All the Presidents' Bankers (69 page)

Bankers knew that issuing initial public (stock) offerings (or IPOs), creating more complicated bonds customized with bells and whistles to suit clients’ needs, and transacting more derivatives business offered much greater rewards than traditional lending did. In banking, the more complicated the deal, the more profit a banker could extract from it. Complexity was the new game in town.

The bankers’ goals still overlapped with those of the White House, which believed in financial deregulation as a means to maintain global supremacy. Treasury Secretary Nicholas Brady was keen to put the bankers’ desires ahead of the public interest. In a press release he warned that “our banks are falling behind international competitors,” as if removing restrictions on their practices would somehow ameliorate the greater economy.
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The reason commercial banks were falling behind, though, was mostly because US bankers had taken larger risks than their European counterparts had in real estate markets. Buildings and complexes along the East Coast erected on the back of liberal bank loans stood nearly 95 percent vacant. Tenants couldn’t meet the massive rents and developers were going bankrupt.
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Meanwhile, the sales of new homes had fallen 17.5 percent in 1990, reaching their lowest levels since 1982.

During the first quarter of 1991, Citicorp’s profits fell 81 percent. And though Chase’s earnings rose slightly in comparison, Labrecque waxed pessimistic about the future. “None of us wants a lowering in the quality of real estate accounting standards,” Labrecque said. “Rather what is needed is a sounder, more balanced approach for evaluating real estate.”
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His intent amounted to effectively massaging the numbers.

The Bush administration aided the bankers by advocating the repeal of key elements of Glass-Steagall. Related bills to dismantle the Depression-era act won support of the House and Senate banking committees in the fall of
1991, though they were defeated in the House in a full vote.
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But for many important regulations, the writing was on the wall.

Preston’s Pledge

While the deregulation dance was going on domestically, a shift in the supranational arena threatened to shake the private bankers’ confidence in the World Bank as a partner for their international aspirations. On March 6, 1991, Bush’s old buddy World Bank president Barber Conable Jr. unexpectedly announced his retirement. Conable had played a critical role in that capacity of integrating private and supranational bank activities. The Bush administration did not want to risk installing someone who would be less sympathetic to the private bankers’ requirements when the general economic atmosphere remained shaky.

Bush’s solution was to appoint another old friend: Lewis Preston, who had just retired from his $2 million a year position as chairman of the executive board of J. P. Morgan & Company.
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Preston was a Harvard graduate, former marine, captain of the 1948 Olympic hockey team, and a lifelong Republican.

Under Preston’s tutelage, Morgan’s global presence and investment banking division had grown considerably. Described as “reticent” and “taciturn,” Preston had been heavily involved in crafting Wall Street’s solutions to the third world debt crisis and shielding Morgan from as much fallout as possible.
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For the first time since their inception, the World Bank, IMF, and other international lenders held more than half of third world debt.
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They were thus exposed to more risk than the private banks were.

Preston pledged to reinstitute a more “market-friendly” balance between public and private investment in underdeveloped countries.
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In practice, this meant more World Bank collaboration with private banks in areas where investors had already extracted profits and left behind weak economies throughout Latin America. It also united economic development and private banking policy under one roof. The reinvigorated alliance would soon lead to another major debt crisis—this time, in Asia.

Breeden Fights for Investment Bankers’ Rights

As commercial bankers pushed to enter nonbanking businesses, Bush’s SEC chairman, Richard Breeden, championed the
other
side of the Glass-Steagall divide: that of the investment banks and securities houses.

Breeden fought for the rights of investment banks to own commercial banks. To him, the balance had been tipping too much in favor of the commercial bankers and their demands.
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Their government-backed deposits could be parlayed into the growing, risky, and highly profitable derivatives business, giving them an advantage over other types of financial institutions. Investment bankers hungered to even the score.

The Fed had already given commercial banks approval to underwrite and sell certain previously “ineligible” securities in December 1986, due to its liberal interpretation of Section 20 of the Glass-Steagall Act.
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Now the Bush administration’s plan to deregulate the financial system presented an opportunity for Breeden to expand his power. It would allow the SEC to monitor the growing number of businesses that banks could enter. As Breeden put it, “I don’t know any parts of the package on financial reform that are not S.E.C. related.”
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With Breeden representing investment banks and Brady representing commercial banks, all bases were covered by Bush’s probanking deregulation team. A return to pre–1929 Crash banking conditions had all the political backing it needed.

Wendy Gramm, head of the Commodity Futures Trading Commission established in 1974, helped the bankers’ goal of unconstrained derivatives trading. Gramm had first been appointed chair of the CFTC by Reagan (who called her his “favorite economist”) in 1988, and then reappointed by Bush.
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She was determined to push for unregulated commodity futures and swaps, in response to lobbying from Texas-based energy trading company Enron and various commodity-trading bankers.

After several behind-the-scenes moves designed to garner appropriate political support around Washington, in June 1990 Gramm had sent a six-page fax to President Bush amalgamating the widespread approval for futures deregulation she had gathered throughout his cabinet. Her package included a letter from Treasury Secretary Brady to influential Senator Charles Robb, a Virginia Democrat, advocating he “join the Administration in supporting the Gorton-Wirth-Heinz proposal.” Championed by Republicans Slade Gorton (Washington) and John Heinz (Pennsylvania) and Democrat Timothy Wirth (Colorado), the proposal modified the “exclusivity clause” of the Commodity Exchange Act of 1936, and removed “barriers to innovation in the financial markets.” Their proposal would allow hybrid securities free regulatory rein. Gramm contended it would add “stability and competition to the markets,” and urged the Senate to consider this when reviewing the broader bill.
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At the time, the SEC regulated both stocks and stock option trading, but stock index futures were regulated by the CFTC. The Gorton-Wirth-Heinz
proposal would put authority for both under the SEC.
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This sounded like tighter regulatory policy on the surface. But the fine print removed regulatory oversight from a host of new “hybrid” derivatives products spewing from the banks—multiheaded, esoteric transactions that, for instance, linked the price of oil with levels of interest rates, or linked the stock prices of energy companies with foreign exchange rates, all within one security whose attributes were difficult to gauge.

Brady also claimed the proposal would “end pointless litigation and remove barriers to innovation in the financial markets.” Like Gramm and the bankers, he argued these financial hybrids were “simply not amenable to trading on a futures exchange.”
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So why bother even trying?

The proposal had been floating around Washington since October 1989 and would continue to do so for another two years. But with the backing of the investment bank trading community and the Bush administration, Gramm kept pushing (Greenspan also lent his support).

The related Bond-Wirth bill was introduced on April 11, 1991. It would essentially leave hybrids outside standard regulatory boundaries. A letter from Goldman Sachs circulated around the White House, praising “the reduction in regulation of hybrid instruments” (though it complained that the law still left too many hybrids subject to regulation.
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)

While awaiting official legislative approval, bankers got the ball rolling, sending their trading exemption requests to Gramm. She began granting exemptions to companies to circumvent various trading limitations.
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In October 1991, she granted J. Aron, a Goldman Sachs subsidiary that specialized in commodity trading, a key exemption. The firm would no longer have to operate under prevailing trading position limits of five thousand futures at a time; they could technically trade volumes of commodity futures without limits. The exemption was granted on the grounds that “their speculative positions were really ‘hedges.’”
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The obfuscation of what constituted a “hedge” versus a “bet” would provide bankers wiggle room for decades and gave Congress and regulators an excuse to avoid doing their jobs properly. If an investment bank wanted to trade a large position in the derivatives market, there was no way for a regulator, much less a senator, to know whether this was necessary to facilitate a client’s business strategy (say a cereal producer buying wheat futures at a certain price that guaranteed him a lower price in the future) or the bank’s desire to make money trading in the markets, period.

Regardless, the Bond-Wirth bill was finally reintroduced in 1991 as part of the Futures Trading Practices Act of 1992, and thus the bill exempting hybrid
instruments was signed into law on October 28, 1992.
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The act also gave the CFTC wider authority to decide whether energy futures contracts should be regulated at all.

Mega-Mergers

In the midst of deregulation talks, mega bank mergers were escalating in a manner not seen since the mid-1950s.
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On July 15, 1991, Chemical Banking Corporation and Manufacturers Hanover announced a $2 billion merger.
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The instigator, Manufacturers chairman and CEO John McGillicuddy, had served as a board director for the New York Fed since 1988, and had been a policy adviser to Bush and Reagan.
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The
New York Times,
like the bankers, seemed to believe that the appropriate reaction to major losses from atrocious LDC bets was bankers’ finding new fertile ground and growing in size. According to the
Times,
“The books of most major New York banks are carrying millions in dud loans to bankrupt Third World countries and on half-empty office buildings. They need to raise more capital and grow to compete worldwide.”
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McGillicuddy added an obligatory public-service justification for the deal: “The result will be a much stronger entity that can serve our customers with distinction and compete effectively with any financial institution in the world. That’s good for New York and good for the United States.”
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Under the Chemical moniker, the new corporation would become the second largest US bank in terms of assets ($135 billion), behind struggling Citicorp. A larger financial marriage would soon eclipse that merger as the biggest in US history: the $5 billion BankAmerica/Security Pacific merger in April 1992.

Since the S&L debacle, federal regulators had been actively promoting such mergers. McGillicuddy and Chemical Banking CEO Walter Shipley had consulted with Gerald Corrigan, president of the Federal Reserve Bank of New York, who publicly urged them to merge.
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Senator Charles Schumer considered the merger critical for the country, as it formed “a large, efficient institution that can compete with the likes of Deutsche Bank and Sumitomo Bank.”
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After the merger, 6,200 people lost their jobs, mostly in the New York area.
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The 1992 Election and the Rise of Clinton

Challenging Bush for his second term, Arkansas governor Bill Clinton announced he would seek the 1992 Democratic nomination for the
presidency on October 2, 1991. The upcoming presidential election would not alter the path of mergers or White House support for deregulation.

Already a consummate fundraiser, Clinton cleverly amassed backing and established early alliances with Wall Street. One of his key supporters would later alter American banking forever. As Clinton put it, he received “invaluable early support” from Ken Brody, a Goldman Sachs executive seeking to delve into Democratic politics. Brody took Clinton “to a dinner with high-powered New York businesspeople, including Bob Rubin, whose tightly reasoned arguments for a new economic policy,” Clinton later wrote, “made a lasting impression on me.”
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The battle for the White House kicked into high gear the following fall. William Schreyer, chairman and CEO of Merrill Lynch (Donald Regan’s old firm), showed his support for Bush by giving the maximum personal contribution to Bush’s campaign committee permitted by law: $1,000. But he wanted to do more. So when one of Bush’s fundraisers solicited him to contribute to the Republican National Committee’s nonfederal, or “soft money,” account, Schreyer made a $100,000 donation.
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The bankers’ alliances remained divided among the candidates, as they considered which man would be best for their own power trajectories, but their donations were plentiful: mortgage and broker company contributions were $1.2 million; 46 percent to the GOP and 54 percent to the Democrats.
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Commercial banks poured in $14.8 million to the 1992 campaigns at a near fifty-fifty split.
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