Lawless Capitalism: The Subprime Crisis and the Case for an Economic Rule of Law

3. Animal Spirits and Financial Regulation

74 > 75 means that regulatory infrastructure must be structured pursuant to legal frameworks designed to meet these challenges. According to the economists Thomas Ferguson and Robert Johnson, the “money driven American political system” drove “every phase of the crisis.”6 A steady drumbeat of deregulation, nonregulation, and misregulation paced the entire causal chain of the financial crisis. Financial elites stood behind the apparently inept regulators and the laissez-faire lawmakers, garnering windfall profits even while saddling the global financial system with enormous losses. From campaign contributions to lucrative job offers, financial elites held sway over lawmakers in ways that vividly illustrate the costs of runaway inequality. For example, Clinton Treasury Secretary Robert Rubin headed Goldman Sachs and led President Clinton’s efforts to raise money from Wall Street interests. He subsequently spearheaded the effort to repeal the Glass-Steagall Act and ended up as the Vice-Chair of Citigroup, the greatest beneficiary of the repeal, raising ethical questions.7 Although some hoped otherwise, nothing much changed with the Obama administration, as Peter Orszag went from member of the Obama cabinet to Vice-Chair at Citigroup, the largest federal bailout recipient.8 On the GOP side, Senator Phil Gramm of Texas pushed for derivatives deregulation and the repeal of the Glass-Steagall Act. He ended up as Vice Chair of UBS. While a senator, Gramm received more support from the financial industry than any other.9 His wife, Commodity Futures Trading Commission (CFTC) Chair Wendy Gramm, also worked to ensure the nonregulation of derivatives, which permitted Enron to engage in dubious transactions. She found herself on the Enron board of directors.10 Financial elites hedge their political investments to ensure bipartisan access and influence. They win regardless of election outcomes. This chapter first shows the nexus of political influence, elite self-interest, and the subversion of legal and regulatory infrastructure in finance. By 2007, these connections led to an unprecedented concentration of wealth within the financial sector with all the adverse implications for law and regulation.11 Next, the chapter seeks solutions in the form of durable legal and regulatory frameworks. Unfortunately, the political prospect for financial regulatory reform dims in the face of increased concentration of wealth within the financial sector, increased CEO power over the public corporation, and general increased concentration of personal wealth held primarily by corporate and financial elites.12 On the other hand, further foreseeable, deep, and painful macroeconomic disruptions could induce the American voting public to repudiate unbridled wealth and lawless concentrated economic power once and for all. 76 > 77 regulatory powers over many subprime lenders. Nevertheless, between 2003 and 2007, at the height of the subprime storm, the Fed brought just a single enforcement action related to subprime lending, levying a $70 million fine against Citigroup. The Office of the Comptroller of the Currency (OCC), as primary regulator of all national banks, and the Office of Thrift Supervision (OTS), as primary regulator of all federal thrifts, similarly ignored problems at national banks and thrifts. Regulators opted for lax enforcement of lending standards rather than risk losing “client” financial institutions to more permissive regulatory schemes. The OCC and the OTS each depend upon fees levied against constituent banks. In fact, Countrywide’s banking subsidiary switched to a thrift charter in 2007 to take advantage of more lax regulation .23 Thus, Bair’s call for regulation fell on deaf ears. In the backwater of this regulatory neglect, subprime lending exploded, increasing fivefold between 2001 and 2005. By 2006, 40 percent of all mortgage -backed securities (MBS) included at least some subprime loans.24 Inevitably, problems emerged. The problems, according to Bair, involved the financial literacy of subprime borrowers (many of whom were subject to America’s subprime educational system for disempowered classes), adequate disclosure of the true costs and risks of subprime loans, and the dispersal of risks through securitization of loans to investors across the global financial system.25 Bair claims that the profits available to all from subprime lending created a political vacuum in Washington in support of any regulation and that regulatory frameworks allowed compensation incentives to be focused too much on the short term. The profits in subprime lending delayed any reasonable regulation until long after the crisis advanced to a critical stage.26 In the meantime, the most economically powerful within our society continued to exploit the most disempowered at considerable profit.27 Ability to repay indebtedness and abusive...