professors and researchers.”[176] The universities have also successfully lobbied for the facilitation of visas in order to swell the ranks of their students; tuition for these foreign students is heavily subsidized by taxpayers. Many universities open up subsidiary campuses abroad. NYU, for example, often boasts of its facility in Abu Dhabi. Exorbitant tuition costs and the lack of employment for recent graduates have resulted in a massive student debt problem. NYU under Sexton currently averages over $40,000 in annual tuition charges. These already exorbitant tuition charges will certainly increase in order to finance NYU’s latest overbuilding.
So it is that the social concerns expressed by academic leaders like Sexton and Bollinger are often belied by their actions. Indeed they stand at the pinnacles of institutions that no longer teach critical thinking or useful skills. And they and their counterparts have inflicted yet one more financial crisis, that of student debt, on the U.S.  Moreover, their actions and inaction as members of the FRBNY Board have also been lacking in social responsibility. The board of directors of the Bank and its chairman in particular, presumably has a responsibility to ask questions, find out what is going on, and alert Congress and the public. And that goes double for directors like Sexton who supposedly don’t come from the banking community. Either he had some knowledge of the impending problem that was brewing underneath the surface during his tenure, and in deference to his friends decided to ignore it. Or he failed in his duty of asking salient questions and probing, as a chairman and director should do.
Fixing a Broken System
There is no doubt that the financial regulatory system is broken; the following briefly outlines some improvements that might be considered.  One proposed solution is to centralize most regulatory functions in a new enforcement agency.[177] However, such a ‘super-regulator’ is unlikely to solve the main problem which is that of regulatory capture. The flood of financial innovation has exacerbated this problem given the difficulty of keeping up with the latest financial industry contrivances. As we have seen in the last chapter innovation has had many positive effects; more efficient markets, more liquidity, lower costs and more widely available information, but these come at a price. Increased complexity and tightly coupled markets along with the correlation arising from banks taking similar positions from the use of similar computer models will inevitably engender financial crises. Volcker was well aware of this: “Almost inevitably, the complexity of much proprietary capital market activity, and the perceived need for confidentiality of such activities limits transparency for investors and creditors alike.”[178]
Indeed, transparency must be an important part of any real reform. “Because derivatives can be a useful tool for risk management, they shouldn’t be banned, but they should be regulated to make sure that they are used appropriately. There should be full transparency.”[179] Transparent regulations will help prevent the financial companies from unduly influencing the regulators. Regulators must also require more public transparency and full disclosure of financial activities on the part of the major firms. Regulatory agency decisions and deliberations should themselves be subject to oversight and scrutiny. The quasi-private regional Reserve Banks, and in particular, that of the uniquely important New York Federal Reserve Bank, already have a mechanism in place, in the form of their Boards of Directors, to provide for greater transparency if used properly. There is a need for oversight on the part of these Boards and by real public interest directors in lieu of a few collaborators from academia. Transparency, along with some restrictions on the ‘revolving door’, will also help to minimize the potential for conflict of interest.
Furthermore, the agencies should also take care to cultivate a professional staff of regulators with the necessary expertise to keep up with the maneuvers and innovations of Wall Street and the big banks. Slowing down the process of innovation might also be useful. This would give time for the firms and regulators to gain experience with the existing standard instruments before allowing new ones. Such a policy may make the markets less finely tuned but they would be more robust and durable  when faced with unexpected events.[180] Capital adequacy on the part of banks and other financial intermediaries is, of course, an important consideration in the regulation of financial innovation. Stiglitz rightly observes that over the counter tailor-made derivatives need to be backed with sufficiently high amounts of capital. “Given a choice between writing transparent exchange-traded derivatives and less transparent over-the counter derivatives, banks will choose the latter”; in the absence of higher capital requirements.[181] In addition a new version of Glass-Steagall updated in light of the recent changes in the structure of the industry is needed to separate deposit banking from high risk activities, avoid moral hazard and prevent the “too big to fail” syndrome.
The recent Dodd–Frank Wall Street Reform and Consumer Protection Act, which supposedly gave the needed solutions for these regulatory problems, will be briefly discussed in the next chapter. The next chapter will describe the great financial meltdown which was the inevitable result of the ideologies of diversity and globalism.









[1] Arnold Ahlert, “Fannie Mae’s Duo of Destruction”,
[2] Charles Gasparino, Bought and Paid For, New York, Sentinel, 2010, p. 471.
[3] Charles Gasparino, The Sellout, New York, Harper, 2009, p. 104.
[4] Gasparino, Bought and Paid For, pp. 17-18.
[5] Gasparino’s Bought and Paid For and The Sellout are the major sources for this section.
[6] Gasparino, Bought and Paid For, pp. xi, 1.
[7] Michael Lewis, The Big Short, New York, Norton, 2011, p. 109.
[9] Gasparino, Sellout, p. 322.
[10] Jim Kouri, “Air Force General blows whistle on Obama, but media deaf”, Law Enforcement Examiner, September 17, 2011.
[11] Michelle Malkin, “Obama's Green Robber Barons”,
[12] Ibid
[13] Gasparino, Bought and Paid For, p. 211.
[14] Brenda Walker, “Sierra Club Puppeteer—Long-Suspected Scandal Revealed”,, February 2, 2005.
[15] Ed Lasky, “How allies of George Soros helped bring down Wachovia Bank” , American Thinker, September 29, 2008.
[16] Paul Sperry, The Great American Bank Robbery, Nashville, Thomas Nelson, 2011, p. 266.
[18] Wikipedia
[19] Matthew Vadum & James Dellinger, “What’s Next for George Soros’s Democracy Alliance?”, January 10, 2008 ,
[20] Matt Taibbi, “The Great American Bubble Machine”, April 5, 2010,
[21] Gasparino, Bought and Paid For, p. 249.
[22] Ibid, p. 146.
[23] Ibid, p. 182.
[24] Ibid, pp. 232-33.
[25] Ibid, p. 20.
[26] Ibid, pp. 77-88.
[27] Ibid, pp. 101-103.
[29] Ahlert, “Fannie Mae’s Duo of Destruction”.
[30] Choate, Hot Property, pp. 41-2.
[31] T.W. Farnam, “MF Global ties awkward for Obama campaign”,
[32] Gasparino, Bought and Paid For, p. 114.
[33] Ibid, p. 56.
[34] Ibid, p. 126.
[35] Ibid, p. 204.
[36] Ahlert, “Fannie Mae’s Duo of Destruction”.
[37] Sperry, The Great American Bank Robbery, p. 245.
[38] Robert Reich, “Washington and Wall Street: The Revolving Door”, May 27, 2011.
[39] Gasparino, Bought and Paid For, p. 165.
[40] Gasparino, The Sellout, p. 424.
[41] Matt Taibbi, “The People vs. Goldman Sachs”,, May 26, 2011.
[42] Gasparino, Bought and Paid For, pp. 129-30.
[43] Gasparino, The Sellout, p. 338.
[44] Ibid, p. 386.
[45] Gasparino, Bought and Paid For, p. 50.
[46] Ibid, pp. 232-33.
[47] Ibid, p. 146.
[48] Ibid, p. 241.
[49] Ibid, pp. 151-52.
[50] Ibid, pp. 45-46.
[51] Ibid, pp. 57-59.
[52] Ibid, pp. 172-73.
[53] Ibid, pp. 30-31.
[54] Ibid, p. 184.
[55] Ibid, p. 55.
[56] Charles Gasparino,
[57] Gasparino, The Sellout, p. 365.
[58] Bookstaber, A Demon of Our Own Design, pp. 131-32.
[59] Joseph Stiglitz, Freefall, New York, Norton, 2010, p. 215.
[60] PBS Frontline Money Power and Wall Street,
[61] Gasparino, Bought and Paid For, p. 53.
[62] “White House Renews Posturing for Illegal Alien Amnesty”, FAIR Immigration Report, May 2011.
[63] Saul Alinsky, Rules for Radicals, New York, Vintage, 1971, p. 195.
[64] Ibid, p. 196.
[65] Gasparino, The Sellout, p. 162.
[66] Ibid, p. 233.
[67] Ahlert, “Fannie Mae’s Duo of Destruction”.
[68] Gasparino, The Sellout, p. 108.
[69] Steve Sailer, “Karl Rove—Architect Of The Minority Mortgage Meltdown”, September 28, 2008.
[70] Gasparino, Bought and Paid For, p. 27.
[71] Ibid, p. 151.
[72] Gasparino, The Sellout, pp. 170-73.
[73] Ibid, pp. 173-75.
[74] Ibid, p. 299.
[75] Ibid, p. 221-35.
[7]6 Ibid, p. 170.
[77] Ibid, p. 312.
[78] Ibid, p. 296.
[79] Ibid, p. 315.
[80] Ibid, p. 211.
[81] Ibid, pp. 396-402.
[82] Diane Harrigan, “Paying Back”, Baruch Alumni Magazine, Spring/Summer 2012
[83] Gasparino, The Sellout, p. 238.
[84] Ibid, p. 233.
[85] Tait Trussell, “The President’s Wall Street”, October 18, 2011,
[86] Dan Eggen and T.W. Farnam, “Obama still flush with cash from financial sector despite frosty relations”,
[87] Ibid
[88] Farnam, “MF Global ties awkward for Obama campaign”.
[89] Arnold Ahlert, “Back in the Sub-Prime Mortgage Habit”, July 13, 2011
[90] Gasparino, Bought and Paid For, pp. 197-209.
[91] Ibid, p. 235.
 [92] Ibid, pp. 233-34.
[93] Ibid, p. 236.
[94] Ibid, pp. 104-110.
[95] Michelle Malkin, “Obama's Green Robber Barons”, Jan 26, 2012,
 [96] Sperry, The Great American Bank Robbery, p. 199.
[97] Wayne Barrett, “How the youngest Housing and Urban Development secretary in history gave birth to the mortgage crisis”, August 05, 2008,

 [98] Sperry, The Great American Bank Robbery, p. 28.
 [99] Ibid, pp. 87-146.
[100] Ibid, pp. 127-29.
[101] Ibid, pp. 121-24.
[102] Ibid, p. 146.
[103] Ibid, pp. 136-46.
[104] Stanley Kurtz, “Spreading The Virus”, October 13, 2008,;jsessionid=190564CA0A0D701CE11780A4A5EE5EA1.
[105] Sperry, The Great American Bank Robbery, p. 150.
[106] Introduction, p. xii, in FRB of Atlanta, Financial Derivatives,
[107] Ibid
[108] Satyajit Das, Swap & Derivative Financing, New York, McGraw-Hill, 1994, p. 1171.
[109] Johan Van Overtveldt, Bernanke’s Test, p. 163.
[110] Jane D’Arista, “Financial Regulation in a Liberalized Global Environment” in John Eatwell and Lance Taylor, International Capital Markets, New York, Oxford, 2002, pp. 81-82.
[111] Geisst, Wheels of Fortune, p. 303.
[112] Basel Committee on Banking Supervision, June 1999, p. 19.
[113] Das, Swap and Derivative Financing pp. 1181-2.
[114] Ibid, p. 1230.
 [115] John Eatwell and Lance Taylor, “A World Financial Authority” in Eatwell and Taylor, International Capital Markets, p. 20.
[116] Basel Committee on Banking Supervision, pp. 2-6.
 [117] Van Overtveldt, Bernanke’s Test, p. 158.
[118] Ibid, pp. 91-92.
 [119] Ibid, p. 93.
[120] Ibid, p. 95.
[121] Ibid, pp. 220-21.
[122] Ibid, p. 244.
[123] Stiglitz, Freefall, p. 121.
[124] Wall, Pringle and McNulty, “Capital Requirements for Interest Rate and Foreign Exchange Hedges” in FRB of Atlanta, Financial Derivatives, p. 235.
[125] Gasparino, The Sellout, p. 196.
[126] Van Overtveldt, Bernanke’s Test, p. 230.
 [127] Ibid, p. 221.
[128] Henry Kaufman, Interest Rates, the Markets and the New Financial World, New York, Times Books, 1986, pp. 76-77.
[129] Geisst, Wheels of Fortune, p. 80.
[130] Ibid, pp. 316-23.
[131] Gasparino, Bought and Paid For, pp. 68-69.
[132] Geisst, Wheels of Fortune, pp. 314-315.
[133] Ibid, pp. 332-333.
[134] Ibid, pp. 346-47.
[135] Ibid, p. 348.
[136] Gasparino, The Sellout, p. 196.
[137] Bookstaber, A Demon of Our Own Design, pp. 195-200.
[138] Ibid, p. 55.
[139] Gasparino, The Sellout, p. 318.
[140] Arnold Ahlert, “Obama’s Financial Guru Faces Congress”,
[141] Gasparino, The Sellout, p. 346.
[142] Rubenstein, “The Twin Crises - Immigration and Infrastructure”, p. 26.
[143] Gasparino, The Sellout, p. 232.
[144] Ibid, p. 249.
[145 Ibid, p. 496.
[146] Peter Abken, “Globalization of Stock, Futures, and Options Markets” in FRB of Atlanta, Financial Derivatives, p. 12.
[147] Gasparino, The Sellout, p. 116.
[148] Stiglitz, Freefall, p. 52.
[149] Ahlert, “Obama’s Financial Guru Faces Congress”.
[150] Ibid
[151] Gasparino, The Sellout, p. 96.
[152] William Greider, “Dismantling the Temple”, The Nation, August 3, 2009, p. 13.
[153] Geisst, Wheels of Fortune, p. 252.
 [154] Gasparino, The Sellout, p. 199.
[155] Geisst, Wheels of Fortune, p. 339.
[156] Gasparino, The Sellout, p. 198.
[157] Stiglitz, Freefall, p. 84.
[158] Ibid, p. 149.
[159] Arnold Ahlert, “S&P Under Fire”, August 19, 2011,
URL to article:
[160] Philip Turner, “Procyclicality of Regulatory Ratios?” in Eatwell and Taylor, International Capital Markets, p. 483.
[161] Gasparino, The Sellout, p. 201.
[162] Gasparino, The Sellout, p. 68.
[163] Ibid, p. 95.
[164] Andrew Sorkin, “At Lehman, Watchdogs Saw It All”, March 15, 2010.
[165] Bookstaber, A Demon of Our Own Design, pp. 45-49.
[166] Stiglitz, Freefall, p. 143.

 [167] Keith Bradsher, “Fed Tightens Its Policies On Ethics” June 9, 1994.
[168] Peter Truell, “New York Fed Official Resigns Over Article in The Times”, July 21, 1995.
[169] Eric Dash, “Dudley Named to Lead New York Fed”, January 27, 2009.
[171] Daily News, “Former Bank Examiner Is Accused of Theft”,
[172] Reuters, “U.S. Charges Programmer With Stealing Code”, January 18, 2012.
[173] Matthew Vadum, “Another Radical Obama Nominee”, September 3, 2012,
[174] Jo Becker and Gretchen Morgenson,
[175], “Ex-Chief of State Fed Joins Goldman”, New York Times, October 20, 1993.
[176] Gene Nelson, “How Record Immigration Levels Robbed American High-Tech Workers of $10 Trillion”, The Social Contract, Spring 2012, p. 37.
[177] Greider, “Dismantling the Temple”, p. 14.
[178] Stiglitz, Freefall, p. 165.
[179] Ibid, p. 174.
[180] Bookstaber, A Demon of Our Own Design, pp. 259-60.
[181] Stiglitz, Freefall, p. 175.



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