April 9, 2012 is the twenty-fifth anniversary of the most infamous savings and loan fraud, Charles Keating’s, successful use of five U.S. Senators to escape sanction for a massive violation of the law. The Senators were Alan Cranston (D. CA), Dennis DeConcini (D. AZ), John Glenn (D OH), John McCain (R. AZ), and Donald Riegle (D. MI). They became infamous as the “Keating Five.” I was one of four regulators who attended the April 9, 1987 meeting. I took the notes of the meeting, in transcript format, that were so detailed and accurate that the Senators testified that they were sure I had tape recorded the meeting. (The reality is that I owe my note taking abilities to Bill Valentine, my high school debate coach, and experience debating for the University of Michigan.)
Reviewing my (near) transcript of the April 9 offers a large number of important lessons that would have allowed us to avoid future crises. We suffered the crises because we ignored all the lessons about which approaches are criminogenic and which are successful. The transcript shows four things that work. First, we were apolitical as regulators. I worked closely in the same regional office with my three regulatory colleagues for years, but I do not know their political affiliation (if any). We went after the S&L frauds and their political cronies regardless of party. Second, we were vigorous and fearless enough as regulators that the frauds (e.g., Keating) feared us. Keating knew that despite his fearsome political power and reputation for trying to ruin his opponents we (the regional S&L regulators based in San Francisco) would never back off.
Third, we were effective. The April 9 meeting exemplified how a largely ineffective office had improved greatly in two years. Ed Gray, the head of the Federal Home Loan Bank Board, inherited an agency driven by an anti-regulatory dogma that was actively making things worse. Gray had been a strong supporter of deregulation. Gray’s great virtue is that he listened to the facts and looked for patterns. What he realized was that the large failures followed a consistent pattern. They were (to use modern criminology jargon) “control frauds” – seemingly legitimate entities controlled by officers who used them as “weapons” to defraud the S&L’s creditors and shareholders. Gray knew that S&Ls that were still open and followed the same pattern were growing at an average annual rate of 50% and that hundreds of similar S&Ls were entering the industry annually. Gray perceived, correctly, that business as usual would produce a catastrophe.
Gray began to reregulate the industry in 1983. That was extraordinary on several dimensions. The Garn-St Germain bill (drafted by Gray’s predecessor, Richard Pratt) that deregulated the S&L industry was enacted in 1982. It passed with one opposing vote in each chamber. For Gray to begin to reregulate the industry only a year later was an enormous repudiation of the will of the Congress, the Reagan administration, neo-classical economics, the anti-governmental zeitgeist, and the agency’s traditional position. It also required Gray to reverse his embrace of deregulation. To succeed in his push to reregulate the industry Gray had to take on, simultaneously, the House, the Senate, the administration, the S&L trade association (rated the third most powerful in America by some political scientists), economists, much of his own agency, and the media. Astonishingly, Gray’s reregulation succeeded and because it was so prompt it contained the crisis and prevented a trillion dollars in fraud losses and a Great Recession.
By contrast, reregulation began in the current crisis in 2009 (the effective date of the Federal Reserve’s rule finally banning liar’s loans (fraudulent mortgage loans made without verifying the borrower’s income). The nine year-to-ten year delay in reregulation (measured from passage of Gramm-Leach-Bliley (1999) or the Commodities Futures Modernization Act (2000) allowed fraud to become epidemic and hyper-inflate the financial bubble, producing the Great Recession.
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Bill Black 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.