The Regulatory Reign of Terror (cont.) Jude Wanniski November 14, 1990

Early this year, when the Office of Thrift Supervision seized Franklin Savings of Ottawa, Kansas, a few days after Drexel Burnham threw in the towel, we observed that it had become "painfully clear that we are well into a regulatory reign of terror that is ever-so-slowly strangling the credit markets....When will it end? Clearly the corporate elites are happy with developments over the past few weeks, the pendulum swinging in their direction. Next, let's all watch the insurance companies get beat up, and then let's get the banks to call their loans to cover their junk losses marked to market! But eventually a reign of terror has a way of turning on the spectators. When enough of them have their blood spilled, we might be able to get a coalition strong enough to fight back. Meanwhile it is not a pleasant sight." [Feb. 21]

The corporate elites, including the banks, had cheered from the stands while the regulatory lions devoured the thrift Christians. Now, the lions are roaming around the stands taking bites out of the spectators, which suggests we may be approaching a climax to this blood sport -- which is nothing less than a savage across-the-board attack on capitalism itself. It may take another year or two for the beasts to be contained. The attack comes from within, as captains of finance and industry use their political clout to undermine competitors and then turn on each other. We don't see any prominent business leaders standing up and saying enough's enough, perhaps because they're all afraid of having to face the lions.
ITEM: SEC Chairman Richard Breeden, a Bush friend and appointee, now proposes to require all financial institutions to use current market value when accounting for financial assets they hold. Fed Chairman Alan Greenspan is fighting back against the bean counters, as Arthur Burns did when the SEC tried a similar move in 1974. If Breeden is successful, and he has personally advised me that he will make the attempt in the interests of "honest accounting," we will observe another sledgehammer blow to the financial services industry and public confidence in the entire credit structure. There is, of course, a direct correlation between regulation and default. Franklin Savings was crushed by nitwit regulators who would not accept the idea that as long as Franklin's liabilities as well as assets are marked to market, there ain't no problem. Even if, as Breeden says, the SEC regs would take this into account, the debates over market values would be endless, and the Lilliputians always win.

ITEM: The SEC's Mr. Breeden now proposes to turn his regulatory lions loose in industrial America. According to BusinessWeek, Nov. 19, "Commercial Paper May Be In For Some Shredding." The SEC plan is to prohibit money-market funds from holding more than 5% of their assets in paper rated below top investment grade. Now, they hold 10%, and there is no cap. Heavily indebted issuers in the $563 billion commercial paper market will have to rely more on bank financing, which costs about another point. A CFO is quoted: "It's mystifying that the SEC would do something that raises the overall cost of capital." The reason is that Mr. Breeden and his boys want to protect the American people from capitalism. If lenders are only permitted to lend to gilt-edged borrowers, there won't ever be any defaults, right?

ITEM: The New York Times reports this morning, Nov. 14, that "the Government has found it almost impossible to sell failed institutions to private investors. As a result, taxpayers are having to shoulder the entire burden of the industry rescue, and those costs are mounting daily." The problem, as we have been observing throughout, is that Congress and the regulators have been eager to dispose of the properties, but with two conditions: 1) The Government must get top dollar; 2) The investor will be watched like a hawk to make sure he doesn't make embarrassing profits, and if he does, the Government will attempt to break the contract. The Times quotes one observer as saying that once you invest, "you've got to deal with harassment from the regulators for the rest of your life. And all your friends basically think a guy who owns a thrift has robbed people blind."

ITEM: The Thrift Attorney newsletter, Nov. 2, reports that the S&L "crime prevention legislation passed by the Congress last weekend imposes prejudgment attachment provisions by statute on officers and directors, as well as on 'institution-related parties,' of thrifts." According to John Villa, a partner in the Washington, D.C. law firm of Williams and Connolly, "the law gives regulators the authority to freeze the assets of a bank officer or director in certain circumstances, and then argue over whether the actions of the individual were egregious enough to impose penalties." Says Mr. Villa: "This confirms my view that no rational person should serve as a director of a troubled bank or thrift."

ITEM: The same law, the "Comprehensive Thrift and Bank Fraud Prosecution and Taxpayer Recovery Act of 1990," provides for a MINIMUM 10-year prison term "for those who organize, manage, or supervise a continuing financial crimes enterprise, and receive $5,000,000 or more in gross receipts from such enterprise during any 24-month period." A feature of the law allows private persons "aware of some banking crime" to bring civil actions against shady capitalists by filing "a declaration of a violation," and win "awards of $5,000 to $100,000 in cash" for successful snitches.

ITEM: As The Wall Street Journal noted in its editorial, "Consumer Fraud," Nov. 9, Ralph Nader's Public Citizen consumer watchdog group has issued a 124-page document: "Insurance: The Next Industry in Crisis? A Report on the Financial Solvency of America's Top 20 Property and Casualty Insurers." WOW! The report lists five of the biggest insurers, including American International Group (AIG), as being at great risk of insolvency. "The firms of course got frantic calls from customers wondering what was going on," the Journal noted. The report, of course, is completely misleading, and the Nader group knew it. AIG's chairman Maurice Greenberg held a press conference to report the Naderites "deliberately" withheld information AIG had provided that demonstrates it is as solid as the rock of Gibraltar. But what the heck. We need a law, don't we, to give the SEC jurisdiction over the insurance industry? Mark to market, folks. Or 10 years in the slammer. And $100,000 rewards for Nader's snitchers.

It's pretty gruesome. Consider in this light our fanatical argument that a good part of all these problems either stem from or are being intensified by the combination of inflation and a 28% capital gains tax. And for two years running, Senate Majority Leader George Mitchell has thwarted Administration attempts to get relief on that score. One can understand how Rep. Newt Gingrich can so easily describe Mitchell as "the most left-wing congressional leader in the nation's history." All the elements described here are aimed at nothing less than the smothering of entrepreneurial capitalism.

Perhaps, after Michael Milken is sentenced next week, we will be able to see some sober reappraisals of the blood-letting we've been going through, and the lions can be driven back into their cages. I was startled today to read, on BusinessWeek's Nov. 19 editorial page, a mild complaint against "An SEC Rule That's All Pain, No Gain," referring to the commercial paper proposal. The magazine has pretty much slept through the Regulatory Reign of Terror, except to give us the score now and then on Christians vs. Lions. In the editorial, we now find the following:

A daunting example of well-meaning regulatory intent is Congress' savings-and-loan bailout bill, which required thrifts to divest themselves of junk bonds. In doing so, they helped to sink the high-yield market — and closed off a reliable method of financing for fledgling companies.

Hurray. At least they finally noticed. The Bush Administration hasn't yet understood any of these forces at work. Treasury Secretary Nick Brady and his team still give every evidence that they think their S&L bailout bill is a feather in their caps. Just like the Budget Deal they helped swing with George Mitchell.