The Washington Mutual Wish List: Optimizing a Criminogenic Environment

On November 7, 2007, the Financial Services Roundtable released its “The Blueprint for U.S. Financial Competitiveness.” I explained in a three-part series of columns how Federal Home Loan Bank Board Chairman Ed Gray and Office of Thrift Supervision Director Tim Ryan led crackdowns on the “control frauds” that caused the S&L debacle. I emphasized how Gray did so in the face of enormous political opposition from the Reagan administration, Speaker of the House Jim Wright, a majority of the House of Representatives, and the “Keating Five.” One of the odd moments during these political attacks was that a Republican Representative from the Dallas area requested a meeting with Gray when Speaker Wright's attacks on Gray's reregulation of the industry and actions against the control frauds were becoming public an notorious. In my naiveté, I thought that Bartlett requested the meeting to support his fellow Republican, Gray. Of course, Bartlett's purpose was the opposite. He was enraged by our efforts against the Texas control frauds and wanted us to back off. Years later, after a stint as Dallas' mayor, the Financial Services Roundtable made Bartlett its head, a position he continues to occupy. Naturally, Bartlett learned nothing productive from being proven disastrously wrong about the S&L debacle. The financial industry chose him as its lead representative because he never learned. He remains an implacable anti-regulator. The Blueprint describes and situates this anti-regulatory effort, which was the product of a “Blue Ribbon Commission” co-chaired by “Richard M. Kovacevich, Chairman, Wells Fargo & Company; and James Dimon, Chairman and CEO, JPMorgan Chase and Co.” “Within the past year, three reports on U.S. financial competitiveness—including the Bloomberg-Schumer Report—have called for a system of principles-based regulation. Last March, Treasury Secretary Henry M. Paulson, Jr. said, “[W]e should also consider whether it would be practically possible and beneficial to move to a more principles-based regulatory system as we see working in other parts of the world.” The Blueprint was part of a coordinated anti-regulatory effort with Goldman Sachs alums at the U.S. Treasury Department and the Chamber of Commerce. “Three major studies - the bipartisan report by New York Mayor Michael R. Bloomberg and New York Senator Charles E. Schumer (D-NY), the U.S. Chamber report, and the study by the Committee on Capital Markets - have concluded that the United States is losing its position as the world's leading financial marketplace.1” The text of the footnote shows the “race to the bottom” rationale that characterized each of these purportedly “independent” “studies.” “1 Michael R. Bloomberg and Charles E. Schumer, Sustaining New York's and the US' Global Financial Services Leadership, January 2007 at www.nyc.gov; hereafter, Bloomberg-Schumer Report. See also Michael R. Bloomberg and Charles E. Schumer, “To Save New York, Learn from London,” Wall Street Journal, November 1, 2006, p. A-18; Committee on Capital Markets Regulation, Interim Report, November 2006 at www.capmktsreg.org; hereafter, Interim Report; Commission on the Regulation of U.S. Capital Markets in the 21st Century (U.S. Chamber of Commerce), Report and Recommendations, March 2007 at www.uschamber.com; hereafter, U.S. Chamber Report.” “To Save New York, Learn from London.” Mayor Bloomberg and Senator Schumer (D. NY) urged the U.S. to adopt the UK's approach to financial regulation, which during this era was the three “de's” – deregulation, desupervision, and de facto decriminalization. Henry Paulson was confirmed by the Senate as Bush's Treasury Secretary on June 28, 2006. Paulson's top priority was deregulation. In particular, he worked to weaken Sarbanes-Oxley (SoX) on an urgent basis. Paulson's strategy was to generate a series of anti-regulatory studies and proposals that would serve as the basis for a broad legislative assault on what remained of financial regulation. He was gearing up to propose this assault when the markets collapsed. This led to the March 31, 2008 roll out of the Treasury's incoherent “reform” package. The Paulson plan was incoherent for an excellent reason. His plan's analysis consisted overwhelmingly of an embrace of the standard anti-regulatory “race to the bottom” dynamic contained in the Blueprint, the Bloomberg-Schumer writings, and the Chamber of Commerce, married to a grudging concession that financial regulation had been too weak. This made no sense, for the U.S. and most of the Western world had just run a real world experiment in which the three “de's” had once again proven intensely criminogenic precisely because they invariably lead to the “bottom.” Paulson's plan was dead on arrival. By late March 2008, the absurdity of embracing the anti-regulatory “race to the bottom” – and then admitting that the dynamic was disastrous – was so obvious that the public reacted with scorn to the Paulson plan. The Blueprint's analytics presented in support of the race to the bottom were even worse than the analytics presented by Paulson, for they did not contain any concession that such a race must cause regulation to become catastrophically weak and lead to crises. The Blueprint was very late in the game – November 2007. The bubble had collapsed over a year ago. Most large mortgage banks had failed – catastrophically. Nonprime mortgage defaults were surging. The secondary market in nonprime mortgages collapsed. The authors of the Blueprint knew that the central dynamic they were embracing – the purported “need” to “win” the anti-regulatory race to the bottom – had again proven disastrous. “More recently, the liquidity crisis and ensuing credit crunch in several significant capital markets sectors has revealed weaknesses in the regulatory system. Many homeowners have been confronted with the prospect of foreclosure, and U.S. financial markets have been roiled by problems that can be traced to aggressive practices by some firms, gaps between national and state regulation of the U.S. mortgage industry, and opaqueness in some structured financial instruments innovations. Many of these problems also have impacted the broader credit and capital markets, both domestically and globally.” The passage illustrates the Blueprint's authors' refusal to be honest with the reader. They embraced euphemisms for fraud (“aggressive practices”) and gravely understated the financial crisis that was sweeping like a tornado through the financial markets. They ignored how the industry had deliberately ignored the FBI's September 2004 warning that the developing “epidemic” of mortgage fraud would cause a financial “crisis.” They ignored how the fraud epidemic, generated overwhelmingly by lenders and their agents, hyper-inflated the largest bubble in financial history. But all of this pales against the Blueprint's fundamental dishonesty. Why were there “gaps” between national and state regulation? The mortgage lending industry deliberately cultivated a race to the bottom by creating regulatory black holes and because the industry successfully urged Fed Chairmen Greenspan and Bernanke not to use their statutory authority under HOEPA to ban fraudulent “liar's” loans. Why were “structured financial instrument innovations” “opaque?” The financial industry demanded passage of the Commodities Futures Modernization Act of 2000 for the specific purpose of making the credit default swap (CDS) market wholly opaque. The express goal of the Act was to prevent all federal and state regulation of CDS. The Act, as the industry intended, created a regulatory black hole. The Fed economist who testified to Congress premised the Fed's support for this obscene Act on the purported need to win the race to the bottom in competition with the City of London. The problem that the Blueprint identified was the insane idea that because the UK, Germany, Ireland, and Iceland were racing toward the anti-regulatory bottom and creating an extraordinarily criminogenic environment the U.S. should respond by creating an even more criminogenic anti-regulatory environment so that more of the accounting control fraud would take place in the U.S. and cause even more catastrophic losses here instead of in Europe. The Blueprint is bizarre primarily because it calls for the U.S. to embrace even more fully the anti- regulatory bottom – even though the disastrous consequences of doing so were obvious at the time the Blueprint was published. The Blueprint (implicitly) identified the problem (the anti-regulatory race to the bottom to “win” global competitiveness – and called it the solution. This was significantly insane. The Blueprint, having found that the anti-regulatory race to the bottom was suicidal, urged the U.S. to run faster. “External factors threatening the competitive position of U.S. financial firms and the stability of financial markets include the relentless growth in international financial services competition, rapidly expanding foreign financial markets, and foreign regulatory regimes purposefully designed to adjust quickly to market developments.” This is nonsensical. The “competitive position of U.S. financial firms” would have been aided immeasurably by competent financial regulation, of the kind we employed in 1990-1991 to forbid S&Ls to make liar's loans. The actions that most impaired the competitive position of U.S. financial firms were the three “de's.” Our firms would have had a decisive competitive advantage over European banks, to an extent not seen since the early post-World War II years, had we not destroyed effective financial regulation. Note the lack of logical coherence in the sentence quoted above. The Blueprint concedes that Europe's race to the bottom “threaten[s] … the stability of financial markets.” That concession is true and it has enormous analytical importance (that escaped the authors). It means that the Europe's anti-regulatory race to the bottom does not “threaten” “the competitive position of U.S. financial firms.” Indeed, it must do the opposite. The European banks are inherently destroying themselves as competitive threats when they destroy effective financial regulation because such an action is so criminogenic. The Blueprint's fundamental incoherence leads the authors to recommend anti-regulatory policies that are the opposite of what their logic (if made internally consistent) would recommend. The authors' total blindness to the internal inconsistency of their logic is revealed in this sentence. Similarly, if Europe's anti-regulatory race has led to “regulatory regimes” that serve as cheerleaders (“adjust quickly”) for criminogenic lending practices (“market developments”) then this is the last thing the U.S. should emulate. The way to enhance both U.S. competitiveness and financial stability, particularly if our competitors are racing to the criminogenic bottom, is to employ effective financial regulation. It's a lot like every mother advises her child: “And if Johnny jumps off a cliff do you think that you should also jump off the cliff?” We all know that the CEOs who co-chaired the “Blue Ribbon” group that produced the Blueprint did not write the Blueprint. Who actually produced this blueprint for creating an even ore criminogenic environment sure to produce recurrent, intensifying financial crises? “The Roundtable is grateful for the outstanding guidance provided throughout this project by William A. Longbrake of Washington Mutual, Inc., who also is the Anthony T. Cluff Senior Policy Advisor to The Financial Services Roundtable.” Yes, unintentional self-parody remains unbeatable. The Financial Services Roundtable, with 100 massive members, chose as its “Senior Policy Advisor” and go-to guy on the Blueprint a WaMu's Vice Chairman. Longbrake served as the Chairman of The Financial Services Roundtable's Housing Policy Council during the hyper-inflation of the housing bubble. When you need expertise on creating the most intensely criminogenic environment possible it only makes sense to go to a bank that made, purchased, and sold hundreds of thousands of fraudulent mortgage loans. Longbrake's bio describes his work for WaMu. “From 1982 to 1994 Longbrake was chief financial officer of Washington Mutual except for a two-year stint when he was the principal executive responsible for retail banking and home lending. When he returned to Washington Mutual from the FDIC in 1996 he resumed the position of chief financial officer until 2002 when he became the bank's first chief enterprise risk officer. In 2001, Longbrake was named CFO of the Year in the Driving Revenue Growth category by CFO Magazine. From 2004 until retirement he served in a non-executive position as the company's liaison with regulators, legislators, and industry trade organizations.” Kerry Killinger, WaMu's Chairman and CEO, was a member of the “Blue Ribbon” group that created the Blueprint for disaster.

Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.

Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives.