William K. Black was a federal regulator during the Savings and Loan crisis and appears in Michael Moore's 'Capitalism: A Love Story'
President Obama's Executive Order on regulatory review was originally set in motion by his February 3, 2009 direction to OMB to create an improved regulatory review process.
The fundamental principles and structures governing contemporary regulatory review were set out in Executive Order 12866 of September 30, 1993. A great deal has been learned since that time. Far more is now known about regulation -- not only about when it is justified, but also about what works and what does not. Far more is also known about the uses of a variety of regulatory tools such as warnings, disclosure requirements, public education, and economic incentives. Years of experience have also provided lessons about how to improve the process of regulatory review. In this time of fundamental transformation, that process--and the principles governing regulation in general -- should be revisited.
September 30, 1993 is an interesting date. I was the deputy director of the National Commission on Financial Institution Reform, Recovery and Enforcement (NCFIRRE). We issued our report in July 1993 on the causes of the S&L debacle. Our report was based on an extensive investigation of what worked and what failed in regulation.
In particular, we found that the deregulation and desupervision created an environment in which at "the typical large failure" "fraud" was "invariably present." By fall 1993, the Office of Thrift Supervision had learned the lessons and developed extremely effective rules, supervision, enforcement, and support for the criminal justice system. Congress passed the Prompt Corrective Action (PCA) law in 1991. The regulators had removed the abusive regulatory accounting rules designed to cover up the scale of the debacle. Administration officials had falsely used this cover up of losses through accounting gimmickry to claim that the S&L crisis had been "resolved" at no cost to the taxpayers. The PCA was based on the finding that such accounting cover ups and "forbearance" greatly increased the eventual cost to the taxpayers.
By fall 1993, a well-functioning partnership of the OTS and the Justice Department had produced over 1,000 felony convictions of "major" S&L frauds -- it remains to this day the greatest success against elite criminals in history. The Justice Department and the OTS ensured that the prosecutions were prioritized properly by creating the "Top 100" list. The OTS (which was created in 1989) had brought over 1,000 serious enforcement actions. The OTS secured over $1 billion in settlements from top tier auditors and brought hundreds of successful civil actions against the elite frauds. The reregulatory effort was so successful that for the next 15 years every U.S. Treasury Secretary flew to Tokyo and urged Japan's leaders to stop relying on dishonest accounting to cover up their main banks' losses and to instead adopt the regulatory policies that prevented the S&L debacle from becoming a catastrophe.
By September 1993, the S&L regulators had written extensively of our research findings about the role of accounting control fraud in driving the crisis and the regulatory and accounting lessons we had learned. My papers, collectively roughly 500 pages, had been circulated among many finance economists. Our work explained why econometric studies produced exceptionally erroneous findings in the presence of accounting control fraud and financial bubbles. Three of the nation's leading white-collar criminologists, Henry Pontell, Kitty Calavita, and Robert Tillman had published several journal articles on these same topics. George Akerlof and Paul Romer formally presented their paper on accounting control fraud -- "Looting: the Economic Underworld of Bankruptcy for Profit" at the Brookings Conference on September 9, 1993 before many of the nation's most prominent finance specialists.
The NCFIRRE report notes that key elements of the Reagan administration -- particularly Treasury and OMB, actively opposed our vital reregulation of the S&L industry. That reregulation was essential to containing a raging epidemic of accounting control fraud in the mid-1980s. Only the fact that the Federal Home Loan Bank Board was an independent regulatory agency prevented OMB from blocking S&L reregulation.
President Obama is correct that white-collar criminologists and a few non-theoclassical economists have continued to add to the useful understanding of regulation since 1993. However, his 2009 direction to OMB is not candid. By September 1993, we not only knew how to regulate effectively -- financial regulation was exceptionally effective -- and employment and growth were surging. The perverse (Gresham's) dynamics that the accounting control frauds had caused that destroyed wealth and jobs had been eliminated or minimized. Even the most elite frauds and their elite political allies were held accountable. Bank Board Chairman Gray led the successful reregulation in late 1983-mid-1987 over the intense opposition of the Reagan administration, a majority of the House of Representatives, Speaker Wright, and the five U.S. Senators that became known as the "Keating Five." Paul Volcker was Gray's sole powerful ally. Wright and the Keating Five intervened on behalf of the two worst control frauds in America. S&L regulators had their careers destroyed, but continued to buck the frauds and their political patrons and do their duty to the public.
In 1991-1992, the OTS' West Region used its supervisory powers to squash a fast-developing trend among a number of California S&Ls to make "liar's" loans. We recognized that such loans were inherently unsafe and unsound and frequently fraudulent. Our efforts were so effective that Long Beach Savings gave up its federal charter to escape our regulatory authority. It became a mortgage banker and rebranded itself as Ameriquest -- the most notorious of the early non-federally regulated lenders specializing fraudulent and predatory nonprime loans.
What happened after September 1993 is that OMB and Treasury, in alliance with Fed Chairman Greenspan and Senator Gramm, lost the accurate understanding of why vigorous financial regulation is essential and how one makes regulation effective. OMB, Treasury, Greenspan, and Gramm adopted anti-regulatory policies that were intensely criminogenic. We had to reregulate without the benefits of the criminology studies by Pontell, Calavita and Tillman and Akerlof & Romer's economic studies. The Clinton and Bush administrations had the advantage of all our research and our demonstration of which financial regulatory policies succeed and which fail. (They also had the benefit of the public administration scholars' books and articles that studied used our reregulation and concluded that it was an exemplar of effective regulation.) Unfortunately, the "completely failed" economic dogma that the Clinton and Bush administrations, Greenspan and Bernanke, and Senator Gramm shared led them to ignore our successes and adopt anti-regulatory policies that were so perverse that they were intensely criminogenic.
The recent epidemics of accounting control fraud, the creation of the largest bubble in history, and the Great Recession could not have occurred if the Clinton and Bush administrations had actually learned a great deal about what works and what fails in regulation. The Clinton and Bush anti-regulatory policies created the "three des" -- deregulation, desupervision, and de facto decriminalization. In late 2008, however, then-Senator Obama proclaimed that he had learned the correct regulatory "lessons" from the resulting economic collapse. From the Washington Post:
"John McCain has spent decades in Washington supporting financial institutions instead of their customers," [Obama] told a crowd of about 2,100 at the Colorado School of Mines. "So let's be clear: What we've seen the last few days is nothing less than the final verdict on an economic philosophy that has completely failed."
Senator Obama was correct -- the Clinton and Bush anti-regulatory policies were a catastrophic failure that permitted the epidemics of fraud that drove the Great Recession and the loss of over 10 million jobs. OMB was among the most virulent opponents of vigorous financial regulation because it has long been dominated by anti-regulatory economists embracing the "economic philosophy that has completely failed." Bush selected financial regulatory leaders on the basis of the strength of their anti-regulatory zeal. President Obama was incorrect, therefore, in his February 3, 2009 directive to the OMB about the improved understanding of regulation. "Years of experience" have not taught the theoclassical economists "far more" "about what works and what does not" in regulation. The theoclassical economists know vastly less about effective regulation now than did OTS in 1993.
The University of Chicago economists that President Obama appointed to senior positions related to regulatory policy scorned financial regulation. Austan Goolsbee, now Chairman of the President's Council of Economic Advisors poured scorn on those who warned of the urgent need to regulate nonprime loans. In a March 29, 2007 column in the New York Times, Goolsbee derided those warning that nonprime loans were a "time bomb."
This op-ed shows why the reasoning and methodology that Goolsbee employed "completely failed" because it relied on anti-regulatory dogma rather than sound economics and white-collar criminology. The column also shows that Obama's regulatory review policy embraces Goolsbee's "completely failed" anti-regulatory dogma and methodology and ignores the sound findings and methodologies employed by successful regulators, economists, and white-collar criminologists. Obama is correct that white-collar criminologists and non-theoclassical economists have learned "far more" "about what works and what does not" in regulation. He is incorrect that his economic team has learned these "lessons."
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