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The Shadow Financial Regulatory Committee

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Tom Schlesinger, FCIC Watch Coordinator

The individuals appointed to the Financial Crisis Inquiry Commission represent a variety of experiences with and perspectives on the financial industry.  During his tenure as California treasurer, for example, Commission chairman Phil Angelides became a significant player (pdf) in institutional investors’ efforts to reform corporate governance as a means to cleaning up financial-sector abuses.  As head of the Commodity Futures Trading Commission in the 1990s, Brooksley Born confronted other policymakers about potential dangers in the OTC derivatives market – an episode that has assumed crucial importance in some narratives of the crisis that exploded in 2008.  Of the Commission’s ten members, however, only one actually played a formative role in U.S. financial policy debates over the past three decades and in the restructuring of financial industry law and oversight practices that emerged from those debates.  His name is Peter Wallison.

A Harvard Law School graduate and member of the Ripon Society, Wallison began his political career working for Nelson Rockefeller in the offices of the New York governor and vice president.  In 1981, he was appointed general counsel of the Treasury Department, where he took charge of Reagan Administration efforts to deregulate the financial services industry.  Following the blueprint formulated by Wallison’s Treasury colleague Roger Mehle, the decontrol campaign discarded previous attempts to expand incrementally the securities powers of commercial banks in favor of simply eliminating all restrictions imposed by the 1933 Glass-Steagall Act and other statutes separating commercial banking, securities and insurance.

In 1985 Wallison left Treasury to practice law at Gibson, Dunn & Crutcher, a firm with longstanding ties to the Republican Party and numerous financial industry clients.  According to Wallison (pdf), the future solicitor general Theodore Olson played an important role in recruiting him to Gibson Dunn as did another partner “who was involved in a lot of the banking stuff that I had been doing at Treasury.”  Wallison remained at Gibson Dunn for most of the next dozen years – taking leave in 1986-1987 to serve as White House counsel – and in 1998 joined the American Enterprise Institute, where he eventually became co-director of the conservative advocacy center’s program on financial policy studies.

Even though the argument for economic deregulation gained substantial traction during Reagan’s presidency, the actual implementation of financial decontrol advanced somewhat fitfully.  Banking, thrift and securities regulators introduced laissez-faire initiatives at the federal level while Congress passed permissive new measures like the Garn-St Germain Act of 1982.  But the grand goal of repealing Glass-Steagall’s restrictions remained elusive – in large part due to ongoing disagreements between competing factions of the financial industry.  By the latter part of the decade, mounting problems in the deposit-taking sector – attributable in no small measure to deregulation and desupervision at the oversight agencies – clouded the prospects for more sweeping decontrol. 

Their irregular progress notwithstanding, proponents of financial deregulation pressed ahead with litigation and state legislation aimed at rolling back restrictions on bank expansion.  They also continued to occupy more space in the intellectual debate over financial policy.  In 1986, a new organization named the Shadow Financial Regulatory Committee made its first public appearance as a champion of regulatory minimalism and self-disciplining markets.  Organized by Loyola University finance professor George Kaufman with funding from the Bank Administration Institute and other donors,[1] the Committee initially consisted of 13 members, including Roger Mehle, the attorney who had conceptualized the Reagan Treasury’s deregulation agenda, and John D. Hawke, a former general counsel of the Federal Reserve Board and the country’s most influential bank lawyer.[2]  The Committee’s doctrinal disposition and policy goals matched up closely with those of the Republican attorneys at Gibson Dunn.  But the group chose to conduct its maiden public meeting at the Washington office of Jerry Hawke’s liberal law firm, Arnold & Porter – a venue that accentuated the acceptability of Shadow Committee goals to interests across the political spectrum.  The three policy statements released at the meeting left little doubt about the group’s orientation; one of them denounced as unjustified and “politically expedient” a Federal Reserve rule limiting the use of junk-bond financing for corporate acquisitions.

Like Hawke, Mehle and Kaufman, other members of the Shadow Committee represented important additional connections to industry, academia and the public sector.  Cochairman Lawrence Connell, a former Connecticut banking commissioner, had served as the country’s top credit union regulator during the Carter Administration, then left Washington to take a series of senior executive positions in the savings and loan industry.  Carnegie-Mellon economist Alan Meltzer had organized his own Shadow Open Market Committee a few years earlier.  Over the years, members of the group like Robert Litan, Kenneth Dam, Jerry Hawke and Randall Kroszner would rotate in and out of senior government positions.  But the Committee did not derive its authority solely – or, in some cases, at all – from proximity to public power.  In 1990, for example, group member George Benston published The Separation of Commercial and Investment Banking, a revisionist history of Glass-Steagall that portrayed the Act as a confused over-reaction to harmless pre-Depression practices at banking firms’ securities affiliates.  Over the following decade, Benston’s reinterpretation would achieve canonical status within the economics profession and the small community of lawyers, lobbyists, legislators, jurists, think tankers and journalists at the center of banking policy. 

Benston’s success in recasting the history of Glass-Steagall exemplified the Shadow Committee’s collective effectiveness in driving public debate about financial-sector policy.  On the surface, the group’s capacity to articulate and promote a deregulatory agenda consisted of little more than a series of quarterly pronouncements, the contents of which soon grew achingly predictable.  Meanwhile, Congress was responding to an epidemic of bank and thrift insolvencies with reregulatory measures like the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) and FDIC Improvement Act (FDICIA).  But even in this seemingly inhospitable environment, the Shadow Committee and its ideas managed to hold their own.  Deregulation “never left the legislative and policy agenda, even when the thrift and banking industries were in greatest difficulty,” noted an official FDIC history (pdf) of American banking’s worst crisis in a half-century.  By 1994, less than two years after that crisis finally crested, liberal Democrats in Congress and the new Clinton Administration were enacting legislation like the Riegle-Neal Interstate Banking and Branching Efficiency Act that granted banks substantial new freedoms. 

Peter Wallison joined the Shadow Committee at the nadir of the banking collapse.  Unlike many of the group’s members, he had never cultivated a reputation as an intellectual heavyweight (in a 2003 book about the Reagan presidency, Wallison grouped Milton Friedman and Alan Meltzer, the two most prominent monetarists of their generation, with Arthur Laffer as “supply side” economists[3]).  But he was able to offer the Committee valuable resources, including an institutional home.  In 1999, the organization followed him to AEI, which has functioned as its sole funder and meeting place ever since.  Shortly after that transition occurred, the longstanding goal of Ronald Reagan’s Treasury Department was realized when Congress passed and President Clinton signed the Gramm Leach Bliley Act (GLBA), which eliminated most of the remaining barriers between banking, securities and insurance businesses.  The Shadow Committee had expressed unconditional support (pdf) for the Citicorp-Travelers merger that helped precipitate the passage of GLBA.  And during the maneuvering that led up to passage of the Act, key members of Congress eagerly sought the Committee’s imprimatur.[4]   

Over the next decade, law, policy and mainstream economic thought would continue to reflect the laissez-faire views of Shadow Committee members.  Not content with the status quo, however, the Committee kept up its opposition to existing and proposed mechanisms for government oversight of the financial sector.  In its post-GLBA pronouncements, the Committee urged repeal of the Community Reinvestment Act (pdf); called for “reduc[ing] the regulatory burden on derivatives markets (pdf) generally;” argued against regulating hedge funds (pdf); endorsed the elimination of government limits on margin borrowing (pdf); embraced the adequacy of existing fraud and unfair trade practice statutes in mortgage markets while warning about the “chilling” effects of regulation on “so-called ‘predatory lending’ (pdf);” pressed authorities to step beyond the boundaries of GLBA to encourage the formation of larger financial conglomerates; opposed consolidated supervision of such conglomerates (pdf); pushed for the unfettered integration of banking and commerce (pdf); endorsed the removal of concentration limits on banks (pdf); complained about excessive regulation and costly litigation making U.S. securities markets uncompetitive (pdf); advocated the shutdown of the Public Company Accounting Oversight Board (pdf); and supported federal preemption (pdf) of tough state restrictions on abusive lending (pdf) practices.

The Shadow Committee’s position on these issues did not always prevail.  But by and large the group’s efforts both reflected and contributed to the extraordinary success of reemergent neoclassical doctrine in influencing the teaching of economics and law, molding public discussion of financial issues and shaping the thinking and practice of regulatory agencies.  Thus, when crisis enveloped the world’s banking and securities markets in 2008, one of the questions it should have raised was what cumulative effects all that success had on the stability, efficiency and underlying economic function of the financial system. 

To date, the Shadow Committee has not engaged that question in any kind of reflective or rigorous fashion.  Instead, it has continued to rail against the alleged excesses and failures of public-sector oversight while equating “market discipline” with “smart regulation” (pdf). Since the onset of crisis in 2008, the Committee has praised “market solutions” as a remedy to escalating home mortgage defaults (pdf); opposed public-sector limits on the compensation of financial industry executives; and argued against imposing taxes on banks with more than $50 billion in assets to help recoup TARP funds.

During this period, no Committee member defended the laissez-faire project or its core assumptions more adamantly than Peter Wallison.  Over the years, the AEI official had focused most of his advocacy work on a few objectives such as the privatization of deposit insurance (an idea developed by his occasional coauthor, banking consultant Bert Ely) and complete elimination of the remaining wall between banking and commerce.  Wallison also remained an arch opponent of enhanced public safeguards for financial consumers.  In July 2009, for example, he published an op ed in the Washington Post asserting that an Obama Administration’s proposal for restricting the sale of complex financial products “prove[d]” that “liberals are elitists who do not respect ordinary Americans.” According to Wallison, who divides his time between Snowmass, Colorado and a luxury coop in Kalorama Heights, the measure “would allow the educated and sophisticated elites to have access to whatever financial services they want” but deprive workaday families of this privilege. 

The cause with which Wallison became most closely identified was the delegitimation and privatization of government-sponsored enterprises, notably the housing finance giants Fannie Mae and Freddie Mac.   Between 2000 and 2004 Wallison churned out a series of opinion pieces and three AEI-published books that attacked Fannie and Freddie as symbols of unchecked power and potential threats to financial stability.  In tandem with FM Policy Focus (initially named FM Watch), an alliance of major lenders and private mortgage insurers that competed with the GSEs, Wallison helped create the first sustained, coordinated and powerful challenge to Fannie and Freddie’s political leverage.

Since 2008, Wallison has attempted to push that challenge to its final resolution by blaming the GSEs and the Community Reinvestment Act (CRA) for lax mortgage lending practices that helped fuel the financial crisis.  Mortgage brokers and originators, investment bankers and rating agencies may have contributed to the collapse, claimed Wallison “but they were only following the economic incentives [for expanded housing credit] that government policy laid out for them.”  While there are many (pdf) reasons (pdf) for questioning this account of the crisis perhaps the most pertinent evidence can be found in Wallison’s own writing.  Like most opponents of the GSEs, he spent much of the 2000s pressing for limits on the overall size of their portfolios while adopting a generally favorable view of financing initiatives designed to expand homeownership.   In June 2005, for example, Wallison declared that the sole “justification for the existence of the GSEs might be the use of their subsidies to assist low-cost or affordable housing” and advocated “CRA-type requirements” in the secondary market as “far preferable” to other mechanisms for ensuring the GSEs would meet that goal.   An opinion piece he coauthored with former Democratic congressman John LaFalce in March 2006 explicitly called on Fannie and Freddie to “do a much better job of providing affordable housing financing to a neglected portion of the mortgage market.”

Even though he officially took a “leave” from the Shadow Committee to serve on the Angelides Commission, Wallison has remained a busy polemicist since the FCIC’s formation.  During the eight months following the announcement of his appointment to the Commission, Wallison hammered out 17 opinion pieces and made numerous public appearances promoting his views on the causes of the collapse while attacking the notion that deregulation or industry abuses might share the blame.   More significantly, he wrapped himself in the authority of the Commission in order to argue that Congress should forestall financial reform legislation until the FCIC has completed its investigation and issues a report in December 2010.  “Doesn’t it make sense,” Wallison asked, “to hear the diagnosis before enacting the prescription?” 

Coming from an advocate for whom “deregulate” has been the default remedy to every financial-sector problem of the past 30 years, few questions could ring more hollow.

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[1] In addition to the BAI’s Foundation for Financial Institutions Research the Committee’s initial donors included the University of North Carolina, University of Michigan and the Mid-American Institute for Policy Research.  Subsequent funders included the Sarah Scaife Foundation.

[2] Leslie Wayne, “The Comptroller for the Moment,” New York Times, December 8, 1998: C1.

[3] Peter Wallison, Ronald Reagan: The Power of Conviction and the Success of His Presidency (Boulder: Westview Press, 2003) 59.

[4] In a representative “Dear Colleague” letter about the measure from the House Financial Service Committee’s ranking Democrat, all four of the cited experts vouching for the safety and soundness of new activities taking place in banks’ operating subsidiaries were members of the Shadow Committee.  [“Independent Economists Support the Op Sub,” Representative John J. LaFalce, June 30, 1999.]