Cruz Seeks Economic Wisdom in the Wrong Place

But Gramm is the topic today, so let's start with a list of particulars.

Gramm was a key sponsor of the Financial Services Modernization Act of 1999, also known as Gramm-Leach-Bliley Act, which effectively repealed the piece of the Glass-Steagall Act that had forced commercial banks to shed their investment banking operations during the Great Depression. The end of this separation didn't so much lead to the financial crisis as remove a key firebreak, allowing the conflagration to rapidly spread throughout the banking system. Recall earlier events before the repeal: the shock caused by the 1987 stock-market crash was confined to Wall Street, while the savings and loan crisis of the late 1980s did little harm to the broader economy.

The damage caused by rolling back Glass-Steagall pales compared with what resulted from the Commodity Futures Modernization Act of 2000. Gramm was a co-sponsor of the legislation, which exempted many derivatives and swaps from regulation. Not only was the law problematic, but it veered into potential conflict-of-interest territory.

At the time the legislation was under consideration, Gramm's wife, Wendy, was on the board of Enron, which as we now know was one of the greatest accounting fiascos in history. Wendy Gramm served on the audit committee, overseeing the finances of the energy-trading giant. Enron, of course, in late 2001 filed the biggest corporate bankruptcy in U.S. history up until then. Before joining Enron, she had served as chairman of the Commodity Futures Trading Commission, from 1988 to 1993, where her tenure was the subject of some controversy.

Enron, a once-sleepy utility, was an early adopter of derivatives and swaps. Brooksley Born, chairman of the CFTC in the late 1990s, had recognized early on the potential danger these things posed. She rightly pressed for her agency to have regulatory oversight of derivatives.

It wasn't to be so because of Gramm's legislation. But there was more. At Wendy Gramm's urging, then-Senator Gramm inserted what became known as the Enron loophole into the Commodity Futures Modernization Act. This allowed Enron to avoid most regulation in its energy-trading business. Enron, coincidentally, was a major campaign contributor to the senator. We don't know what impact the loophole would have had on the company; it collapsed in 2001 due to accounting fraud before it had a chance to collapse due to bad energy derivatives. However, the legislation Gramm pushed had other unintended consequences.

We got a chance to see those consequences a few years later when American International Group failed, thanks in part to swaps — a form of insurance really — on $441 billion of securities that turned out to be junk. AIG wasn't required to put up much in the way of collateral, set aside capital or hedge its risk on the swaps. Why would it, when the law said it didn't have to? The taxpayers were then called upon to bail out AIG to the tune of more than $180 billion.

Maybe it isn't too surprising that Cruz would seek advice from Gramm. Cruz, after all, seems to want to hobble modern economic policy by returning to the gold standard. The Cruz-Gramm school of economics doesn't seem very promising. We have seen these movies before, and they end in tragedy and tears.