Public Policy Analysis & Opinion

On your side

And Congress continues to fiddle, waiting for the next conflagration

By Kevin P. Hennosy

JPMorgan Chase's "trading loss" of $2 billion is an insurance story. The big bank engaged in the transfer of economic risk through "credit derivatives," "credit default swaps" or "company default swaps." The only reason not to call these transfers of risk of financial loss anything other than insurance is to avoid regulatory oversight and overstate the bank's financial standing.

As was the case in the failure of American International Group (AIG), the insurance operations by another name were centered in London, but answerable to a New York-based financial institution.

A week before the JPMorgan Chase meltdown, British Prime Minister David Cameron, leader of the Conservative Party, announced through the queen's speech his party's intention to further deregulate the financial services sector. In the United States, presumptive Republican Party nominee Mitt Romney was promising to "repeal" the tepid financial regulatory reforms contained in the Dodd-Frank Act.

We have been down this road before and a miracle drug from Wall Street does not wait at the end of the highway.

The JPMorgan Chase debacle underlines one reason why consumer and investor confidence lags: Wall Street was never punished, and there is a sense that the economic foundations of the country could shake again.

As of yet, the public has not seen meaningful re-regulation of the financial sector coupled with punishment of the executives whose misdeeds triggered the financial crises. Pompous executives in London can still make billions of dollars vanish, and no one has gone to jail.

"More than three years since the greatest financial crisis in generations, working families are still suffering from unemployment, underwater mortgages, and other economic pressures while there has still been no real accountability for the people who broke this economy," said Massachusetts Democratic Senate candidate Elizabeth Warren. "The people whose illegal actions are responsible for this crisis need to be prosecuted and thrown in jail."

It is the kind of rhetoric that elicits a public response that Senator Sherrod Brown (D-Ohio) describes as "they're on our side." While Warren and Senator Brown are both Democrats, they use a type of rhetoric that "progressive" Republicans of the last quarter of the 19th century espoused.

A brief history of financial reform politics

Reform of financial services has proved a winning platform plank for political parties throughout American history. The Republican Party was the first to benefit from the issue, which tends to communicate to the great mass of voters that the party is on their side.

For most of American history, the Democratic Party, or "The Democracy" as it was often called in the South, had aligned its political fortunes with the great financial fortunes. In the South that meant cotton farming that was dependent on slave labor. In the Northeast and Middle Atlantic, Democrats like Jefferson and Jackson courted urban merchants and traders, who used their excess profits to form the first American insurance enterprises.

By the end of the Civil War, Democratic machines like Tammany Hall were dependent on financiers like Jim Fisk and Jay Gould for cash. Sometimes the cash provided party-based social insurance mechanisms that solidified voter loyalty, and sometimes it provided financial security to the Tammany Hall sachems.

A Tammany-aligned New York insurance superintendent called together the first convention of insurance regulators, which became the National Association of Insurance Commissioners (NAIC). No one has been able to document who called for the meeting. It appears to be the stock fire insurance companies, but the call for that meeting did not come from the voters. There were men behind the officials whispering in their ears.

It was a Republican, Theodore Roosevelt of New York, who personified the progressive reform movement in the late 19th century. As governor, Roosevelt argued with the state Republican machine over the appointment of an insurance superintendent, who he believed was an unearned dividend to the regulated industry. It was in a letter recounting the course of intraparty conflict over the patronage of the insurance regulator, where Roosevelt first cited the African proverb that advises: "Speak softly and carry a big stick."

Roosevelt was not the only GOP leader who built a political career jousting with commercial power. Robert "Fightin' Bob" La Follette Sr., as governor of Wisconsin, tackled the railroad sector and applied a rational system of state regulated rates, which he borrowed and applied to the fire insurance sector.

Officials like Roosevelt and La Follette earned a dynamic loyalty from voters, which party "regulars" despised but longed for as elections approached. Marcus Alonzo Hanna was the most regular of the regulars. The Ohio Republican had created an organized system of raising campaign contributions from corporations through an assessment mechanism that put Tammany Hall to shame. Companies that participated in the assessments could expect positive legislative treatment, and those that did not could expect the reverse.

"Mark" Hanna first tried to move into national politics through advising Senator John Sherman, of antitrust act fame. Mark Hanna succeeded with Ohio Governor William McKinley's presidential campaign, but he had to accept Roosevelt, whom he did not trust, on the ticket. That dynamic loyalty of voters was a currency that Hanna could not collect through his assessment mechanism.

The progressive reformers remained with the Republican Party until the national elections of 1912, when the Grand Old Party split into the Taft and Roosevelt wings. Denied the nomination, Roosevelt bolted from the Republican Party and took his progressive followers with him. The divisions within the Republican Party allowed the Democratic governor of New Jersey, Woodrow Wilson, a lesser reformer than Roosevelt, to claim the presidency.

Wilson's efforts at economic reform were always tempered by his bigoted views on race. Still, Wilson attempted to pass a national health insurance program in his second term. The proposal went down to defeat at the hands of two proverbial strange bedfellows: the life insurance sector and the American Federation of Labor (AFL). Life insurers wanted to include health insurance as a sweetener to sell life insurance policies. Samuel Gompers, the president of the AFL, opposed public health insurance because he believed that workers should look to unions, not the government, for benefits.

Both the Democratic and Republican parties hid away the banner of progressive reform of the financial system in the 1920s. In response to moralist proponents of Prohibition, Democrats put forward conservative candidates in 1920 (James M. Cox, a newspaper executive) and 1924 (John W. Davis, a Wall Street lawyer) and were rewarded with landslide defeats. The Republicans put forward Warren G. Harding and Calvin Coolidge, who personified business and limited government. Progressive activists wandered in the political wilderness.

It was not until the economy collapsed and Franklin Roosevelt came to power with a mandate for change that progressive financial reform returned to the national political agenda. Some of Roosevelt's most activist New Dealers began their public careers as progressive Republicans. The result was reforms of banking, securities and ultimately insurance, which restored American confidence in commerce and finance.

A picture of former president of the New York Stock Exchange Richard Whitney entering the gates of "Sing-Sing" prison as an inmate, which ran in hundreds of newspapers and magazines, let people know the government was on their side.

The Democrats made various aspects of financial services reform a central part of the party platform until the presidencies of Jimmy Carter and Bill Clinton. These Southern centrists rejected the confrontational aspects of reform politics. In the absence of the reform fervor, wage earning lower middle class voters began to drift away from the Democratic Party. Many voters no longer believed government was on their side.

The "behind guys"

For all the talk of vicious partisanship by cable news pundits, modern politicians are schooled to campaign in a bloodless manner, so when people like Elizabeth Warren or Senator Sherrod Brown come along, it is difficult not to stare. They use the kind of rhetoric that is not heard in American politics any more.

Choosing sides, or even acknowledging that sides exist, is taboo. It is difficult to go raise money from one side to finance the vast corporate enterprises that political campaigns have become, and then govern to benefit the other side. Pundits, who tend to work for large corporate conglomerates, deride choosing sides as "class warfare" even if the status quo of the past 40 years has witnessed one class running roughshod over the populace.

In Robert Penn Warren's masterwork, All The King's Men, the fictional Governor Willie Stark tries to explain reality to an altruistic attorney general, who is tendering his resignation because the governor has decided not to prosecute a corrupt state auditor. Governor Stark had brought the squeaky clean lawyer into government. The governor empowered the advocate to use the prosecutorial powers of the office, and the attorney general enjoyed the public acclaim. Governor Stark expounded:

"You made the fur fly and you put nine tin-horn grafters in the pen. But you never touched what was behind 'em. The law isn't made for that. All you can do about that is take the government away from the behind guys and keep it away from 'em. Whatever way you can."

This exchange between Governor Stark and his attorney general provides an early hint that the governor would fall from power and grace. Today, some fur needs to fly.

A new poster child

The insurance conglomerate AIG is not the only institution with responsibility for the evaporation of trillions of dollars in American's wealth, but it is as good a place as any to start. For decades, AIG was one of the lobbying thugs of the insurance sector, which the company used to write rules that gave it a competitive advantage and allowed it to conduct its business unfettered by the public interest.

Through bullying at the NAIC, in state capitals and in Washington, AIG created a financial system that allowed a subsidiary to sell insurance products to financial institutions without receiving direct and affirmative regulatory oversight.

It should be noted that state regulators possess a great deal of discretionary power related to the operations of affiliates and subsidiaries of insurers. Insurers have authority to monitor the actions of subsidiaries and affiliates of insurance holding companies. Furthermore, the Gramm Leach Bliley Act, which repealed Glass-Steagall, established the doctrine of "Functional Regulation," which holds insurance activities conducted by a financial institution subject to insurance regulatory oversight, without regard for whether the institution is an insurer, bank or securities firm.

Make no mistake, the credit default swaps sold by AIG through a subsidiary were insurance. In the September 28, 2008 edition of The New York Times, financial reporter Gretchen Morgensen explained: "[The investment bank JP]Morgan proposed the following: AIG should try writing insurance on packages of debt known as 'collateralized debt obligations.' C.D.O.s were pools of loans sliced into tranches and sold to investors based on the credit quality of the underlying securities."

The sale of the AIG insurance products encouraged the destructive financial transactions that resulted in the 2008 financial panic. Through these insurance products, AIG took on more weight of risk than it could carry and integrated with so many investment banks that recognizing the failure of the insurer would have resulted in an even deeper and more catastrophic financial collapse.

Even before the financial crisis, AIG was identified as a bad actor. The Securities and Exchange Commission and the Department of Justice had deployed investigators and attorneys to the insurer's headquarters. The New York Attorney General brought charges against the company and select officers under The Martin Act, which gives that office sweeping powers over corporations operating in New York.

In the case of AIG, state insurance regulators did not have the nerve to act. AIG was too big to regulate before it was too big to fail.

Inaction damaged the dreams of countless Americans, and scuttled the plans of American businesses. Employees, agents and brokers connected to the company lost hard-earned business and consumer confidence as a result of Wall Street financiers' manipulation of needed financial services.

Former CEO of AIG Hank Greenberg was run out of AIG-proper in 2005, but he managed to lurk around the company's operations through an off-shore shell corporation named for AIG's founder: Cornelius Vander Starr. Greenberg is awaiting trial on fraud charges.