Phil Gramm: There's More

by hilzoy

Recently, two more articles about Phil Gramm, "McCain's Economic Brain", have appeared. MSNBC had reported a week ago that Gramm was a paid lobbyist for UBS, one of the banks most heavily involved in the subprime scandal, until six weeks ago. Now Newsweek adds this:

"NEWSWEEK has learned that UBS is also currently the focus of congressional and Justice Department investigations into schemes that allegedly enabled wealthy Americans to evade income taxes by stashing their money in overseas havens, according to several law-enforcement and banking officials in both the United States and Europe, who all asked for anonymity when discussing ongoing investigations. In April, UBS withdrew Gramm's lobbying registration, but one of his former congressional aides, John Savercool, is still registered to lobby legislators for UBS on numerous issues, including a bill cosponsored by Sen. Barack Obama that would crack down on foreign tax havens. "UBS is treating these investigations with the utmost seriousness and has committed substantial resources to cooperate," a UBS spokesman told NEWSWEEK, adding that Gramm was deregistered as a lobbyist because he spends less than 20 percent of his time on such activity. Hazelbaker said the McCain campaign "will not comment on the details … of ongoing investigations and legal charges not yet proved in court.""

A new article in the Texas Monthly Observer is even more interesting, and worth reading in its entirety. It begins:

"In the early evening of Friday, December 15, 2000, with Christmas break only hours away, the U.S. Senate rushed to pass an essential, 11,000-page government reauthorization bill. In what one legal textbook would later call “a stunning departure from normal legislative practice,” the Senate tacked on a complex, 262-page amendment at the urging of Texas Sen. Phil Gramm.

There was little debate on the floor. According to the Congressional Record, Gramm promised that the amendment—also known as the Commodity Futures Modernization Act—along with other landmark legislation he had authored, would usher in a new era for the U.S. financial services industry.(...)

With the U.S. economy now battered by a tsunami of mortgage foreclosures, the $30-billion Bear Stearns Companies bailout and spiking food and energy prices, many congressional leaders and Wall Street analysts are questioning the wisdom of the radical deregulation launched by Gramm’s legislative package. Financial wizard Warren Buffett has labeled the risky new investment instruments Gramm unleashed “financial weapons of mass destruction.” They have fed the subprime mortgage crisis like an accelerant. While his distracted peers probably finalized their Christmas gift lists, Gramm created what Wall Street analysts now refer to as the “shadow banking system,” an industry that operates outside any government oversight, but, as witnessed by the Bear Stearns debacle, requiring rescue by taxpayers to avert a national economic catastrophe."

One part of that bill was what's called the 'Enron Loophole':

"The impact of the “Enron loophole” has been enormous. Since its passage, the Senate Permanent Subcommittee on Investigations has concluded that the loophole contributed to inflated energy prices for American consumers. In 2006, its report found credible expert estimates that the loophole—by encouraging speculation—accounted for $20 of the price of a barrel of oil, then at $70. In 2007, the same committee blamed the loophole for price manipulation of the natural gas market by a single hedge fund, Amaranth Advisors."

But Gramm's legislation also seems to have legalized what are known as 'credit default swaps':

"Prior to its passage, they say, banks underwrote mortgages and were responsible for the risks involved. Now, through the use of credit default swaps—which in theory insure the banks against bad debts—those risks are passed along to insurance companies and other investors.

Maryland law professor Greenberger believes credit default swaps “were a key factor in encouraging lenders to feel they could make loans without knowing the risks or whether the loan would be paid back. The Commodity Futures Modernization Act freed them of federal oversight.”

Before passage of the modernization act, the Commodity Futures Trading Commission was attempting to regulate the swaps market through rule-making. The modernization act, Gramm noted in his remarks on the Senate floor, provided “legal certainty” for the growing swaps market. That was necessary, Greenberger says, because at the time, “banks were doing these trades in direct violation of federal law.”"

There's a decent explanation of credit default swaps here. As I understand it, the basic idea is this:

Suppose I have a risky loan, and I want to insure against losses. I agree with someone else -- call him or her X -- that she will pay back my loan if the person I made it to defaults. In exchange for this insurance policy, I will pay her -- maybe I'll send her the loan payments, suitably adjusted for risk. In any case, X gets cash, and I (supposedly) get peace of mind.

In a normal, regulated insurance market, there would be requirements that (for instance) X have enough capital to make good if my loan defaults. X would also not be able to sell the contract to make good my losses to just anyone, and X would certainly have to tell me about any such sale. But in the world of CDSs, neither requirement exists. CDS contracts can be sold and resold, and I might have no idea who is actually supposed to repay me if my loan goes into default. Moreover, there are no capital requirements on some of the people who can buy them. So if a lot of CDSs require payment from X all at once, there's no guarantee that X will be able to pay up. As the NYT puts it:

"It would be as if homeowners, facing losses after a hurricane, could not identify the insurance companies to pay on their claims. Or, if they could, they discovered that their insurer had transferred the policy to another company that could not cover the claim."

But it gets worse: in a lot of cases, X is a hedge fund. Hedge funds are highly leveraged, and therefore a relatively small downturn in their underlying assets (like some of their CDSs needing to be paid up) can wipe them out. Moreover, the alternative to a CDS, normally, would be to buy the underlying risky asset. CDSs allow people to assume the risks and benefits of owning that asset without actually putting money down. Instead, they get money: a cash stream, which they can then use to make more highly leveraged bets.

This is just a recipe for instability: for allowing unregulated financial institutions to place themselves, and the rest of the financial universe, at risk through unregulated, highly leveraged, and deeply risky maneuvers. And the CDS market is huge:

"The CDS market exploded over the past decade to more than $45 trillion in mid-2007, according to the International Swaps and Derivatives Association. This is roughly twice the size of the U.S. stock market (which is valued at about $22 trillion and falling) and far exceeds the $7.1 trillion mortgage market and $4.4 trillion U.S. treasuries market, notes Harvey Miller, senior partner at Weil, Gotshal & Manges. "It could be another — I hate to use the expression — nail in the coffin," said Miller, when referring to how this troubled CDS market could impact the country's credit crisis."

If Gramm basically legalized credit default swaps, then his involvement in the subprime crisis goes far beyond his work for UBS. And John McCain should have to explain why he thinks that Phil Gramm is a good person to turn to for economic advice.

Comments

[JakeB]

Gramm should rather be rotting in a cell, it seems.

[kindness]

You should also include SameFacts piece titled Phil Gramm, ghoul:

"Phil Gramm tried to get the state of Texas to sell bonds to buy life insurance on state employees. Not insurance to help support the employees' families, you understand. No, that would be liberal. Insurance whose proceeds were to go to Gramm's employer, UBS, which would use them to pay off the bonds and then share the profit with various state pension plans. This scheme is a variant on the rather gruesome financial maneuver called "dead peasant insurance," in which employers take out insurance policies on the lives of their low-wage employees...In the private sector, "dead peasant insurance" is big business: billions of dollars per year. Some states have banned it, but the rather mild scandal that erupted when word of the scheme hit the press has largely faded away. The IRS had actually managed to take away the tax benefits of the scheme, but in August 2006 the Republican-controlled Congress gave them back again....(The fact that the Republican-dominated government of Texas decided to take a pass suggests either that their morals are better than Gramm's or that they have more political sense than he does.)"

[kindness]

You should also include SameFacts piece titled Phil Gramm, ghoul:

"Phil Gramm tried to get the state of Texas to sell bonds to buy life insurance on state employees. Not insurance to help support the employees' families, you understand. No, that would be liberal. Insurance whose proceeds were to go to Gramm's employer, UBS, which would use them to pay off the bonds and then share the profit with various state pension plans. This scheme is a variant on the rather gruesome financial maneuver called "dead peasant insurance," in which employers take out insurance policies on the lives of their low-wage employees...In the private sector, "dead peasant insurance" is big business: billions of dollars per year. Some states have banned it, but the rather mild scandal that erupted when word of the scheme hit the press has largely faded away. The IRS had actually managed to take away the tax benefits of the scheme, but in August 2006 the Republican-controlled Congress gave them back again....(The fact that the Republican-dominated government of Texas decided to take a pass suggests either that their morals are better than Gramm's or that they have more political sense than he does.)"

[jdog]

This is a compelling post. But how can such arcane details be packaged to be understood by most Americans? I suppose the place to start is the high price of gas; one could also re-examine the price bubble in California energy markets caused by deregulation.

Ultimately it calls for a compelling narrative about regulated markets as a good thing, as opposed to the overly simplistic mantra of free markets that has been the calling card of the Reagan and post-Reagan Republican party. Of course few (if any) markets are in fact "free." But to make the case in a simple and compelling manner is still wanting.

This may be a task for the Obama campaign. But of course there is risk inherent in that, because it could then expose him to being a "big government liberal". The case needs to be made first by intellectuals.

And by the way, corporations do not exist without grants from the state. And they cannot merge without permission from the state. No market with a corporation in it is a "free" market.

[Sebastian]

"I suppose the place to start is the high price of gas; one could also re-examine the price bubble in California energy markets caused by deregulation.

Ultimately it calls for a compelling narrative about regulated markets as a good thing, as opposed to the overly simplistic mantra of free markets that has been the calling card of the Reagan and post-Reagan Republican party."

The California case doesn't show what you seem to think it shows. Energy providers were banned from making the routine long term supply contracts which are necessary to smooth out spot-price problems. CA legislators thought that the lowest prices at the time were the norm and thus specifically did not allow long term contracts with a price any higher than the nearly 30-year low spot price. That doesn't excuse the fact that speculators attempted to use the fact that California was required by law to use daily spot prices (or was it weekly, I can't remember). But even without the speculation, the contract prices would have been much lower than the spot price only a few years later. Legislators disallowed one of the most normal market tools, and got burned. That example doesn't make for much of a "caused by deregulation" narrative.

The price of gas doesn't help you either so far as I can tell. Looks like high demand and limited supply equals high price to me.

[Nate]

Didn't Enron admit to manipulating the California electricity market to defraud the state of billions of dollars?

[gwangung]

Didn't Enron admit to manipulating the California electricity market to defraud the state of billions of dollars?

Well, they were taped saying so with respect to Snohomish County in Washington.

[mss]

The article linked in the main post is from the Texas Observer, not the Texas Monthly. The Observer is a fantastic left-leaning political and investigative journalism mag that's been around in Texas for decades, and deserves a lot more love in the blogosphere. It was Molly Ivins' home, and broke the Tulia drug story, just to name a couple of reasons to keep it on your radar.

[aimai]

synchronicity:

I just opened my newly acquired copy of "The Way we Never were" to this apt quote (p 10)

Sen. Phil Gram, for example...is well known for his opposition to government handouts. However, his personal history is quite different from his political rhetoric. born in Gerogia in 1942 to a father who was living on a federal veterans disability pension, Gramm attended a publicly funded university on a grant paid for by the federal War Orphans Act. His graduate work was financed by a National Defense Education Act fellowship, and his first job was at Texas A and M University, a federal land-grant institution. yet when Gramm fianlly struck out on his own, the first thing he did was set up a consulting business where he could be, in his own words, "an advocate of fiscal responsibility and free enterprise." From there he moved on to Congress, where he has consistently attempted to slash federal assistance programs for low income people."

aimai

[hilzoy]

mss: thanks; corrected.

[OriGuy]

But does he wear a flag pin?

[joel hanes]

Democrats should make "Enron" become Phil Gramm's new middle name.
Phil "Enron" Gramm.
Gramm is a crook, a mean and selfish bastard; his presence on McCain's team is a huge opening for Democrats seeking ammunition in the general election.

Here is Molly Ivins explaining about Phil and Enron;
here is another 2004 Ivins piece about Gramm;
here's one from 2002.

Here's an Aug 1995 Mother Jones piece about one of Phil's good-ol'boy associates.

[david kilmer]

"This is a compelling post. But how can such arcane details be packaged to be understood by most Americans?"

Let me try....

"Phil Gramm's irresponsible legislation led to the subprime crisis".

[david kilmer]

"This may be a task for the Obama campaign. But of course there is risk inherent in that, because it could then expose him to being a "big government liberal". The case needs to be made first by intellectuals."

I couldn't disagree more. The "big government liberal" charge is made directly to the public by almost any conservative you could name. It goes right to the heart of progressive politics. What's needed is an argument with some ethos, rather than an intellectual argument. Something like:

"Conservatives have been talking for years about 'getting government out of your life'. They think the way to do this is to privatize, deregulate, and give more power to large corporations. Corporations control what you pay for healthcare and medications. They control whether you can get insurance, or whether you can get a loan to go to school. They even control what you're allowed to see on the news. So.... who is going to get big corporations out of your life?"

Vote Democrat.

[david kilmer]

Here's another one - for the young voters:

Republicans talk a lot about 'big government' versus 'small government'
Why is it that they never talk about 'good government' versus 'bad government'?
Why are they so obsessed with size?
Maybe they're compensating for something.

[Gary Farber]

"But in the world of SBCs, neither requirement exists. SBC contracts can be sold and resold"

Perhaps it might be helpful to explain what an "SBC" is in your post? Or just what the letters stand for?

I've gone through eight of your linked articles so far, and still haven't found the acronym, or an explanation. Probably this is something everyone but me knows, though.

[Gary Farber]

Or did you possibly mean "CDS"?

[Mark D]

"Republicans talk a lot about 'big government' versus 'small government'
Why is it that they never talk about 'good government' versus 'bad government'?
Why are they so obsessed with size?
Maybe they're compensating for something.

Posted by: david kilmer"

Brilliant. Simply brilliant.

**golf clap**

As far as a sound bite goes:

"McCain admits he 'doesn't know much about the economy' so he takes advice from Phil Gramm, whose legislation led to the subprime crisis. So who are you going to trust with your family's home -- someone with a plan for you to keep it, or someone who created the foreclosure crisis?"

Or, shorter:

"McCain's economic adviser is the reason you lost your house."

The latter is a bit of a stretch, though ...

[Bernard Yomtov]

The NYT explanation is a little puzzling. If you don't know who your counterparty is, how do you know who to send the premiums to? And are there really no limits on who can buy the contracts, thereby assuming the default risk? That's an obvious recipe for disaster, since it would be easy, and I suppose legal, to buy a bunch of contracts without having the means to pay off, and then declare bankruptcy if necessary.

One of the important functions of a futures exchange is to guarantee performance on traded contracts. That is, if I buy a carload of wheat for delivery in November it is the exchange, in effect, that guarantees performance (in the form of cash, not wheat). That makes anonymous trading possible.

In over-the-counter derivatives trading there is normally an intermediary between the parties who perfoms the same function. Surely some similar mechanism exists in the CDO market. Doesn't it?

Maybe someone with experience in the area can explain.

[Gary Farber]

"Vote Democrat."

Better to either vote for the Democrat, or to vote Democratic. We don't actually call ourselves the "Democrat" Party.

[hilzoy]

Gary: fixed; thanks. (Duelling acronyms in my head.)

[trilobite]

What is the harm in Dead Peasant Insurance? I don't know a durned thing about it, just googled and read a couple of news stories that confirm the description upthread, but I don't see how the workers are harmed by it - I kinda doubt the company is slipping asbestos into the break room coffee to cash in on the policies, and it's not their money being spent on premiums. It's a weird, ill-targeted way to give large employers a tax break on otherwise mediocre investments, but stupid tax breaks for big corporations are not exactly a new part of the Republican platform. Why the outrage?

[hilzoy]

trilobite: that's why I didn't mention it. I thought it was ghoulish, but probably harmless, unlike credit default swaps, and the Enron loophole.

[david kilmer]

"Better to either vote for the Democrat, or to vote Democratic. We don't actually call ourselves the "Democrat" Party."

Do you mean it's better to say that in an ad, or better to actually vote for Democrats?

If the latter, I agree with you.

[aimai]

What's so difficult about "Phil Gramm wanted to see your kid's teachers die?" and "Phil Gramm hates workers so much he wants to bet on their deaths?" Short and sweet.

aimai

[Nell]

David Kilmer: So.... who is going to get big corporations out of your life?"

Vote Democrat.

That's 'Vote Democratic'.

Which, as things now stand, has about as much chance of getting big corporations out of our lives as it has of causing the sun to revolve around the earth.

[david kilmer]

"That's 'Vote Democratic'."

Says you. And Gary.

"Which, as things now stand, has about as much chance of getting big corporations out of our lives as it has of causing the sun to revolve around the earth."

You're officially evicted from my target audience ;).

[russell]

Former federal office holders should not be allowed to work as lobbyists, ever. While they are in office, their family members should not be allowed to work as lobbyists. Period, full stop, no exceptions.

Won't that be a strong disincentive for lots of folks to run for office? Yes, it will. That's the point. Those are not the folks we want in office.

Tangential to Gramm, of course, but offered as a modest proposal.

Thanks -

[Robert M.]

...Maybe they're compensating for something.

I'm with Nell on the practical aspect, but I lol'ed.

[Gary Farber]

"Former federal office holders should not be allowed to work as lobbyists, ever."

I suggest a ten-years-long ban is more reasonable and sufficient.

[russell]

I suggest a ten-years-long ban is more reasonable and sufficient.

Sounds fine to me. It's pretty unlikely that policy-makers will be influenced by the prospect of a fat gig ten years down the line.

Plus, it's something I could actually imagine becoming law, as opposed to my original proposal.

Thanks -

[Robert]

Oddly enough, there doesn't seem to be any mention that the bill was signed into law by Bill Clinton...

Hmmm, rather strange, that...

[liberal japonicus]

the U.S. Senate rushed to pass an essential, 11,000-page government reauthorization bill.

I think you may have missed that adjective, Robert.