What prompted lax oversight? For politicians, a $64 million question

McClatchy NewspapersOctober 2, 2008 

WASHINGTON — The Wall Street financiers and firms whose problems have prompted a $700 billion federal bailout are no strangers to Capitol Hill or to politics.

Since 2001, eight of the most troubled firms have donated $64.2 million to congressional candidates, presidential candidates and the Republican and Democratic parties, according to data from the nonpartisan Center for Responsive Politics.

The donors include investment bankers Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch, Morgan Stanley, insurer American International Group and mortgage giants Fannie Mae and Freddie Mac. Since March, with the exception of Goldman Sachs and Morgan Stanley, all of these companies have been bailed out by the government, sold to other companies at deeply discounted prices or simply failed.

Both political parties have become beholden to Wall Street.

Legislators failed in several instances to conduct oversight hearings or to raise concerns as the Bush administration adopted rules that fed the mortgage frenzy and set Wall Street on a path to disaster.

For instance, in 2004 when the Securities and Exchange Commission adopted a major rule change that freed investment banks to plunge tens of billions of dollars in borrowed money into subprime mortgages and other risky plays, congressional banking committees held no oversight hearings.

Congressional inaction also allowed mortgage agents to earn high fees for peddling loans to unqualified homebuyers and prevented states from toughening regulations on predatory lending practices.

Democratic Sen. Christopher Dodd of Connecticut, the chairman of the Senate Banking Committee who ran unsuccessfully for his party's 2008 presidential nomination, has received nearly $1.3 million from employees of the eight troubled firms since 2001.

Dodd spokeswoman Kate Szostak said that since Dodd was first assigned to the banking committee in 1981, he's "taken independent, tough positions at odds with the industries the committee oversees," including the mortgage lending industry.

"In no way does he allow contributions to influence any decision he makes," she said.

Dodd's office stressed that he was the first to "sound the alarm about the subprime crisis," shortly after assuming the chairmanship in 2007.

In the House of Representatives, Massachusetts Democrat Barney Frank has collected about $78,000. Frank, the chairman of the House Financial Services Committee, has taken the least cash of the four House and Senate banking chairmen of recent years.

He said that's probably because he "fought like hell'' against administration limits on state predatory lending laws, but had limited influence until Democrats won the House majority and he became chairman in 2007. He said he'd just become the panel's ranking Democrat in 2004 when the SEC rule was adopted, and "I don't remember that issue coming before us."

Former Ohio Rep. Michael Oxley, who was the Republican chairman of the financial services committee in 2004, when the SEC rule was adopted, received more than $260,000 from the eight banks before he left Congress in 2007. Oxley last year was named vice chairman of the tech-heavy Nasdaq stock market. He couldn't be reached for comment.

Sen. Richard Shelby, the Alabama Republican who was the banking committee chairman when the SEC rule was adopted, received more than $152,000 in donations. Jonathan Graffeo, a spokesman for Shelby, said that campaign donations "are not a factor in Sen. Shelby's decision-making."

Shelby said that Democrats blocked his attempts to rein in the roles of mortgage giants Fannie Mae and Freddie Mac and his push for a closer review of the SEC's regulation of investment banks. He said the SEC rule left a staff of fewer than 20 overseeing trillions of dollars in assets.

The Democratic and Republican presidential candidates, Sens. Barack Obama and John McCain, have received a combined total of $3.1 million. A small portion went to their Senate campaigns.

Indeed, it's impossible to say what, if anything, Wall Street bought with its $64 million. Politicians and political parties take money from a wide variety of sources, many of them with competing interests and opinions, but experts interviewed by McClatchy said that inaction by the Congress helped set the stage for the current crisis.

Some state regulators, recognizing early signs of trouble in housing markets, sought help from Congress when the Bush administration adopted rules barring states from enforcing tough laws targeting predatory lending — the practices that were enabling unqualified applicants to obtain subprime mortgages.

With Wall Street serving a key role in buying, bundling and reselling subprime mortgages, state officials couldn't get Congress to intervene, said John Ryan, the executive vice president of the Conference of State Bank Supervisors.

"You could say that the finance industry got their money's worth by supporting members of Congress who were inclined to look the other way," said Lawrence Jacobs, the director of the University of Minnesota's Center for the Study of Politics and Governance.

"When the spotlight's on, sometimes reason carries," Ryan said. "But when it's not on, all of the influence is overwhelming."

Jacobs, the co-author of a new book, The Private Abuse of the Public Interest, said, "the big impact that money may have is in discouraging certain topics from ever coming for a vote or even being seriously considered in a committee hearing."

John Coffee, a Columbia University law professor who specializes in banking and securities regulation, said that investment banks were well positioned politically when the SEC changed its rules in 2004.

The commission acted, Coffee said, after the European Union threatened to examine the financial soundness of the London affiliates of U.S. investment banks, especially those of Goldman Sachs, Merrill Lynch and Morgan Stanley, unless equivalent regulation was imposed in America.

Until then, U.S. regulators had paid little attention to investment banks' forays into subprime mortgages and other exotic securities, monitoring only the firms' broker-dealer operations, he said.

In return for accepting new regulatory supervision, which fell far short of Europe's, the investment banks got a huge carrot, Coffee said: The SEC relaxed the federal limits on their borrowing and, he said, they used their new leverage "to the hilt."

Michael Calhoun, the president of the Center for Responsible Lending, said the investment banks would use $100 million in cash to borrow $500 million, and then plunk all the borrowed money into risky mortgages, seemingly oblivious to the danger that the real-estate bubble would burst and trigger a nationwide decline in housing markets.

Coffee said that there were no obvious signs of an impending economic collapse in 2004, but he questioned the lack of oversight hearings on such an important rule change.

"It's unusual that Congress lets a major new program go through without at least oversight hearings," Coffee said. "And they didn't happen."

After the SEC changed its rules, Coffee said, Merrill Lynch's and Morgan Stanley's debt-to-equity ratios soared to 40-to-1 and 37-to-1 respectively from the old limit of 12-to-1, leading to Bank of America's $50 billion purchase of Merrill and contributing to calls for a bailout to rescue Morgan Stanley and other Wall Street giants.

The banking committees also took no action when the Department of Housing and Urban Development adopted a rule change that made it easier for mortgage brokers to collect hefty incentive payments for arranging loans with above-market interest rates for marginal buyers.

The panels also watched from the sidelines when the federal Comptroller of the Currency preempted more than 30 state attorneys general from enforcing state laws holding investment banks liable for predatory lending practices on subprime mortgages.

Ryan, of the Conference of State Bank Supervisors, said he was "cut off at the knees" when he tried to fight the Bush administration's ruling on predatory pricing regulation.

He said the state officials agreed to "make as much noise as we can," but recognized that they were facing banking and securities industries with enormous influence from years of financial support to members of Congress.

While his group and state attorneys general testified to the banking committees, he said, there was no indication that the panel members "were recognizing the alarm bells we were setting off."

(Kevin G. Hall contributed to this article.)

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